For estate tax purposes, an estate freeze separates a business owner’s current interest in a growing company from its future appreciation. The owner converts a growth position into a fixed-value position, typically preferred shares with a set dividend and liquidation preference. In contrast, the growth position transfers to heirs or a trust at today’s valuation. Future appreciation attributable to the transferred growth interest accrues outside the owner’s taxable estate.
The mechanics matter less than the timing. A freeze executed while the business is valued at $5 million is designed to fix the owner’s retained interest at approximately that value, shifting subsequent appreciation to the transferred growth interest. Wait, and the same structure may have to lock in a much higher starting value. At 12% annual growth, a business nearly doubles in six years, which is how quickly the effective entry point for a freeze can move.
Congress made the higher federal estate and gift tax exemption permanent under the One Big Beautiful Bill Act. The basic exclusion amount is set at $15 million per individual for 2026, or up to $30 million for a married couple when both spouses’ exclusions are preserved and available, and it’s indexed for inflation thereafter, replacing the roughly $7 million figure that had been scheduled under prior law.
That raised the bar for most estates, but it did not eliminate the planning issue for growing businesses that outpace the exclusion, including many here in Utah. A $10 million business growing at 12% a year reaches roughly $17.6 million in five years. That puts approximately $2.6 million above the $15 million 2026 individual exclusion. At the 40% maximum federal estate-tax rate, that excess alone represents more than $1 million in potential tax before accounting for deductions, credits, prior taxable gifts, and other estate-planning factors.
This guide covers how the freeze works, the vehicles used to execute it, who it fits, and where the mistakes tend to happen.
An estate freeze is a restructuring of ownership interests that fixes the value of the owner’s position while directing all future growth to the next generation, executed through share recapitalization, trust structures, or both.
The owner exchanges common stock for preferred shares carrying a fixed dividend and liquidation value. New common shares, representing every dollar of future appreciation, go to children, a family trust, or a holding entity. The business can continue operating normally, but the ownership and economic rights attached to its shares change.
Three vehicles drive most estate freeze structures: share recapitalization, irrevocable trusts, and sales to Intentionally Defective Grantor Trusts (IDGTs). They are frequently layered together rather than used in isolation.
In a recapitalization, the owner exchanges common (growth) shares for preferred shares with a fixed dividend rate and liquidation value. New common shares are then issued to the next generation or a trust, with value determined under the valuation rules of IRC Section 2701.
Because the growth shares carry no guaranteed dividend or liquidation preference, their determined value is typically lower than the preferred shares’ value. The actual relative values turn on each interest’s specific economic rights, the company’s financial condition, and its growth prospects. Section 2701 exists specifically to prevent artificial undervaluation in these transactions; structured incorrectly, the recapitalization can produce a taxable gift far larger than intended, or an outright IRS challenge to the valuation.
A properly structured irrevocable trust, often a dynasty trust, can hold the growth interest outside the owner’s taxable estate, with spendthrift protections, distribution controls, and multi-generational provisions built into the trust document. Whether the assets remain outside the estate depends on the trust’s terms and how it is administered; retained control or informal access can undo the protection. For business owners layering asset protection strategy into the same plan, the trust does double duty.
An IDGT is structured to be treated as a grantor trust for income tax purposes while being designed to avoid estate tax inclusion under the applicable transfer-tax rules. Grantor trust status alone doesn’t accomplish that; the trust also has to avoid retained rights or powers, the kind addressed under IRC Section 2036, that would pull the transferred property back into the owner’s estate. Getting both objectives right in the same structure is the point of the tool.
The more common execution isn’t a straight gift into the trust. It’s a sale. The owner may first make a seed gift to give the trust independent economic substance. A seed gift equal to roughly 10% of the value being transferred is a commonly cited planning convention, not a statutory or IRS-mandated threshold. The appropriate amount depends on the specific facts and structure. The owner then sells the growth shares to the trust for a promissory note bearing interest at the applicable federal rate. Because the sale is to a grantor trust, it’s disregarded for income tax purposes, so no gain is recognized on the sale itself.
If the shares appreciate faster than the note’s stated rate, that excess appreciation can accumulate in the trust rather than in the owner’s taxable estate, assuming the transaction is respected and the trust is properly structured. The note itself, a fixed-value asset, remains in the estate. The owner also continues paying income tax on the trust’s earnings, which is not treated as an additional gift, so the trust compounds without that tax drag.
Suitability turns on the owner’s income tax situation and liquidity. An owner with enough outside cash flow to cover the trust’s tax liability without straining personal finances gets more leverage from an IDGT sale than from a straight gift structure.
The three vehicles above fix value through a sale price, a gift valuation, or a fixed dividend and liquidation preference, mechanics that work the same way whether the recipient is active in the business or not. A profits interest operates on a different basis and fits a specific, recurring scenario: a second- or third-generation actively working in the business, buying out an earlier generation’s interest over time, rather than a passive heir receiving a gift of the growth position. Because the value shifts to the recipient through their own ongoing contribution to the business rather than through a purchase price or a fixed payment stream, it functions as its own category of freeze, one earned through activity in the business rather than executed as a transaction.
When a child works in the business as an employee, officer, or manager and is buying out a parent’s or grandparent’s stake over time, an equity compensation structure can run alongside the recapitalization and sale already covered. Profits interests are usually the most efficient tool for that layer.
A profits interest is an equity grant in a partnership or an LLC taxed as a partnership that gives the holder a share of future profits and appreciation, with no claim on the entity’s existing value at the time of the grant. Under Revenue Procedure 93-27 and Revenue Procedure 2001-43, a profits interest structured with a liquidation threshold, a “hurdle,” set at or above the entity’s fair market value on the grant date generally isn’t taxed to the recipient at grant or at vesting. The child reports a share of the entity’s income on a K-1 during the vesting period, but the grant itself is compensation for services rather than a gift. It doesn’t consume gift tax exemption or require a Form 709 filing the way a transfer of growth shares to a trust does.
That distinction matters when an owner wants to treat a working child differently from siblings who hold passive interests through a trust. The parent can still execute the preferred-stock recapitalization described above, then sell or gift the resulting growth shares to a trust for the benefit of all the children, and separately grant the working child a profits interest in a subsidiary, division, or holding entity tied to the value that child is building through active management. The profits interest adds compensation for services on top of the freeze rather than substituting for it, and it needs to be sized as reasonable compensation under IRC Section 162 so it isn’t recharacterized as a disguised gift.
The mechanism only works where the operating entity, or a holding company layered above it, is taxed as a partnership. A C-corporation or an S-corporation can’t issue profits interests. For a corporate structure, restricted stock, stock options, or phantom equity serve a similar purpose, but each carries its own rules, including Section 83(b) elections for restricted stock and Section 409A compliance for phantom equity and other deferred compensation arrangements. The choice between an LLC-based profits interest and a corporate equity award usually turns on the business’s existing entity structure.
Layering a profits interest into a freeze that already uses a preferred/common recapitalization puts several ownership classes into the same family-controlled entity, and IRC Section 2704 can affect how some of those interests are valued alongside the Section 2701 rules already at play. Section 2704(a) can treat the lapse of a family member’s voting or liquidation right as a taxable transfer if the family controls the entity before and after the lapse, which matters if the parent’s retained rights change as the working child’s profits interest vests or converts. Section 2704(b) disregards certain liquidation restrictions, not every minority-interest or marketability discount, when a restriction goes beyond default state law, and the family itself has the power to remove it.
Practitioners sometimes describe structuring interests proportionately across an entity’s capital and profit classes, rather than concentrating restrictive terms in the interest being valued, as taking a “slice of the pie.” Whether that approach holds up under Section 2704(b) depends on the entity’s specific governing documents and the restriction at issue, so this is an area to work through with tax counsel case by case rather than a formula to apply on its own. The 2016 proposed regulations that would have curtailed these discounts further were withdrawn in October 2017, and the rules in place since 1992 still govern, though that’s worth reconfirming before a transaction relies on it.
The strategy fits an owner whose company has room to grow, who has or expects a taxable estate, and who wants ownership to transfer without a large gift or estate tax event triggered at the wrong time. It applies most directly to:
The earlier the freeze relative to the growth curve, the more value shifts out of the estate. A $3 million business with a credible path to $10 million creates more room to work with than one already at $10 million.
It’s a poor fit for owners comfortably under the exclusion with no expectation of crossing it, businesses with flat or declining value, or situations requiring full liquidity from the business in the near term.
Thinking about protecting your business’s value for the next generation? Allegis Law helps business owners craft customized estate freeze strategies. Explore our business succession planning services to see how we can help.
The tax treatment of the freeze depends heavily on obtaining a well-supported, independent valuation at the time of the transaction. That valuation helps establish the value of the preferred shares the owner retains and the transfer value of the growth shares. Discounts for lack of control or lack of marketability may apply to minority interests, reducing the taxable gift, but the appraiser needs to be prepared to defend the conclusion if the IRS examines it.
New articles, operating agreements, or shareholder agreements create the two-tier ownership structure. This requires coordination between legal and tax counsel, often alongside broader business formation work, to avoid triggering gain recognition or running afoul of IRC Section 2701’s transfer rules. The preferred shares are typically structured with a qualified payment right, such as a cumulative dividend payable at a fixed rate, because Section 2701 can impose unfavorable valuation treatment on retained interests that don’t qualify for that treatment.
If a trust is the recipient, it has to be drafted, executed, and funded before the sale occurs. The trust’s terms (trustee selection, distribution mechanics, what happens at the owner’s death) are highly customizable. For IDGT structures specifically, the trust needs provisions establishing grantor trust status for income tax while remaining outside the owner’s estate for estate tax purposes, and the sale documentation (promissory note, interest rate, payment terms) needs to withstand scrutiny as a bona fide transaction.
A freeze isn’t a one-time event. Required preferred payments need to be made according to the governing documents and applicable tax rules. The note, if there is one, has to be serviced. The trust has to be administered according to its terms, a process our probate and trust administration team also supports when a trustee needs guidance. Gift tax returns (Form 709) may need to be filed to report the transfer, even when no tax is due. Annual reviews keep the structure aligned with the owner’s goals and current tax law.
The One Big Beautiful Bill Act, signed July 4, 2025, made the higher exclusion permanent and canceled the scheduled drop to roughly $7 million that Tax Cuts and Jobs Act provisions were set to trigger at the end of 2025. The $15 million figure itself isn’t frozen: starting in 2027, it adjusts annually for inflation, so the number will climb even though the higher framework has no expiration date.
Utah does not impose a separate state estate or inheritance tax, so Utah business owners generally face the federal estate-tax system rather than a separate Utah death tax. That exposure is still real for fast-growing companies, especially once other assets are added to the mix: real estate, investment accounts, life insurance not held in an ILIT. An estate tax attorney can model the specific numbers against your timeline.
An estate freeze is one component of a succession strategy, not the whole plan. Buy-sell agreements, key person insurance, governance structures, and family communication about roles still need to be addressed separately.
A frequent misconception equates the freeze with losing control of the business. It doesn’t have to. Preferred share structures preserve dividend income and, depending on how the shares are drawn up, voting rights and board influence. An estate freeze doesn’t require the owner to step back from operating the business, but retained voting, management, and economic rights need to be structured carefully. Excessive retained control can create its own estate-tax inclusion problems under rules like IRC Section 2036.
Where heirs aren’t ready to run the company, the trust can hold the growth shares as an interim owner, with an appropriately selected trustee administering the trust until the next generation is prepared. That separates the tax strategy’s timing from the operational succession timeline, which don’t have to move together.
Undervaluing preferred shares to minimize gift tax on the growth shares. This invites scrutiny under Section 2701. If the IRS determines the preferred shares were undervalued, the intended estate-tax benefits can be substantially reduced or eliminated. A qualified, well-supported appraisal is critical to defending the transaction’s valuation.
Failing to pay the required preferred dividend. Failure to make required preferred payments can create adverse transfer-tax consequences, particularly where cumulative but unpaid distributions coincide with a later taxable event. The business needs sufficient cash flow to support the dividend, or the mechanics need to account for deferrals up front.
Granting a profits interest without a properly set hurdle. If the liquidation threshold is set below the entity’s fair market value on the grant date, the working child can recognize immediate compensation income on the grant, undermining the tax efficiency the structure is meant to provide. A contemporaneous valuation supports the hurdle the same way it supports the preferred share value in a recapitalization.
Treating the freeze as the entire estate plan. It addresses one dimension of a succession strategy. Without a coordinated will, powers of attorney, healthcare directives, and a trust administration plan, the freeze on its own won’t achieve the broader objective. Comprehensive estate planning is what ties the pieces together.
The owner splits ownership into two pieces. One piece, usually preferred shares, keeps a fixed value and stays with the owner. The other piece, usually common shares, captures all future growth and goes to the owner’s heirs or a trust. The goal is for that future growth to stay outside the owner’s taxable estate.
A direct gift of appreciated shares generally uses gift tax exemption based on the shares’ full current fair market value, consuming a meaningful portion of the lifetime exclusion even if no tax is owed. A freeze transfers only the growth interest, often at a much lower current value, preserving more of the exclusion for other planning.
No, though appreciation potential alone doesn’t automatically make it the right fit. It tends to benefit owners who expect substantial appreciation and whose broader estate, liquidity, and succession goals make the strategy appropriate. With the exclusion now permanently set at $15 million per individual for 2026 (indexed thereafter), it matters most for owners whose businesses are likely to grow past that threshold.
Not necessarily. The negotiated dividend rights of the preferred shares, along with trusteeship of the trust holding the growth shares, can preserve operational authority while the tax objective is met.
Often, yes, if the operating entity or a holding company above it is taxed as a partnership. A profits interest lets the working child capture future growth as compensation for services rather than as a gift, and it can be layered alongside the freeze structure used for other heirs. It requires its own valuation to set the liquidation threshold correctly and needs to reflect reasonable compensation for the work performed.
Before significant appreciation occurs, since the value locked in reflects the business’s worth on that date. Waiting even a few years can mean freezing a much larger, and more expensive, starting point.
Yes. An IRS-defensible valuation sets the value of the preferred shares and the transfer value of the growth interest. Without it, the structure is vulnerable to an IRS challenge that unwinds the intended tax result.
Estate freeze planning is designed to fix the value of the owner’s retained business interest at today’s value while directing future appreciation to the next generation. For companies on a strong growth trajectory, the cost of waiting is measured in real, avoidable estate tax dollars.
Allegis Law works with business owners to design and implement estate freeze strategies, integrating share recapitalizations, IDGT sales, and broader succession planning into one coordinated approach. The firm is based in Sandy, Utah, and serves clients nationwide.
Ready to lock in your business’s value and reduce estate taxes? Contact Allegis Law at (801) 938-4035 or request a consultation with our estate planning attorney.
This post is for informational purposes only and does not constitute legal advice. Every situation is unique. Please consult with a qualified attorney to discuss your specific circumstances.
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