Life Insurance for Estate Liquidity: Paying Estate Tax Without Selling Assets

How is estate tax paid without selling the estate’s assets?

Federal estate tax is due nine months after death, with the return (IRC § 6075(a); § 6151(a)). An estate short of cash has three sources other than a sale. The Code allows installment payment where a closely held business exceeds 35% of the adjusted gross estate (§ 6166). A corporation can redeem stock to pay death taxes (§ 303). And a life insurance death benefit arrives as cash, generally excluded from income (§ 101(a)(1)).

The sections below take each in turn: who owes the tax, the deadline, the Code’s own relief provisions, and how a death benefit held outside the estate can supply cash. Policy selection and coverage amounts are outside the scope of this page.

Who owes estate tax

An estate tax return is required when the gross estate of a U.S. citizen or resident exceeds the basic exclusion amount for the year of death, a threshold that is reduced by certain lifetime gifts (IRC § 6018(a)). The basic exclusion amount is $15,000,000 for a decedent dying in 2026 (IRC § 2010(c)(3); Rev. Proc. 2025-32) and $15,480,000 for a decedent dying in 2027 (Rev. Proc. 2026-35). The IRS states that most relatively simple estates do not require the filing of an estate tax return (IRS, Estate Tax).

Above the exclusion the tax is computed on a rate schedule whose top bracket is 40% of the amount over $1,000,000, a figure fixed in the statute (IRC § 2001(c)). A credit equal to the tentative tax on the exclusion amount offsets the lower brackets (§ 2010(c)(1)). Read together, and with an exclusion well above $1,000,000, these provisions tax the amount above the exclusion at 40%. The exemption is explained on the lifetime-exemption page.

Some states impose their own estate or inheritance tax, with their own thresholds. Those are listed on the state estate-tax comparison.

When the tax is due

The estate tax return is filed within nine months after the date of death (§ 6075(a)). The tax is paid at the time fixed for filing the return, determined without regard to any extension of time for filing (§ 6151(a)). An extension to file is therefore not an extension to pay.

Tax not paid by the last date prescribed for payment bears interest at the underpayment rate from that date until it is paid (IRC § 6601(a)).

The deadline is the same whatever the estate holds. An estate made up mostly of a business, a farm or real estate owes the tax on the same date as one made up of cash. Business owners will find the ownership side of this on the business-succession page.

Extensions and installment payment

Extension of time to pay (§ 6161). The IRS may extend the time to pay estate tax for a reasonable period of up to 12 months from the date fixed for payment (IRC § 6161(a)(1)). For reasonable cause it may extend the time to pay any part of the tax for a reasonable period of up to 10 years from the original due date (§ 6161(a)(2)). Both are discretionary: the statute says the Secretary “may” extend.

Installment payment for a closely held business (§ 6166). This is an election by the executor, not a matter of IRS discretion. Its terms:

• The 35% test. The decedent was a U.S. citizen or resident, and the value of an interest in a closely held business included in the gross estate exceeds 35% of the adjusted gross estate (§ 6166(a)(1)). The adjusted gross estate is the gross estate reduced by the deductions allowable under §§ 2053 and 2054 (§ 6166(b)(6)).
• What counts as a closely held business. A proprietorship; a partnership interest, if 20% or more of the capital interest is in the gross estate or the partnership had 45 or fewer partners; or corporate stock, if 20% or more in value of the voting stock is in the gross estate or the corporation had 45 or fewer shareholders. In each case the entity must carry on a trade or business (§ 6166(b)(1)).
• How much can be deferred. Only the share of the tax that matches the business’s share of the adjusted gross estate (§ 6166(a)(2)).
• The schedule. The deferred tax is paid in two to ten equal annual installments. The first is due on a date the executor selects, no more than five years after the original due date (§ 6166(a)(3)). On those terms the last of ten installments can fall as late as 14 years after the original due date.
• Interest. Interest is paid annually during the deferral period and then with each installment (§ 6166(f)). The rate is 2% on the “2-percent portion” of the deferred tax and 45% of the regular underpayment rate on the rest (§ 6601(j)). The dollar amount used to determine the 2-percent portion is $1,940,000 for a decedent dying in 2026 (Rev. Proc. 2025-32) and $2,010,000 for a decedent dying in 2027 (Rev. Proc. 2026-35).
• Election deadline. The election is made no later than the time for filing the estate tax return, including extensions (§ 6166(d)).

Section 6166(g) requires earlier payment in three situations:

• Portions of the business interest are distributed, sold, exchanged or otherwise disposed of, or money and property are withdrawn from the business, and the total equals or exceeds 50% of the value of the interest. The unpaid tax then becomes due on notice and demand. Transfers to the persons entitled to the property by reason of the decedent’s death are not counted, and qualifying § 303 redemptions are treated separately.
• A payment of principal or interest is missed. The unpaid tax then becomes due on notice and demand. If the missed payment is made within six months of its due date the deferral continues, but a penalty of 5% of the payment for each month applies and the reduced interest rate is lost for that payment.
• The estate has undistributed net income for a year ending on or after the due date of the first installment. That income must be paid toward the unpaid tax.

Stock redemptions and farm valuation

Redemption to pay death taxes (§ 303). When a corporation redeems stock that was included in a decedent’s gross estate, the distribution is treated as a payment in exchange for the stock, up to the total of the estate, inheritance, legacy and succession taxes imposed because of the death and the deductible funeral and administration expenses (IRC § 303(a)). The percentage test uses the same 35% measure as § 6166: the value of the corporation’s stock in the gross estate must exceed 35% of the gross estate reduced by the deductions allowable under §§ 2053 and 2054 (§ 303(b)(2)(A)). The rule applies only to the extent the redeeming shareholder’s interest is reduced by paying those taxes or expenses (§ 303(b)(3)), and the redemption must occur within the period the statute sets (§ 303(b)(1)).

Special-use valuation (§ 2032A). This provision reduces the value subject to tax rather than supplying cash. If the executor elects it and files the required agreement, qualified real property used as a farm or in another trade or business is valued at its value for that use (IRC § 2032A(a)). The total reduction in value cannot exceed $1,460,000 for a decedent dying in 2026 (Rev. Proc. 2025-32) or $1,500,000 for a decedent dying in 2027 (Rev. Proc. 2026-35). The qualification rules are on the farm and ranch estate guide.

Where life insurance fits

A death benefit becomes payable in cash at the event that starts the nine-month period. Amounts received under a life insurance contract by reason of the insured’s death are generally not included in gross income (§ 101(a)(1)).

Estate tax is a separate question. Proceeds payable to anyone other than the executor are included in the insured’s gross estate if the insured held any incident of ownership in the policy at death (IRC § 2042(2)). For an estate already above the exclusion, an included death benefit that qualifies for no deduction is itself taxed in the 40% bracket.

Married couples. Property that passes to a surviving spouse is deducted from the gross estate, within the limits of § 2056(b) and (d) (IRC § 2056(a)). Read with the general rule that a gross estate includes the property a decedent owns at death (IRC § 2033), this means a couple’s estate tax can fall due at the second death rather than the first.

Insurance owned by a company. Insurance a corporation owns to fund a purchase of a deceased owner’s shares raises a valuation issue of its own. In Connelly v. United States, No. 23-146 (U.S. June 6, 2024), the Supreme Court held that a corporation’s contractual obligation to redeem shares is not necessarily a liability that reduces the corporation’s value for federal estate-tax purposes. See buy-sell agreements.

Moving trust cash to the estate

When a trust collects the death benefit, the cash is in the trust and the tax bill is in the estate. How the trust instrument connects the two determines whether the proceeds stay outside the gross estate.

The regulation is specific. If proceeds are receivable by another beneficiary but are subject to an obligation, legally binding on that beneficiary, to pay taxes, debts or other charges enforceable against the estate, then the amount of the proceeds required to pay those charges in full, to the extent of the obligation, is included in the gross estate (Treas. Reg. § 20.2042-1(b)(1)).

The test is a legally binding obligation. On its terms the regulation does not describe a trustee who is permitted, but not required, to lend money to the estate or to buy assets from it. In a loan the trust holds the estate’s note in place of the cash; in a purchase it holds the asset. Whether a particular trust instrument creates an obligation depends on its wording and on state law.

A worked example

This example is hypothetical. An unmarried U.S. citizen dies in 2026 having made no taxable gifts. The gross estate is $25,000,000, of which $15,000,000 is stock in a corporation with three shareholders that carries on a business. To keep the arithmetic simple, the estate has no deductions.

The $4,000,000 tax equals 40% of the $10,000,000 by which the estate exceeds the 2026 exclusion. With a § 6166 election, $1,600,000 is still due nine months after death. Interest is paid each year on the deferred $2,400,000: at 2% on $776,000 of it and at 45% of the underpayment rate on the other $1,624,000, until installments reduce the balance.

In this example a $1,000,000 death benefit payable to a trust, under a policy in which the decedent had no incident of ownership, would add nothing to the gross estate under § 2042. The same policy owned by the decedent would add $1,000,000 to the gross estate and, at 40%, $400,000 to the tax.

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