Section 6601(j)(4) provides:
(4) Treatment of payments
If the amount of tax imposed by chapter 11 which is extended as provided in section 6166 exceeds the 2-percent portion, any payment of a portion of such amount shall, for purposes of computing interest for periods after such payment, be treated as reducing the 2-percent portion by an amount which bears the same ratio to the amount of such payment as the amount of the 2-percent portion (determined without regard to this paragraph) bears to the amount of the tax which is extended as provided in section 6166.
The purpose of §6601(j)(4) is to determine the 2% and 45% of R% amounts of tax on which interest is to be computed, and to properly allocate payments to both such portions of the deferred tax. This affects only §6166(a) or §6166(b)(10) elections, since they are the only elections with a 2% interest component. For §6166(b)(7) and §6166(b)(7) elections, the 2% portion of deferred tax is treated as zero and all payments are allocated solely to the 45% of R% portion of deferred tax, i.e., the entire balance of deferred tax. See sections 6166(b)(7)(A)(iii) and 6166(b)(8)(A)(iii), each of which provides:
- (iii) for purposes of applying section 6601(j), the 2-percent portion (as defined in such section) shall be treated as being zero.
Section 6601(j) Example 3 §6601(j)(4) 2% Allocation Examples §6166(b)(10) Installment Payments from Example 2 | ||||
| The factors for the §6601(j)(4) 2% and 45% of R% tax allocations should be carried out to 6 decimal places. IRS uses 9 decimal place interest factors for all interest computations pursuant to Rev. Proc. 95-17, but the same rule is not used for determining the section 6601(j)(4) ratios. | ||||
| In this example the annual installment tax payments equal the amounts due and are timely paid on each installment due date. | ||||
| Determine the §6601(j)(4) 2% and 45% of R% Factors | ||||
| 2% portion of deferred tax | 592,000.00 | = | 0.130467 | The 2% portion of any tax payment |
| Total amount of deferred tax | 4,537,541.57 | |||
| 45% of R% portion of deferred tax | 3,945,541.57 | = | 0.869533 | The 45% of R% portion of any tax payment (or, 1 - 0.130467124 = 0.869533876) |
4,537,541.57 | ||||
| Apply the §6601(j)(4) Factors to the Payments Received | |||||
| Feb-10-2017 | Feb-10-2018 | Feb-10-2019 | Feb-10-2020 | Feb-10-2021 | |
| Payment received | 907,508.31 | 974,404.20 | 957,680.22 | 940,945.90 | 924,237.46 |
| Interest included in the payment | 0.00 | 66,895.88 | 50,171.91 | 33,437.58 | 16,729.15 |
| Tax portion of the payment | 907,508.31 | 907,508.32 | 907,508.31 | 907,508.32 | 907,508.31 |
| 2% §6601(j)(4) factor | 0.130467 | 0.130467 | 0.130467 | 0.130467 | 0.130467 |
| 2% portion of payment | 118,400.00 | 118,400.00 | 118,400.00 | 118,400.00 | 118,400.00 |
| 45% of R% §6601(j)(4) factor | 0.869533 | 0.869533 | 0.869533 | 0.869533 | 0.869533 |
| 45% of R% portion of payment | 789,108.31 | 789,108.32 | 789,108.31 | 789,108.32 | 789,108.31 |
| Determine the Annual Installment Interest Computation Base After Applying §6601(j)(4) | |||||
| Return Due Date | 1st Anniversary Date | 2nd Anniversary Date | 3rd Anniversary Date | 4th and Final Anniversary Date | |
| Feb-10-2017 | Feb-10-2018 | Feb-10-2019 | Feb-10-2020 | Feb-10-2021 | |
| 2% Deferred Tax base on which 2% interest is computed | 592,000.00 | 473,600.00 | 355,200.00 | 236,800.00 | 118,400.00 |
| Fraction due | 1/5 | 1/4 | 1/3 | 1/2 | 1/1 |
| 2% iInstallment due | 118,400.00 | 118,400.00 | 118,400.00 | 118,400.00 | 118,400.00 |
| 45% of R% Deferred Tax base on which 45% of R% interest is computed | 3,945,541.57 | 3,156,433.26 | 2,367,324.94 | 1,578,216.63 | 789,108.31 |
| Fraction due | 1/5 | 1/4 | 1/3 | 1/2 | 1/1 |
| 45% of R% installment due | 789,108.31 | 789,108.32 | 789,108.31 | 789,108.32 | 789,108.31 |
| Total tax portion of installment due | 907,508.31 | 907,508.32 | 907,508.31 | 907,508.32 | 907,508.31 |
| Total interest due - computed from the preceding anniversary date to the current anniversary date | 0.00 | 66,895.88 | 50,171.91 | 33,437.58 | 16,729.15 |
| Total installment payment due | 907,508.31 | 974,404.20 | 957,680.22 | 940,945.90 | 924,237.46 |
The step-down in amounts on which 2% and 45% of R% interest is computed occurs on every tax installment anniversary date whether or not any payments have been received. This process is required for computing interest on deferred tax that will be due on the next installment due date. If an installment is not paid when due (e.g. the time for payment is extended under §6161), interest on the unpaid installment will be computed at the regular underpayment interest (R%) rates from the payment due date forward until paid; the §6601(j) rules will no longer apply to that past-due installment. See Rev. Rul. 89-32, 1989-1 C.B. 307.
The §6601(j)(4) fraction remains constant over the life of the §6166(b)(10) payout even though the unpaid balance of deferred tax decreases each year. The numerator and denominator of the fraction use the figures first determined when the §6166 election was filed, and as modified by any examination (audit) adjustments made when the election was finally accepted by the IRS. They do not change until there is a subsequent change in the total estate tax or in the closely held business value at the time immediately before the decedent's death.
Any overpayments of interest would also be applied between the 2% and 45% of R% portions of deferred tax pursuant to §6601(j)(4). However, in this example there are no excess tax payments or interest overpayment credits to be applied against the deferred tax base on which interest is to be computed, and the §6601(j)(4) computations are straightforward.