One of the upsides to owning a small business is the chance to provide a financial legacy for your family members to participate in after you exit the business. However, there are federal tax implications to transferring ownership to your loved ones. Whether you’re ready to retire, scale back your participation in the business or want to give shares to family members currently employed by the company, there are two popular options to consider.

Option 1: Make an Outright Gift

If you’re feeling generous, you might simply give some stock to your family member. For federal tax purposes, the fair market value (FMV) of the gifted stock will reduce or possibly use up your unified federal gift and estate tax exemption.

For 2025, the unified federal gift and estate tax exemption is $13.99 million. To calculate the tax impact, reduce the FMV of the stock by the annual federal gift tax exclusion ($19,000 for 2025). The remainder is the amount that will reduce or use up your exemption.

If you’re married, your spouse has a separate $13.99 million unified federal gift and estate tax exemption for 2025. If you and your spouse choose to make a joint gift of the stock — commonly called “gift splitting — each of your exemptions will be reduced. To calculate the tax impact, take half of the FMV of the gifted stock minus the $19,000 annual exclusion for 2025. The remainder is the amount that would reduce or use up your exemption. The same math applies to your spouse’s separate exemption.

If the gift’s value, after subtracting the $19,000 annual exclusion, exceeds the gift giver’s unified federal estate and gift tax exemption, the excess is taxed at the flat 40% federal gift tax rate. (See “Why Now Might Be a Good Time for a Gift” at right.)

Important: If you’ve made gifts in the past that exceeded the annual gift tax exclusion (so-called taxable gifts), those excess gifts reduced your unified federal gift and estate tax exemption. In this situation, your remaining exemption will be less than $13.99 million. Consult your tax advisor if you’ve previously made taxable gifts.

To illustrate how an outright gift works, suppose Tony and Nelly are married and own a small business. They want to give their adult daughter, Enola, a joint stock gift valued at $8 million.

After subtracting two annual exclusions, the FMV of the joint gift for federal gift tax purposes is $7.962 million ($8 million minus $38,000 for two annual exclusions). So, Tony’s $13.99 million unified federal gift and estate tax exemption is reduced by $3.981 million (half of $7.962 million). Nelly’s separate exemption is reduced by the same amount. Because the gift is sheltered by their respective exemptions, neither parent owes any federal gift tax. Although they both have used up some of their exemptions, a significant amount remains. The remainder can later be used to make additional tax-free gifts or reduce their taxable estates when Tony and Nelly die.

Enola takes over her parents’ presumably low tax basis in the gifted stock. So, she effectively has a built-in tax liability that she must pay if she sells the shares. However, if Enola holds the stock until she dies, the current federal income tax rules allow the tax basis of the stock to be stepped up to the date-of-death FMV of the shares. So, if Enola’s heirs sell the shares, they’ll owe capital gains tax only on any appreciation that occurs after Enola’s death.

In effect, choosing to make a joint gift with your spouse allows a gift made by one spouse or both spouses to be treated as if each spouse had made half the gift, regardless of who actually made the gift. As the example demonstrates, this treatment is beneficial because each spouse uses up less of his or her unified federal gift and estate tax exemption than if only one parent had made the gift. Generally, each spouse must file a separate federal gift tax return for the year the joint gift is made.

Option 2: Sell Some Shares and Gift the Rest

If your generosity is limited, you might consider splitting your gift into two parts. First, sell some shares to your family member. Then, give him or her the remaining shares you want to transfer.

For example, Sally is an unmarried small business owner. In 2025, she decides to transfer some of her stock, valued at $4 million, to her son, Andre. Sally arranges to sell Andre $500,000 of stock; that becomes his tax basis in the shares. Then Sally will gift him the remaining shares worth $3.5 million.

Sally’s taxable gain on the sale would be $500,000 minus her tax basis in the shares. If Sally owned the shares for more than one year, the gain is a long-term capital gain that will probably be taxed at a federal rate of 15% or 20%. She may also owe the 3.8% net investment income tax on at least part of the gain and state income tax, if applicable.

As for the $3.5 million stock gift, after subtracting the annual gift exclusion, the FMV of the gift for federal gift tax purposes is $3.481 million ($3.5 million minus $19,000). So, Sally’s $13.99 million unified federal gift and estate tax exemption is reduced by $3.481 million. Assuming Sally hasn’t previously made any taxable gifts, she would still have a significant amount of her unified exemption remaining under current law.

Andre takes over Sally’s presumably low tax basis in the gifted shares. So, he effectively has a built-in tax liability that he must pay if he sells the gifted stock. However, if Andre holds the stock until he dies, the current federal income tax rules allow the tax basis of the stock to be stepped up to the date-of-death FMV of the shares. So, if Andre’s heirs sell the shares, they’ll owe capital gains tax only on any appreciation that occurs after Andre’s death.

Important: The federal income tax on the shares Sally sells to Andre could make this option cost prohibitive. However, the tax results will be better if the stock is qualified small business stock. (See “Special Favorable Tax Treatment for Sales of QSBS” below.)

Determining the Value of Small Business Stock

How much is your business worth today? Closely held stock isn’t traded on an active market, so it can be difficult to value compared to publicly traded stocks.

For federal gift and estate tax purposes, FMV is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”

Do-it-yourself appraisals may raise a red flag with the IRS. Instead, consider hiring a business valuation professional to determine the FMV of your business. Under IRS Revenue Ruling 59-60, valuators must consider eight factors when valuing a private business:

1. Its nature and history,
2. The outlook for the industry and economy,
3. The company’s book value and financial condition,
4. Its earnings capacity,
5. How much in dividends the company could (or does) pay out,
6. The value of goodwill and other intangible assets,
7. Prior sales of the company’s stock and the size of the block, and
8. The price paid in comparable stock transactions.

In addition, smaller ownership interests may be eligible for discounts for lack of control and marketability. Valuation experts use real-world empirical data to support their analyses, rather than gut instinct or industry rules of thumb.

Using a “qualified appraiser” demonstrates that you acted in good faith when filing a gift or estate tax return. A qualified appraiser has earned an appraisal designation from a recognized professional organization or otherwise meets certain minimum education and experience requirements. The appraiser should also have appropriate education and experience in valuing private businesses and comply with generally accepted appraisal standards.

Pass the Torch without Getting Burned by Taxes

Federal taxes are an important consideration when transferring ownership of closely held business stock to family members. We can help to determine the tax implications of using these two options and other possible wealth-transfer alternatives.