Business Inheritance Tax: Rates, Valuation, and Payment Options

A business passed through an estate can face federal estate tax of up to 40% on value above the $15 million per-person exemption in 2026, and because the company is often the estate’s largest asset, that bill can force a sale unless the family plans for it. The federal rules on business inheritance tax include several tools to shrink the taxable value, defer payments over more than a decade, or pull cash out of the company without triggering a dividend, but every one of them has qualification tests and deadlines that punish delay.¹

The 2026 Exemption and the 40% Rate

The basic exclusion amount is $15 million per individual for 2026. Estates below that number owe no federal estate tax.² The One, Big, Beautiful Bill, signed on July 4, 2025, locked in this figure.¹ A married couple can shelter up to $30 million combined when both exemptions are preserved.

Rates are graduated, but because the exemption already covers the first $15 million, any estate that actually owes tax is in the 40% top bracket on the excess.³ A $20 million estate would owe roughly $2 million on the $5 million above the line.

To preserve a deceased spouse’s unused exemption for the surviving spouse (portability, or the DSUE amount), the executor must file Form 706 on time even if no tax is due. Miss the filing and the unused amount is lost. Revenue Procedure 2022-32 allows a late portability election within five years of death for estates below the filing threshold, but that is a fallback, not a plan.⁴

How the Business Is Valued

The gross estate includes property at fair market value on the date of death.⁵ For a closely held business, the IRS looks at the factors set out in Revenue Ruling 59-60, weighed together rather than by any single formula. Earnings history and earning capacity usually dominate for operating companies. Book value, dividend-paying capacity, goodwill, comparable company data, prior arm’s-length sales of the stock, and the economic outlook at death all feed into the number. A real estate holding company will lean more on net asset value; a professional services firm on earnings.

Appraisals for estate tax purposes typically run $5,000 to $20,000, depending on complexity. The report has to walk through methodology, cite comparables and market studies, and show its work, because poorly supported valuations are a common audit trigger.

Alternate Valuation Date

If asset values drop meaningfully after death, Section 2032 lets the executor value the whole estate as of six months after death instead. Any asset sold or distributed during that window is valued at the date it left the estate. The election is available only if it actually reduces both the gross estate and the tax owed, and it applies to everything, not just the business.

Valuation Discounts That Lower the Taxable Value

Two discounts appear in nearly every closely held business valuation and can dramatically reduce the tax bill.

A discount for lack of marketability reflects that private-company shares can’t be sold on an exchange. Empirical studies used in Tax Court cases commonly show discounts in the 30% to 50% range, depending on the company’s financials, transfer restrictions, and market conditions.

A discount for lack of control applies when the inherited interest lacks the voting power to influence management, set dividends, or approve major transactions. A 30% stake is not worth 30% of a company if someone else controls every decision. Limited voting rights, no board seat, and a concentrated ownership structure all increase this discount.

The two discounts are applied multiplicatively. A 10% control discount combined with a 20% marketability discount produces a combined 28% reduction, not 30%. The IRS scrutinizes these numbers hard, so the appraisal has to support them with recognized valuation models and market data.

Step-Up in Basis for the Heirs

Inherited business assets generally receive a new tax basis equal to fair market value at the date of death.⁶ If the founder bought a building for $500,000 and it’s worth $3 million at death, the heir’s basis resets to $3 million, wiping out the capital gains tax on lifetime appreciation if the heir sells.

The step-up covers real property, equipment, inventory, and stock. It does not cover IRAs, 401(k) plans, or tax-deferred annuities, which are taxed as ordinary income when the beneficiary takes distributions. If the executor elects special use valuation under Section 2032A, basis steps up only to the special use value, not full fair market value, and that trade-off is worth modeling before making the election.⁶

Paying the Tax Without Selling the Business

Section 6166 Installment Payments

Section 6166 lets an estate with a closely held business spread estate tax payments across as many as 14 years instead of paying within nine months. The estate pays interest only for the first five years, then pays the tax itself in up to 10 annual installments.⁷

To qualify, the closely held business interest must exceed 35% of the adjusted gross estate (the gross estate minus debts, funeral, and administration expenses).⁷ The business must also meet the definition of closely held:

Any sole proprietorship qualifies automatically.
A partnership qualifies if the estate owns 20% or more of the capital, or the partnership has 45 or fewer partners.
A corporation qualifies if the estate owns 20% or more of the voting stock, or the corporation has 45 or fewer shareholders.

A 2% interest rate applies to the tax attributable to a defined threshold of business value under Section 6601(j); tax on value above the threshold accrues interest at 45% of the normal underpayment rate. The election is made on the estate tax return, and the deferral can be lost by a missed installment or by disposing of a significant portion of the business interest.

Section 303 Stock Redemptions

When the business is a corporation, Section 303 lets the company redeem stock from the estate to fund estate tax, inheritance tax, and funeral and administration expenses without the payment being taxed as a dividend. The corporation’s stock in the gross estate must exceed 35% of the adjusted gross estate, and the redemption can’t exceed the taxes owed plus allowable expenses.⁸ Paired with a Section 6166 deferral, the corporation can redeem enough stock each year to cover the installment, keeping the business intact and heirs’ proportional ownership steady.

Special Use Valuation for Farm and Business Real Property

Section 2032A lets qualifying real property be valued at its current use rather than highest-and-best-use market value. A working farm worth $5 million as a subdivision but $1.5 million as farmland can be valued at the lower number, subject to a total reduction cap of $750,000 adjusted for inflation.⁹

Qualification is strict:

At least 50% of the adjusted gross estate must consist of farm or business property used in the operation at death and passing to a qualifying heir.
At least 25% of the adjusted gross estate must be qualifying real property specifically.
During the eight years before death, the property must have been used in the farm or business for at least five years, with material participation by the decedent or a family member.
Every person with an interest must sign a recapture agreement consenting to additional tax if the property is sold or converted to a non-qualifying use within 10 years.

Sell or convert within that decade and the saved tax comes back with interest. Families committed to keeping the operation running benefit most.

Buy-Sell Agreements and Section 2703

A buy-sell agreement can fix the price at which a deceased owner’s interest passes to the surviving owners or the company, and that price can set the estate tax value if the agreement is drafted correctly. Section 2703 lays out three tests that must all be met:¹⁰

A bona fide business arrangement, such as continuity of operations or blocking outside ownership.
Not a device to transfer property to family for less than full value.
Terms comparable to what unrelated parties would agree to at arm’s length.

The arm’s-length prong is the usual failure point. A 15-year-old agreement with a stale fixed price will not hold up. Formulas tied to earnings or book value, or periodic independent appraisals, work better than static dollar amounts, and reviewing the agreement every few years avoids a surprise at death.

State Estate and Inheritance Taxes

Federal exemption is not the whole story. Roughly 18 states and the District of Columbia impose their own estate or inheritance taxes, with exemptions running from as low as $1 million up to amounts approaching the federal figure and top rates as high as 16%.

An estate tax is assessed against the estate on total value. An inheritance tax is assessed against each beneficiary based on what they receive and their relationship to the deceased, with spouses typically exempt or taxed at the lowest rate. A business owner in a state with a low threshold can owe state death taxes even when the federal $15 million shelter covers everything, which makes state-level review a required step, not an optional one.

Lifetime Gifts and Trusts

The strongest way to reduce business inheritance tax is to move value out of the estate before death. Every dollar transferred during life is a dollar that isn’t taxed at 40% later.

The annual gift tax exclusion for 2026 is $19,000 per recipient, and gifts within that limit don’t touch the lifetime exemption.¹ For an owner with three children and their spouses, that’s $114,000 a year of tax-free transfers, doubled if a spouse consents to gift-splitting.

Gifting minority interests amplifies the effect. A 5% interest in a company worth $10 million has a pro-rata value of $500,000, but after control and marketability discounts, the gift tax value may drop to $300,000 or less. Sustained annual gifting can shift a substantial share of the business at a fraction of its economic value.

Irrevocable trusts extend the toolkit. A grantor retained annuity trust transfers appreciating business interests to heirs while paying the grantor a fixed annuity; growth above the IRS’s assumed rate passes to the trust beneficiaries free of gift and estate tax. Life insurance held in an irrevocable life insurance trust can fund the estate tax bill outside the taxable estate, giving heirs the cash to pay the IRS instead of selling the company.

The Nine-Month Filing Clock

Form 706 is due nine months after death. A six-month filing extension is available on Form 4768, but the extension covers filing only; the estimated tax is still due at nine months, with interest running on any underpayment.¹¹

The return must document every asset, the business valuation, any discounts claimed, and every election made. Special use valuation under Section 2032A and installment payments under Section 6166 are elected on the return itself.¹² A return is also required to elect portability, even when no tax is owed.⁴

Nine months is tight for a business estate. A defensible appraisal, partnership records, buy-sell reconciliation, and supporting schedules all take time. Waiting until month seven to hire the appraiser is how executors end up filing incomplete returns and amending them under audit pressure. Starting the valuation within the first few weeks after death is the single best move an executor can make.

1
Internal Revenue Service. What’s New – Estate and Gift Tax
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Internal Revenue Service. Estate Tax
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Office of the Law Revision Counsel. 26 USC 2001 – Imposition and Rate of Tax
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Internal Revenue Service. Frequently Asked Questions on Estate Taxes
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Office of the Law Revision Counsel. 26 USC 2031 – Definition of Gross Estate
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Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
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Office of the Law Revision Counsel. 26 USC 6166 – Extension of Time for Payment of Estate Tax Where Estate Consists Largely of Interest in Closely Held Business
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Office of the Law Revision Counsel. 26 USC 303 – Distributions in Redemption of Stock to Pay Death Taxes
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Office of the Law Revision Counsel. 26 USC 2032A – Valuation of Certain Farm, Etc., Real Property
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Office of the Law Revision Counsel. 26 USC 2703 – Certain Rights and Restrictions Disregarded
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Internal Revenue Service. Filing Estate and Gift Tax Returns
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Internal Revenue Service. Instructions for Form 706