Business Succession Tax Implications

At The Farano Law Group APC, we understand that estate planning for business owners in California requires careful attention to tax laws and long-term objectives. 

Business succession isn’t just about naming a successor or transferring shares; it often brings significant tax considerations that can impact the future of both the business and the family. 

When preparing for the next generation of leadership or ownership, our estate planning strategies are shaped by the tax consequences that follow every decision.

The Value of Advance Planning

In California, business succession carries unique tax consequences. Whether a business is structured as a sole proprietorship, partnership, LLC, or corporation, the transition of ownership can trigger gift taxes, estate taxes, and capital gains taxes. 

Through estate planning, we help our clients look ahead and address these tax burdens before they reduce the value of what gets passed down.

Failing to consider tax implications in succession can lead to unnecessary costs. The IRS may assess the fair market value of a business higher than expected, especially if there are strong earnings or valuable goodwill. 

That valuation becomes central to both federal estate tax liability and any gift tax exposure that may arise from lifetime transfers. In our estate planning practice, we often consult with valuation professionals to support well-grounded assessments and reduce the risk of disputes with taxing authorities.

Federal and California Estate Taxes

California does not currently impose a state-level estate tax, but federal estate tax laws still apply. The exemption amount under federal law is significant, but high-value business interests can easily push an estate above the threshold. 

When a business is transferred at death, the estate tax must be paid within nine months—sometimes creating cash flow problems for heirs who inherit illiquid assets.

In estate planning, we guide business owners in identifying ways to reduce the taxable estate. Lifetime gifts, structured buy-sell agreements, and trusts can be used to minimize exposure and maintain continuity. 

Many of our clients have used irrevocable trusts to move appreciating assets out of their estate, limiting future tax liability while still preserving control through thoughtful planning.

Gift Tax Considerations in Lifetime Transfers

Lifetime transfers of business interests can be beneficial, but they must be handled with care. The federal gift tax applies to transfers of value where full consideration is not received. Giving away shares or partial ownership to children or other successors may reduce the taxable estate but can also create immediate gift tax consequences.

Through estate planning, we help clients make use of the annual exclusion and lifetime exemption to transfer interests without triggering unnecessary tax bills. 

We also advise on how to structure these transfers to take advantage of valuation discounts for lack of marketability or minority interests. These techniques help reduce the taxable value of gifts and can make long-term succession plans more efficient.

Step-Up in Basis and Capital Gains

One benefit of transferring business interests at death, rather than during life, is the potential step-up in basis. Under current tax law, assets included in an estate receive a new basis equal to fair market value on the date of death. This step-up can significantly reduce capital gains taxes for heirs who later sell the business.

In our estate planning discussions, we consider whether clients are better served by making lifetime transfers or holding assets until death. The decision often comes down to weighing gift tax savings against the potential loss of a step-up in basis. 

This is especially important in California, where capital gains taxes at the state level are significant and must be taken into account when planning for liquidity and future sales.

Succession Through Buy-Sell Agreements

Buy-sell agreements are a valuable tool for business succession and can also support broader estate planning goals. These agreements allow owners to set terms for future ownership changes, typically triggered by death, disability, or retirement. 

A well-structured buy-sell agreement can lock in a valuation, reduce uncertainty, and prevent conflict among surviving owners or heirs.

We help our clients draft buy-sell agreements that align with estate planning objectives, incorporating tax-efficient funding mechanisms like life insurance or installment sales. In family businesses, these agreements can also provide a structure that balances fairness among children who are active in the business and those who are not.

Using Trusts in Business Succession

Trusts play a vital role in our estate planning strategies for business owners. A revocable living trust can be used to hold business interests, allowing for a smoother transfer of control at death while avoiding probate. 

Irrevocable trusts offer additional tax benefits, particularly when structured to remove appreciating business assets from the estate.

We often recommend grantor retained annuity trusts (GRATs) or intentionally defective grantor trusts (IDGTs) for clients who wish to pass along business interests while minimizing gift and estate taxes. These trusts can be tailored to maintain income for the original owner while shifting future growth to beneficiaries.

In California, where probate can be time-consuming and expensive, trust-based planning also supports continuity. Successors can step in more quickly, and ownership can pass without the public disclosures required in court proceedings.

Liquidity Challenges and Tax Deadlines

Estate taxes must be paid in cash, typically within nine months of death. For business owners, that can present serious liquidity challenges. The business may not generate enough income to cover the tax bill, and heirs may be forced to sell assets to satisfy IRS demands.

Through estate planning, we help clients anticipate these issues. Life insurance can be used to provide liquidity, or business structures can be adjusted to allow partial sales or redemptions that raise funds. In some cases, Section 6166 of the Internal Revenue 

Code allows for installment payments of estate taxes when a closely held business represents a significant portion of the estate. We advise on eligibility and help with the application process when necessary.

Succession and Generation-Skipping Transfer Tax

For clients interested in passing business interests directly to grandchildren or other younger generations, the generation-skipping transfer (GST) tax must be considered. 

The GST tax is separate from estate and gift taxes and is assessed at the highest estate tax rate. It applies when a transfer skips a generation, and it can undermine even the best succession intentions.

Our estate planning process includes a review of GST exposure and the use of GST exemption amounts to shield transfers. Trusts can be drafted to take advantage of these exemptions while maintaining flexibility for future changes. Proper structuring is essential to avoid unexpected tax burdens for the next generation.

California-Specific Concerns

Although California does not currently impose an estate tax, it does have unique income tax considerations that affect business succession. 

The state taxes capital gains as ordinary income, which can make asset sales or redemptions more expensive than in other jurisdictions. This is especially important for businesses that plan to sell interests as part of succession.

We help clients evaluate whether a stock sale, asset sale, or partial buyout will lead to the best tax result. In some cases, creating a holding company or restructuring an entity before transfer can reduce overall tax exposure. These decisions are informed by current California tax law and our experience with local business transitions.

Coordinating With Business Goals

Estate planning for business owners must align with long-term goals. Whether the intent is to pass the business to family members, sell it to a third party, or transition leadership internally, tax planning must support that vision. 

We spend time with our clients understanding their business operations, future prospects, and personal values before building a strategy.

Ownership is just one aspect of succession. Control, income rights, voting power, and operational authority must all be addressed to prevent future disputes. We draft documents that clarify these details and avoid confusion when transitions occur. 

When the next generation is involved, we work to balance control with fairness and long-term sustainability.

The Next Steps

At The Farano Law Group APC, estate planning for business succession is not just about protecting wealth—it’s about preserving a legacy. We’re proud to serve Orange County, Riverside County, and Los Angeles County, California. Call today.