If you are a business owner, you may have heard about the looming “sunset” of the federal gift and estate tax exemption. Unless Congress acts, the current lifetime exemption amount (which is the amount of assets you can transfer without paying any federal gift and/or estate tax) of $13.61 million per individual and $27.22 million per married couple will sunset on Dec. 31, 2025. At that time, the exemption amount will revert to the pre-Tax Cuts and Jobs Act level of $5.6 million per individual and $11.2 million for married couples (adjusted for inflation from 2017 to an estimated $7 million per individual).
This significant tax change is particularly important for individuals who have a net worth in excess of $14 million. It also impacts business owners who anticipate an exit in the next 18 months, which will likely put them at or above the $14 million joint gross estate threshold. Essentially, every dollar above the lifetime exemption amount will be taxed at a 40% tax rate upon death.
While Jan. 1, 2026, may seem like “forever” from now, for business owners who are planning for a sale in the near term, the time to begin planning is now. Estate planning strategies that can help shelter assets take time to set up, and the IRS will often scrutinize such planning techniques that are done AFTER a letter of intent (LOI) is signed with a potential buyer. Therefore, business owners are advised to implement estate planning strategies well before any offer is documented or LOI drafted, generally at least 6-8 months in advance of a transaction.
It's worth noting the IRS has stated that the estate tax exemption amount will not be subject to a “clawback” if the sunset happens. So, business owners should not have to worry about fully leveraging the current exemption amount and later having those assets taken back.
The following are three estate planning strategies that business owners should consider leveraging now in preparation for the potential sunset of the current estate tax exemption amount:
Spousal Lifetime Access Trust (SLAT)
The objective of a SLAT is to get assets out of your estate so that they are not subject to any estate tax at death while simultaneously reserving the right to use those assets. As the creator and person funding the trust, you can benefit from the money in the trust indirectly through your spouse, even though you technically do not have a retained interest in the trust so long as you are married to your spouse and the spouse is living. Not having a retained interest in those assets as the person funding the trust is what makes those assets exempt from your own estate. Providing your spouse access to those funds as the designated beneficiary, if needed, is attractive to many couples who may be unsure of what their future liquidity needs might be or who might not be ready to transfer wealth to children or other beneficiaries.
All future appreciation of the assets transferred to the trust is exempt from estate taxes. Therefore, in order to get the most bang for the buck, it’s ideal not to access those funds until exhausting money that is still held in your personal name.
Business owners who choose to wait and set up a SLAT until after the federal estate tax exemption sunsets (assuming it does) could be giving up the opportunity to transfer up to $13.61 million into trust. Instead, they would be limited to transferring only the estimated $7 million to their heirs free of federal estate tax (not to mention the potential appreciation of assets placed in the trust).
Grantor Retained Annuity Trust (GRAT)
A GRAT is a powerful and underutilized estate planning tool that transfers the future growth of assets out of one’s estate (and therefore not subject to federal gift tax) either outright or into a trust for descendants. The creator of a GRAT retains an interest in the trust assets for a specified period of time through the receipt of an annuity payment that is made each year until the total value of the assets originally put into the GRAT is paid back. Essentially, a GRAT pays back all of the money you put into the trust over the GRAT term, plus interest at a rate known as the applicable federal rate. Those assets paid back to the trust creator remain subject to estate tax, BUT all future appreciation of assets placed into the GRAT is allowed to grow without being subject to federal gift or estate tax, which can represent millions of dollars over time.
Alternatively, without a GRAT, all future appreciation of those assets would be subject to a 40% estate tax on your passing.
For business owners who are expecting a liquidity event, things get even more advantageous with a GRAT. The reason is that private stock in a business needs to be appraised before being placed into a GRAT to derive a value, which is typically discounted (generally 20-40%) because of the inherent lack of marketability of private stock. For example, if a business owner’s shares of stock are appraised at a discounted value of $5 million, but in actuality, they are worth $8 million, that essentially represents an instantaneous appreciation of $3 million, which again would be estate tax-free if placed into a GRAT.
Finally, business owners should generally explore using short-term GRATS (e.g., 2 years) for two reasons: First, the estate tax-free benefit of a GRAT is only secured once a GRAT term is complete. Second, the appreciation of private stock placed into a GRAT occurs essentially immediately. In other words, if you were to pass before the completion of a GRAT term, the assets transferred into the trust would be pulled back into your gross estate, and you (and, more importantly, your heirs) would not receive the estate tax avoidance for the appreciation of the assets in the GRAT. Longer-term GRATs can make sense in certain cases but have a greater risk of assets being pulled back into one’s estate in the event of a premature death.
Sale to Defective Grantor Trust (Installment Sale)
An installment sale closely resembles a GRAT but can be more effective if the timing of the business sale is less certain. Similar to a GRAT, business stock can be sold to a trust in exchange for a promissory note. With an installment sale, only the IRS-mandated interest is required to be paid back annually, but the outstanding principal owed to the creator can take place at the end of the term via a balloon payment. Compared to a GRAT, the installment sale method will likely result in more growth free of estate tax since the principal remains in the trust longer and, therefore, will likely produce more growth and income.
Using the same numbers in the GRAT example above, you could implement an installment sale with a 10-year loan of business stock that is valued at a discounted $5 million but that is really worth $8 million. In between years one and 10, the business is sold, and the stock owned by the trust would monetize for $8 million and remain in the trust. Small interest payments on the $5 million contributed would be paid back annually, and in year 10, the trust would pay back the original valuation of $5 million. In the meantime, the $3 million difference, along with all growth and income earned on the total amount of assets held in the trust, would be eligible to pass to your beneficiaries free of estate tax. Keep in mind that even after the trust pays back the loan, the remaining trust assets (the $3 million plus earnings) will continue to grow free of estate tax.
It is worth noting that these three strategies are not always implemented in isolation. Many families utilize a combination of SLATs, GRATs, and installment sales to shield their assets from estate tax efficiently.
Cort Haber is Managing Director at New Republic Partners.