Taxes are not an enjoyable subject for most people. However, understanding all the potential tax liabilities associated with your business is crucial for planning for the future. Aside from annual taxes on net income, two key taxes to consider are estate taxes and the tax implications from selling or transferring ownership of your business. Despite the media attention given to estate or “death” taxes, more owners will be subject to tax regulations on the transfer of their business interest, regardless of whether they are gifting shares or selling to a third party.
To better understand which taxes are going to matter to you, let’s start with an example of the estate tax. In 2024, the estate tax exemption is $13.61 million for individuals and $27.22 million for married couples filing jointly. Business owners only pay estate tax if their total estate exceeds this exemption. Further, married owners can transfer an unlimited amount to their spouse, potentially avoiding estate taxes altogether until the surviving spouse’s death.
To help clarify the impact of the estate tax, we will talk through an example. Assume that an LBM dealer is co-owned by a husband and wife. If they both die without transitioning the business, and their gross estate totals $20 million, no federal estate tax is owed. However, it is important to note that certain states have their own estate tax, and those limits are typically lower than the federal government. Therefore, it is important for all dealers to know and update the value of their illiquid assets, specifically their business and real estate.
Going forward, if Congress does not act, the estate tax exemption will be reduced by 50% starting on January 1, 2026. Assuming a 3% increase in the estate tax exemption for the next two years, followed by a decrease of 50% on January 1, 2026, the estimated exemption would be $7.22 million for individuals and $14.44 million for married couples filing jointly. If the same dealer owner couple died in 2026, they would owe estate tax.
For succession planning purposes, it is critical to plan for this decrease in the estate tax exemption because it is very difficult to pay estate taxes if the bulk of your estate is in illiquid assets such as stock of a privately held business or real estate.
While the estate tax is likely to gain significance for business owners, it is important to recognize that all owners will inevitably transfer ownership, regardless of their level of preparation. When this transition occurs, taxes can have a material impact on the final amount of money received by the owner and their family. Here is a summary of the tax implications of various ownership transition strategies:
Gift: An owner can gift his or her interest in the business to an immediate family member or to certain trusts. If the gift is less than the estate tax exemption, then no taxes are due. However, the owner who makes the gift will need to have the interest valued and file a gift tax return.
Grant: An owner can grant his or her interest in the business to a non-family member or to another entity. The granting of an interest shifts the tax burden from the owner to the grantee. For example, if the granted interest is valued at $1 million, then the recipient of the grant owes ordinary income taxes on the $1 million value of the grant.
Stock Sale: These transitions typically take place when the business interest is sold to a family member, key employee, ESOP, cooperative, or perpetual purpose trust. Stock sales are typically taxed at long-term capital gains rates. C Corporation stock that is sold in a stock sale is typically only taxed once.
Asset Sale: These transactions typically take place when a business interest is sold to a competitor or private equity group. Asset sales are typically taxed at a mix of ordinary income and long-term capital gains rates. Further, C Corporation stock sold in an asset sale will be taxed twice.
Donation: There are instances when a business interest can be donated to a tax-exempt organization. In this instance, the interest will need to be valued and the owner making the donation may be able to receive a tax deduction for some or all of the donated amount.
Every business owner will transfer ownership regardless of whether they have prepared for this transfer. Because your business has value, it will be subject to taxes. To ensure that your net worth is protected and can be passed to future generations, it is critical that you and your advisors perform estate and ownership transfer tax planning alongside your annual operational tax planning.
