Selling a company that you put your heart and soul into building can provide significant rewards, including financial security for the remainder of your lifetime and potentially your heirs. Nevertheless, achieving that aim and reaping the full potential of the proceeds from a business sale requires careful reviews of where your business currently fits within your existing estate plan and how a liquidity event will impact those plans and your longer-term needs and goals. Failure to engage in estate planning long before executing a sales agreement can result in significant tax liabilities that can reduce your payout.
When considering the sale of a closely held business, owners often focus on maximizing business value to help increase the sale price. After all, who wouldn’t want to sell their company for top dollar? However, this line of thinking fails to consider a liquidity event’s impact on an individual’s tax circumstances, including their exposure to federal and state estate taxes.
Understanding U.S. Estate and Gift Tax Basics
In 2024, U.S. taxpayers have a very generous federal lifetime gift and estate exemption of $13.61 million, or $22.22 million for married couples filing joint returns. Assets exceeding these limits at the time of death are subject to a 40 percent federal estate tax rate. Depending on where you live and the value of your estate at the time of death, you may also be exposed to state-level inheritance tax.
The tax code also provides individuals with a separate annual gift-tax exclusion with which they may make annual tax-free gifts of as much as $18,000 to as many beneficiaries they choose (or $36,000 for married couples filing joint tax returns.) These yearly gifts remove assets from your taxable estate, excluding them from your lifetime gift and estate tax exemption and reducing your estate’s exposure to federal and state inheritance tax. Gifts exceeding the annual gift tax exclusion reduce the value of your lifetime estate tax exemption. At this time, it is important to remember that current law calls for the federal estate tax exemption to be reduced by more than half in 2025, potentially exposing a significantly larger number of individuals to estate taxes in the future.
Gifting Strategies
Generally, the proceeds from a business sale are added to a business owner’s taxable estate. When the value of an estate at the time of the owner’s death exceeds the federal estate tax exemption and/or the estate and inheritance tax exclusions set by various states, federal and state taxes will be applied. This, in and of itself, makes it critical for business owners to plan far in advance of a business sale, taking into consideration how they may minimize future estate tax liabilities and protect assets for the beneficiaries they leave behind. One of the best ways to accomplish this is to have a plan for shifting wealth, such as creating certain trusts to hold the proceeds from a business sale or employing gifting.
Before you put your company up for sale, engage a qualified appraiser to determine its value and assess its ownership and legal structure. The earlier you start planning, the more time you have to prepare, and the greater the opportunity to restructure and recapitalize the company for improved tax efficiency.
For example, the tax code allows business owners to take advantage of valuation discounts of between 25 and 50 percent for noncontrolling interests they transfer by gift or sale to family members or trusts for the benefit of their heirs. This essentially removes assets from the owner’s taxable estate, thereby reducing the amount of his or her estate subject to tax while also helping to reduce the transfer tax value of the noncontrolling interests gifted or sold to a trust. Among the most common types of trusts business owners may use when preparing their estate for the eventual sale of a business are intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATS), grantor retained income trusts (GRITs), charitable remainder trusts (CRTs) and charitable lead trusts (CLDs).
An IDGT is an irrevocable trust treated as separate from the grantor for estate and gift tax purposes but owned by the grantor for income tax purposes. The grantor gifts or sells assets to the trust, effectively removing them and their future appreciation from their taxable estate. However, due to the “defective’ nature of the trust, the grantor is required to report trust activity and pay its income tax liabilities with non-trust assets, thereby allowing the trust’s principal to grow unfettered by income taxes while enabling the grantor to further reduce the value of their estate subject to estate taxes.
With a GRAT, a person may transfer appreciating assets, including shares of business stock, outside their taxable estate and into an irrevocable trust to pass tax-free to their children. During the term of the GRAT, however, the grantor retains the right to receive an annuity from the trust equal to a percentage of the value of the original trust assets. Should the grantor pass away before the end of the trust terms, they may pass the right to receive remaining annuity payments to their spouse, thereby eliminating any potential tax liabilities of the surviving spouse’s estate. Moreover, if the investment return on GRAT assets increases above the interest rate the IRS uses to determine the value of the grantor’s retained interest, the excess amount will escape gift taxes. It is important to note that the grantor is entitled to an annuity payment, not the trust income. These annuities must be paid regardless of whether the trust produces income equal to the annuity, meaning the trust’s principal may be invaded to make the annuity payment. One way to avoid this scenario is to supplement the GRAT with a grantor-retained income trust (GRIT) that pays a fixed interest rate on trust assets.
Finally, a CRT is an irrevocable trust funded with appreciable assets, including business interests, that can qualify for an immediate charitable tax deduction and allow the assets to grow income-tax-free. It is considered a split-interest trust because you may take distributions of income from the CRT during your lifetime, but any assets remaining in the trust after your death pass to a qualifying non-profit charity you name as a secondary beneficiary. Assets held in the CRT are protected from creditors and escape capital gains tax when sold.
Preparing to sell a business can take many years. Business owners must work with experienced financial advisors to develop strategies that meet their long-term goals, protect their assets and reduce their exposure to gift and estate tax liabilities.
About the Author: Eric Zeitlin is managing director of Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Fort Lauderdale, Fla., office at (954) 712-8888 or info@provwealth.com.
 Provenance Wealth Advisors (PWA), 200 E. Las Olas Blvd., 19th Floor, Ft. Lauderdale, FL 33301 (954) 712-8888.
 Eric Zeitlin is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult with your financial advisor about your individual situation.
To learn more about Provenance Wealth Advisors financial planning services click here or contact us at info@provwealth.com
Updated April 8, 2024