Estate Tax Planning for Business Owners: Exemption, Valuation Discounts, and the 2026 Sunset

Key estate tax concepts for business owners:

1. Exemption sunset (scheduled for January 1, 2026): The exemption drops from approximately $14 million to approximately $7 million per person. A married couple’s combined exemption drops from $28 million to $14 million. Gifts made while the higher exemption is in effect aren’t clawed back (IRS anti-clawback regulation, TD 9884).

2. Valuation discounts for closely held businesses: Minority interest and lack of marketability discounts can reduce the taxable value of business interests by 20-40%. A 50% interest in a $4 million business is not worth $2 million (50%) on the open market because the buyer would own a minority stake in an illiquid business. Discounts of 25-35% are commonly applied.

3. Grantor Retained Annuity Trust (GRAT): The owner transfers business interests to a trust, retaining an annuity payment for a term of years. If the business grows faster than the IRS assumed interest rate (Section 7520 rate), the excess growth passes to the beneficiaries estate-tax-free.

4. Irrevocable Life Insurance Trust (ILIT): Life insurance proceeds can be excluded from the estate if the policy is owned by an irrevocable trust (not the business owner). The death benefit provides liquidity to pay estate taxes without selling business assets.

5. IRC 6166 installment deferral: If the business represents more than 35% of the estate, estate taxes can be deferred for up to 5 years (interest-only) and then paid in installments over 10 years. The interest rate on the first approximately $1.8 million of deferred tax is only 2%.

6. Stepped-up basis at death: Assets included in the estate receive a basis adjustment to FMV at the date of death. This eliminates all unrealized capital gains. A business interest with a $500,000 basis and $5 million FMV at death passes to heirs with a $5 million basis.