Preparing for Taxes

Estate Planning for Family Business Owners

Most of us will use wills to distribute our assets and protect loved ones when we’re no longer around. Many business owners, however, don’t have the same mechanisms in place to ensure their firms stay in the family. Proper estate planning can help mitigate any risks following a business owner’s passing by determining how money and assets will be divided upon death. Not only does estate planning help ensure that the right people inherit your business, but it also enables you to minimize taxes during the transition while avoiding legal snafus.

Many business owners make the mistake of assuming that they can pass a family company down to their children without issue. The truth is that failing to create an estate plan may subject your estate to a federal gift tax. Coupled with the expense of funeral planning, this tax can put a serious burden on those family members left behind. Additionally, failing to communicate your intentions to family members and other business partners can leave your company floundering.

By creating a detailed estate plan for your family business now, you can rest assured knowing the company will transition smoothly when you’re no longer around. Here’s a brief list of what your plan should account for.

Ownership Transfer Issues

After a family business owner passes on, those left behind are often left scrambling to make decisions about daily operations. A good business estate plan doesn’t just address ownership transfer, but can also help coordinate the day-to-day management and operations of the company after the owner’s death.

For best results, ensure your estate plan includes details on dealing with directors, consultants and shareholders outside the family, as well as a plan that addresses the business’ key employees. Additionally, it’s important to specify who will be running the business if this person is different from the individual who ends up owning it. Taking the above steps before a death will help protect the legacy of the business for years to come.

If you’re the sole owner of your family business, you can create an estate plan that details the transfer of ownership and managerial power to your next of kin. The situation becomes more complicated for family businesses with multiple owners. In these cases, consulting the shareholder or partnership agreement is crucial. Not only does this document dictate who can and cannot acquire shares after a current owner passes on, but it may also prevent spouses and children from becoming owners by requiring surviving shareholders to buy out the deceased member’s portion of the business.

Tax Considerations

If you’re like most family business owners, then the odds are good that a majority of your wealth is tied up in the company you operate. Hence, it’s important to take steps to protect your loved ones from unnecessary tax payments when you’re gone. Without an estate plan, your business’ new owner may be on the hook for an estate tax (sometimes called the “death tax”) ranging from 35 to 50% of the company’s value. Because few family businesses possess this much liquid cash, new owners have to choose between selling the company and taking out large loans to cover the IRS bill.

One of the benefits of estate planning is that it lets family businesses plan for the future and take advantage of applicable IRS tax breaks. Under Section 303, the estate can redeem stock at a lesser tax cost. On the other hand, Section 6166 allows executors to pay estate taxes in installments as opposed to a single hefty sum.

Additionally, a business owner may want to gift stock to family members during his or her lifetime. While doing this prevents the owner from having to pay income tax on the gift, family members may be on the hook should they decide to sell the stocks at a later date. Business owners may want to consider a stock’s short- and long-term tax situation before gifting it to younger family members.

Key Documents for Estate Planning

Detailed legal documents are crucial for protecting your family business after a death. While you may assume that a will would be sufficient to protect your business interests, a living trust may afford you stronger protections. Whereas a will is a document that coordinates the division of your property after your death, a living trust effectively owns your ownership share in the business and allows you to continue to make all decisions. Assets included in a living trust—like your business—will not be subject to normal probate-related proceedings after death.

Additionally, a living trust assists family businesses in transferring ownership. After transferring the company to the trust, the owner can specify a successor who will take over the trust at a designated time, usually upon the owner’s death. Forming a living trust can also reduce estate taxes that would apply during the probate process.

While a living trust is ideal for single-owner businesses, companies with multiple owners (e.g. partnerships, multiple-member LLCs, corporations) may require a buy-sell agreement to protect their assets. Also known as buyout agreements, these documents prevent beneficiaries from being burdened with businesses they don’t want while protecting partners in the event of one owner’s death. By using a conservative valuation formula when creating the buy-sell agreement, owners can lawfully establish the value of the ownership interest at a price beneath the sales value upon death.

An estate plan doesn’t just protect your family—it also safeguards the legacy of the business you worked hard to build. Luckily, business owners can arrange for the transfer of a company during their lifetimes, thereby minimizing the chance of a discounted sale. By putting your estate plan into place now, while you’re still around, you can avoid undue tax burdens and enjoy your golden years knowing your family business is in good hands.

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Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.