Small Business Estate Tax: What Heirs Need to Know

Does the Business Owe Estate Tax?

Most inherited small businesses will not owe federal estate tax. The federal basic exclusion amount for 2026 is $15 million per individual. A married couple may have up to $30 million of combined exclusions if each spouse's exclusion is available, including any required portability election. Only estates that exceed the applicable exclusion owe tax, at rates up to 40%.

For the Form 706 filing test, the gross estate is generally combined with adjusted taxable gifts to determine whether the filing threshold is exceeded. A return may also be filed to elect portability even when the estate is below the threshold. Allowable deductions are then applied in calculating the taxable estate.

For small businesses, the question is not whether estate tax applies in general, but whether the business valuation pushes the total estate above the exclusion. A business owner with $6 million in personal assets and a business valued at $10 million has a total estate of $16 million — above the $15 million threshold and potentially triggering tax on the excess.

How the Business Gets Valued for Estate Tax

The IRS requires that closely held businesses be valued at fair market value as of the date of death. Fair market value means the price a willing buyer would pay a willing seller, with both parties having reasonable knowledge of the relevant facts and neither being under compulsion.

For private businesses that have no publicly traded shares, this valuation must follow the standards in IRS Revenue Ruling 59-60, which examines eight factors including earnings history, asset values, industry conditions, and comparable sales.

Appraisers typically apply one or more of three approaches:

• Income approach: Converts the company's expected future earnings or cash flows into present value. This is the most common method for operating businesses with stable revenue
• Market approach: Compares the business to similar companies that have recently sold, using pricing multiples like price-to-earnings or price-to-revenue
• Asset approach: Calculates the net value of the company's assets minus liabilities. Most commonly used for holding companies, real estate-heavy businesses, or companies being liquidated

For minority interests — when the deceased owned less than 50% — the appraiser will typically apply a discount for lack of control (DLOC) and a discount for lack of marketability (DLOM). These discounts can reduce the taxable value by 20% to 40%, which can make a meaningful difference in whether the estate exceeds the exemption threshold.

The Alternate Valuation Date Election

If the business declines in value after the owner's death — which is common when the owner was the primary revenue driver — the executor can elect to value the entire estate at the date six months after death instead of the date of death itself.

This alternate valuation date election (IRC Section 2032) applies to the entire estate, not just the business. The executor cannot cherry-pick which assets to revalue. And the election is only available if it reduces both the total estate value and the estate tax liability.

For businesses that experience rapid client attrition, employee departures, or revenue drops after the owner's death, the six-month revaluation can substantially reduce the estate tax bill. But the election must be made on the estate tax return (Form 706), which is due nine months after death (with a six-month extension available).

IRC Section 6166: Paying Estate Tax in Installments

If the business represents more than 35% of the adjusted gross estate, the executor may qualify to defer estate tax payments under IRC Section 6166. Instead of paying the full tax bill within nine months, the estate can:

• Pay only interest for the first four years after the due date
• Then pay the tax in up to 10 equal annual installments
• Pay interest at 2% on the "2-percent portion" of deferred estate tax (for a decedent who dies in 2026, the amount used to determine this portion is $1.94 million), with the remaining deferred tax subject to 45% of the regular underpayment rate

This provision exists specifically to prevent families from having to liquidate an operating business to pay estate taxes. The total deferral period can stretch up to 14 years from the original due date of the return.

To secure deferred payments, the IRS may require a bond or a special lien; a lien is not automatic in every case. If dispositions or withdrawals reach 50% of the qualifying business interest's value, or required payments are missed by six months, the IRS may terminate installment treatment and accelerate the unpaid tax upon notice and demand, subject to statutory exceptions.

State Estate Taxes Add Another Layer

Even if the federal estate tax does not apply, state-level estate taxes may. As of 2026, 12 states and the District of Columbia impose their own estate taxes, many with exemption thresholds far below the federal level. Massachusetts sets its threshold at $2 million for deaths on or after January 1, 2023, while Oregon's threshold is $1 million — meaning a business valued at $1.5 million could contribute to a state estate-tax filing or liability even though it falls well below the federal exclusion.

New York imposes a particularly aggressive structure: if the taxable estate exceeds the state exemption by more than 5%, the exemption disappears entirely, and the state taxes the full estate from the first dollar. This "cliff" effect can create a sudden, massive state tax bill on estates that are just slightly above the threshold.

What Heirs Should Do First

Before worrying about tax strategy, get a professional valuation. The valuation drives every downstream decision — whether estate tax is owed, which elections to make, and what the business interest is worth for buyout purposes.

The Small Business Owner Dies guide includes a business valuation preparation worksheet that helps executors gather the financial records, tax returns, and operational data that an appraiser needs, along with a tax filing checklist that maps every form to its deadline.