The Most Dangerous Asset in an Estate Is an Illiquid One
By: Randall A. Denha, J.D., LL.M.
Many business owners believe their company itself solves the estate problem because “the business is worth a lot.” Valuation and liquidity are two completely different concepts and conflating them is one of the costliest mistakes I see in succession planning. The balance sheet says one thing. The checkbook says something very different when the estate tax bill arrives.
A company may be worth $30 million on paper and still be impossible to monetize quickly without massive valuation discounts, seller financing that stretches over a decade, a loss of operational control, distressed sale conditions driven by a tax deadline, or the kind of internal family conflict that destroys both the business and the relationships around it. The IRS does not accept stock certificates in payment of estate tax. Under IRC Section 6075, the federal estate tax return is due nine months from the date of death, and the tax is due with the return. Section 6166 offers a deferral election for estates where the closely held business interest exceeds 35 percent of the adjusted gross estate, allowing tax attributable to that interest to be deferred for up to five years (with interest-only payments during that period) and then paid in up to ten annual installments. It is genuine relief, but it is not free money. The interest rate on the deferred tax is a two-tier structure: a special 2 percent rate applies to the tax on the first approximately $1.86 million (indexed for inflation) of taxable value attributable to the business interest, and 45 percent of the regular underpayment rate applies to the remainder. The estate remains exposed to acceleration if 50 percent or more of the business interest is sold or distributed, and the IRS may require a bond or special lien under Section 6324A. Section 6166 is a bridge, not a solution.
Why Illiquidity Costs More Than the Tax Itself
The hidden cost of an illiquid estate is rarely the tax. It is the discount the family takes to raise the cash.
When a forced sale enters the conversation, three things happen simultaneously. First, the buyer pool shrinks, because every sophisticated acquirer knows the seller has a clock running. Second, the price compresses, often by 20 to 40 percent below what a patient sale would have produced. Third, the deal terms deteriorate, with larger holdbacks, longer earnouts, broader indemnification, and seller financing at rates that do not reflect actual risk.
A $30 million company sold under estate pressure frequently nets the family closer to $18 to $22 million after discounts, fees, and tax. The estate tax was perhaps $6 million. The illiquidity cost was another $8 to $12 million on top of that. Planning is not about avoiding the tax. It is about avoiding the discount.
The Inheritance Math No One Wants to Do
When multiple children inherit a business unequally, the fault lines are predictable. One child works in the business and has spent twenty years building enterprise value. One child does not, and never wanted to. One child wants cash because they have their own family, their own mortgage, their own life. One child wants control because they believe they have earned it. One child wants out entirely and views the company as a complication rather than a legacy.
Equal is not the same as equitable, and the document that treats them as identical concepts is the document that creates the lawsuit. If three children inherit equal voting interests, and only one of them runs the company, the operating child now answers to siblings who have no operational understanding but full statutory rights to financial information, distribution decisions, major transactions, and in some states, judicial dissolution. The operating child resents the passive siblings drawing distributions. The passive siblings suspect the operating child of paying themselves too much, expensing too aggressively, or suppressing dividends to fund a future buyout at a depressed price. Buy-sell triggers get litigated. Minority oppression claims surface under state LLC and corporate statutes. Forensic accountants are retained. The company that took thirty years to build can be hollowed out in three.
What Liquidity Planning Actually Looks Like
The structural answers are not exotic, but they require committed execution well before the founder’s capacity or life expectancy becomes an open question. Five tools do most of the work.
The buy-sell agreement, properly funded and properly structured. This is the foundation, and most agreements I review are out of date. The threshold question is structure: redemption, cross-purchase, or hybrid. After Connelly v. United States, the Supreme Court’s June 2024 decision, the analysis changed materially. The Court held that life insurance proceeds received by a corporation to fund a redemption obligation are included in the value of the company for estate tax purposes, and that the redemption obligation itself does not offset that value. The result is that entity-owned insurance funding a redemption can inflate the decedent’s estate by the full death benefit without producing a corresponding reduction in company value. Cross-purchase structures avoid this problem because the insurance is owned by the surviving shareholders rather than the entity, but cross-purchase becomes administratively unwieldy with more than two or three owners. Insurance LLCs and special purpose partnerships have emerged as the practical workaround, allowing a single policy per insured to fund cross-purchase obligations across multiple shareholders without the policy ever being owned by the operating company. Every buy-sell signed before 2024 deserves a fresh look.
The Irrevocable Life Insurance Trust. An ILIT holding survivorship or single-life coverage gives the estate the cash it needs to pay tax, equalize among non-operating children, or fund a buyout of the operating child’s siblings. The premium dollars are leveraged, the death benefit sits outside the taxable estate when the trust is properly structured so that the insured retains no incidents of ownership under Section 2042 (with premium gifts typically qualifying for the annual exclusion through Crummey withdrawal rights or hanging powers), and the trustee can be directed to lend proceeds to the estate or purchase illiquid assets from the estate at fair value. That last technique, the ILIT-to-estate loan or purchase, is often the cleanest way to inject liquidity without the policy proceeds themselves becoming an estate inclusion problem.
Lifetime transfers using the increased exemption. The One Big Beautiful Bill Act made the increased exemption permanent beginning in 2026, indexed for inflation (approximately $15 million per individual as of the effective date). For a married couple, that is $30 million of combined exemption, and the planning calculus is very different than it was when sunset was looming. Gifts of non-voting interests to grantor trusts for the benefit of children, or installment sales to Intentionally Defective Grantor Trusts in exchange for promissory notes at the applicable federal rate, allow the founder to move appreciation outside the taxable estate while retaining a fixed-dollar receivable. Done with a recapitalization that creates voting and non-voting classes, the transferred interests carry valuation discounts for lack of control and lack of marketability that frequently range from 25 to 40 percent depending on the appraisal, the entity structure, and the operating agreement restrictions. The leverage compounds. A $10 million pre-discount interest gifted at a 35 percent combined discount uses $6.5 million of exemption and removes all future appreciation on $10 million of underlying value.
The freeze partnership or preferred equity recapitalization. For founders who are not ready to give up cash flow, a freeze structure under IRC Section 2701 allows the senior generation to retain a preferred interest paying a qualified payment, while the common interest, which captures all future appreciation, is transferred to children or trusts for their benefit. Drafted correctly, with a cumulative qualified payment right and proper valuation, the freeze caps the senior generation’s estate at the preferred interest’s stated value while shifting growth out of the taxable estate. The complexity is real and the Section 2701 rules are unforgiving, but for the right facts the technique is extraordinarily efficient.
Governance separated from economics. This is the planning move that gets the least attention and prevents the most litigation. Voting interests go to the operating child or to a small voting trust controlled by the operating child. Non-voting interests, or other assets entirely, go to the non-operating children. A well-drafted operating agreement defines manager authority, distribution policy, related-party transactions, information rights, deadlock resolution, and exit mechanics in enough detail that no one needs to guess. The non-operating children get economic participation without the leverage to disrupt operations. The operating child gets control without the temptation to abuse it, because the document constrains both sides.
The Conversation No One Schedules
The planning failures I see most often are not technical. They are conversational. The founder never told the children what the plan is. The operating child assumes she is getting the company. The non-operating children assume they are getting equal shares of everything. Both assumptions are usually wrong, and the discovery happens at the worst possible moment, in a lawyer’s conference room a week after the funeral, when grief and suspicion are still doing most of the talking.
A family meeting with counsel present, even an uncomfortable one, is worth more than any document. The point is not to take a vote, and it is not to negotiate the founder’s intentions. The point is to make sure that when the founder is no longer in the room, the children already know what was decided, why it was decided, what role each of them is expected to play, and where the liquidity is coming from. The document can do a great deal, but it cannot answer the question of why one sibling got the voting interests and the other did not. Only the founder can answer that, and only while she is alive. The business does not have to become the battlefield. But avoiding that outcome requires treating liquidity, governance, and family dynamics as the same problem, because in an illiquid estate they always are. The advisor who solves for the tax but ignores the family has solved the easier half of the equation.
