August 10, 2022   //   Business Consulting   //   By PKF Mueller Solutions


By David Kolan, Managing Director

The decision to sell a closely held business can be both rewarding and fraught with challenges. On one hand, the proceeds from a business sale may provide owners with the financial security needed to carry them through their remaining years while allowing them to leave behind a substantial legacy for their heirs. Yet, such a liquidity event can also come with significant tax liabilities, especially when owners fail to engage in estate planning far in advance of executing a sales agreement.

Most business owners looking to sell their companies will focus on maximizing business value to help increase the sale price. After all, who wouldn’t want to sell their company for top dollar? This line of thinking, however, fails to consider the impact a liquidity event ultimately will have on an individual’s tax circumstances, including their exposure to federal and state estate taxes.

Understanding U.S. Estate and Gift Tax Basics

In 2022, U.S. taxpayers have a very generous federal lifetime gift and estate exemption of $12.06 million, or $24.12 million for married taxpayers filing joint tax returns. Under current law, these exemptions are scheduled to be reduced by more than half in 2025, potentially exposing a significantly larger number of individuals to estate taxes in the future. Assets exceeding these federal estate tax exemptions that a decedent owns 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 have exposure to a state-level inheritance estate tax.

Taxpayers also receive a separate annual gift-tax exclusion that allows them to make annual tax-free gifts of as much as $16,000 to as many beneficiaries they choose (or $32,000 for married couples filing joint tax returns). These annual gifts remove assets from your taxable estate, thereby excluding them from your lifetime gift and estate tax exemption and reducing your estate’s exposure to federal and state inheritance tax. However, any gifts exceeding the annual gift tax exclusion reduce the value of your lifetime estate tax exemption.

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. To minimize the resulting tax liabilities, business owners must have a plan in place before a business sale to shift wealth outside of their taxable estates either by gift or through the creation of a certain trusts, including intentionally defective grantor trusts.

Even before you consider putting your company up for sale, you should first engage a qualified appraiser to determine the value of the business and assess its ownership and legal structure. The earlier you start planning, the more time you have to prepare, and the greater the opportunity you have 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 to 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 that is 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 his or her 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 his or her estate subject to estate taxes.

A GRAT enables a grantor to transfer appreciating assets, including shares of business stock, outside his or her taxable estate and into an irrevocable trust to eventually pass tax-free to his/her children. During the term of the GRAT, however, the grantor retains the right to receive from the trust an annuity equal to a percentage of the value of the original trust assets. Should the grantor pass away before the end of the trust terms, he or she may pass to a spouse the right to receive remaining annuity payments, 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.

A CRT is an irrevocable trust funded with appreciable assets, including business interests, that can provide the grantor with tax-free income during his or her lifetime and enable him or her to pass any remaining assets to qualifying non-profit charities upon the grantor’s death. Assets put into the CRT grow tax-free outside the grantor’s estate and qualify for an immediate income tax charitable deduction at the time of funding. Moreover, CRT assets are protected from creditors and escape capital gains tax when they are sold.

The steps required to sell a business can take many years. It is critical owners work with experienced advisors and CPAs far in advance of an eventual sale to develop the right strategies to meet their long-term goals, protect their assets and reduce exposure to gift and estate tax liabilities.


David Kolan
Managing Director
Tel: 954.712.7027