Sources for Estate Liquidity

Estate liquidity refers to the availability of cash or assets that can quickly be converted to cash to meet the financial obligations that arise at death. Without adequate liquidity, executors may be forced to sell valuable assets at unfavorable prices, potentially destroying the value of family businesses or other illiquid holdings.

Why Estate Liquidity Is Needed

When a person dies, their estate faces numerous immediate cash needs:

Funeral and Final Expenses

• Funeral costs typically range from $10,000 to $25,000
• Medical bills from final illness
• Personal debts and credit obligations

Estate Administration Costs

• Executor/personal representative fees
• Attorney and accounting fees
• Appraisal costs for assets
• Court costs and filing fees

Tax Obligations

• Federal estate tax (40% rate on amounts exceeding the exemption)
• State estate or inheritance taxes
• Final income tax returns (decedent and estate)
• Gift taxes due on lifetime transfers

Ongoing Obligations

• Family living expenses during estate administration
• Business operating expenses
• Property maintenance and insurance

The estate tax is due nine months after death, creating significant time pressure to generate liquidity.

Primary Sources of Estate Liquidity

1. Life Insurance

Life insurance is often the preferred source of estate liquidity for several reasons:

• Immediate availability: Proceeds are paid shortly after death
• Income tax-free: Death benefits are generally not subject to income tax
• Known amount: The death benefit provides a predictable liquidity source
• Leverage: Relatively small premium payments create substantial liquidity

Life insurance can be structured to remain outside the taxable estate when owned by an Irrevocable Life Insurance Trust (ILIT), providing tax-free liquidity without increasing estate taxes.

2. Liquid Assets

Cash and readily marketable securities provide immediate liquidity:

• Bank accounts and money market funds
• Publicly traded stocks and bonds
• Mutual funds and ETFs
• Treasury securities

However, relying solely on liquid assets for estate liquidity has drawbacks:

• Assets may be subject to estate tax
• Investment returns may be suboptimal compared to less liquid investments
• Market conditions at death may require selling at a loss

3. Section 303 Stock Redemption

Section 303 of the Internal Revenue Code provides special relief for estates that include closely held business stock. It allows the corporation to redeem stock from the estate and treats the redemption as a sale or exchange (capital transaction) rather than a dividend.

Key Requirements for Section 303:

Benefits of Section 303:

• Estate receives cash without dividend treatment
• No recognition of gain to extent of basis in stock
• Corporation provides liquidity using corporate assets
• Allows continued family ownership of remaining stock

4. Section 6166 Installment Payment of Estate Tax

Section 6166 allows estates with closely held business interests to pay the federal estate tax attributable to the business in installments over an extended period.

Key Requirements for Section 6166:

Section 6166 Payment Structure:

Interest Rates on Deferred Tax:

• 2% interest applies to the first $1,790,000 (2025, adjusted for inflation) of taxable value in excess of the applicable exclusion amount
• 45% of the underpayment rate (approximately 3.6% in current environment) applies to amounts above this threshold
• Interest is deductible for estate tax purposes

Acceleration Events - The following trigger immediate payment:

• Disposition of 50% or more of the business
• Withdrawal of 50% or more of business assets
• Failure to make timely interest or principal payments
• Business ceases to qualify as closely held

Comparison of Estate Liquidity Sources

Planning Considerations

Coordination of Strategies: Section 303 and Section 6166 can be used together. The 303 redemption provides immediate cash for expenses and some taxes, while Section 6166 spreads the remaining estate tax over time.

Life Insurance Advantages: Unlike Sections 303 and 6166, life insurance:

• Is not limited to business owners
• Provides immediate, certain liquidity
• Can be structured outside the estate (ILIT)
• Does not require IRS approval or create liens on estate assets

Section 6166 Considerations: While attractive for deferral, Section 6166:

• Creates a lien on estate assets
• Requires annual payments with acceleration penalties
• May not be available if business is sold or assets distributed
• Interest is an additional cost (though deductible)