Estate planning for small business owners is a detailed process. There are multiple questions to answer, scenarios to think about, and hypotheticals to address. For this reason, you shouldn’t attempt to put together an estate plan on your own. One missed issue can result in years of litigation if you die or become incapacitated. It’s vital to get the advice of a lawyer and financial professional who you trust and who have significant experience in business estate planning. Here are the basic steps of estate planning for small business owners:
Step 1: Start With a Will and Basic Estate Plan. The following basic documents should form the core of your business estate plan:
* A Will that states your wishes about how your business and other property should be divided upon your death.
* A durable power of attorney, which appoints another individual to manage your finances and undertake business transactions in the event you’re incapacitated.
* A healthcare power of attorney, which appoints another individual to make medical decisions for you if you cannot do so for yourself.
Without a Will, your business will be divided up according to the default laws in your state. A Will, durable power of attorney, and healthcare power of attorney ensure that someone you trust inherits business property and manages business transactions on your behalf.
Beyond these basic documents, there are deeper things to talk through with your lawyer and financial advisor. Just a basic Will might not be sufficient for your needs. By placing your assets into a trust and titling business assets in the trust’s name, you can make things much easier on your surviving spouse and family.
Step 2: Plan for Tax Efficiencies. A big part of estate planning is tax planning. Tax laws are constantly in flux, so this is an ongoing discussion you should have with your lawyer and financial advisor.
The federal government levies an estate tax, which must come out of your estate before your beneficiaries receive their inheritance. Currently, the 40% federal estate tax only applies to estates that are valued at more than $11.58 million. That leaves most small businesses in the clear. But states also charge their own estate and inheritance taxes. Here in Washington, the exemption amount is $2.193 million.
There are ways you can minimize estate taxes with good planning. For example, dividing up your estate into multiple trusts or creating a family limited partnership allows you to reduce your tax burden. An experienced lawyer should be able to assist you further with this.
Even if estate taxes aren’t an issue for you, other tax considerations are still at play. For example, a good chunk of your assets might currently be in a 401(k), IRA, or other retirement account. Those assets will flow to your beneficiaries upon your death and will be taxed on withdrawal later. Your lawyer or financial advisor can discuss specific ways to tap into retirement money for business without tax penalties.
Step 3: Sort out Issues in Family-Owned Businesses. Family-owned businesses can face particularly prickly estate planning issues. It’s not uncommon, for instance, for there to be a situation where one child of a business owner is interested in taking over the business and the other isn’t. Your lawyer and financial advisor should be able to help you address issues like these in your estate planning documents. For example, one solution is to grant all of the business assets over to one child and the remaining assets to the other. That way, you can still be “fair” but avoid future inter-sibling fights that could put your company at risk.
Another common concern with family-owned businesses is to keep the business assets within the bloodline. If a small business owner gives business assets to their child, those assets may be jointly owned by the child and the child’s spouse under marital property laws. Same goes if the business owner passes their assets to a spouse. Any future spouses of that person may also own in the assets. Fortunately, there are ways to keep the business in the family with careful estate planning.
Step 4. Draft a Buy-Sell Agreement. If your small business has multiple owners, then a buy-sell agreement is an essential part of your estate plan. Buy-sell agreements specify who can buy an owner’s share of a business, under what conditions, and at what price. A buy-sell agreement keeps a business in the hands of existing owners when one owner dies, becomes disabled, retires, or otherwise exits the business. Usually, the agreement grants existing owners first rights to buy the exiting owner’s share of the business according to a pre-set valuation formula. Those owners will buy out the exiting owner’s share either by directly paying the owner (if still alive) or the owner’s estate. The agreement might also set rules around when an exiting owner’s ex spouse can lay claim to business assets as part of a divorce proceeding. Buy-sell agreements can be structured in multiple ways, so be sure to consult a lawyer to figure out which way is best for your company.
Step 5: Buy Life and Disability Insurance. Life insurance is a must for small business owners. Life insurance coverage provides your family or named beneficiary with a source of income when you die. In addition, life insurance can guarantee an income stream to the business to keep your company operating in your absence. Disability insurance provides similar coverage if you experience a short-term or long-term disability. In most cases, business owners need to purchase two different types of life and disability policies:
* A personal life and disability policy with your family as the beneficiaries
* A key person life and disability policy with the business as the beneficiary
Think of your family first, and make sure they’re well taken care of should you die or become disabled. Term life insurance provides coverage if death occurs within a specific time frame. Whole life insurance comes with an investment component and remains in place for your entire lifetime. Disability coverage can be purchased separately or added on as a rider to a life insurance policy. Your lawyer or financial planner can help you figure out how much coverage to purchase, based on your age and health, your family’s lifestyle, and the age of any children in the household.
Key person insurance is similar to personal life insurance, but the beneficiary is the company instead of a family member. If the key person of the business dies or becomes disabled, the company gets a payout equal to a multiple of the owner’s salary or the business’s profits. The remaining members of your business can utilize that money to pay employees, train staff, and keep the company afloat. Key person insurance can be a lifesaver for mom-and-pop shops, where the owners are critical to the business’s success.
Step 6: Create a Succession Plan. Creating a succession or continuity plan is where the lines blur between estate planning and succession planning. Your estate planning documents specify who is entitled to your estate upon your death or who should run your business if you’re disabled. Succession planning specifies how you, your family, and your company will prepare for a transition in ownership.
The focus of succession planning is keeping a viable business running, or preparing the business for sale, in your absence. A succession plan is a written document that starts off much like a business plan. It contains background information about your business, your target market, and your competitors. It goes on to list the proposed organizational structure of the business in the event of a succession and what positions key personnel will assume in the event of your death or disability. You’ll also want to identify training opportunities or compensation adjustments for any of the key staff members. In the finances section of your succession plan, you’ll want to outline the financial state of the business, such as profits, assets, and the current valuation.
Remember to keep your succession plan document consistent with your Will and other estate planning documents. This will prevent unnecessary and costly litigation down the line.
Step 7: Have a Discussion With Affected Parties. After you create your estate plan, make sure all the affected parties know what’s at stake. These are hard topics to talk about but ideally, you should consult your family members and friends throughout the process. This helps avoid conflict down the line. For instance, if you’re unsure about one of your children’s interest in the family business, you should find out for estate planning purposes.
Once the estate plan is in place, you and your family should sit down with your financial advisor and lawyer to make sure everyone understands what’s in the plan. This discussion doesn’t need to reveal specific assets of value or the size of the estate, particularly if you have young children. Family members should also know how and where to locate your Will, succession plan, and other estate planning documents.
Step 8: Update Your Estate Plan as Necessary. Once you have your estate plan in place, you’ll have to update it on a regular basis to make sure it reflects current laws and your current wishes for what you want to happen to your business.
Tax laws change regularly, both at the federal and state level, which can upend your current plan. Similarly, life events, such as a divorce, a child’s marriage, or the birth of a child or grandchild, can all affect your estate planning efforts. Having a lawyer who intimately understands your business’s needs can help you keep up with transitions over the years.
Don't delay. Estate planning is important for everyone, but especially for small business owners. Your company is one of your biggest assets and something that you’ve worked very hard on. Business estate planning lets you ensure that your company continues as a successful, thriving venture. It starts with creating a Will, but estate planning for business owners is more complicated than that. There are tax, insurance, and family issues to think through and discuss with your lawyer to ensure that you, your loved ones, and your business will be well taken care of now and in the future. If you have questions, give us a call at 253.858.5434 to see how we can be of service. We represent clients throughout Washington and Idaho and are available to meet in person (with appropriate social distancing protocols in place), by phone, or via video conference.