Special Tax Considerations for Passing on a Family Business 

Joseph A. Carna, (412) 594-5564, jcarna@tuckerlaw.com

As the son of a former business owner, I understand how crucial it is to plan for the future, whether that be passing down your business or preparing for a transition. As a business owner, the decision of how to transfer your family or closely-held business to your heirs is one of the most critical decisions you will ever make. Without proper planning, you may expose yourself or your heirs to devastating state and federal tax consequences, including significant gift, estate, and capital gains taxes.

As you consider passing on your business, here are key factors you need to evaluate to ensure a seamless and tax-efficient transition:

1. Gifting business interest during life 

Under Internal Revenue Code (IRC) Section 1015, when a business interest is gifted, the recipient (donee) assumes a carryover basis in the property. This means that the transferee inherits the donor’s (transferor/ business owner) basis in the business interest, which may result in larger capital gains taxes if the interest is eventually sold.

Gifting a business interest during your lifetime is also subject to the federal gift tax. However, each individual may use their gift tax annual exclusion (currently $19,000 per person in 2026) or their lifetime exemption ($15,000,000 per person for 2026) to avoid paying a gift tax. This exemption can be leveraged over time, allowing the transferor to gradually pass on their business to heirs, all while maintaining control during the transition. This strategy facilitates a smoother, more controlled transfer of ownership to the next generation.

2. Passing a business interest at death 

IRC Section 1014 offers a significant tax advantage by allowing the transferee of property received due to the transferor’s death to inherit property with a “step-up” in the basis of the gifted asset. This basis is stepped-up to the fair market value (“FMV”) of the property on the date of the transferor’s death. 

When a business interest is passed along with a stepped-up basis, the transferee benefits from a substantially lower capital gains tax upon the eventual sale or disposition of the business. This is because capital gains would be determined using the new basis calculated based on the stepped-up FMV rather than the transferor’s original basis in the property (which is ordinarily less than the FMV of the property at the time of death).

Given these complexities, careful planning is essential to determine whether the best option to pass your business on to your heirs should occur during life, at death, or a combination thereof. The right approach can significantly impact both tax liabilities and the financial legacy you leave behind.

3. Selling your business interest to your children

A business owner wishing to sell their business interest to the next generation can utilize the sale as a powerful retirement tool.

While a sale may trigger capital gains, structuring the sale as an installment sale can assist in spreading out the tax liability over time. This can minimize the immediate tax impact of the sale and preserve more of the sale proceeds.

An installment sale not only allows a business owner to defer taxes but also provides the added benefit of a steady income stream over the duration of the sale term. This can serve as an effective method of financial planning for retirement, providing cash flow while gradually transferring ownership of the business to the next generation.

In certain situations, there are also trusts that can allow you to sell your business to the next generation and not recognize any capital gains.

If the transaction is structured to allow your heirs to purchase your business interest for an amount less than its FMV, special “part gift/part sale” tax considerations can be triggered. In a “part gift/part sale,” the transferee’s basis ordinarily will be the lesser of the property’s FMV at the time of the gift or the transferor’s basis (increased by any amount of gift tax paid).

Transferring a family business to heirs is a complex process that requires careful consideration of the various tax implications to ensure a smooth and tax-efficient transition. Tucker Arensberg can assist in creating customized plans to implement your unique needs.

If you are getting ready to begin passing on your legacy to the next generation, contact Joseph Carna at (412) 594-5564 or jcarna@tuckerlaw.com.