If your estate owes federal estate taxes, then they will be due and payable nine months after your date of death, and the IRS won't accept a piece of real estate, diamond ring, or stock in your business for payment. Thus, your Personal Representative or Successor Trustee will be faced with the challenge of determining where the cash will come from to pay the tax bill. Here are the four options for paying estate taxes.
Using Readily Available Cash
In the ideal situation, an estate will have enough cash sitting in the bank or enough assets that can be easily liquidated, such as publicly traded stocks and bonds, to pay estate taxes. Under this rare circumstance, the Personal Representative, Successor Trustee or beneficiaries will simply be able to pay the taxes when they're due.
Using Life Insurance Proceeds
Life insurance that is payable to a Revocable Living Trust can be easily collected and used to pay estate taxes. If the insurance is owned by an Irrevocable Life Insurance Trust, then your Personal Representative and Successor Trustee will need to work together with an estate planning attorney to properly use the proceeds to pay the taxes. Note that if life insurance proceeds are paid directly to an individual beneficiary, the beneficiary will have absolutely no obligation to turn over any of the proceeds to pay estate taxes. But if there aren't enough other assets to pay the tax bill, then the IRS can and will go after the beneficiary and the insurance proceeds.
Selling Illiquid Assets Through Fire Sales or Borrowing Against Illiquid Assets
If an estate doesn't have enough cash, assets that can be easily liquidated or life insurance proceeds to pay estate taxes, then the Personal Representative or Successor Trustee will be forced to liquidate or borrow against property such as real estate or stock of a closely held business to pay the tax bill. Since estate taxes are due and payable nine months after the date of death, this can lead to fire sales at greatly reduced prices or mortgages above standard market rates, in turn significantly reducing the amount going to your beneficiaries. Note that the IRS can grant an extension of time to pay taxes if an undue hardship can be demonstrated, but interest will continue to accrue on the unpaid balance until the taxes are paid in full.
Using Estate Tax Elections
There are several different estate tax elections that can be used to stretch out the payment of estate taxes over a number of years. To take advantage of these elections, however, your estate will need to own a specific type of assets such as a family farm or other type of closely held business. The rules governing these elections are complicated, and if your estate fails to meet just one requirement, then your estate won't qualify for the election and the estate taxes will be due in nine months.
Therefore, you shouldn't rely on these elections when planning for the payment of estate taxes. Instead, you should look for sources of immediate cash such as life insurance or specific ways to reduce the value of your taxable estate.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.