Estate Planning for Small Business Owners

Unique issues arise when an individual owns a small business. Fortunately, there are a variety of techniques that can be used to mitigate these issues.

Issue 1: How much will surviving family members receive from the sale of a business?

It is probable that a closely held business comprises a large portion of an individual’s estate. A business that produces steady profits is undoubtedly valuable. However, the estimated value of small operating businesses is often quite speculative. Financing can be difficult to obtain and the value of the business is highly susceptible to market fluctuations. The business owner may expect that his or her heirs can quickly sell the business for a large sum. But, a prospective purchaser may insist upon an installment sale or a low purchase price.

Possible solution:

The business owner could establish a life insurance trust. In the event of his or her death, the insurance would flow into the trust, free of estate tax. The trust could make distributions to surviving family members who have an immediate need for cash. The insurance payout would also give the family the freedom to market the business for an extended period of time. The comfort offered by the life insurance trust would allow the surviving family members to reject low purchase offers and hold out for the highest possible purchase price.

Issue 2: Will the business cause a large estate tax?

Although a small business owner may be hard pressed to give a precise value for the business, an appraiser will ultimately be enlisted to provide a value for the estate tax return. The downside of a successful business is that it may cause a large estate tax.

Possible solution:

It is well established that a minority interest in a business are traded at discounts that reflect their lack of marketability and control. Purchasers recognize that minority shareholders have very little influence over the business. Also, few people are interested in purchasing minority interests in small businesses.

These economic realities present a planning strategy. A business owner can make lifetime gifts of fractional interests in the business. The value of these transfers for gift tax purposes will reflect that the donee can not control the business or readily sell the interest. Ultimately, these transfers will reduce the size of the future taxable estate.

Issue 3: The business does not have a succession plan

A small business may be highly dependant on a single individual. If a succession plan is not in place, a significant part of the business’s value may be lost.

Possible solution:

A business owner may draft a succession plan that states who will assume leadership roles in the business. This provides a continuity of management and avoids intra-family disputes over the business owner’s intent.

Issue 4: There are other partners in the business

A successful business may be owned by several individuals. During the early years of a business, it is common to have informal arrangements. However, it is critical to prepare a binding document outlining what happens when a partner dies. A partner’s family members may want to join in the operation of the business or sell to outsiders. The remaining partners may want to buy out the decedent’s family, but be unable to do so because of liquidity problems.

It is also important to verify that the parties can realistically carry out their promises. For example, if the agreement provides that the surviving partners will buy the business, there needs to be sufficient funds to make the purchase.

Possible solution:

The small business owner and his or her partner(s) may want to consider purchasing insurance on each other’s lives and placing such insurance in trust to avoid inclusion in the insured’s estate. Also, if a small business owner leaves the business to one family member, that child may receive a disproportionate share of the estate’s assets. It is possible to resolve this inequity by making specific gifts under the will to other family members.

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