Quick overview

Gifting business interests—transferring a portion or all of an LLC membership, S‑corp shares, partnership units, or closely held C‑corp stock—can be a powerful tool for succession, liquidity management, and estate-tax reduction. But these gifts are treated differently than cash or publicly traded stock: they require a defensible valuation, may reduce your lifetime gift-and-estate tax exemption, can change the recipient’s cost basis, and often trigger the need to file IRS Form 709 (United States Gift (and Generation‑Skipping Transfer) Tax Return). For current filing rules and forms, see the IRS Form 709 page (IRS, Form 709).

This article explains the principal tax considerations, practical planning techniques, common mistakes, and where to get authoritative guidance.

Why valuation matters—and how the IRS views it

The tax consequences of a gift depend on the fair market value (FMV) of the interest transferred. For closely held businesses FMV is rarely the same as the company’s book value. Valuation typically considers: revenue and profit trends, comparable transactions, discounted cash‑flow models, and marketability and minority‑interest discounts.

  • Hire a qualified business appraiser (credentialed ABV, ASA, or similar) and document assumptions—IRS examiners scrutinize discounts for lack of marketability and lack of control.
  • Keep contemporaneous workpapers, valuations, and legal agreements to support the gift value if the IRS questions the return (see IRS guidance on valuation and audit procedures).

For readers who want a deeper dive into valuation techniques specific to closely held businesses, see FinHelp’s piece on Valuing Closely Held Businesses for Gifting and Estate Tax Purposes.

Reporting: When to file Form 709 and deadlines

If you give a gift of a business interest that exceeds the annual gift-tax exclusion per donee in the tax year, or if you want to allocate any portion of your lifetime exclusion to the gift, you must file Form 709. Gift-splitting (allocating gifts made by one spouse to both spouses) also requires Form 709. Key points:

  • File Form 709 with your individual income‑tax return by the usual tax deadline (typically April 15, with available extensions).
  • Even if no tax is due because the gift uses part of your lifetime exemption, a timely‑filed Form 709 documents the allocation.
  • Failure to file can complicate future estate tax filings and portability of a deceased spouse’s unused exclusion.

See FinHelp’s guide on How to file a gift tax return for practical steps and checklists.

(Authoritative source: IRS, About Form 709 — https://www.irs.gov/forms-pubs/about-form-709)

Gift-tax limits, lifetime exemption, and the annual exclusion

Two principal federal limits affect gifting: the annual exclusion (a per-recipient amount you can give tax-free each year) and the lifetime gift-and-estate tax exemption that shields larger lifetime gifts from immediate tax but uses up estate-tax protection. These amounts are adjusted periodically for inflation. Because federal figures can change, check IRS current-year guidance before planning. (IRS Gift Tax Overview.)

Practical implications:

  • Use the annual exclusion to move value out of your estate without tapping your lifetime exemption—this works well with cash or highly liquid stock but is harder with illiquid business interests.
  • For illiquid business interests, consider fractional gifts over multiple years or creating structures that allow valuation discounts and controlled transfers.

FinHelp’s explainer on How the Federal Gift Tax Exclusion Works provides background on division of yearly exclusions and how they interact with Form 709 filings.

Income-tax basis and capital gains effects for the recipient

When you gift a business interest, the recipient generally receives a carryover basis equal to your adjusted basis (the donor’s basis), not the fair market value at the time of the gift. This means:

  • If the donee later sells the interest, they’ll have capital gain or loss based on the donor’s original basis and holding period (the donor’s holding period typically tacks on).
  • Recipients who inherit interests at death receive a stepped-up basis to date‑of‑death fair market value; gifting during life removes that potential step-up.

Because gifting shifts the later capital‑gains burden onto the recipient, communicate with donees about future tax expectations and consider whether gifting or retaining and bequeathing assets better meets family tax goals.

Planning techniques commonly used (and their trade-offs)

  • Annual exclusion gifting: Give small fractional interests each year to multiple family members (per donee). This reduces estate exposure without using lifetime exemption. Works best when you can value the interest defensibly and when transfers are administratively practical.

  • Family limited partnerships (FLPs) or family LLCs: Transfer interests to family members while retaining management control. Properly structured FLPs may justify minority-interest and lack-of-marketability discounts for valuation—but the IRS examines these closely.

  • Grantor trusts and intentionally defective grantor trusts (IDGTs): Selling business interests to a grantor trust can remove future appreciation from your estate while generating an installment sale and possible income-tax benefits. These strategies require careful legal and tax drafting.

  • Installment sales to a defective trust: The owner sells the business to a trust in exchange for note payments; the sale freezes value and can be combined with valuation discounts.

  • Charitable techniques: Charitable lead trusts (CLTs) or charitable remainder vehicles can move business value out of the estate while preserving some income benefits.

Each technique has legal, valuation, and administration costs. In my practice I typically run model scenarios showing projected estate-tax savings, cash‑flow impacts, and worst‑case audit adjustments before recommending any structure.

State tax and GST considerations

  • Some states impose their own estate or gift taxes with lower exemption amounts; check state rules before gifting.
  • Generation‑skipping transfer (GST) tax may apply if you give interests to grandchildren or unrelated younger beneficiaries; proper allocation of GST exemption is important for multigenerational planning.

Common pitfalls and how to avoid them

  • Skipping a professional valuation: Don’t rely on informal spreadsheets or internal bookkeeping; use an independent appraiser.
  • Losing the step-up in basis: Gifting during life removes potential basis step-up at death—model the capital gains exposure for donees.
  • Over-reliance on discounts: Aggressive discounts for lack of marketability or control invite IRS challenges; document and support every assumption.
  • Failure to file Form 709: Even when tax isn’t due, filing protects portability and documents your use of exemption.

Example scenario (simplified)

A business owner holds 100% of an S‑Corp valued at $4 million with a $500,000 adjusted basis. The owner wants to move 25% to three children. Before doing so, we:
1) Order a formal appraisal to set FMV of the 25% fractional interest.
2) Model how much of the annual exclusion can apply and how much would use the lifetime exemption.
3) Estimate the donees’ future capital gains exposure (carryover basis) and compare that to retaining the interest and allowing a step-up at death.
4) Evaluate entity restructuring (family LLC) to facilitate phased transfers while preserving management control.

That analysis often changes the recommended approach—sometimes smaller, staged gifts or a sale to a grantor trust makes more sense than a large immediate gift.

Documentation and audit readiness

Keep the following documentation for audit defense: written appraisal, minutes or operating agreement amendments authorizing transfers, subscription or transfer agreements, contemporaneous tax advice, and copies of filed Form 709. I advise clients to retain records for at least seven years and to work with both a tax attorney and an appraiser when transferring material business interests.

Where to get authoritative guidance

Additional FinHelp resources:

Bottom line

Gifting business interests during life can transfer wealth, delegate ownership, and reduce estate exposure—but it alters income-tax basis, uses limited transfer exemptions, and requires defensible valuation and careful documentation. Work with a team: a CPA or tax attorney, a qualified business appraiser, and an estate-planning attorney. In my practice, combining a conservative valuation report with a phased gifting plan and timely filing of Form 709 produces the best outcomes and minimizes audit risk.

Professional disclaimer: This article is educational and does not constitute legal, tax, or investment advice. For personalized guidance, consult a qualified tax advisor or estate-planning attorney.

(Authority: IRS publications and Form 709 instructions; see links above for current limits and filing details.)