In a recent Chief Counsel Memorandum (CCM), the IRS indicated that in most cases it will not allow a deduction from income tax for interest that accrues during the period that an extension for paying estate tax is in effect because such interest is non-deductible personal interest. See CCM 200836027.
In the case, the estate lacked liquid assets to pay its estate tax. Under Internal Revenue Code section 6161, the estate was granted (due to economic hardship) an extension of time for paying the estate tax. During the period of extension, interest on the unpaid estate tax continued to accrue. On the estate’s income tax return, Form 1041, U.S. Income Tax Return for Estates and Trusts, it claimed a deduction for the amount of interest due on the unpaid estate tax.
In the memorandum, which is binding only on the taxpayer whose case was under consideration but is very informative for the rest of us, the IRS made it clear that if an estate is large enough to owe estate tax, but does not have enough liquid assets to pay the tax, there will be no tax break on the interest the IRS will charge for paying the tax late. We see this scenario often in cases where the major assets of the estate are assets that either cannot be sold quickly for a good price, such as a business or a family home, or retirement assets, on which income tax is due upon liquidation. In estates like this we often encourage clients to add life insurance, and possibly an irrevocable life insurance trust, to their estate plans.
Kirsten Howe practices estate planning law in Walnut Creek. Send your estate planning questions to Kirsten by e-mail.