Estate Planning for Private Equity Partners

How to structure illiquid carry, GP commitment, and portfolio company equity around the federal estate tax — before a liquidity event forces the issue. Not legal or tax advice; your documents and jurisdiction govern.

The PE estate planning problem

Estate planning for a PE partner is structurally different from planning for a physician, an executive, or even a hedge fund manager. The wealth is real but mostly illiquid. Carried interest on paper has no immediate cash value. GP commitment capital is deployed into a fund. Portfolio company co-investments are locked up. The typical PE partner at age 45 might have $15M of net worth with less than $2M actually accessible without triggering a margin call or a fund violation.

That illiquidity creates two related estate planning problems:

• Estate tax on assets you can't sell. A federal estate tax bill is due nine months after death — in cash. If 80% of your estate is illiquid fund interests and carry, your heirs may need to borrow, liquidate at distressed prices, or miss the distribution cycle that would have paid the bill naturally.
• Appreciation happening inside your estate. If your carry doubles in value over the next five years, that appreciation happens in your taxable estate. Every dollar of appreciation that stays inside the estate increases the eventual estate tax exposure — at a 40% marginal rate. Moving appreciation outside the estate, early, is where most PE estate planning value is created.

What the OBBBA changed — and what it didn't

The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, permanently raised the federal estate, gift, and generation-skipping transfer (GST) exemption to $15M per person — up from $13.99M in 2025, and eliminating the 2025 sunset that would have reduced it to roughly $7M.¹ For a married couple, the combined exemption with portability is $30M.

Timing the gift: when is carry worth the least?

The foundational insight in PE estate planning is that carried interest has its lowest gift/estate tax value early in a fund's life — sometimes near zero. If you gift or sell a fund interest when the underlying portfolio is at cost and carry is deeply out of the money, you transfer the right to future appreciation at minimal gift-tax cost.

Under Rev. Proc. 93-27, a profits interest granted in connection with services is not taxable compensation at grant if its liquidation value at grant is zero — i.e., the fund couldn't pay out the carry waterfall on day one.² The same logic applies to gift tax: an out-of-the-money carry right gifted at Fund I, Year 1 has minimal fair market value. The $15M in carry that materializes at Fund I, Year 8 was never in the grantor's taxable estate.

This timing window matters more than most PE professionals realize. Gifting a carry interest at fund inception — when it's worth close to zero — shifts eight years of appreciation to the recipient. Waiting until the carry is clearly in the money (later vintages, strong portfolio performance) dramatically increases the taxable gift value.

GRATs for PE fund interests

A Grantor Retained Annuity Trust (GRAT) under IRC § 2702 allows you to transfer an asset to a trust while retaining an annuity stream. At the end of the GRAT term, any appreciation above the IRS § 7520 hurdle rate passes to the remainder beneficiaries estate-tax-free.³ The § 7520 rate is set monthly by the IRS; GRATs work best when the transferred asset is expected to significantly outperform it.

PE fund interests are well-suited to GRATs for three reasons:

• High expected appreciation. A fund expected to return 2–3× (a 15–25% IRR) will easily outrun the § 7520 rate on the carry allocation. Every dollar of appreciation above the hurdle passes gift-tax-free.
• Low initial value. Funding a GRAT with a GP interest or carry allocation early in a fund's life — when the portfolio is near cost — means the annuity stream is sized against a low value, so the "zeroed-out" GRAT structure uses minimal gift-tax exemption.
• Valuation discounts. A limited partnership or LLC interest transferred to the GRAT may qualify for minority-interest and marketability discounts (see below), further reducing the taxable gift amount.

Practical constraints: GRATs must have a fixed term; if you die during the term, the trust assets return to your estate. Short-term rolling GRATs (2–3 years) are common for this reason. GRATs also cannot be used for GST purposes — assets passing from a GRAT to a dynasty trust require separate GST exemption allocation.

IDGTs: selling your estate to yourself

An Intentionally Defective Grantor Trust (IDGT) is an irrevocable trust that is outside your estate for estate tax purposes but is treated as a grantor trust for income tax purposes — meaning you pay the income tax on the trust's earnings without those tax payments being considered additional taxable gifts.⁴

The standard IDGT technique for PE professionals:

1. Seed the trust with gift. Transfer $1–2M of liquid assets to the IDGT using annual exclusions or a small portion of your lifetime exemption. The seed gift establishes the trust.
2. Sell the PE interest to the trust. Sell your fund LP interest, co-investment, or carry allocation to the IDGT for a promissory note at the applicable federal rate (AFR). Because the trust is a grantor trust, the sale is not a taxable event — no capital gains on the transfer. The note payments (at AFR, currently well below expected fund IRRs) come back to you; the appreciation above AFR stays in the trust forever.
3. You pay the income tax. Trust earnings are taxed on your personal return. This is the "defect" — but it's deliberate. Each dollar of income tax you pay is a further tax-free transfer to the trust's beneficiaries (you've paid their tax bill with no gift tax). On a $10M trust generating $400K of annual income at a 40% effective rate, you're adding $160K/year to the trust tax-free.

The IDGT is particularly powerful for PE co-investments and fund interests because: (a) the APR is typically well below fund expected returns, (b) the grantor's income-tax payments on phantom income (unrealized fund gains reported on a K-1) further deplete the taxable estate, and (c) carried interest gains inside the IDGT are eventually taxed at the beneficiaries' rates, not the grantor's.

Valuation discounts for PE fund interests

When a limited partnership interest or LLC membership interest is transferred by gift or at death, its fair market value for estate/gift tax purposes is not necessarily dollar-for-dollar with the underlying asset value. A minority LP interest with no control rights and no ability to force liquidation or redemption is worth less than a proportional claim on the fund's NAV.⁵

Two discounts commonly apply:

• Lack of marketability discount (LOMD). An LP interest in a private fund cannot be sold on the open market — transfer restrictions, GP consent requirements, and fund lock-up periods reduce marketability. LOMD discounts of 15–30% are supportable in most PE fund contexts.
• Lack of control discount (LOCD). An LP interest has no ability to control investment decisions, force distributions, or liquidate the fund. Combined with LOMD, total discounts of 25–40% on fund interests are defensible with proper appraisal.

Estate liquidity: solving the cash problem

The practical estate planning problem for a PE partner isn't always the exemption — it's the cash. A 45-year-old partner with a $30M estate, $15M exemption, and $15M above the exemption faces a $6M estate tax bill due nine months after death. If 80% of the estate is illiquid fund interests, the heirs need to raise $6M quickly — potentially during a down market, at forced-sale prices, at an unfavorable point in the fund cycle.

Two approaches solve this:

1. Irrevocable Life Insurance Trust (ILIT)

A life insurance policy owned inside an Irrevocable Life Insurance Trust (ILIT) pays out outside the taxable estate — the death benefit is not subject to estate tax, and proceeds are available immediately to pay the estate tax bill.⁶ The ILIT is funded via annual exclusion gifts ($19,000 per beneficiary per year in 2026) to pay the premiums. On death, the trust provides liquidity to the estate, typically via a loan or asset purchase — without the proceeds themselves being included in the estate.

This is the primary tool for PE partners whose estate tax liability is predictable but whose liquid assets are insufficient to cover it without disrupting fund distributions.

2. Installment payment under IRC § 6166

If more than 35% of the adjusted gross estate consists of a closely held business interest, IRC § 6166 allows the estate to defer payment of the portion of estate tax attributable to that interest over up to 14 years (5-year deferral + 9-year installments).⁶ A PE firm's general partner interest often qualifies as a "closely held business." The deferred tax accrues interest at 2% on the first $1.78M (2026) of deferred tax and 45% of the underpayment rate on the balance.

§ 6166 is a planning option, not a windfall — the interest costs are real, and the installment election requires precise documentation of the GP interest at death. It works best when the estate has other assets to service the interest payments while fund distributions mature.

Dynasty trusts and the GST exemption

The $15M GST exemption matches the gift/estate exemption for 2026.¹ Allocating GST exemption to a dynasty trust locks carry appreciation away from estate tax for multiple generations — in perpetuity in states like South Dakota, Nevada, Delaware, Alaska, and Wyoming, which have abolished the Rule Against Perpetuities.

A PE partner with $10M of carry at Fund III inception can seed a dynasty trust with that carry interest (valued at near-zero if the carry is out of the money), allocate GST exemption of close to $0, and let fund appreciation compound inside the trust. At exit, $40M of carry proceeds sit in the trust — never taxed at 40% at your death, never taxed again at your children's deaths, compounding through grandchildren and beyond. The carry gain itself was taxed as LTCG in the year of distribution; the dynasty trust simply prevents the estate-tax layer from applying to subsequent compounding.

Charitable planning at liquidity events

Carry distributions are lumpy. A PE partner may receive $0 for seven years, then a $10M distribution in a single year. That $10M is taxable (at LTCG rates if the 3-year holding rule is met — roughly 23.8% federal, plus state). Charitable planning before or at the distribution reduces this bill:

• Donor-Advised Fund (DAF). Contributing appreciated carry — or cash in the year of distribution — to a DAF generates a charitable deduction in the year of contribution, deductible up to 60% of AGI for cash and 30% for appreciated assets (with a 5-year carryforward). The DAF invests the assets; you direct grants over time. Simple, flexible, and effective for most sizes.
• Charitable Lead Annuity Trust (CLAT). A CLAT pays a fixed annuity to charity for a term of years; the remainder passes to beneficiaries (or a dynasty trust) gift-tax-free if structured correctly. The larger the § 7520 rate, the larger the charitable deduction. CLATs work well when funded at a liquidity event with a large asset expected to grow above the § 7520 rate.
• Charitable Remainder Trust (CRT). A CRT allows you to contribute an appreciated, illiquid asset, avoid immediate capital gains, receive an income stream for life or a term, and pass the remainder to charity. For PE co-investments expected to exit but not yet distributing, a CRT is occasionally used to monetize the position tax-efficiently while maintaining income. Useful when the co-invest is a significant illiquid position with a near-term exit horizon.

Coordinating with your carry, QSBS, and state tax plan

PE estate planning doesn't sit in a silo — every decision intersects with carry taxation, QSBS planning, and state residency strategy:

• Carry and estate planning: A GRAT seeded with a fund carry interest shifts appreciation outside the estate. But the GRAT's annuity payments are taxed to you as ordinary income or LTCG depending on the fund's distributions. Model both the estate tax and income tax implications together.
• QSBS and estate planning: QSBS stacking requires non-grantor trusts — each is a separate taxpayer with its own $15M exclusion cap. But transfers to non-grantor trusts are taxable gifts; coordinate with the estate exemption and annual exclusion. The trust must hold the QSBS long enough to meet the 3/4/5-year holding period (post-OBBBA). Don't transfer in the year before a sale.
• State residency and estate planning: Moving to Florida or Texas eliminates state income tax on carry — but it also affects the state estate tax. No state estate tax in FL/TX; CA has no state estate tax but NY does (top rate 16%, exemption only $7.06M in 2026). If you're planning a state residency change, coordinate it with the timing of trust establishments and GRAT fundings — trust situs matters.

What a specialist advisor does here

Generic estate attorneys don't know PE fund documents. Most PE fund lawyers don't know estate planning. The coordination gap is where most value is left on the table. A specialist fee-only financial advisor who works with PE professionals will:

• Map the full estate — carry, GP commitment, fund LP interests, co-investments, ManCo equity, deferred comp, personal assets — and identify which assets are most advantageous to move outside the estate, and when
• Model GRAT structures at current fund marks vs. projected exits — identify the optimal vintage and fund for the initial transfer
• Coordinate with estate counsel on IDGT note pricing (AFR selection), GRAT term, and trust situs
• Identify QSBS positions that should be transferred to non-grantor trusts before any exit is in motion
• Size the ILIT and insurance need based on current and projected estate value
• Project carry distributions by year and integrate charitable planning (DAF vs. CLAT vs. CRT) with income tax projections
• Coordinate all of the above with state residency timing if a move is in scope

Sources

1. IRS — 2026 Tax Inflation Adjustments (OBBBA). 2026 estate/gift/GST exemption: $15,000,000 per person (indexed). Annual gift exclusion: $19,000. Non-citizen spouse annual exclusion: $194,000. Source of all 2026 threshold figures in this guide.
2. Rev. Proc. 93-27 — Profits Interests Not Taxable at Grant — IRS. A profits interest granted in connection with the performance of services is not taxable at grant if it has zero liquidation value on day one. Foundational authority for gift/estate valuation of newly issued PE carry rights.
3. IRC § 2702 — Special Valuation Rules for GRATs — Cornell LII. Framework for grantor retained annuity trusts: remainder-interest valuation, §7520 hurdle rate, actuarial tables. The "zeroed-out" GRAT is structured so the annuity present value equals the transferred asset's fair market value at funding.
4. Kitces — IDGTs: The Income Tax Freeze Strategy — Michael Kitces, CFP. Explains the IDGT sale-for-note structure: why grantor trust treatment eliminates capital gain on the sale, how grantor's income-tax payments are an additional tax-free gift, and coordination with estate freeze planning.
5. IRC § 2704 — Valuation of Certain Restrictions on Family Entities — Cornell LII. Limits the use of lapse provisions and applicable restrictions in valuing family partnership and LLC interests for gift/estate purposes. Governs the defensibility of LOMD and LOCD discounts in family situations.
6. IRC § 6166 — Extension of Time for Payment of Estate Tax Where Estate Consists Largely of Interest in Closely Held Business — Cornell LII. 14-year installment election (5-year deferral + 9-year payments); 35% threshold; interest rate on deferred tax; applicable to qualifying GP interests.

Values verified as of April 2026. Estate and gift tax law changes with legislation and inflation adjustments; verify current thresholds at IRS.gov before acting. This guide does not constitute legal, tax, or estate planning advice.