The first step in your estate and tax planning considerations should be to invest in an independent, reliable, unbiased business valuation. With the last two years of economic turbulence, having an objective value of your company provides the foundation for effective estate and tax planning. The strategy for how the sale of your business fits into your estate and personal financial planning can keep more money in your pocket. However, you must first understand the value of your business to create an effective strategy.
Once you know the value of your business, you can then prepare or adjust your estate plan to cover various scenarios. One common scenario is the transition of ownership to a child. In this instance, it is important to remember that the current lifetime gift tax exemption is $12.06 million for individuals and $24.12 million for couples who file jointly. These lifetime exemptions are high by historical standards and allow you to gift a substantial portion of your business to your children if you do not need to monetize the value of the business to reach your post ownership goals. However, remember that as of January 1, 2026, these lifetime exemptions are set to reduce by 50%. Therefore, a discussion about your estimated ownership transition timeline is critical to creating an effective estate plan.
Knowing the value of your business is also critical when you start to think about the tax impact of various ownership transition scenarios. Below we outline typical ownership transition options and important tax considerations.
Sale to a child: When transferring ownership to a child, you can take advantage of the lifetime gift tax exemption. A planning scenario we often use is to gift a certain percentage of the business (e.g., 30%) to the child and then sign a seller’s note to purchase the remaining 70% over a 5-to-7-year period.
Sale to a key employee(s): Like the transfer to a child, there are ways to grant a partial interest in the business to a key employee to recognize their contributions. This grant transfers a portion of the tax liability to the key employee. You can then finance the remainder of the purchase using a seller’s note with terms like those outlined in the sale to a child.
Sale to a third party: If you plan to sell to a third party, your entity structure (e.g., C Corporation) and whether the sale is an asset or stock sale are critical pieces of information. When selling to your child or a key employee, the sale is likely to be a stock sale because you are transferring the entire entity (both assets and liabilities). By contrast, most third-party transactions are asset sales because a strategic or financial buyer does not want to assume your liabilities. The tax liability for an asset sale is determined by allocating the purchase price to your assets starting with the most liquid asset (cash) and ending with the least liquid asset (goodwill). Assets that are typically taxed at ordinary income rates include cash, accounts receivable, inventory, and fixed assets—which can account for most of the purchase price for independent dealers. Therefore, it is critical to negotiate a favorable purchase price allocation and to create a payout and distribution strategy with the goal of limiting your tax liability.
Sale to an employee stock ownership plan (ESOP) or co-operative (co-op): Selling the business to your employees can be good for business sustainability and your legacy while also providing favorable tax benefits. For example, an owner who sells at least 30% of their business to an ESOP or co-op in the first year of the ownership transition can invest the proceeds in qualified securities (e.g., U.S. stocks) and defer the realization of capital gains until the qualified securities are sold. If the qualified securities are held until the death of the selling owner, under current tax law, the heirs will receive a step-up in cost basis to the date of death value and the qualified securities could potentially be sold with minimal capital gains.
Other than death and taxes, we know there are certain inevitabilities that business owners face:
- You will have to transfer ownership of your business at some point.
- You will need a plan to mitigate taxes at this juncture.
- It is hard but important to start conversations with key internal stakeholders and external advisors.
To preserve your family’s net worth and your company’s legacy in the community, you should engage a valuation analyst to determine the value of your business right now and let that be the basis for ongoing estate and tax planning.
Stratus Wealth Advisors owner and founder Sam Brownell helps independent dealers by quarterbacking a comprehensive succession planning process to provide clients with essential data and advice to make the best decisions for their company and their family. Reach Sam at sbrownell@stratuswealthadvisors.com.
