Preparing an Exit Strategy to Preserve Business Wealth

Every franchise owner will eventually step away from the business. Whether that happens in a few years or many years from now, planning an exit early can help reduce the tax impact of selling or transferring the company. Here are five tax approaches franchise owners may want to consider as part of that plan.

Annual gift tax exclusion

Franchise owners who want to pass the business to children or other chosen beneficiaries may choose to give shares in stages over several years. Under the annual federal gift tax exclusion, an individual can give up to $19,000 to each recipient each year without incurring gift tax. Married couples can double that amount.

Spreading gifts across multiple years and recipients can allow a substantial amount of ownership to move tax-free. By the time the franchise owner leaves the business, the next generation may already hold a sizable ownership stake.

Unified tax credit

The unified tax credit is the amount a person may give during life or leave at death without triggering gift or estate tax. The lifetime unified tax credit for 2026 is $15 million for an individual and $30 million for a married couple, indexed for inflation. A person may pass on an estate worth $15 million without estate taxes, though that amount is reduced by any prior gifts that exceeded the federal annual gift tax exclusion.

Owners can also use part of this lifetime exemption before death by moving business interests into a dynasty trust. This is an irrevocable trust designed to benefit several generations, including children and grandchildren. When structured correctly, the transferred assets and any future growth on them may be kept out of the owner’s taxable estate.

To see how the unified tax credit works, consider this example. A franchise owner gives each of three children $25,000 a year for 10 years. That exceeds the annual exclusion by $6,000 per child each year ($25,000 minus $19,000). Over 10 years and three children, the total amount above the annual federal tax-free limit would be $180,000 ($6,000 x 10 years x 3 children). If the owner dies in year 11, the estate amount that could pass free of estate tax would be $14,820,000 ($15 million minus $180,000).

Family limited partnership

Another way to transfer ownership to children is through a family limited partnership, or FLP. In this structure, the franchise owner forms an FLP and contributes the business assets to it, while keeping a 99% limited partnership interest and a 1% general partnership interest, which preserves control of the business.

Over time, the owner can give partnership interests to family members. Because limited partnership interests may have limited control and marketability, a qualified valuation may support discounts from their pro rata enterprise value. These discounts depend heavily on the facts and can draw IRS review. Since the per-share value is lower, more limited partnership interests may be transferred each year before reaching the federal annual gift exemption. When it is time to exit, the owner can transfer the general partnership interest, allowing the next generation to take control.

Grantor retained annuity trust (GRAT)

A GRAT is designed to shift asset appreciation to others while reducing or eliminating gift tax on that growth. It is set up as an irrevocable trust with a fixed term, often ranging from two to 10 years. The person transferring the assets, known as the grantor, places assets into the trust and cannot take them back until the term ends. In return, the grantor receives annuity payments based on the value of the assets placed into the trust plus interest calculated using the IRS Section 7520 rate, also called the hurdle rate.

When the term ends, the trust beneficiaries, such as family members, receive the appreciation in the assets, minus the interest paid to the grantor under Section 7520. That is why these trusts can work well for assets expected to rise sharply in value during the trust period, such as startup stock.

Employee stock ownership plans (ESOPs)

For franchise owners considering a transfer to employees or family members, an employee stock ownership plan may provide a tax-efficient exit route. Under an ESOP, the company gives stock to employees as part of a qualified retirement plan. Depending on how the plan is structured, employees may be able to sell their shares back when they leave the company, retire, become disabled, or die.

One major benefit of an ESOP is that it allows the current owner to shift ownership gradually while taking money out over time instead of receiving the full value all at once. In some C corporation ESOP deals, Section 1042 may allow selling shareholders to defer capital gains tax by reinvesting the proceeds in qualified replacement property, as long as strict legal requirements are met.

Key takeaway

Any tax strategy should be reviewed with a qualified accountant or tax professional to make sure the records and compliance steps are handled properly. Still, it is wise to begin those discussions early, since choices made now could lead to meaningful tax savings later.