Business Succession Planning: Tax Strategies for Transferring Ownership

By Yarik Yarosh, CPA ·September 5, 2026 ·7 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Business succession is the most expensive tax event many business owners will face, and it is also the most commonly unplanned. The federal estate tax exemption is $13.61 million per person (2024), which shelters most small businesses from estate tax, but the exemption is scheduled to drop to approximately $7 million in 2026 (unless extended by Congress). Income tax on a sale, capital gains on appreciated assets, and state estate taxes can consume 30-50% of the business’s value without proper planning.

✓Key takeaway

Succession planning options:

1. Sale to a third party.

Asset sale vs. stock sale. The buyer usually prefers an asset sale (higher depreciation basis). The seller usually prefers a stock sale (capital gains treatment on the entire amount, one level of tax). IRC 338(h)(10) election allows a stock sale to be treated as an asset sale for tax purposes (both parties agree).
Installment sale (IRC 453). The seller receives payments over time and recognizes gain as payments are received. Spreads capital gains over multiple years, potentially keeping the seller in a lower bracket.
Self-canceling installment note (SCIN). A SCIN cancels the remaining balance at the seller’s death, removing it from the estate. The trade-off: the seller charges a premium (higher price or higher interest) to compensate for the cancellation feature.
Purchase price allocation (IRC 1060). The sale price must be allocated across asset classes (Class I through VII). Allocation to goodwill (Class VII) produces capital gains for the seller. Allocation to equipment (Class V) produces depreciation for the buyer but ordinary income (depreciation recapture) for the seller.

2. Transfer to family.

Gifting. Annual exclusion: $18,000 per donee (2024). Gifts above the annual exclusion reduce the lifetime estate tax exemption. Gifting early, when the business value is lower, transfers future appreciation out of the estate.
GRAT (Grantor Retained Annuity Trust). The owner transfers business interests to a trust, retains an annuity for a term of years, and the remainder passes to the next generation. If the business appreciates faster than the IRS’s assumed rate (Section 7520 rate), the excess passes gift-tax-free.
Family LLC or FLP. The owner transfers business interests to a family limited partnership or LLC, gifts minority interests to family members, and applies valuation discounts (lack of marketability, lack of control) of 20-35%. A $1 million interest might be valued at $650,000 for gift tax purposes.
Installment sale to an IDIT (Intentionally Defective Irrevocable Trust). The owner sells the business to a trust in exchange for a promissory note. The sale is not a taxable event (the trust is a grantor trust). The business value (and future appreciation) is removed from the estate. The note payments provide the owner with retirement income.

3. Transfer to co-owners or key employees.

Buy-sell agreement. A binding agreement that sets the purchase price and payment terms in advance. Funded by life insurance (entity-purchase or cross-purchase structure). The agreement sets the estate tax value of the interest (if the agreement meets IRC 2703 requirements).
ESOP (Employee Stock Ownership Plan). The business establishes an ESOP that buys the owner’s stock. The owner can defer capital gains on the sale under IRC 1042 (if the business is a C-Corp and the ESOP holds 30%+ of the stock after the sale). The business gets a tax deduction for contributions to the ESOP. For S-Corps, the ESOP’s share of S-Corp income is tax-exempt (the ESOP trust is a tax-exempt entity). ESOPs are complex and expensive to establish ($50,000-$150,000), but can provide significant tax benefits for larger businesses.

4. Estate plan (death without prior transfer).

Stepped-up basis (IRC 1014). Heirs receive the business at fair market value at the date of death. All built-in capital gains are eliminated.
Estate tax. If the estate exceeds the exemption ($13.61M per person, $27.22M per married couple in 2024), the excess is taxed at 40%.
IRC 6166 installment payments. If the business is a closely held business representing more than 35% of the adjusted gross estate, the estate can pay the estate tax attributable to the business over 14 years (4-year deferral, then 10 annual installments, with a favorable interest rate on the first $1.8M of deferred tax).

How do these strategies compare in practice?

Hypothetical example

Round numbers. For current guidance, see IRS Publication 334 (Tax Guide for Small Business). A business owner (age 62) owns an S-Corp valued at $3 million. The owner’s basis in the S-Corp stock is $500,000. The owner wants to retire in 3 years and transfer the business to their adult child who is already working in the business.

Option 1: Outright gift.

Gift value: $3,000,000
Annual exclusion: $18,000
Taxable gift: $2,982,000
Uses $2,982,000 of the $13.61M lifetime exemption
No income tax (gifts of appreciated property do not trigger capital gains)
Child’s basis: $500,000 (carryover basis, no step-up)
If child sells for $3M later: $2.5M capital gain

Option 2: Installment sale to child.

Sale price: $3,000,000 over 10 years at the AFR rate
Capital gain: $2,500,000 (recognized as payments received)
Annual capital gain recognition: $250,000/year
Tax at 20% + 3.8% NIIT: approximately $59,500/year
Total tax over 10 years: $595,000
Child’s basis: $3,000,000 (full purchase price)
Provides the owner with $300,000/year in retirement income

Option 3: Gift to family LLC with valuation discounts.

FMV of S-Corp: $3,000,000
Transfer to family LLC
Gift of 90% limited partner interest to child
Valuation discount (30%): $3,000,000 x 90% x 70% = $1,890,000
Taxable gift: $1,890,000 (saves $1,092,000 of lifetime exemption vs. outright gift)
No income tax
Child’s basis: $450,000 (90% of $500,000 carryover basis)

Option 4: Wait and transfer at death.

At death, child inherits the S-Corp stock at stepped-up basis of $3,000,000
No capital gains (ever, on the $2.5M of built-in gain)
Estate tax: $0 (under the $13.61M exemption)
If the exemption drops to $7M and the owner’s total estate exceeds that: potential 40% estate tax on the excess

Best choice depends on:

Does the owner need retirement income? (installment sale)
Is the owner’s estate likely to exceed the exemption? (gift now, before exemption drops)
Does the child need to preserve basis for future depreciation or sale? (installment sale gives full basis)
Tax certainty vs. flexibility? (gift is irrevocable, death is uncertain)

The hybrid approach (most common in practice): Start gifting stock now (uses the annual exclusion, locks in the current lower valuation, takes advantage of valuation discounts). Sell a portion via installment sale (provides retirement income to the departing owner). Leave the remainder to transfer at death (stepped-up basis). This approach spreads the tax impact across multiple mechanisms and typically produces the best overall result.

Illustrative numbers only, not a real client and not advice for your facts.

How does a buy-sell agreement work in practice?

Hypothetical example

Round numbers. Two equal partners own a business worth $2,000,000. Each partner’s interest is worth $1,000,000.

Cross-purchase buy-sell (funded by life insurance):

Each partner owns a life insurance policy on the other partner for $1,000,000
Annual premium: approximately $3,000-$5,000 each (depending on age and health)
Premiums are NOT tax-deductible (life insurance premiums are personal expenses)
Death benefit is TAX-FREE to the surviving partner under IRC 101(a)

When Partner A dies:

Partner B receives $1,000,000 life insurance death benefit (tax-free)
Partner B uses the $1,000,000 to buy Partner A’s interest from A’s estate
Partner B’s basis in the purchased interest: $1,000,000 (the purchase price)
Partner A’s estate receives $1,000,000 cash (included in the estate, but offset by the sale)
Partner A’s heirs receive $1,000,000 (subject to estate tax if above the exemption)

Without a buy-sell agreement:

Partner A’s heirs inherit a 50% interest in the business
The surviving partner is now in business with the heirs (who may have no interest in or knowledge of the business)
Disputes over management, distributions, and valuation are common
The business may need to be sold or liquidated to satisfy the estate

Illustrative numbers only, not a real client and not advice for your facts.

On the IRC 6166 deferral: the interest rate on the deferred estate tax is 2% on the first approximately $1.8 million of deferred tax (2024 figure), well below market interest rates. This makes IRC 6166 one of the most favorable financing options available for estate tax owed on a closely held business.

Related guides:

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Cite this page

Yarik Yarosh, CPA. "Business Succession Planning: Tax Strategies for Transferring Ownership." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-business-succession-planning-tax

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.