Brace yourselves.
Business owners should prepare to be inundated over the next 12-18 months (if not already) with urgent appeals from estate planners, financial advisors, and accountants to get their tax planning in order before the federal lifetime estate and gift tax exemption potentially sunsets at the end of 2025. While that might seem like a long way off, and the urgent appeals might come across as a “the-sky-is-falling” overreaction, there is genuine reason for business owners to pay attention now, especially those who are contemplating selling or transferring some or all of their businesses’ equity in the near term.
As background, unless Congress acts, as of Jan. 1, 2026, the current lifetime estate and gift tax exemption of $12.92 million ($25.84 million for a married couple) will be cut in half. Whether or not this comes to pass is unknown at this time, but the threat is very real. So business owners who are facing estate tax liability in 2026 (which the sale of a business could affect significantly) are strongly encouraged to start planning now.
As a starting point, below are four key concepts business owners who are considering an exit should act upon or be aware of to mitigate the impact of the potential sunsetting of the estate and gift tax exemption. The bottom line is this: don’t delay.
- Understand that this is no bluff. As stated above, the threat of the estate and gift tax exemption being cut in half is very real. Don’t expect a repeat of past legislative procrastination like when the Bush tax cuts (including an increased estate tax exemption) were allowed to continue under the Obama administration. In that situation, the IRS and the Treasury Department were not prepared to deal with the ramifications of those tax cuts expiring, so the decision was made to make most of them permanent.
However, the situation is very different today. This time the IRS and the Treasury ARE ready to handle an estate tax exemption cut. So, don’t assume they will “kick the can down the road” again. In other words, the sunsetting of the current estate and gift tax exemption amounts could very well become a reality. Be prepared.
- Bring your family into the conversation early on. While the need for timely tax-planning may put stress on your schedule, is it still important to include family members in this decision-making process. As openly and transparently as possible, gather your family together to share your plans for the business and how you intend to sell or transfer ownership. Make it clear that equal is not the same as equitable, depending on the various roles family members have had with the business. Differing expectations around the sale or transfer of a business can be one of the most common points of friction within a family-owned business, with family members who are actively involved in operating the business often holding different expectations than family members who have not had a role in running the business.
To be sure, every family is different, and there are a multitude of sophisticated planning solutions that can be leveraged to recognize and reward family members for how they’ve contributed to a business’s success. If you haven’t started these conversations yet, there is no time like the present.
- Know that business transactions can take many different forms. Although the threat of the estate and gift tax exemption sunsetting will no doubt trigger many business transactions, it’s important to understand that not all transactions look the same. There are in fact a number of options for business owners, including an outright sale to a third party, moving equity interests to family members, as well as minority investments from outside parties. In other words, a “transaction” doesn’t necessarily equate to “walking away” and giving up control.
In fact, there has been an uptick recently in successful family businesses taking on minority investments from outside parties. Doing so can provide an infusion of cash, or “liquidity,” while still letting the family retain a degree of control in the future of the business. Minority investments are generally passive investments (less than a 50% stake in a company) from outside parties who are not empowered to run the company or make day-to-day decisions. However, minority investors typically want a role on a board of directors or have other influence on the overall direction of the company. Think of them as new partners who are vested in the ongoing success of the business.
- Effective estate tax planning relies on business valuations, and those valuations take time. One of the most common forms of estate tax mitigation for business owners is the concept of “valuation freezes.” Under this construct, families choose to have their ownership interest appraised at depressed values long before a potential third-party transaction takes place at a higher sale price. Business owners will typically transfer equity of their companies at these lower “frozen” values prior to a transaction to allow family members (or their trusts) to receive the benefit of the stock’s appreciation free of gift taxes. If structured correctly, this appreciation can permanently escape the estate tax system (thus allowing for the efficient transfer of wealth to the next generation).
Sounds great, right? But here’s the problem: reasonable business appraisals take time. And those valuations need some “breathing room” from any potential transactions. For example, if your equity is valued at $100 per share in August and sold for $1,000 per share in September, there’s very little chance that the IRS will respect any of the hard work you just put into your tax planning.
Couple these timing considerations with the impending estate tax exemption deadline and it’s easy to see why time is of the essence for business owners.
Regardless of what type of transaction makes sense for you and your business, the point is to start your planning soon. Working with a qualified advisor, visualize the financial impact of what you are considering through sophisticated modeling tools. Being able to literally see the potential impact can be extremely valuable.
Remember, the closer you are to an exit event, the more limited you are for tax savings strategies. The clock is ticking….
This material is provided for general and educational purposes only, is not intended to provide legal or tax advice, and is not for use to avoid penalties that may be imposed under U.S. federal tax laws. Contact your attorney or other advisor regarding your specific legal, investment or tax situation.
