Estate planning allows for your assets to be distributed the way you want them to be after you are gone. As a business owner, estate planning takes on even greater importance, as a significant portion of your wealth (and your family’s source of income after you are gone) is likely tied up in your business. Failing to put measures into place for your business can leave your business legacy by the wayside. It’s important to start estate planning early and communicate and reassess with your advisors, business partners and family. With a strategy in place, you can feel confident that your business and your loved ones will be taken care of, no matter what.
When creating an estate planning strategy, you should consider the following:
You may be a sole proprietor with an owner-dependent business who does not intend to keep your business open after your death. You may have multiple business partners who you’d like to set up a buy-sell agreement with. You may have a family-run business and be faced with the difficult decision of choosing a successor from amongst your children. The bottom line is that each business has different estate planning needs, and without assessing those needs, it’s impossible to put a strategy into place.
Before designing an estate planning strategy, you should consider the following questions:
Determining the answers to these questions will help identify the direction of your estate planning strategy.
A will is the most basic aspect of an estate planning strategy. If you don’t have one, the court will decide how your assets are divided instead of you or your family. Many think that designating how assets should be distributed in a will is enough, but for business owners in particular, other measures should be put in place to ensure the proper transfer of assets.
Wills are subject to probate, the process where a court examines a will, deals with any conflicts and approves or carries out its requests. Probate prohibits the immediate transfer of your assets and depending on the complexity of the will can last for months or even years. Probate is a public process, so anyone will be able to see what you owned and what you owe. Creating a living trust, on the other hand, sets up a separate entity that legally holds ownership of your assets so that, unlike a will, their distribution cannot be contested in court. Living trusts bypass probate, which offers you increased privacy and decreased legal fees. It also allows the transfer of your assets to happen immediately and ensures that your business assets will be transferred in exactly the way that you want—they are not subject to the decisions of a judge. Trusts also allow more control over assets, as they allow the creator to put specific restrictions or amendments on its distribution.
While establishing a living trust is beneficial for business owners, you will still need a will. A will allows you to name guardians for your children or forgive debts, which a living trust cannot. Also, you usually don’t transfer all of your assets to a living trust—even if you try, it’s likely that you’ll miss something or you may acquire an asset shortly before your death. A will takes care of those assets not owned directly by a living trust. Fortunately, if you have a living trust, you should only need a simple will that states who should inherit the remainder of your property.
Federal estate taxes apply to estates of $11.58 million (2020 indexed for inflation) or above and will be assessed on the value of the estate on your date of death. Estate taxes are due nine months after the date of death and can be assessed up to 40 percent, so without a strategy in place to minimize or fund these taxes, some businesses have to be sold below market value so that the estate beneficiaries can raise the funds in time. If your estate will be subject to estate taxes, there are several strategies to consider to reduce the amount of taxes your family will have to pay.
Grantor retained annuity trusts (GRATs) and grantor retained unitrusts (GRUTs) are effective options for those who will be passing on a rapidly growing business and want to avoid rapidly growing estate taxes. These types of trusts allow you to “freeze” the value of the trust, so if you transfer your business assets into a GRAT or GRUT and they grow within the trust, the appreciation will not be subject to estate taxes. In addition, you retain the right to receive distribution payments from the trust, so you can continue to have a source of income even if you no longer own the business assets.
One option to provide family with a source of funds for possible estate taxes is an irrevocable life insurance trust (ILIT). An ILIT is a trust designed to hold your life insurance policy, which allows the trust to avoid probate and gives your family immediate access to income. Once an ILIT has existed for three years, it is considered outside of your estate, so creating an ILIT also helps to lower estate taxes.
If you own a family-run business, you can consider creating a family limited partnership (FLP) or family limited liability company to hold business assets. Family members can buy in to be given limited partnership interests, which then eliminates this interest from your taxable estate. It also allows you to gift shares to your family members and take advantage of gift tax exemptions. However, the tax advantages of these structures have caused the IRS to heavily monitor their creation. The IRS closely scrutinizes most family limited partnerships to make sure their valuation is correct and to stop families from creating “death bed” partnerships, or partnerships created solely to obtain estate valuation discounts. If the IRS finds that you have created an FLP solely for avoiding taxes, they can bring the assets back into your estate. Make sure you consult your lawyer before establishing an FLP, as the IRS repercussions can be severe.
The simplest of tax minimization strategies would be to use your $15,000 (2020, indexed for inflation) per year tax exclusion to gift your business interests to your successor. This can allow you to transfer a large part of your business tax-free. It’s important to keep in mind that this strategy can take a significant amount of time, depending on the size of your business. However, lifetime gifts allow you to have significant control over transfer amount and timing, so you can transfer your business in the way that you are most comfortable.
Beyond protecting the financial assets of your business, it’s important to have a strategy in place to protect the integrity of your business. A business succession strategy should address how you will transfer management and ownership of your business. It will usually involve details such as how you will develop and train successors, how and in what timeframe you will delegate responsibility and authority to successors, and what employees or practices you see as vital to the company. You will also have to choose how you want to pass on your share of the business.
Whether you choose to sell to an external party, name an internal successor or liquidate your business, the way you pass on your business will affect your finances and, in turn, your estate plan. For example, if you choose to sell the business, you’ll likely receive a lump sum that can help ease the burden of any estate taxes you may incur. If you choose to name an internal successor within your company, you will have to decide whether to sell your share of the company or leave it for your family to inherit. As with all other aspects of estate planning, this decision will require a lot of consideration. You’ll have to find a balance between protecting the business you helped build and ensuring that your family will be well cared for. You should think about factors such as how involved your family is in the business, how successful the business is and how much you could profit from selling the business. While there are many business succession options available, only you can decide what is best for both your business and your family.
Whichever methods you use to set up your strategy, keep the following business-estate planning practices in mind:
This article was written by Advicent Solutions, an entity unrelated to Prudential. ©2020 Advicent Solutions. All rights reserved.
White Rose Wealth Management
Peter Kelly
White Rose Wealth Management is not an affiliate of Prudential Financial. Pete Kelly sells insurance products of Prudential Financial's affiliated insurance companies in addition to products of non-affiliated insurance companies. White Rose Wealth Management and its representatives do not render tax or legal advice. Please consult with your own advisors regarding your particular situation.
Peter Kelly offers financial planning, Aaron Trinh offers investment advisory services through Pruco Securities, LLC(Pruco), under the marketing name Prudential Financial Planning Services (PFPS), pursuant to separate client agreement. offering insurance and securities products and services as a registered representative of Pruco and an agent of issuing insurance companies. 1-800-778-2255.
White Rose Wealth Management, LLC is not affiliated with The Prudential Insurance Company of America and its affiliates, including Pruco. Other products and services may be offered through a non-Pruco entity. Peter Kelly, Aaron Trinh, nor White Rose Wealth Management, LLC do not render tax or legal advice. You should consult with your own advisors regarding your particular situation.
White Rose Wealth Management, LLC does business in the following states:
Securities: PA, NJ, MD, MI, FL
Life Insurance: PA, NJ, MD
Variable Life Insurance: PA, NJ, MD
Property and Casualty: PA, NJ, MD
Mutual Funds: PA, NJ, MD, MI, FL
Fixed Annuities: PA, NJ, MD
Variable Annuities: PA, NJ, MD
1048175-00001-00
%402x.svg){kind=icon}