Summary. A business owner's estate plan must solve three problems at once, and solving one badly defeats the others. Control must pass to someone who can run the business. The estate must have liquidity to pay taxes and equalize among heirs without selling the business to raise it. And the transfer should minimize transfer tax while preserving the basis step-up where that matters more. This guide covers each: a defensible valuation, structuring and funding a buy-sell agreement including what Connelly changed about redemptions, the estate tax framework and the deferral provisions for closely held businesses, the lifetime transfer techniques that actually move value, how to treat children in and out of the business, and how to align the entity documents with the plan.

A founder dies owning 100 percent of a manufacturing company worth $19 million. His will leaves everything to his three children equally. Two work in the business; one is a physician in another state.

What happens over the following two years:

The estate owes federal estate tax, and the illiquid asset is 91 percent of the estate. The children must find the cash, sell part of the business, or borrow against it.

The three children now own the company equally, which means the two who run it can be outvoted by the one who does not, and the one who does not is entitled to nothing unless the company distributes — which the two operators, who take salaries, are not eager to do.

There is no buy-sell agreement, so there is no mechanism and no price at which the outside child can be bought out. Negotiation begins with no framework and with three siblings who have just buried their father.

The company's operating agreement contains a transfer restriction that was drafted for a different circumstance and that now prevents the operators from bringing in an outside investor to fund the buyout.

A key customer, learning of the death and the uncertainty, moves 30 percent of its volume to a competitor.

The valuation the estate reports is challenged on audit. There is no contemporaneous appraisal and no agreement fixing the value, so the argument runs on the government's expert against one retained after the fact.

Every one of those was solvable in advance, and none of them was solved, because the founder had a will and believed that was an estate plan.

A business owner's estate plan is not a will. It is a set of interlocking documents — the will and trusts, the buy-sell agreement, the entity documents, the insurance, and the succession plan — that must be drafted together and must agree with each other.

The three problems

Control. Who runs the business, and who owns it? These are separable and should usually be separated. Voting and non-voting equity, a manager-managed LLC, a trust with a business-savvy trustee or a separate business trustee, and a shareholders' agreement allocating governance are all mechanisms for giving economic value to people who should not be making operating decisions.

Liquidity. Federal estate tax is due nine months after death. State estate or inheritance tax may be due sooner. If the business is most of the estate and there is no cash, the estate must sell, borrow, or qualify for deferral. Insurance is the ordinary answer, and it must be structured correctly to work.

Transfer tax versus basis. This is the tension that has reversed the conventional wisdom for most families. Assets included in the estate receive a step-up in basis to fair market value at death under § 1014; assets given away during life carry over the donor's basis. For a business with a very low basis, the income tax cost of a carryover basis can exceed the estate tax saved by removing the asset from the estate — unless the estate is large enough that estate tax is certain, in which case removing appreciation is worth a great deal. The analysis has to be run with actual numbers, and it changes as the exemption changes.

Start with a valuation

Nearly everything in this guide depends on a defensible number, and most business owners are working from a figure they invented.

Get a qualified appraisal from a credentialed business appraiser. Uses: setting the buy-sell price, supporting gift and estate tax reporting, informing insurance amounts, and — critically — establishing a contemporaneous record. A qualified appraisal is required to substantiate a gift for tax purposes and to start the three-year statute of limitations on a gift tax return through adequate disclosure, which is one of the most valuable and least understood protections in this area.

Understand the standard of value. Fair market value — what a hypothetical willing buyer would pay a hypothetical willing seller, neither under compulsion, both with reasonable knowledge — under Revenue Ruling 59-60, which sets out the factors: the nature and history of the business, the economic outlook, book value and financial condition, earning capacity, dividend-paying capacity, goodwill, prior sales of stock, and the market price of comparable public companies.

Valuation discounts. A minority interest in a closely held business is worth less than a proportionate share of the whole, because it cannot control distributions or a sale, and because there is no market for it. Discounts for lack of control and lack of marketability commonly total 20 to 40 percent and sometimes more.

Statutory constraints:

  • § 2703 disregards, for valuation purposes, any option, agreement, or restriction that permits acquisition or use at less than fair market value — unless it is a bona fide business arrangement, is not a device to transfer to family members for less than full consideration, and has terms comparable to arm's-length arrangements. A family buy-sell agreement must satisfy all three prongs to fix the value for estate tax purposes.
  • § 2704 disregards certain lapsing rights and applicable restrictions on liquidation in family-controlled entities. Proposed regulations that would have severely curtailed discounts were withdrawn; the statute remains.

Update the valuation periodically — annually or every two to three years — because a stale appraisal used for a gift or a buyout is worth much less than a current one.

The buy-sell agreement

This is the single most important document for a business owner with co-owners, and it is frequently the least well drafted.

What it does. Creates a market for an interest that has none, sets the price and the terms, prevents unwanted owners, and — properly structured — provides the liquidity for the estate.

Triggering events, each of which should be addressed separately because the right answer differs:

  • Death — mandatory purchase, usually.
  • Disability, with a definition and a waiting period.
  • Retirement.
  • Voluntary departure, frequently with a right of first refusal rather than a mandatory purchase.
  • Involuntary termination of employment, with different pricing for cause and without.
  • Divorce, so the interest does not pass to a spouse. This requires a spousal consent signed at the outset.
  • Bankruptcy or creditor attachment.
  • Loss of a professional license, for a professional practice.
  • Attempted transfer in violation of the agreement.
  • Deadlock, with a mechanism.

Pricing. Options, in rough order of reliability:

  • A formula — a multiple of EBITDA or of book value, defined precisely. Simple and it goes stale.
  • Annual agreed value, set by the owners each year and recited in a certificate. Excellent when actually done, and it is almost never done after year two — so include a fallback.
  • Appraisal at the time of the triggering event, with the appraiser selection process and the cost allocation defined. Most reliable and slowest.
  • A combination: agreed value if updated within the last 12 months, otherwise appraisal.

Address discounts explicitly. Whether a departing minority owner's interest is valued with or without a minority discount is a real economic term and should be a decision rather than an ambiguity.

Payment terms. Lump sum where funded by insurance; otherwise a promissory note over five to ten years with a market interest rate, security, and — importantly — subordination to the company's senior lender, which the lender will require. Model whether the company can actually service the note alongside its existing debt, because a buy-sell obligation the business cannot fund is a default waiting to happen.

Structures:

  • Cross-purchase — the remaining owners buy the departing owner's interest. Advantages: the buyers get a cost basis in the purchased interest, which matters enormously on a later sale; no corporate-level issues. Disadvantages: with more than three or four owners the number of insurance policies becomes unmanageable, and the owners must have the cash.
  • Redemption (entity purchase) — the company buys the interest. Advantages: simple, one set of policies, and the company may be better able to fund it. Disadvantages: no basis step-up for the remaining owners; corporate distribution and accumulated earnings considerations; and the Connelly problem described below.
  • Hybrid — the company has the right and the owners have an option, or vice versa, permitting the decision to be made at the time with the tax advice then available. This is usually the best structure, and it is worth the added drafting.
  • Insurance LLC — a separate entity owns the policies and distributes proceeds to the owners for a cross-purchase, solving the multiple-policy problem while preserving basis.

Funding. Life insurance is the ordinary mechanism, and disability buy-out insurance is available for the disability trigger. Confirm: the amount is adequate against a current valuation; ownership and beneficiary designations match the structure; premiums are being paid; and the arrangement is reviewed when the value changes materially.

What Connelly changed

In Connelly v. United States, 602 U.S. 257 (2024), the Supreme Court held that life insurance proceeds a corporation receives to fund a redemption of a deceased shareholder's stock are included in the corporation's fair market value for estate tax purposes, and that the corporation's obligation to redeem is not a liability that offsets them.

The consequence is direct and significant. Under a redemption structure funded by company-owned insurance, the deceased owner's estate is valued on a company whose value includes the insurance proceeds — so a $3 million policy purchased to fund a $3 million redemption increases the company's value by $3 million, increasing the estate's includible interest and, in a taxable estate, the tax.

Responses to consider:

  • Convert to a cross-purchase, where the surviving owners own the policies and the proceeds never enter the company. This also produces the basis benefit.
  • Use an insurance LLC to hold the policies, achieving a cross-purchase result with manageable administration.
  • Consider a partnership structure to hold the insurance.
  • Where a redemption structure is retained, model the effect and size the insurance to cover the additional tax it creates.

Every business owner with a company-owned, insurance-funded redemption agreement should have it reviewed. Many such agreements were drafted decades ago and have not been examined since.

Estate tax and the liquidity problem

The framework. A unified credit shelters transfers up to the basic exclusion amount, which is indexed and which is subject to statutory changes — the amount has been substantially increased and is scheduled to change, so verify the current figure and the scheduled sunset before planning around it. Transfers above it are taxed at a top rate of 40 percent. The marital deduction defers tax on transfers to a citizen spouse, and portability permits a surviving spouse to use the deceased spouse's unused exclusion — but only if a timely estate tax return is filed electing it, which is the most commonly missed election in estate administration and which should be made even in estates well below the threshold.

State taxes are a separate and frequently overlooked layer. A number of states impose their own estate tax with exemptions far below the federal amount, and several impose an inheritance tax on the recipient. A family whose estate is well under the federal exemption may face a meaningful state tax, and the planning is different.

Deferral provisions for closely held businesses:

§ 6166 permits an estate whose closely held business interest exceeds 35 percent of the adjusted gross estate to pay the estate tax attributable to that interest in installments: interest only for up to five years, then principal and interest over up to ten years — a total deferral of up to fourteen years, with a favorable interest rate on a portion of the deferred tax. Requirements and traps: the 35 percent test, aggregation rules for multiple businesses, the election on a timely return, a special lien on the business assets, and acceleration if 50 percent or more of the interest is disposed of or if an installment is missed. It is a genuine solution for the right estate and it requires that the business continue to be held.

§ 2032A special use valuation permits farm and certain closely held business real property to be valued at its actual use rather than at its highest and best use, subject to a cap on the reduction, a qualified heir requirement, and a recapture period during which a disposition or a change in use triggers additional tax. Primarily relevant to farms and ranches.

§ 303 redemptions permit a corporation to redeem stock from an estate in an amount up to the death taxes and funeral and administration expenses, with the redemption treated as a sale rather than as a dividend — which, combined with the basis step-up, frequently means little or no gain. A useful liquidity tool that does not require the deferral machinery.

The alternate valuation date under § 2032 permits valuing the estate six months after death, if the election reduces both the gross estate and the tax — which can matter where a business declines after the owner's death.

Insurance as the liquidity answer. For most owners this is simpler and more reliable than deferral.

Structure it correctly: a policy the decedent owns or has incidents of ownership in is included in the estate under § 2042, which is exactly backwards. Instead, use an irrevocable life insurance trust (ILIT) — the trust owns the policy and is the beneficiary, the insured has no incidents of ownership, premiums are funded by gifts to the trust supported by Crummey withdrawal rights to qualify for the annual exclusion, and the proceeds are outside the estate and available to the family. The trust can then purchase assets from or lend to the estate, providing liquidity without the estate owning the policy.

Watch the three-year rule under § 2035: a policy transferred to an ILIT within three years of death is pulled back into the estate. A new policy issued to the trust avoids the problem entirely, which is a reason to establish the ILIT before buying the insurance rather than after.

Lifetime transfer techniques

The premise: transferring assets during life removes future appreciation from the estate. The cost: carryover basis. Run the comparison.

Annual exclusion gifts — a per-donee, per-year amount, indexed, doubled for a married couple with gift-splitting. Unremarkable individually and substantial over time and across a family. Gifts of business interests must be of a present interest to qualify, which for an entity interest generally requires that the donee have a right to income or a withdrawal right.

Lifetime use of the exclusion. Using the exclusion now, while it is at a historically high level, removes future appreciation permanently — and the regulations provide an anti-clawback rule so that gifts made under a higher exclusion are not penalized if the exclusion later declines. Where a sunset is scheduled, this is a use-it-or-lose-it decision with a deadline.

Grantor retained annuity trust (GRAT). The grantor transfers assets to a trust and retains an annuity for a term. If the assets outperform the § 7520 rate, the excess passes to the remainder beneficiaries with little or no gift tax. A zeroed-out GRAT produces a near-zero taxable gift, so the downside is limited to the transaction cost. The risk is mortality — if the grantor dies during the term, the assets are pulled back into the estate. Best for assets expected to appreciate substantially, and frequently used in series with short terms.

Intentionally defective grantor trust (IDGT) and the installment sale. The grantor sells assets to an irrevocable trust that is a grantor trust for income tax purposes but is outside the estate for transfer tax purposes, in exchange for a promissory note at the applicable federal rate. Because the trust is a grantor trust, the sale is not a recognition event and the interest is not taxable income to the grantor — and the grantor's payment of the trust's income tax is itself a further transfer to the beneficiaries that is not treated as a gift. Appreciation above the AFR passes free of transfer tax. Requires meaningful seed capital in the trust (conventionally 10 percent of the value transferred), a defensible valuation, and careful drafting.

Family limited partnerships and LLCs. The family entity holds assets, the senior generation transfers limited interests to the next generation, and the transferred interests are valued with lack of control and marketability discounts. Requirements for the discounts to survive: a legitimate non-tax business purpose — consolidated management, creditor protection, preservation of family assets — actual respect for the entity's formalities, no retained right to income or possession, and no implied agreement that the senior generation may reach the assets. The recurring failures are entities funded with personal-use assets, entities used as a checking account, and entities formed on a deathbed, all of which have produced adverse decisions under § 2036.

Charitable techniques — charitable remainder trusts converting an appreciated illiquid asset into an income stream with a deduction, charitable lead trusts, and donor-advised funds — which can be effective for an owner with charitable intent and an appreciated business interest, and which require care where a sale is already under negotiation.

Qualified small business stock. For C corporation stock meeting the § 1202 requirements, a substantial amount of gain may be excluded on sale after a five-year holding period — and the exclusion is per shareholder, so gifts to non-grantor trusts and to family members can multiply it. This is a large opportunity for the right company and requires planning years ahead.

Sale to family members — an installment sale to a child at a defensible price and an adequate interest rate. Note § 2036 and the retained interest rules, and note that a self-canceling installment note (SCIN) or a private annuity can be used with care.

Family dynamics: the part that actually decides outcomes

The children who work in the business and the children who do not are the hardest problem in this field, and it is not a technical one.

Options for equalization:

  • Insurance to the non-participating children, funded by the business or by the parents, which is the cleanest solution and requires only that it be adequately funded.
  • Other assets — real estate, investments, retirement accounts — allocated to the non-participants.
  • Non-voting equity to the non-participants, with the operators holding voting control. This preserves economic fairness and creates a permanent relationship between siblings with divergent interests, and it requires a distribution policy and a buy-out mechanism to be tolerable.
  • A buy-out over time, funded from business cash flow, with a note and security.
  • Unequal division, with the business to the participants and less to the others — which is defensible and should be explained, in the parents' lifetime, to everyone.

The most reliable predictor of a bad outcome is a family that has not had the conversation. Children who learn the plan by reading the will after the funeral react to the surprise as much as to the substance.

Also address:

  • Compensation — the operating children should be paid market compensation for their work, documented, so that the value they build is distinguishable from the value they inherit.
  • In-law protection — trusts rather than outright gifts, and spousal consents in the buy-sell agreement.
  • Governance — a real board, an advisory board, or a family council, established while the founder is alive so it has authority afterward.
  • Selecting the successor on merit, and telling the family the reasoning.
  • The founder's own transition, which is frequently the binding constraint. A succession plan whose first step is the founder relinquishing control does not execute unless the founder has decided to.

Aligning the documents

The most common failure in this field is documents that contradict each other.

The estate plan — the will, the revocable trust, the powers of attorney, and the beneficiary designations — must be consistent with the entity documents — the operating agreement or shareholders' agreement, the buy-sell agreement, and any voting agreement.

Check specifically:

  • Does the buy-sell agreement permit the transfer the will directs, or does it require a purchase that overrides the bequest?
  • Do the transfer restrictions in the operating agreement permit a transfer to a trust?
  • Is the trustee authorized to hold and vote a closely held business interest, and is the trustee competent to do so? Consider a directed trust with a separate business trustee.
  • Do the beneficiary designations on retirement accounts and insurance match the plan? They control over the will, and this is the most common error in every estate.
  • Is there a durable power of attorney with express authority over business matters, and does the operating agreement recognize an agent's authority?
  • Does the plan address incapacity as well as death — which is statistically the more likely event and the one most plans handle worst?
  • Are the S corporation eligibility rules satisfied by every intended recipient? An S corporation's stock cannot be held by most trusts unless the trust qualifies as a QSST or an ESBT and the election is made, and an ineligible holder terminates the S election with severe consequences.
  • Is there key person insurance on the operators, separate from the buy-sell funding?
  • Is the debt structured so that a death does not accelerate it? Loan agreements frequently contain key person and change-of-control provisions.
  • Are licenses and regulatory approvals transferable, and what does the regulator require on a change of ownership?

Review the whole set together, every two to three years, and after any material change in the business, the family, or the law.

A short case study

A founder, 64, owns 80 percent of a $24 million distribution business; a long-time general manager owns 20 percent. Three children: two in the business, one not. The founder's other assets total $4 million.

Step one — valuation. A credentialed appraisal establishes $24 million, with a 28 percent combined discount applicable to transferred minority interests.

Step two — the buy-sell agreement. Rewritten as a hybrid: on death, the company has a right and the surviving owners have an option to purchase, decided at the time. Triggers cover death, disability, retirement, termination, divorce, and attempted transfer. Pricing is annual agreed value with an appraisal fallback if not updated within twelve months. Payment is lump sum to the extent of insurance, with the balance over seven years, subordinated to the senior lender. Spousal consents are obtained.

Step three — insurance restructured. The existing company-owned policy funding a redemption is analyzed against Connelly and moved to an insurance LLC owned by the founder's trust and the general manager, achieving a cross-purchase result and keeping the proceeds out of the company's value. An ILIT is established, and a new $6 million policy is issued to the trust for estate liquidity — issued to the trust rather than transferred, avoiding the three-year rule.

Step four — lifetime transfers. The founder recapitalizes into voting and non-voting units, and over three years sells non-voting units representing 30 percent of the company to an IDGT in exchange for a note at the AFR, seeded with a 10 percent gift. A qualified appraisal supports the value, and the gift tax return is filed with adequate disclosure to start the three-year statute.

Step five — the family. The two operating children receive the voting units over time and are paid market compensation, documented. The non-participating child receives the ILIT proceeds, the founder's real estate, and non-voting units with a defined distribution policy and a put right after ten years. The plan is explained to all three children, together, while the founder is alive, which is the step the founder resisted most and which counsel insisted on.

Step six — alignment. The operating agreement is amended to permit trust ownership and to recognize an agent under the power of attorney. Trustee provisions are revised to appoint a directed trust structure with a business trustee. Beneficiary designations are updated. The S election eligibility of every intended holder is confirmed and QSST elections are prepared.

Result. When the founder dies six years later, the transition takes weeks rather than years. The estate has liquidity, the buy-sell mechanism operates, the operating children control the business, the non-participating child is treated fairly and knew the plan, and the valuation is supported by contemporaneous appraisals and a closed gift tax statute.

Conclusion

Three points carry the weight.

The buy-sell agreement is the center of the plan, and Connelly means the funding structure must be re-examined. A company-owned, insurance-funded redemption increases the company's estate tax value by the amount of the proceeds. Cross-purchase and insurance LLC structures avoid that and produce a basis benefit as well. Any agreement drafted before 2024 deserves a review.

Solve for liquidity first. Estate tax is due in nine months, and a business is not a liquid asset. Insurance held outside the estate through an ILIT is the ordinary answer; § 6166 deferral and § 303 redemptions are real alternatives for the right estate. A plan that is elegant on transfer tax and produces a forced sale has failed.

The documents must agree, and the family must know. Contradictions between the will, the trust, the operating agreement, the buy-sell agreement, and the beneficiary designations are the most common technical failure — and a plan the family learns about after the funeral is the most common human one. Both are fixed by the same thing: reviewing the whole set together, out loud, while the owner is alive.

Frequently asked questions

Do I need a buy-sell agreement if I own the whole company? Yes, though it does different work. With no co-owners there is no purchase mechanism to design, but the plan still needs to address who takes control, how the estate obtains liquidity, and whether the business will be sold — and a documented valuation and a succession plan serve the same functions the agreement would.

Should I give shares to my children now? It depends on the arithmetic, and the answer has changed. Gifting removes future appreciation from the estate and gives up the basis step-up. Where the estate will clearly exceed the exemption, gifting appreciating interests is powerful. Where it will not, holding until death for the step-up is frequently better. Run both with real numbers, and revisit when the exemption changes.

Will my heirs have to sell the business to pay estate tax? Only if the plan lets that happen. Insurance held in an ILIT, § 6166 installment payment, and a § 303 redemption are all designed to prevent it. This is a solvable problem and it is solved in advance or not at all.

How do I treat the child who does not work in the business? Insurance is the cleanest equalizer. Other assets, non-voting equity with a distribution policy and a put right, and a funded buy-out over time all work. What does not work is dividing voting control equally among children with different roles and different interests.

What did Connelly change? For a corporation that owns life insurance to fund a redemption of a deceased shareholder's stock, the proceeds increase the corporation's value for estate tax purposes and the redemption obligation does not offset them. Any company-owned, insurance-funded redemption agreement should be reviewed, and cross-purchase or insurance LLC structures should be considered.

How often should the plan be reviewed? Every two to three years, and immediately on a material change in the business's value, a change in family circumstances (marriage, divorce, death, a child joining or leaving the business), a change in ownership, or a change in the transfer tax law. Plans left untouched for a decade are the ones that produce the outcomes described at the top of this guide.

What if I want to sell instead? Then the estate planning work has a deadline, because gifts of interests must be made before a letter of intent establishes value. Valuation discounts available on a minority interest in an operating company are unavailable on the cash proceeds, and the difference is frequently seven figures. Start the planning at least a year before any sale process.

Related articles

This guide is provided for general informational purposes and does not constitute legal or tax advice. Exemption amounts, rates, and several provisions discussed here are indexed or subject to scheduled statutory changes, and state estate and inheritance taxes vary substantially. Consult qualified estate planning and tax counsel before implementing any technique described here.