Paying the Tax on an Illiquid Estate

If your estate clears the exemption, the 40% tax is due in cash nine months after death—and the IRS does not accept shares of the family business. When the wealth is locked in an operating company, a ranch, or commercial real estate, the heirs face a brutal choice: fire-sell prime operating assets at a distressed valuation to a competitor who knows you are forced sellers, or find another way. Life insurance in an ILIT (section “Life Insurance Workaround”) is the cleanest pre-funding, but three statutory tools exist for estates that did not insure enough:

§6166 installment payments

If a closely held business makes up more than 35% of your adjusted gross estate, IRC §6166, “Extension of time for payment of estate tax where estate consists largely of interest in closely held business” lets the estate defer the business-attributable tax: interest-only for up to five years, then principal in up to ten annual installments—about fourteen years after the return’s original due date—at a deeply subsidized 2% rate on the tax attributable to the first $1,940,000 of taxable value for a 2026 death (indexed; IRC §6601(j), “Interest on certain extensions of time for payment”), with a reduced rate—45% of the underpayment rate—on the excess. For an asset-rich, cash-poor estate, this is the difference between keeping and losing the business.

§303 stock redemption

Normally, pulling cash out of a C corporation is taxed as a dividend. IRC §303, “Distributions in redemption of stock to pay death taxes” carves out an exception: a corporation can redeem a deceased shareholder’s stock—up to the amount of estate taxes plus funeral and administration expenses—as a tax-favored sale instead of a dividend, giving the estate liquidity from corporate cash without a punitive second tax.

§2032A special-use valuation

If the estate holds farmland or real property used in a closely held business, IRC §2032A, “Valuation of certain farm, etc., real property” lets the executor value it at its actual use, not its highest-and-best-use development value—the difference between a farm valued as a farm and the same acreage valued as a subdivision. The reduction is capped ($1,460,000 for a 2026 death, indexed), the real property must be at least 25% of the adjusted gross estate with all qualifying business property at 50%, and the heirs must sign a recapture agreement committing to material participation and continued qualified use for ten years—sell or convert inside that window and the tax comes back. For an operating farm or ranch it is the first election to run, ahead of the deferral tools above.

Graegin loans

The estate borrows the cash to pay the tax (often from a related entity) on a fixed, non-prepayable note, and—under Estate of Graegin v. Commissioner, T.C. Memo 1988-477—deducts the entire future interest as an administration expense under IRC §2053, “Expenses, indebtedness, and taxes” on Form 706, reducing the taxable estate today. The loan must have genuine economic substance, so the IRS litigates aggressive versions; structure it with a real lender and a real business need.

A Worked Example: §6166 Maria dies in 2026 leaving a $25 million estate: a $20 million manufacturing company she built, a $2 million home, and $3 million in cash and securities. After her $15 million exemption, the taxable estate is $10 million and the estate tax is $4 million—due in cash nine months after death. Her $3 million of liquid assets, part of it already spoken for by debts and administration expenses, cannot cover it. Without relief, the company is sold to pay the IRS.

Section 6166 rescues the estate because the business ($20 million) is 80% of the estate, far above the 35% threshold. The deferrable share is the tax times the business’s share of the adjusted gross estate:

and that portion can be stretched over about fourteen years: interest only for the first five years, then ten annual principal installments. The 2% interest rate applies to the tax on the first $1,940,000 of taxable value for a 2026 death, with a reduced rate above it. So instead of finding $4 million in nine months, Maria’s executor pays the $800,000 of non-business tax up front and services the remaining $3.2 million out of the company’s own annual earnings over more than a decade. The business survives intact—which was the entire point of Maria building it.

These are not mutually exclusive with insurance—they are the backstop when the policy is too small or was never bought. The planning lesson is to identify the liquidity gap while you are alive, when you can still buy coverage, restructure the entity, or start gifting interests, instead of leaving your executor to negotiate a fire sale.