Business Succession Planning for Pennsylvania Family Businesses

A family business usually changes hands once a generation, and the handoff needs its own plan. Business succession planning covers who takes over, how they pay for it or receive it, who controls the company in the meantime, and what happens if an owner dies or becomes disabled before any of that is settled. Your personal will, trusts and powers of attorney are covered on our page on estate planning for business owners. This page is about moving the business.

Start with the successor

Every other decision follows from who will own and run the business next. There are three usual answers.

• A family member. The question is rarely just “which child”. It is whether the child who runs the business should also own all of it, and how to treat the children who are not in the business. Many families give the business to the child who works in it and balance the other children with other assets or life insurance.
• A key employee or management team. They often know the business well but seldom have the cash to buy it. A sale to employees is usually paid over several years under a written purchase agreement, which means the seller stays financially tied to the business after leaving it.
• An outside buyer. A competitor or investor may pay more up front, but a sale planned years ahead looks very different from one forced by an owner’s death.

Some owners combine these. Decide before the documents are drafted.

Buy-sell agreements

If the business has more than one owner, the buy-sell agreement is the core document. It says what happens to an owner’s interest on specific events (death, disability, retirement, divorce or leaving the business), who must or may buy it, at what price, and where the money comes from. Without one, a deceased owner’s shares pass under that owner’s will to people the surviving owners may never have chosen as partners.

Cross-purchase or entity redemption

The last row matters after Connelly v. United States, No. 23-146 (U.S. June 6, 2024). Two brothers owned a corporation that held life insurance to redeem a deceased brother’s shares. The Supreme Court held that the company’s contractual obligation to redeem the shares did not reduce their value for federal estate tax purposes, and it treated the insurance proceeds as a company asset. The Court noted that a cross-purchase agreement would have avoided that risk, while observing that cross-purchase arrangements have their own tax consequences. Redemption agreements funded with company-owned insurance should be reviewed in light of it.

Funding with life insurance

Life insurance is the usual way to make sure the buyer can actually pay when an owner dies. If the company owns the policy on an employee’s life, federal law imposes paperwork that is easy to miss. Before the policy is issued, the insured must be told in writing that the company intends to insure his or her life and the maximum face amount, must consent in writing, and must be told in writing that the company will be a beneficiary. If those steps are skipped, the company’s tax-free share of the death benefit can be limited to the premiums it paid (26 U.S.C. § 101(j)).

Valuation clauses

The price clause is where buy-sell agreements most often go wrong, because a fixed price that nobody updates goes stale. Common approaches are an agreed value that the owners must update on a schedule, a formula tied to the company’s financial statements, or an independent appraisal at the time of the triggering event.

A price set by agreement does not automatically control the federal estate or gift tax value. Under 26 U.S.C. § 2703, an agreement or restriction on sale is disregarded for those taxes unless it is a bona fide business arrangement, is not a device to transfer the business to family members for less than full value, and has terms comparable to similar arm’s-length arrangements. For a business owned entirely by one family, the price clause should be drafted with all three tests in mind.

Gifting and selling interests over time

Ownership can move in pieces over a number of years, by gift, by sale, or both.

• Gifts. For 2026 the federal annual gift tax exclusion is $19,000 per recipient, or $38,000 when spouses give together (IRS). A gift of a business interest needs a supportable value, so an appraisal usually comes first. Larger gifts draw on the lifetime exemption described on our page on federal estate and gift tax exemption planning.
• Sales. A child or key employee can buy a portion of the business each year, or buy it all and pay over time. A sale gives the owner retirement income; a gift does not.

Pennsylvania inheritance tax has two traps for lifetime gifts. Gifts made within one year of death are taxable to the extent they exceed $3,000 per recipient per calendar year (72 P.S. § 9107(c)(3)). And a gift where the owner keeps the income or enjoyment of the property for life is taxable at death (72 P.S. § 9107(c)(5)). Giving away shares while continuing to take all of their distributions can fall into the second category.

Voting and non-voting interests

Most owners want to move value to the next generation before they give up control. Splitting ownership into voting and non-voting interests does both. The owner keeps the voting interests and makes decisions; the children receive non-voting interests over time; the voting interests pass to the chosen successor last.

Two federal rules shape this.

• S corporations. An S corporation may have only one class of stock, but differences in voting rights among shares of common stock do not create a second class (26 U.S.C. § 1361(b)(1)(D), (c)(4)). Voting and non-voting common shares are therefore available to an S corporation.
• Keeping the vote on gifted shares. If you give away stock in a corporation you control and keep the right to vote the shares you gave away, those shares can be pulled back into your taxable estate. A corporation is treated as controlled if, at any time after the transfer and within three years before death, you owned (counting stock attributed to you under 26 U.S.C. § 318) or could vote stock with at least 20% of the combined voting power (26 U.S.C. § 2036(b)). This is why the shares that are given away are usually the non-voting ones.

An LLC can create the same split through its operating agreement, with managing and non-managing interests.

Trusts that hold business interests

A trust can hold business interests during your life, after your death, or both. A revocable trust keeps the business running if you become incapacitated and lets your interest pass at death without waiting for probate. An irrevocable trust can receive gifted interests for children who are not yet ready to own them outright, with a trustee voting the shares in the meantime.

Two points come up in almost every plan. First, the trustee must be able to make business decisions, or the trust needs a separate person for the business. Second, the buy-sell agreement and the trust must fit together: the agreement should bind the trust as an owner, and the trust should allow the trustee to sell when the agreement requires it. If the company is an S corporation, only certain kinds of trusts can hold the stock without ending the election. Our guide to S corporation estate planning in Pennsylvania covers those rules.

Timing

Succession plans are easiest to put in place while the owner is healthy, the business is stable and there is time to change course. Several of the rules above reward an early start:

• Life insurance for a buy-sell agreement depends on the owners being insurable.
• Gifts made within one year of death are pulled back into the Pennsylvania inheritance tax above the $3,000 exclusion.
• The § 2036(b) control test looks back three years before death.
• A key employee who buys over time needs years of the business’s earnings to pay for it.

A typical sequence:

1. Choose the successor, or decide the business will be sold.
2. Have the business appraised.
3. Sign or update the buy-sell agreement, including the price clause and funding.
4. Restructure into voting and non-voting interests if ownership will move gradually.
5. Start the gifts or sales, and put any trusts that will hold interests in place.
6. Make your will and trusts match the business documents.

Pennsylvania inheritance tax and the family-owned business exemption

Pennsylvania exempts from inheritance tax a qualified family-owned business interest that passes at death to members of the owner’s family, if the family keeps owning it for seven years, certifies that to the Department of Revenue each year, and claims the exemption on a timely filed return (72 P.S. § 9111(t)). The business must also meet size, age and ownership tests at death. We set those out, and compare this exemption with the farm exemptions, in Pennsylvania inheritance tax: the family business and family farm exemptions.

Two of the rules bear directly on succession planning. First, an entity must be wholly owned at death by the owner, family members, a trust solely for them or an entity they solely own (72 P.S. § 9111(t)(5)(ii)(C)). Selling even a small stake to a key employee during your life can take the business out of the exemption. Second, if the interest leaves the family within seven years after death, for example in a sale to a key employee or an outside buyer, the tax comes back with interest (72 P.S. § 9111(t)(2)). A plan that ends in a sale outside the family should allow for that.

Frequently asked questions

Do we need a buy-sell agreement if only family members own the business?

Usually, yes. Family owners still die, become disabled, divorce and disagree. Without an agreement, an owner’s shares pass to that owner’s heirs, which may mean to a spouse or child who is not involved in the business.

Does the price in our buy-sell agreement set the value for estate tax?

Not automatically. For federal estate and gift tax, the agreed price is disregarded unless the agreement meets the three tests in 26 U.S.C. § 2703: a bona fide business arrangement, not a device to pass the business to family for less than full value, and terms comparable to arm’s-length deals.

Can I give shares to my children and keep control of the company?

Yes, usually by giving non-voting shares and keeping the voting shares. If you keep the right to vote the shares you gave away in a corporation you control, those shares can be included in your estate (26 U.S.C. § 2036(b)).

How we work with business owners

We work with family business owners in Bethlehem and across the Lehigh Valley. The first conversation is usually about who you see running the business next and what is already in writing. We work alongside your accountant and financial advisor, and if you decide to go ahead, we give you a written fee proposal before any work begins.

Joseph F. Leeson III trained and practiced as a CPA before he practiced law, with four years in tax accounting. He holds a JD from Indiana University Maurer School of Law and an MBA in accounting from DeSales University. He was born and raised in Bethlehem, and practices at Leeson & Co. Read more about Joseph F. Leeson III.

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This page explains general principles of Pennsylvania and federal law and is not legal advice for your situation. Tax figures change, and some change every year. Please speak to us before acting on anything here.