General Instructions

Purpose of Form

If the estate of a decedent dying before January 1, 2004, claimed a qualified family-owned business interest (QFOBI) deduction on Schedule T of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, each qualified heir assumed personal liability for a portion of the reduction in estate tax resulting from the QFOBI deduction.

Section 2057 imposes an additional estate tax on a qualified heir when certain “taxable events” occur with respect to a QFOBI received by the qualified heir. The qualified heir uses Form 706-D to report and pay the additional estate tax. A qualified heir also uses Form 706-D to report certain nontaxable events.

Note.

In order to properly prepare Form 706-D, you will need a copy of, or information from, the original Form 706 that the executor of the decedent's estate filed with the IRS. Generally, any heir at law, next of kin, or beneficiary under the decedent's will is entitled to inspect a return or receive return information in the case of the return of an estate if such heir, next of kin, or beneficiary has a material interest which will be affected by information contained in the return of the estate. See section 6103(e)(1)(E)(ii).

Who Must File

Each qualified heir must file a Form 706-D to report:

  • A taxable event (see Taxable Events on page 2),

  • An involuntary conversion or exchange of a QFOBI,

  • A transfer to a family member,

  • A qualified conservation contribution, or

  • The loss of U.S. citizenship if the QFOBI passes or is acquired or held in a qualified trust.

When To File and Pay

File Form 706-D and pay any additional tax due within 6 months after the taxable disposition, disqualifying act, or failure to materially participate in the QFOBI, unless an extension of time has been granted.

Use Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, to apply for an automatic 6-month extension of time to file. Check the “Form 706-D” box in Part II of Form 4768.

Make the check or money order payable to the “United States Treasury” and write “Form 706-D” and the qualified heir's social security number on the check or money order.

Where To File

File Form 706-D at the following address.

Department of the Treasury
Internal Revenue Service Center
Cincinnati, OH 45999

Penalties

Return preparer.   The Small Business and Work Opportunity Tax Act of 2007 (Act) extends the application of return preparer penalties to preparers of estate tax returns. Under section 6694, as amended by the Act, and the transitional relief provided by Notice 2007-54, 2007-27 I.R.B. 12, estate tax return preparers, who prepare any return or claim for refund which reflects an understatement of tax liability due to willful or reckless conduct, are subject to a penalty of $5,000 or 50% of the income derived (or income to be derived), whichever is greater, for the preparation of each such return. See section 6694, Notice 2008-11, 2008-3 I.R.B. 279, Notice 2008-13, 2008-3 I.R.B. 282, and Notice 2008-46, 2008-18 I.R.B. 868 for more details.

Statute of Limitations

The additional estate tax may be assessed until 3 years after the IRS receives notice that the qualified heir disposed of the QFOBI, material participation ended, or a disqualifying act occurred.

However, if the property was disposed of in an involuntary conversion or in an exchange, the tax may be assessed up to 3 years after the IRS receives notice that the property was replaced or will not be replaced. See section 2032A(f) for details.

Lien

If the estate elected to take the QFOBI deduction, section 6324B establishes a special lien against the QFOBI equal to the adjusted tax difference attributable to such an interest.

Definitions

Ownership rules.    Ownership of the business interest may either be direct, or indirect through a corporation, partnership, or a trust. An interest owned, directly or indirectly, by or for such an entity, is considered owned proportionately by or for the entity's shareholders, partners, or beneficiaries. A person is the beneficiary of a trust only if he or she has a present interest in the trust.

Qualified heir.   A person is a qualified heir of property if he or she is a member of the decedent's family and acquired or received the QFOBI from the decedent.

  If a qualified heir disposes of any QFOBI to any member of his or her family, that person will then be treated as the qualified heir with respect to that interest.

For the purpose of the QFOBI deduction, a qualified heir also includes any active employee of the trade or business to which the QFOBI relates, if the employee has been employed by the trade or business for a period of at least 10 years before the date of the decedent's death.

Member of family.   The term “member of the family” includes only:
  • An ancestor (parent, grandparent, etc.) of such individual;

  • The spouse of such individual;

  • The lineal descendent (child, stepchild, grandchild, etc.) of the individual, of the individual's spouse, or of a parent of such individual; and

  • The spouse, widow, or widower of any lineal descendent described above.

  A legally adopted child of an individual is treated as a child of that individual by blood.

Taxable Events

Section 2057 imposes an additional estate tax when there is a taxable event. A taxable event occurs if, within 10 years of the decedent's death and before the qualified heir's death, one of the following events occurs:

  • The qualified heir disposes of any portion of his or her interest in the qualified family-owned business, other than by a disposition to a member of the qualified heir's family or through a qualified conservation contribution under section 170(h);

  • The qualified heir fails to meet material participation requirements because neither the qualified heir nor any member of his or her family has materially participated in the trade or business for at least five years of any 8-year period (see Material Participation below);

  • The principal place of business of the qualified family-owned business ceases to be located in the United States; or

  • The qualified heir loses U.S. citizenship and a qualified trust was not created nor was a security arrangement made. (See Loss of U.S. citizenship beginning on page 5 for more information.)

Note.

For special rules for involuntary conversions and exchanges, see the instructions for Schedule B on page 3.

The 10-year recapture period may be extended for a period of up to two years if the qualified heir does not begin to use the property for a period of up to two years after the decedent's death. (See Two-Year Grace Period—Commencement Date on page 3.)

Only one additional estate tax will be imposed with respect to any one interest in the qualified family-owned business. For example, if additional estate tax is imposed for failure to materially participate in the QFOBI, a second additional estate tax will not be imposed for a subsequent early disposition of the same part of the QFOBI.

A sale or disposition, in the ordinary course of business, of assets such as, inventory or a piece of equipment used in the business (for example, the sale of crops or a tractor) would not result in recapture of the benefits of the QFOBI deduction.

Also, a distribution in redemption of stock that is part of a QFOBI and that qualifies under section 303 is not a disposition for recapture purposes.

Each qualified heir is personally liable for the portion of the recapture tax imposed with respect to his or her interest in the qualified family-owned business.

Thus, for example, if a brother and sister inherit a qualified family-owned business from their father, and only the sister materially participates in the business, her participation will cause both her and her brother to meet the material participation test.

If she fails to materially participate in the business within 10 years after her father's death (and the brother still does not materially participate), the sister and brother would both be liable for the additional estate tax (that is, each would be liable for the additional estate tax attributable to his or her interest).

Disposition to family member.   If a transferee who is a family member enters into an agreement to be personally liable for any additional tax under section 2057, the disposition is nontaxable, and you should enter it on Schedule C. Otherwise, a disposition of an interest in property to a family member of the qualified heir is a taxable event, and you should enter it on Schedule A.

Material Participation

For this purpose, material participation is defined under section 2032A (special-use valuation) and the related regulations. See Regulations section 20.2032A-3.

Under such regulations, no one factor is determinative of the presence of material participation. The nature of the particular industry (for example, farming, manufacturing, etc.) must be considered.

Physical work and participation in management decisions are the principal factors for consideration. For example, an individual generally is considered to be materially participating in the business if he or she personally manages the business fully, regardless of the number of hours worked, as long as any necessary functions are performed.

If a qualified heir rents qualifying property to a member of the qualified heir's family on a net cash basis, and that family member materially participates in the business, the material participation requirement is met with respect to the qualified heir for purposes of this provision.

If a qualified heir dies before the required period has passed, any material participation requirement ends for that heir's portion of the property, provided the heir received a separate or other undivided interest from the decedent.

If qualified heirs receive successive interests in the QFOBI (for example, a life estate and remainder interests) the material participation requirement does not end for any part of the property until the later of the expiration of the recapture period or the death of the last qualified heir.

In determining whether the required participation has occurred, disregard brief periods (for example, 30 days or less) during which there was no material participation, as long as such periods were preceded and followed by substantial periods (more than 120 days) during which there was uninterrupted material participation.

Surviving spouse.   A surviving spouse who received qualified real property from the predeceased spouse is considered to have materially participated if he or she was engaged in the active management of the business.

  For additional details regarding material participation, see Regulations section 20.2032A-3(e).

Additional Estate Tax

The amount of the additional estate tax is equal to the applicable percentage of the adjusted tax difference attributable to the QFOBI deduction. The applicable percentage is based on the number of years that the qualified heir (or members of the qualified heir's family) materially participated in the trade or business after the decedent's death.

In addition, interest is due at the underpayment rate established under section 6621 for the period beginning on the date the estate tax liability was due under section 2001 and ending on the date such additional estate tax is due (section 2057(f)(2)(A)).

You may calculate this interest amount yourself, or you may have the IRS calculate it for you. If the IRS calculates the interest, there may be additional interest charged under section 6601 until the full amount is paid.

If you want the IRS to calculate the interest, you may estimate the amount of interest and pay it with the tax, according to the Note below. This may avoid any additional interest.

Note.

If you include interest with your payment, indicate the amount of interest paid on the dotted line for line 15. Do not include the interest in the entry space for line 15.

Applicable Percentage

IF the taxable event occurred in the following year of material participation. . . THEN the applicable percentage is . . .
Years 1 through 6 100%
Year 7 80%
Year 8 60%
Year 9 40%
Year 10 20%

Two-Year Grace Period—Commencement Date

No additional tax is imposed if the qualified heir begins material participation in the QFOBI within the 2-year period after the decedent's death. The date on which the qualified heir begins material participation is the commencement date.

The 10-year recapture period is extended by the period after the decedent's death and before the commencement date.

For example, if the decedent died February 28, 2003, and the commencement date is August 1, 2004, the recapture period would begin August 1, 2004, and end July 31, 2014.

How To Complete Form 706-D

You may only file Form 706-D for one qualified heir. If a disposition, failure to materially participate, disqualifying act, involuntary conversion or exchange, or nontaxable transfer involves more than one qualified heir, each must file a separate Form 706-D.

Complete Form 706-D in this order:

Note.

The qualified heir (or an authorized person acting on his or her behalf) must sign the return.

  1. Part I,

  2. Schedules A and B,

  3. Part II,

  4. Schedule C.


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