Section 6166(g) is captioned “Acceleration of Payment.” It provides for the termination of a section 6166 election or assertion of penalties if certain actions are taken with regard to the assets constituting the qualifying business interests (section 6166(g)(1)), or if there is undistributed net income of the estate in any taxable year ending on or after the due date of the first installment (section 6166(g)(2), or if there is a failure to make payment of principal or interest (section 6166(g)(3)).
The section 6166(g)(1) penalty is procedural. When 50% or more of an interest in a closely held business is distributed, sold, exchanged, or otherwise disposed of, the section 6166 election automatically terminates on the date when the sum of such transactions constitutes 50% or more of the qualifying interest. There is no monetary penalty. The entire unpaid amount of tax and interest no longer qualifies for deferral under section 6166 and is payable on notice and demand from the Secretary.
The section 6166(g)(2) penalty is monetary. An amount equal to the undistributed net income is due as a prepayment of the unpaid balance of tax deferred under section 6166, and the prepayment is allocated equally as a credit against the remaining installments under the section 6166 deferral as they come due. This is a different result from an ordinary voluntary prepayment, which is allocated entirely against the next installment coming due. The penalty component is therefore twofold: first, it requires a prepayment of deferred tax; and, second, it denies recognition of the full benefit of the prepayment when the next installment comes due. If the prepayment equal to the undistributed net income is not paid, however, it becomes a section 6166(g)(3) matter.
Section 6166(g)(3) provides for either a monetary penalty or a procedural penalty. There is a 6-month window within which to save the section 6166 election. To save the election, a penalty equal to 5% per month or any part thereof times the past-due principal and interest must be paid. The maximum section 6166(g)(3)(B)(iii) penalty is 30% (6 months times 5% per month). If the penalty and the underlying past-due principal or interest is not paid, the section 6166 election terminates and the unpaid portion of tax shall be paid on notice and demand from the Secretary. The section 6166 election is terminated on the date of such notice and demand. When the section 6166 election terminates for this reason, the section 6166(g)(3)(B)(iii) penalty no longer applies, and it is automatically abated by the IRS if it has been assessed. (Penalty assessments for prior periods, in which the section 6166 election was saved, remain in place as assessed.) There is no reasonable cause exception to assertion of this penalty, nor is there any deficiency procedure before it can be assessed - it is immediately assessable per the final sentence of 6166(g)(3), which reads:
The penalty imposed under clause (iii) shall be treated in the same manner as a penalty imposed under subchapter B of chapter 68.