Passive Assets and §6166 Deferral

by Beverly R. Budin, Esq.
Ballard Spahr Andrews & Ingersoll, LLP
Philadelphia, PA

When the value of an interest in a closely held business that is included in the decedent's gross estate exceeds 35% of the “adjusted gross estate,” the executor may elect to defer estate tax under §6166. In determining (i) whether the business interest meets the 35% test and (ii) how much of the estate tax can be deferred, the value of the business will be reduced by the value of its “passive assets.” Private Letter Ruling 200845023 provides insight into the Service's approach in determining what is a “passive asset.”

Under the facts in this ruling, the assets held by the decedent's wholly owned LLC were a tenant-in-common interest in three pieces of real estate, cash, securities, and an automobile. There was a verbal agreement that the LLC would manage two of the real estate properties in which the LLC had an interest, but neither the decedent nor the LLC provided any management services with respect to the third piece of real estate. The automobile owned by the LLC was used by the decedent in her capacity as manager of the Company, automobile expenses were deducted by the LLC, “and the estate claims the automobile was used predominately in the business.”

In applying the passive-asset test, the Service analyzed the different assets of the LLC as follows:

1. The management services performed by the LLC with respect to the two pieces of real estate that it managed were part of an active rental business.
2. The piece of real estate that was not managed by the LLC was a passive asset.
3. The Service stated the following with respect to the automobile:
Even though LLC X held title to the vehicle and it was predominantly used in management activities, the use of the vehicle in part for non-business purposes limits the value of the asset for purposes of section 6166. Insufficient information has been provided to determine whether all or only part of the value of the automobile is an asset used in the trade or business.

The implication is that the taxpayer had not submitted sufficient information as to whether the automobile was used, in part, for non-business purposes and, if so, information regarding the break down between the business and non-business uses.

4. The Service stated the following with respect to the cash and securities:
No information beyond value was provided regarding the cash and securities held by LLC X. No ruling was requested or is given as to whether any amount of cash or securities should not be considered a passive asset.

Presumably, the cash and securities would not be considered passive assets if they could be shown to be necessary for working capital.

The Service expressed no opinion as to the eligibility for installment payments of the estate tax attributable to the cash, securities or automobile. The ruling makes clear that Service will dig deep to determine which assets are “passive,” and will limit the amount that can be deferred to the estate tax attributable to assets for which there is a clear showing of business use.