(FORTUNE Magazine) – Sure, you labored like a mule to build your company, and you fought like a lion to protect it, so take a bow. But don't let the applause go to your head--yet. When the time comes to sell your business and retire, will you be ready? Unless you've already done a lot of planning and consultation with accountants and lawyers, the answer is probably no. So start thinking this thing through carefully. Disposing of a business is one of the most important decisions you will make. One wrong move, and the IRS could walk off with more than half of your life's work.

Before you sell your business, you must ask yourself some important questions. Do you want to retire completely, or would you like to be involved in the business in a limited way? Are your spouse and children provided for, and will you have enough cash to live as you would like in retirement? Should you give the business to the kids?

Once you've got your plans straight, you need to choose the best way to cash out. Financial planners say that there are three basic approaches: You can sell the business outright, form a limited partnership, or create a personal holding company. Each one has its own advantages and disadvantages. The trick is knowing which fits your plans for retirement the best.

Probably the simplest way to retire is to sell the company outright for cash, buy bonds or an annuity, kick up your feet, and relax. Assuming you get full value in the sale, this may be the safest path. But safety has its price, and in this case the price is a thunderous tax burden. When you sell your company, you pay a capital gains tax of 28% on the sale price minus your investment in the company. Thus, if you're an entrepreneur who starts a company with a few thousand dollars stashed in a sock, you will shell out almost 28% of the entire value of the company when you sell. Now assume that you sell, pay the tax, get in a few good years of grandchildren and golf, and then die. Anything you leave your spouse is not taxed. But all other heirs combined receive only $600,000 tax-free and then must pay between 37% and 55% of the value of the remaining assets to the IRS in estate taxes. (The 55% bracket applies to any estate in excess of $3.5 million.) The combined bite of the capital gains tax and the estate tax can be around 70%. Yikes.

If that ticks you off more than a little bit, take heart: Financial planners have cooked up some creative solutions that can reduce the tax burden substantially. For instance, a person who dreams of leaving the children the company, or the wealth that is in the company, can save a lot of tax by giving it away piecemeal over time. Each year you are allowed to give a tax-free gift worth $10,000 to as many family members or friends as you wish. Thus a parent can give each child an annual gift of company stock worth $10,000. Or the parents together can give each child $20,000. Later on, if your kids decide to sell their shares, they pay only capital gains tax (28%) and avoid the much heavier estate tax rate (55%).

This is the strategy Jack Krenzen adopted soon after he founded Krenzen Indoor Auto Mall, a Duluth, Minnesota, car dealership. "When I started the company in 1971," says Krenzen, who just turned 65, "my three boys learned the business around the kitchen table and by pushing brooms at the showroom." In 1977, Krenzen began giving each son annual gifts of stock, until today he owns only one-third of the company. But Krenzen senior still gets income from a consulting contract. "Most people let ego stand in the way," says Krenzen, "but I know I did the right thing. The kids got most of the company tax-free, and it's legal." He says sales have been growing 30% a year since his sons took over full-time management five years ago.

If giving the kids stock that they could sell to anyone (even a rival) in a fit of pique makes you nervous, consider forming a family limited partnership. Here the company is owned by two classes of partners: the general partners and the limited partners. Under this arrangement you, as general partner, keep 1% of the company and total control. Your kids get 99% of ownership (which can be subject to gift taxes) but little or no say in how the company is run. Consequently, your kids' share of the company is almost unmarketable. Says Kevin Flatley, a vice president at the Private Bank of the Bank of Boston: "Who wants to buy my interest if my cranky old father is my controlling partner?" Since the shares are hard to sell, they can be discounted by up to 40%. That means a $10,000 tax-free grant of stock is actually worth about $16,000.

If you have no children to leave the company to and you're not interested in running the company any longer, you might consider transforming it into a personal holding company. This would allow you to realize the financial value of your business without paying very much capital-gains tax. Here's how it works. Your company sells its hard assets--including inventory, parts, buildings, machinery, and the like-takes the proceeds, and invests them. Flatley suggests that the funds could be used to buy dividend-paying preferred stock. That's because the dividends paid to a company (such as your new holding company) are 70% tax-free. However, any money that you take out of your new holding company is subject to income tax.

The tax savings in the holding company and the limited partnership are nifty, but as new creations they have not been fully vetted in the courts and by the IRS, a process that may take another five years. Kenneth Werner, a partner at Day Berry & Howard, a Boston law firm, says, for instance, that the size of discounts assigned for gifts of minority shares of stock may undergo some challenge and review. The risk is that avoided gift tax or estate tax will have to be paid at a later time--in some cases with interest and penalties. Have professionals scrutinize anything you do.

Whatever strategy you choose for selling your business, keep in mind it takes time. Don't make the mistake of waiting until the last minute. For example, there's no way you could give your company to your kids in annual $10,000 tax-free chunks if you decide to sell it tomorrow. And you never know exactly when you might retire. Says David Gerson of Ernst & Young: "Entrepreneurs think they are indestructible. They aren't, and they should start planning in their 40s." Go to it.