Estate Planning for Small Business Owners

It is long-held wisdom that “with great power comes great responsibility.” The freedom of owning a business and making all decisions related to its operation affords many of our clients the opportunity for great success, but also requires additional efforts to be made in planning their personal estates. The standard estate recommendations of wills, trusts and powers of attorney apply to each owner, but an entrepreneur has the additional burden of planning for the transfer of a business upon death. The complications of business ownership require succession planning to insure that the business either continues into the future, or is eventually disposed of in a way that provides the most benefit to the family.

The first consideration is to determine what type of business you own. An owner-dependent business is one in which the majority of the value lies in the efforts of the owner, such that upon the death of the owner, there is not much left to transfer. Think of a solo law or medical practice, an art studio, or a small advertising company. Often called “lifestyle practices,” these businesses can be very lucrative while the creative/working force behind them is at the helm. The personal relationship between entrepreneurs and clients is what powers these businesses. Upon the death of the owner, the income stream largely dries up or disappears entirely if long-term contracts and new company leaders are not in place. As such, this type of business owner may not need additional estate planning documents, and instead should focus on financial and insurance planning to provide for surviving family members that may be dependent upon the income of the business.

Small businesses that will survive the death of an owner require a more sophisticated approach to insure a successful transfer. If the goal is to pass a family business down to the next generation, working with a financial advisor and an accountant, as well as an estate planning attorney, can minimize the tax consequences for both the family members inheriting the business and the estate of the original owner. For example, using a family limited partnership or a family limited liability company to hold the business assets can reduce the estate tax owed upon the transfer to future generations. During the owner’s lifetime, some of the limited partnership units can be transferred to future successors. Because limited partnership interests do not carry control of the partnership, the value of the transferred assets may be discounted for gift tax purposes, thereby reducing the amount to transfer at the owner’s death without giving up any operational control during life.

While the most enduring small businesses often include non-family partners who can continue to run the business long after the death of a founder, small business ownership is also complicated by having these partners in the business. When one partner dies, the remaining owners are left running a business with the surviving spouse or children, any of whom may be ill-equipped or completely disinterested in such a role. In multi-owner situations, a buy-sell agreement (BSA) is nearly essential. This agreement is a contract between co-owners of a business that dictates the transfer of ownership of the business should a co-owner die, become incapacitated, or choose to leave the business. The BSA may control who can purchase the departing owner’s share of the business, the events that will trigger a buyout, and the price (or the method for arriving at a price) that must be paid for the departing owner’s share in the business.

The BSA can be structured in several ways. The business itself can purchase the ownership interest from the estate of the deceased owner, or the co-owners can agree to purchase each other’s interest. Whichever form is used, life insurance is often the source of funds to make these payments. Insurance policies are taken out on the lives of each owner, with either the business or the other owners listed as beneficiaries. The value of the policies is sufficient to pay the agreed-upon amount to the estate of the deceased owner to satisfy the BSA.

Small business owners commonly say, “Yes, but my business is unique because…” And they are right. Each successful small business is unique in its product, service, audience, structure, size, ownership, taxation and challenges. The correct estate plan will be as unique as your company is, and you need a team that has the expertise and experience to design the plan to address your company’s needs. To find out more about how our team can help you, contact us at teamdbt@brennanfinancialservices.com.

This material is intended for informational purposes only and should not be construed or acted upon as individualized investment advice. Neither FSC Securities Corporation, nor its registered representatives, offer tax or legal advice. Federal tax laws are complex and subject to change. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.