Transferring ownership of a family business can be a complex affair, and not just because you have to change the job title on your business card. When it comes to transferring company ownership, there are many tax implications to consider. Understanding the relevant tax rules helps you avoid costly mistakes, regardless of whether you are giving your business to a relative as a gift or selling it.

Below, we outline six key tax rules to help you transfer ownership efficiently and minimize any potential tax liabilities.

1. Review gift and estate tax exemptions

When transferring ownership of a business to a family member, it’s important to understand how gift and estate taxes may apply. In 2024, the IRS allows individuals to gift up to $18,000 per recipient annually without triggering gift taxes.

If your business transfer exceeds this limit, the excess amount will count against your lifetime gift and estate tax exemption, which currently stands at $13.25 million.

For example, if you give a $2 million business to a family member, $18,000 of that gift will be exempt from the tax each year. The rest of the money, $1,982,000, will reduce your lifetime exemption. This exemption is set to decrease in 2026 unless Congress enacts changes, so business owners should plan transfers while the higher limits remain in effect.

2. Use a Family Limited Partnership (FLP)

Family Limited Partnerships (FLPs) can be a tax-efficient tool for transferring business ownership. With an FLP, you can gift limited partnership interests to family members while maintaining control of the business. This method also allows for discounted valuations, as FLP interests are often worth less due to a lack of marketability and control.

Many family businesses use FLPs to pass business ownership to the next generation while reducing any taxable estate values. When you use an FLP, you can transfer a significant portion of the business without triggering a large gift tax bill, making it an attractive option for family business succession.

The only major drawback is the increased scrutiny that the IRS places on FLPs. For example, the lack of attention to partnership formalities, can suggest that an FLP was established purely as a tax-reduction vehicle.

3. Capital gains taxes on business transfers

If you plan to sell the business to a family member rather than gift it, you will need to account for capital gains taxes. The sale of a business is subject to capital gains tax, which is calculated based on the difference between the sale price and the original purchase price (your “basis”).

Long-term capital gains are taxed at rates ranging from 15% to 20%, depending on your income bracket.

Family business owners who sell their businesses often face unexpected tax costs. Before selling a business, consider meeting with a tax professional like David’s Family CPA to ensure that the sale is structured in a way that minimizes capital gains. For example, sometimes it is possible to spread the sale over multiple years to reduce ‌annual tax liability.

4. The role of installment sales

An installment sale can be an effective way to reduce the immediate tax burden of a business transfer. In an installment sale, the buyer (your family member) makes payments over time, and you only pay taxes on the income received each year. This allows you to defer a significant portion of your capital gains tax liability.

Many family business transfers now involve installment sales to spread out the tax impact. The key advantage is that taxes are paid incrementally as you receive the sale proceeds, rather than in one lump sum. However, keep in mind that interest on the payments may be taxable, and you should structure the sale carefully to comply with IRS rules.

5. The impact of section 1202

For owners of certain small businesses, Section 1202 of the IRS code offers a valuable tax break. This provision allows you to exclude up to 100% of the capital gains from the sale of qualified small business stock (QSBS), provided certain conditions are met. To qualify, the business must be a C corporation, and you must have held the stock for at least five years.

If your family business qualifies, this can significantly reduce or even eliminate your capital gains tax liability when transferring ownership. Consult a tax advisor to determine whether your business meets the necessary qualifications and how you can take advantage of this exclusion.

6. Plan for estate taxes through Grantor Retained Annuity Trusts (GRATs)

For business owners looking to transfer ownership while still retaining some control, a Grantor Retained Annuity Trust (GRAT) might be worth looking at. GRATs allow you to transfer assets, such as business ownership, to your heirs while retaining the right to receive annuity payments for a set period of time.

 

The present value of the annuity, which can result in significant estate tax savings, reduces the value of the gift for tax purposes.

When you use a GRAT, you can freeze the value of your business for estate tax purposes while still benefiting from its income-generating potential. This is particularly useful if you expect the business to appreciate in value after the transfer, as the future growth will not be subject to estate taxes. In fact, it is kept out of your main estate.

Ironically, Congress created GRATs by accident in the 1990s while moving to close an estate tax loophole. They gained notoriety in 2000 after a high-profile ruling by the US Tax Court involving a case with the sister-in-law of Walmart founder Sam Walton. Since then, they have gained ever more popularity as a wealth transfer strategy.

However, be aware that GRATs aren’t immune to the choppy waters of the financial world. Their performance can be affected by interest rate changes.

Future Appreciation

Transferring ownership of a business to a family member requires careful consideration of the tax rules to avoid unexpected liabilities.

When you gain a critical understanding of gift and estate tax exemptions, use Family Limited Partnerships and installment sales, and take advantage of tax-efficient strategies such as Section 1202 and GRATs, you can significantly reduce the tax burden on your business transfer.

A seasoned tax professional like David’s Family CPA can make sure that your family business remains intact and that the next generation is free to continue its success without being weighed down by excessive taxes.