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.

Who Must File

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

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.

Penalties

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

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.

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 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).

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.

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.

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:

Valuation

When computing the amounts to enter on Form 706-D, use the same values and estate tax that the executor reported on the Form 706 filed for the decedent. However, if the IRS has completed the audit of the estate tax return, use the agreed values and tax rather than the reported values and tax.

Schedule A. Disposition of Qualified Family-Owned Business Interest, Failure to Materially Participate, or Disqualifying Act

Schedule B. Involuntary Conversions or Exchanges

Involuntary conversions of qualified property (under the rules of section 1033) and exchanges of qualified property (under the rules of section 1031) are treated similarly when computing the additional estate tax on Form 706-D.

If you are reporting an involuntary conversion or exchange, you may not use the same Form 706-D to report any other taxable events that are not involuntary conversions or exchanges. Use a separate Form 706-D for the other taxable events.

You may report conversions and exchanges together on the same return.

Part II—Tax Computation

Schedule C. Nontaxable Transfers

Signature(s)

Form 706-D must be signed. The taxpayer (or person filing on his or her behalf) must verify and sign the declaration on page 1 under penalties of perjury. The taxpayer may use Form 2848, Power of Attorney and Declaration of Representative, to authorize another person to act for him or her before the Internal Revenue Service.

Generally, anyone who is paid to prepare the return must sign the return in the space provided and fill in the Paid Preparer's Use Only area. See section 7701(a)(36)(B) for exceptions.

In addition to signing and completing the required information, the paid preparer must give a copy of the completed return to the taxpayer.