Articles & White Papers

DYING TO GET OUT -
ESTATE PLANNING ADVICE FOR BUSINESS OWNERS

By James A. Castleman, Esq.

      Unfortunately, over the years I have seen many successful business owners die, only to leave their enterprises and their affairs in a shambles. I have seen widows saddled with huge amounts of debt. I have seen surviving partners not knowing what they own. I have seen life savings eaten up by estate taxes. I have seen surviving children spend more on legal fees to fight over business valuation than the business itself is worth. 

      What is disturbing about all of these situations, is that they could have been prevented by some common sense planning. Whether you are a one man operation or a large multi-owner company, or somewhere in between, it is worth a consultation with your lawyer, your accountant, and your insurance agent to make sure that your family, employees, and co-owners are protected when you die. And, as hard as it may be for you to accept, we are all going to die someday. 

      When you do meet with your various professional advisors, here are a few of the issues that are essential to discuss:

1. Do you have a Will, and should you have a Trust?

      Having a Will is an absolute must. If you do not have a Will, then the law will dictate who will get your assets, and that might not be who you think or who you want. Provisions in Wills can also make sure that a person that you trust is appointed to manage your estate as Executor, can make sure that someone is appointed to continue to run your business, can make sure that your children are provided for, and can even make sure that certain people do not get any part of your assets.

      Whether or not a Trust is appropriate for you depends on your particular situation. Sometimes a Trust is appropriate to avoid having to go through “probate” of your assets, so that they are privately passed on to your heirs. Sometimes a Trust makes sense to allow you to make incremental transfers of your assets while you are still alive. Sometimes a Trust can assure that your assets are intelligently managed after your death, so that minor children or other heirs with little business expertise are protected. Sometimes a Trust is appropriate to make sure that real estate interests are managed in a favorable manner.

      If you are married, and if you have assets worth over a million dollars, then you almost certainly need a Trust to help minimize potential estate taxes that may have to be paid after your death. Do you think that a million dollars sounds like a lot? Think again:  Do you own a home? Do you own the real estate where your business is located? Do you have any life insurance? Do you have a retirement plan or an IRA? Do you have any personal savings, or own any stocks, bonds or mutual funds? The value of all of these assets, and any other assets that you have an interest in, are added together to determine the value of your potentially taxable estate. Owning assets jointly does not prevent them from being part of your taxable estate. 

      Although the amount of assets you must have before you pay a federal estate tax is relatively substantial, currently a Massachusetts estate tax is potentially imposed on the value of all assets over one million dollars. Once you hit the federal floor, the tax rate that is imposed is relatively high. Although the state estate tax rate is much less than the federal rate, once you reach that million dollar threshold, the Massachusetts tax can still be significant. 

2. What Business Entity is Right for You?

      The answer to this question varies, according to your particular circumstances. Today there are many options available to you, from sole proprietorships, to partnerships, to “C” corporations, to “S” corporations, to limited liability companies. Each has its own attributes with regard to complexity of operation, manner of control, tax treatment, protection from personal liability, and transferability of ownership interests. 

      A sole proprietorship may be appropriate for a relatively small operation; but the business will end at your death, there is little flexibility as to how you are taxed, and you have no protection from personal liability or debts of the business, or for injuries caused by negligent work. If there is more than one owner of your business, then a partnership may provide a relatively straightforward manner of operation; but note that you should always have a written partnership agreement to define what your individual rights are, that a partnership ordinarily terminates at one of the partner’s death, that there are limits on tax planning flexibility, and that there is also no protection from personal liability. Corporations give you more protection from personal liability, usually allow greater flexibility on the transfer of business interests, and greater flexibility for tax planning; but, there is more complexity of the operation of a corporation, and there may be additional costs involved in the running of a corporation. Limited liability companies allow for great flexibility in fashioning ownership interests and transferability of those interests, while offering the same protection from personal liability as corporations; but “LLC’s” may involve more complexity than you are comfortable with, and generally have greater administrative costs than sole proprietorships or simple partnerships. 

      Again, what is best for you depends upon your individual situation. You can only make an intelligent decision after consulting with your professional business advisors. But, note that the type of business entity that you have may greatly affect whether your business continues after you die, and whether your heirs are protected after you die.

3. Do you have a Business “Buy-Sell” or “Redemption” Agreement?

      If there is more than one person with an ownership interest in your business, then it is imperative that you make provisions for how the business is to continue if one of you dies. Usually, the parties will want the surviving owner(s) to be able to continue without interference, and to have the decedent’s heirs get paid fair value for the decedent’s part of the business. Without a written agreement providing how this is to occur, neither side is likely to be happy with the end result, and only lawyers representing each of the sides are likely to benefit. Properly drawn agreements can provide for the continuation of the business, as well as for a structured payout for the decedent’s interest, perhaps through a long term Note, or through insurance on the life of the decedent, or through a combination of the two.

      A “Buy-Sell” Agreement usually provides that the surviving owners are personally obligated to buy out the decedent’s interest in the business; a “Redemption” Agreement ordinarily provides that the business itself pays for the decedent’s interest. What is appropriate for you and your business varies according to your particular circumstances, and may hinge on the very different tax consequences for each of these types of agreement. In any case, it is imperative that you have something in writing that is acceptable to everybody. 

      If you are going to have one of these types of agreement, then it is also important to know what your business is worth. Hopefully, your advisors can help you make this determination. You may also be able to determine this through an agreement with your business co-owners. It is important to have an agreed upon manner of valuing the business not just now, but also at the time of your death, so that both your co-owners and your heirs are protected. 

      Note that it is important to have a business buy out agreement, even if your co-owners are family members. In fact, sometimes it is more important to have a properly drafted agreement when your business partners are siblings or children.

4. Do You Have Adequate Life Insurance?

      I am not an insurance agent. And, quite frankly, I find most of them grating on my nerves. But, the reality is that life insurance can provide a relatively inexpensive and simple way to make sure that your heirs are properly provided for. If you are a sole proprietorship, then your business may have virtually no value upon your death, and life insurance may be the only way to make sure that your survivors are provided for. If you have co-owners in your business, then life insurance may be the appropriate way to make sure that a decedent’s interest can be purchased by the remaining owners. Insurance may also be a way to make sure that there are sufficient assets to pay any death taxes. And, in the right circumstances, an irrevocable life insurance Trust may be set up to make sure that your heirs get significant amounts of money, tax free. 

      For what it is worth, I recommend talking to your lawyer and accountant, not just your insurance agent about insurance. They may have a different view of whether insurance is appropriate for you, and, if so, how much and what type of insurance is appropriate for you. 

5. Do You Have a Retirement Plan?

      If you plan to retire some day, then some type of “qualified” retirement plan may be appropriate, to reduce your current taxes, and to make sure that you have sufficient income when you do retire. Even if you do not intend to retire, a qualified plan may be appropriate to defer taxes, and to make sure that your heirs get significant assets at your death. Again, what is appropriate for you depends upon your particular circumstances. Again, talk to your lawyer, your accountant and your insurance agent about what might be appropriate for you.

6. Do You Have any Type of General Business Plan?

      What do you see for the future? Are you in business with someone who is considerably older (or younger) than you, or who may have different goals in life? Do you have children involved in your business, whom you may want to gradually pass your business interests on to? These are all matters that you should consider, and for which you should plan. 

      Depending upon your circumstances, you may want to have an agreement that provides for a buy out of an interest when an owner retires. You may want to have a plan for gradually giving or selling your interest in the business to your children. You may want to retain control of your business, but transfer equity interests to children, or to co-owners, or even to employees. Sometimes it is difficult to think about these things, but if you do, then a plan can be established to make sure that what you want is accomplished in an orderly fashion, and to make sure that the plan has the most advantageous tax consequences available to you. These are important issues, and they should be addressed.

Conclusion

      Are you dying to get of your business? Well, whether you like it or not, some day you are going to be. While it may be difficult to do, the earlier that you plan, the better things will be for your survivors when that day comes. Please consider the advice given in this article, and act accordingly.

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  James A. Castleman is a managing member of the law firm of Paster, Rice & Castleman, LLC, in Quincy, Massachusetts.

Information obtained from this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.
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