Business Succession Planning: Tax Implications of Transferring Ownership

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

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

Every business owner will eventually exit their business. The exit method (sale to a third party, transfer to family, sale to employees, or liquidation) determines the tax treatment. Succession planning that starts 5-10 years before the transition can save $100,000-$500,000+ in taxes by taking advantage of valuation discounts, annual gift tax exclusions, installment sales, and generation-skipping strategies. The worst outcome is an unplanned transfer at death, where the estate may owe estate tax on the full fair market value of the business with no liquidity to pay it.

✓Key takeaway

Succession methods and their tax treatment:

1. Lifetime gift to family members:

Gift tax applies (federal gift tax exemption: $13.99 million per individual in 2025, $27.98 million per married couple)
Annual gift tax exclusion: $19,000 per recipient (2025)
Valuation discounts (lack of marketability, minority interest): 20-40% discount on the appraised value
The recipient’s basis in the gifted interest = the donor’s basis (carryover basis), NOT fair market value
If the business appreciates after the gift, the appreciation is outside the donor’s estate
Best for: transferring a growing business to the next generation while the valuation is still low

2. Sale to family or employees (installment sale):

Capital gains tax applies to the seller on the gain (sale price minus basis)
Installment sale under IRC 453: seller reports gain as payments are received
Interest on the installment note: AFR (Applicable Federal Rate) minimum, or the agreed rate
The buyer’s basis = purchase price (stepped-up basis)
If sold to family at below-market price: the discount is a gift (gift tax applies to the difference between FMV and sale price)
Self-canceling installment note (SCIN): the note is canceled at the seller’s death, removing the remaining balance from the estate

3. Buy-sell agreement (funded with life insurance):

Partners/shareholders agree in advance on the price and terms of a buyout (triggered by death, disability, retirement)
Cross-purchase: the remaining owners buy the departing owner’s interest (buyer’s basis = purchase price)
Entity redemption: the entity buys back the departing owner’s interest (more complex, potential IRC 302 issues)
Life insurance funds the buyout at death: insurance proceeds are received income-tax-free by the buyer(s), and the proceeds purchase the deceased owner’s interest from the estate
Properly structured: no income tax on the insurance proceeds, no capital gains tax at death (stepped-up basis), and the buyout price establishes the estate tax value

4. Transfer at death (no plan):

The business interest is included in the decedent’s gross estate at fair market value
Estate tax applies if the total estate exceeds $13.99 million (2025 exemption)
Estate tax rate: 40% on amounts above the exemption
The heirs receive a stepped-up basis under IRC 1014 (basis = fair market value at date of death)
Stepped-up basis eliminates capital gains on all pre-death appreciation
Problem: the estate may owe estate tax with no cash to pay it (the business is illiquid). IRC 6166 allows installment payments of estate tax attributable to a closely held business (up to 14 years)

5. Employee Stock Ownership Plan (ESOP):

The company establishes an ESOP trust that purchases the owner’s stock
For C-Corps: the seller can defer capital gains by reinvesting in qualified replacement property within 12 months (IRC 1042 rollover)
For S-Corps: the ESOP’s share of S-Corp income is tax-exempt (because the ESOP trust is a tax-exempt entity)
ESOPs are complex and expensive to set up ($50,000-$150,000), but can provide significant tax benefits for larger businesses

How does a family succession plan work in practice?

Hypothetical example

Round numbers. A business owner (age 60) owns an S-Corp valued at $2,000,000. The owner’s basis in the stock is $200,000. The owner wants to transfer the business to their child over 10 years while remaining involved during the transition.

Option A: Sell to the child outright.

Capital gain: $2,000,000 - $200,000 = $1,800,000
Capital gains tax (20%): $360,000
NIIT (3.8%): $68,400
Total tax: $428,400

Option B: Installment sale over 10 years.

$200,000/year for 10 years (plus AFR interest)
Annual capital gain recognized: $200,000 x ($1,800,000 / $2,000,000) = $180,000
Annual capital gains tax: $180,000 x 23.8% = $42,840
10-year total: $428,400 (same total, but spread over 10 years)
Tax benefit: the deferred tax can be invested by the seller during the 10 years
Present value savings at 5% discount rate: approximately $50,000-$60,000

Option C: Gradual gifting + discounted sale. Year 1-10: gift $19,000/year of stock to the child ($190,000 over 10 years, no gift tax) With a 30% valuation discount (minority interest + lack of marketability):

$19,000 annual gift = $27,143 of stock value transferred per year
10 years: $271,430 of stock value transferred tax-free
Remaining stock: $2,000,000 - $271,430 = $1,728,570
Sell remaining stock to child via installment: capital gain on $1,728,570 - $200,000 adjusted basis = $1,528,570
Tax on the sale: $1,528,570 x 23.8% = $363,799
Total tax: $363,799 (savings vs. outright sale: $64,601)

Option D: Hold until death.

At death, the child inherits the stock with a stepped-up basis of $2,000,000
Capital gains tax: $0 (the $1,800,000 of gain is eliminated by the step-up)
Estate tax: $0 if the total estate is under $13.99 million (2025)
Total tax: $0
But: the owner loses control and income during their lifetime, and there’s no guarantee the exemption amount won’t decrease

The hybrid approach (most common): Start gifting stock now (uses annual exclusion, locks in current low values, takes advantage of valuation discounts). Sell a portion via installment sale (provides income to the retiring owner). Leave the remainder to transfer at death (stepped-up basis). This approach spreads the tax impact, provides retirement income, and maximizes the overall tax savings.

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

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Cite this page

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

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