Unfortunately, a lot of small businesses don’t survive past the first generation. The reason? It’s not because those businesses are not successful; it’s typically because of failures in communication and estate planning.
For example, who’ll run the business once the owner/operator passed? Will partners buy the deceased partner out or should the heirs handle the business? Decisions like these have to be made and documented properly, which is where estate planning comes in.
Here we cover basic estate planning issues including reducing estate taxes, the purpose of life insurance plans, the benefits of buy-sell agreements, and matters regarding family-run small businesses or sole proprietorships.
The Death Tax
If nothing else, a solid reason to prioritize estate planning is to lower how much your estate will be taxed upon your death. This death tax is typically about 35% up to 50% of your small business’s value and must be paid within nine months after your death.
Because most small businesses aren’t liquid enough, they’re usually sold to pay the estate tax. Unfortunately, because of the nine-month time limit, they’re often sold at a price below their actual value. Fortunately, estate planning could help relieve this tax burden with help from two specific tax breaks.
In general, Section 303 gives your estate the chance to use your stock at a low tax cost, while Section 6166 allows deferral of the estate tax. Seek advice from an experienced attorney to ensure that you leverage these tax breaks.
The Buy-Sell Agreement
The main advantage of having a buy-sell agreement is establishing a price for your share of the small business and the business itself. Basically, it allows you to document whether you wish to sell your share through your heirs, block specific people from joining the business, or have your partners buy you out upon your death or if you become incapacitated. Because you’ve already established a price, family members and relevant individuals know they’re getting a fair price.
The Purpose of Life Insurance
What if your small business isn’t liquid? Where does your partner obtain the capital needed to buy out your shares upon your passing? In cases like these, the funds usually come from a life insurance plan. Having a life insurance plan is a common practice among small business owners.
All partners take out an insurance plan and names all the other owners as their beneficiaries. In turn, this offers the surviving owners a chance to buy out the deceased partner using tax-free proceeds.
Sole Proprietorships
Sole proprietors must note that your personal assets could be used to pay off your small business’s debts. This means that you should prepare and delegate a successor if you plan on passing on your business. If you’re planning on selling, seek help from a lawyer on selling the business. Do some research to ensure that selling it will be easy for your heirs. Ensure your family about your plans and document those plans in your estate plan to avoid potential disagreements in the future.
Heirs and Family-Run Small Businesses
Some heirs might be involved in running the business in family-run small businesses, and others might not. So how can you distribute the business assets fairly? Many individuals opt to distribute their assets according to an heir’s contribution to the business. No matter your decision, documenting your wishes in your estate plan is a must.
If you want to ensure that your small business will be taken care of when you pass away, you have to make sure that you have a solid estate plan that details your wishes for your small business. Meet with your legal team, discuss it with your family, and make your plans known to make sure there will be little trouble in the future.