As a family business owner, there comes a time when you must decide when and how to step away from the business. There are several estate and tax planning tools that you can use to transfer a business. Some of the more common strategies for minimizing taxes are explained in the following sections.

Family Limited Partnerships

A family limited partnership can assist in transferring your business interest to family members. A partnership is established with both general and limited partnership interests, and the business is transferred to the partnership. You can maintain control over the day-to-day operation of the business by retaining the general partnership interest for yourself. Over time, you can gift the limited partnership interest to family members. Minority interest and lack of marketability discounts are often used to reduce the value of the gifts for gift tax purposes.

Grantor Retained Annuity Trusts & Defective Grantor Trusts

Irrevocable trusts are popular business transfer tools as well. Both grantor retained annuity trusts (GRATs) and sales to intentionally defective grantor trusts (IDGTs) are effective strategies that can allow for the business to be transferred to your beneficiaries while retaining an income stream for a set period.

GRATs are irrevocable trusts to which you transfer appreciating assets while retaining an annuity payment for a set period. At either the end of the payment period or your death, the assets in the trust pass to the trust’s remainder beneficiaries. The value of the retained annuity interest is subtracted from the value of the property transferred to the trust, so if you live beyond the specified payment period, the business may ultimately be transferred to the next generation at a reduced value for estate or gift tax purposes.

A sale to an IDGT is a strategy wherein you sell, all or a part of, the family business at favorable valuations to an irrevocable trust in exchange for an installment note. The distributions from the business can then be used to repay the installment note. A variety of payment structures can be used for the note, including traditional amortization over the term of the note or interest-only payments with a balloon at the end.

Private Annuities and Self-Canceling Installment Notes

A private annuity is the sale of property in exchange for a promise to make payments to you for the remainder of your life. Here, you transfer complete ownership of the business to family members or another party (the buyer). The buyer in turn makes an unsecured promise to make periodic payments for the rest of your life (a single life annuity) or for your life and the life of a second person (a joint and survivor annuity).

A self-canceling installment note allows you to transfer the business to the buyer in exchange for a promissory installment note. The buyer must make a series of payments to you under that note; however, a provision in the note states that at your death, the remaining payments will be canceled. The interest rate on these types of instruments must be higher to account for a “mortality risk premium.” With interest rates at historic lows, this interest rate premium may still result in a rate that is at or below rates on traditional installment notes in a more normalized interest rate environment.

Relief under the Internal Revenue Code

In the absence of any transition planning, there is a very real possibility that estate taxes will be due. Section 6166 of the Internal Revenue Code allows for any estate taxes incurred because of the inclusion of a closely held business that exceeds 35% of your gross estate to be deferred for 5 years (with interest-only payments for the first four years), and then paid in annual installments over a period of up to 10 years. This allows your beneficiaries more time to raise sufficient funds or obtain lower interest rates.

As is often the case, none of these strategies are without drawbacks. It’s important to consult a tax professional as well as your estate planning attorney to explore all available strategies. Contact your advisor or go to if you would like to discuss business succession planning opportunities.


For more information on this topics, contact Michael Baker.