The basic purpose of this provision is to permit continuation of a business enterprise where the death of a business owner results in the imposition of a significant estate tax. Consequently, a "distress sale" at reduced prices is not necessary to generate funds to pay the estate tax liability. By extending the period for payment of estate tax, the tax can be paid from later earnings. With more time, the heirs may be able to retain the business within the family or plan for an orderly disposition.

Closely Held Business

The term "interest in a closely held business" is defined in IRC Sec. 6166(b)(1) as:

1. An interest as sole proprietor in a trade or business;

2. A partnership interest in a trade or business if either a) the partnership has no more than 15 partners or b) 20% or more of the total capital interest in the partnership is included in the gross estate; or

3. Stock in a corporation carrying on a trade or business if either a) the corporation has no more than 15 stockholders or b) 20% or more of the value of the corporation's voting stock is included in the decedent's gross estate. The number of partners or shareholders is determined as of the time immediately before the decedent's death.

In Rev. Rul. 75-365, the IRS set forth a more narrow definition of "trade or business" than the meaning given the phrase in other areas of the tax law. The IRS stated that the election was not intended to protect continued management of income-producing properties or to permit deferral of the tax merely because the payment of the tax might make necessary the sale of income-producing assets. An exception would be where the income-producing assets formed a part of an active enterprise producing business income rather than income solely from the ownership of property. Although the management of rental property by the owner may, for some purposes, be considered the conduct of a trade or business in the case of a sole proprietorship, IRC Sec. 6166 was intended to apply only with regard to a business such as a manufacturing, mercantile, or service enterprise, as distinguished from management of investment assets.

Recent Developments

In PLR 9128024, the IRS determined that real estate interests may qualify as an interest in a closely held business. In the facts of the ruling, the decedent owned real estate interests in twelve apartment buildings. The properties were owned in the following forms: sole proprietorship, sole stockholder of corporation owning property, tenant in common with sons, and partner of a partnership owning property. The decedent personally attended to the day-to-day operation and management of the twelve properties. Some of the decedent's responsibilities included:

* Interviewing and screening prospective tenants;

* Negotiating leases;

* Collecting rents;

* Preparing apartments for new tenants;

* Maintaining all common areas;

* Installing and repairing household fixtures;

* Maintaining water, heating, and sewer systems;

* Contracting for and supervising the work of painters, plumbers, roofers, electricians, and other craftsmen for major repairs and renovations;

* Maintaining financial records;

* Paying bills;

* Obtaining and reviewing insurance coverage;

* Maintaining good tenant relations;

* Resolving complaints from tenants and mediating tenant disputes; and

* Consulting with legal counsel and accountants;

The decedent was assisted by one of his sons full-time, a handyman, and a garbage remover. The handyman and garbage remover were paid from a management account that was used for all properties. The decedent was on call 24 hours a day, including weekends. None of the properties were managed by an outside management company. The decedent had no source of earned income other than the management of the real estate interests.

Rationale

The IRS ruled that level of activity is the factor that distinguishes an "active business" from mere passive ownership of income-producing assets. In determining the level of business activity carried on by a proprietorship, partnership, or corporation, the activities of its agents or employees are taken into account. The activities of persons such as independent contractors or lessees who are neither agents nor employees, are not taken into account. The decedent's son, handyman, and garbage remover can be viewed as agents of the decedent. Therefore, their activities were attributed to the decedent.

The decedent's activities (as assisted) went beyond merely collecting rents, making mortgage payments and making necessary repairs (considered management of investments). Therefore, decedent was engaged in a trade or business as a proprietor with respect to these properties and the tax deferral benefits of IRC Sec. 6166 were available to the estate.