Business Succession Planning: Tax Strategies for Transferring a Business to Family or Key Employees

By Yarik Yarosh, CPA ·September 5, 2026 ·10 min read

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

Succession planning is the process of transferring business ownership to the next generation, to key employees, or to an outside buyer in a way that minimizes the combined income, gift, and estate taxes on the transfer. For family businesses, the federal estate and gift tax can consume up to 40% of the business’s value at the owner’s death if no planning is done. The $13.99 million lifetime gift and estate tax exemption (2025, indexed for inflation) provides a large shield, but it is scheduled to revert to approximately $7 million (inflation-adjusted) after 2025 unless Congress extends it. Transferring business interests during the owner’s lifetime, while the exemption is high, locks in the current exemption and removes future appreciation from the estate. Valuation discounts for minority interests (lack of control) and closely held interests (lack of marketability) can reduce the taxable value of transferred interests by 25-45%, effectively multiplying the exemption. The key tools are gifts of minority interests, sales to intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs), family limited partnerships (FLPs), and buy-sell agreements funded by life insurance.

✓Key takeaway

Succession planning tools comparison:

Tool	How It Works	Tax Benefit	Best For
Outright gift	Transfer interests directly to family members	Uses lifetime exemption; future appreciation excluded from estate	Simple transfers under the exemption
Sale to family (FMV)	Sell at fair market value, installment note at AFR	No gift tax; seller recognizes capital gains; removes asset from estate	Owner needs proceeds; income tax planning
GRAT (Grantor Retained Annuity Trust)	Transfer to irrevocable trust, retain annuity payments for a term	If business appreciates faster than IRC 7520 rate, excess passes gift-tax-free	High-growth businesses
IDGT (Intentionally Defective Grantor Trust)	Sell interests to a trust in exchange for an installment note	No income tax on the sale (grantor trust); future appreciation outside estate	Large transfers, avoiding gift tax
FLP/FLLC (Family Limited Partnership)	Transfer business to partnership, gift limited partnership interests	Valuation discounts (25-45%) reduce gift tax value	Family businesses with multiple heirs
Buy-sell agreement (life insurance funded)	Agreement to purchase owner’s interest at death, funded by insurance	Insurance proceeds pay estate tax or purchase price; income tax-free death benefit	Ensuring liquidity at owner’s death
ESOP (Employee Stock Ownership Plan)	Sell stock to ESOP trust for employees	Seller can defer gain (IRC 1042 for C-Corps); ESOP deducts contributions	Selling to employees; C-Corp structure

Valuation discounts:

Discount	Range	Justification
Lack of marketability (DLOM)	15-35%	No public market to sell the interest; restricted transferability
Lack of control (minority discount)	15-40%	Minority interest cannot control distributions, operations, or liquidation
Combined discount	25-45%	Stacked (e.g., 30% DLOM on top of 25% minority = ~47.5% total)

Example: $10,000,000 business, transfer 40% interest

Without Discounts	With Discounts
40% interest = $4,000,000	40% interest = $4,000,000
Gift tax value = $4,000,000	Minority discount (25%) = ($1,000,000)
	DLOM (20%) = ($600,000)
	Gift tax value = $2,400,000
Uses $4,000,000 of exemption	Uses $2,400,000 of exemption

How do you transfer a business tax-free?

Hypothetical example

Round numbers. For current guidance, see IRS estate and gift tax resources. A business owner, age 65, owns 100% of an S-Corp valued at $5,000,000. Cost basis in stock: $500,000. Three adult children will inherit the business. The owner wants to retire in 5 years and transfer the business to the children while minimizing combined income, gift, and estate taxes.

Option 1: Do nothing (die owning the business)

Item	Amount
Estate value of business	$5,000,000 (or more if it appreciates)
Lifetime exemption (2025)	$13,990,000
Estate tax (if total estate exceeds exemption)	40% on excess
Stepped-up basis to heirs (IRC 1014)	$5,000,000 (full FMV at death)
Capital gains tax if heirs sell immediately	$0 (stepped-up basis = FMV)

If the total estate is under $13.99 million, no estate tax is owed, and the heirs receive a stepped-up basis. This is the simplest approach, but it gambles on: (1) the exemption remaining high, (2) the business not appreciating beyond the exemption, and (3) the owner not dying before planning is complete.

Option 2: Gift minority interests with valuation discounts

Step	Detail
1. Restructure to FLP or FLLC	Owner transfers S-Corp stock to a family LLC; owner = 2% general partner + 98% limited partner
2. Gift 30% limited partnership interest to each child (90% total)	FMV of 30% interest = $1,500,000
3. Apply valuation discounts	Minority discount (25%) + DLOM (20%) = combined ~40% discount
4. Gift tax value of each 30% interest	$1,500,000 x (1 - 40%) = $900,000
5. Total gift tax value (3 children)	$900,000 x 3 = $2,700,000
6. Lifetime exemption used	$2,700,000 (leaves $11,290,000 remaining)
7. Gift tax owed	$0 (within exemption)

Result	Amount
Business value transferred	$4,500,000 (90% of $5M)
Exemption used	$2,700,000 (discounted value)
Effective exemption multiplier	1.67x ($4.5M transferred using only $2.7M of exemption)
Future appreciation outside estate	All growth on the 90% transferred interest

Option 3: Installment sale to an IDGT

Step	Detail
1. Create IDGT (irrevocable trust for children’s benefit)	Fund with a seed gift (10% of sale price, ~$500,000)
2. Sell S-Corp stock to IDGT for $5,000,000 installment note	Note at AFR (e.g., 4.5%, 9-year term)
3. No gain recognized on the sale	Grantor trust rules: owner is treated as selling to themselves
4. IDGT uses business cash flow to pay the installment note	Payments are not income to the owner (grantor trust)
5. After 9 years, note is paid off	Business is fully owned by the IDGT (for the children)

Tax result	Amount
Gift tax	$0 on the sale (only the $500,000 seed gift uses exemption)
Income tax on sale	$0 (grantor trust, no gain recognized)
Estate tax	Business removed from estate (only the installment note is in the estate, and it decreases as payments are received)
Business appreciation during 9-year term	Passes to children tax-free

If the business grows from $5M to $8M during the 9-year term:

Item	Do Nothing	IDGT Sale
Estate value of business	$8,000,000	$0 (transferred to IDGT)
Estate value of installment note	$0	Decreasing (paid down)
Value to children	$8,000,000 (minus estate tax if applicable)	$8,000,000 (no estate tax)
Estate tax savings	$0	Up to $3,200,000 (40% of $8M) if estate exceeds exemption

Option 4: Buy-sell agreement with life insurance

Structure	Detail
Cross-purchase agreement	Children agree to buy owner’s interest at death
Life insurance	Children purchase $5,000,000 policy on owner’s life
Annual premium	~$25,000-$40,000 (age 65, term or whole life)
At owner’s death	Insurance pays $5,000,000 tax-free; children use proceeds to buy the stock from the estate
Estate receives	$5,000,000 cash (included in estate)
Children receive	Business (with stepped-up basis from the purchase)
Estate tax	Covered by insurance proceeds (estate has cash to pay)

The buy-sell agreement ensures: (1) the children get the business, (2) the estate has liquidity to pay taxes, and (3) the purchase price is pre-established (avoiding disputes).

Comparison of strategies:

Strategy	Gift Tax	Income Tax	Estate Tax Exposure	Complexity
Do nothing	$0	$0	Full (business value in estate)	None
Gift with discounts	$0 (within exemption)	$0	Reduced (transferred interests out)	Moderate
IDGT installment sale	$0 (only seed gift)	$0 (grantor trust)	Minimal (business out of estate)	High
Buy-sell with insurance	$0	$0	Managed (insurance covers tax)	Moderate
ESOP	Potential IRC 1042 deferral	Deferred or eliminated	Depends on structure	High

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

How do valuation discounts work for family business transfers?

When transferring a minority interest in a closely held business to family members, the fair market value can be reduced by a lack-of-control discount (typically 15-40%) and a lack-of-marketability discount (typically 15-35%). These discounts reflect that a minority, non-publicly-traded interest is worth less than its proportional share of the total business value because the buyer can’t control operations or easily sell the interest. The combined effect can reduce the taxable value of a transfer by 25-50%, significantly lowering gift and estate tax exposure. The IRS frequently challenges aggressive discount claims, so a qualified business appraiser’s report is essential to defend the valuation. Proposed regulations have periodically targeted family entity discounts, but as of current law, they remain available when properly documented.

Should I use a revocable or irrevocable trust for estate planning?

A revocable living trust avoids probate and provides management continuity if you become incapacitated, but offers no tax benefits because the assets are still in your taxable estate. An irrevocable trust removes assets from your estate, potentially reducing estate tax, and can protect assets from creditors. The trade-off is control: you cannot easily modify or revoke an irrevocable trust. For most small business owners below the estate tax exemption ($13.61 million in 2024), a revocable trust paired with proper beneficiary designations is sufficient. Business owners above the exemption (or expecting to exceed it before the 2026 sunset) should consider irrevocable structures like GRATs, SLATs, or intentionally defective grantor trusts.

How does the lifetime gift and estate tax exemption work for business owners?

The combined lifetime gift and estate tax exemption for 2025 is $13.99 million per individual ($27.98 million for married couples), meaning you can transfer this amount during life or at death without owing federal gift or estate tax. Gifts to individuals up to the annual exclusion ($19,000 per recipient for 2025) don’t count against your lifetime exemption and don’t require a gift tax return. The current elevated exemption is set to sunset after 2025 under the Tax Cuts and Jobs Act, potentially dropping to approximately $7 million (indexed for inflation), which creates urgency for business owners to lock in transfers at today’s higher levels. Transferring discounted interests in a family business entity (LLC or FLP) can leverage the exemption because valuation discounts for lack of marketability and lack of control can reduce the taxable value of the transferred interest by 25-40%.

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Cite this page

Yarik Yarosh, CPA. "Business Succession Planning: Tax Strategies for Transferring a Business to Family or Key Employees." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-succession-planning-tax-strategies

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