Skip to main content

Site Navigation

Site Search

global Tax

4 Tax-Smart Options for Transferring Ownership to the Next Generation

May 14, 2024

Do you own a growing business? It is wise to consider your options for transferring ownership to the next generation. This requires careful tax planning! Here’s what you should know.

If you own a growing business, you might want to transfer ownership to family members while the company’s value is still comparatively low due to continuing economic uncertainty. Here are four possible tax-effective vehicles for you to consider.

1. Outright Gifts

By leveraging the gift and estate tax exemptions, you can gift your business all at once or over time. When you gift ownership interests during your lifetime, it freezes the value of the interests for gift and estate tax purposes. If you delay such gifts until your death, both the interests and any appreciation will be included in your estate — but your heirs will benefit from stepped-up basis.

The Tax Cuts and Jobs Act of 2017 provides an incentive to make gifts soon. It nearly doubled the gift and estate tax exemption limits, but the higher limits are scheduled to sunset after 2025, unless Congress passes legislation to extend them. For 2024, the annual gift tax exemption is $18,000 per recipient ($36,000 for a married couple), and the lifetime exemption is $13.61 million ($27.22 million for a married couple). Importantly, the IRS has signaled that it won’t claw back into your estate gifts made under the higher exemptions if you die after 2025.

2. Grantor-Retained Annuity Trusts (GRATs)

You can fund a GRAT with a one-time contribution of business shares in exchange for an annuity. This removes the shares from your estate (although you’re responsible for income taxes). When the annuity period expires, the appreciated shares are transferred to your designated beneficiaries and excluded from your estate. If you die before the period ends, the shares return to your estate.

The amount of the annuity generally is calculated to “zero out” or equal the amount of the initial contribution, so no gift occurs. Growth passes tax-free to beneficiaries and is excluded from your estate.

3. Intentionally Defective Grantor Trusts (IDGTs)

An IDGT is another type of irrevocable trust where ownership interests can be removed from your estate and appreciate tax-free. The IRS treats you as the trust owner for income tax purposes, but your tax payments further reduce your estate and aren’t treated as gifts.

When you transfer ownership interests to the IDGT, only the initial value is applied against your gift and estate tax exemptions. Or you can sell the interests to the trust at fair market value for a promissory note. You generally won’t have to recognize a gain on the sale because you’re the grantor. The note will be included in your estate, but it probably will appreciate much more slowly than the sold interest would.

4. Family Limited Partnerships (FLPs)

You can transfer the business to a limited partnership, taking a small general partnership interest and a large limited partnership interest. Then you can gift limited partnership interests to your family members. You’ll retain management and control of the business, and the limited partners’ rights to sell their interests usually are subject to restrictions. As a result, the value of your gifts of the business interests can be substantially discounted. And the gifted interests, along with any appreciation, are removed from your estate.

Beware: The IRS may challenge an FLP after your death, arguing that its assets should be included in your taxable estate. To withstand such an attack, you must show that:

  • The assets were transferred in a bona fide sale (with a non-tax purpose) for adequate and full consideration in money or something of monetary value, and
  • The decedent didn’t retain possession or enjoyment of — or the right to income from — the transferred assets.

Don’t Delay

Regardless of the method you choose, transferring the ownership of your business to the next generation requires careful tax planning.

June CTA

Stay informed. Get all the latest news delivered straight to your inbox.

Also in Tax Blog

up arrow Scroll to Top