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Why Your Closely-held Business Needs an Estate Plan

A lot of time and effort goes into building a closely-held business. That’s why it’s important to determine what will happen to the business after your death.

A closely-held business is a corporate entity with a limited number of stockholders. Its stock is not traded publicly and its operations generally remain private. Only a limited number of people have a say in the operation of the business. Generally, a closely-held business may be organized as a sole proprietorship, an S-corporation, a C-corporation, a professional corporation, an LLC or a limited liability partnership.

While some closely-held businesses are family-owned and intended to pass from generation to generation, others may operate as a partnership among unrelated parties. No matter how a closely-held business is organized, however, the death of an owner or shareholder may have significant estate and gift tax consequences. Planning ahead ensures that those consequences are minimized so they will not create a financial hardship for family members or remaining partners.

An estate plan will clarify whether a business should continue. It will also specify to whom and how shares of the business should be distributed upon the owner’s death. Sometimes called  “succession planning,” an estate plan should address these issues:

  • What are the family or partner objectives regarding the business? For example, will the business cease to operate upon the death of an owner or will control be assumed by others? Who will receive the stock or others assets? Should the business be sold or transferred?
  • How will the business interest be valued if it is to be transferred, during the owner’s lifetime and upon death? This is particularly important when a business operates as a partnership and a buy-sell agreement is in place. That agreement should determine how the interest will be valued, and what tax discounts or deductions will be applied.
  • How will the business interest be transferred? Generally, business interests may be transferred by gift, trust, a buy-sell agreement, or through a Family Limited Partnership (FLP) or Limited Liability Company (LLC).
  • What is the best vehicle for making gifts? Lifetime gifting programs offer a variety of options for transferring business interests. For example, gifts may be made outright or placed in trust for the benefit of a younger family member or a business partner.
    • Outright gifts. In 2019, the annual gift tax exclusion was $15,000 for individuals or $30,000 for married couples. The exemption will remain the same in 2020. An interest in the business valued at or below those amounts may be given without incurring a tax penalty. Gifts that exceed the annual exclusion are applied to the Applicable Federal Estate Tax Exclusion upon death. In the alternative, gifts of higher value may be spread out over several years to take advantage of the annual gift tax exclusion.
    • Generally, a trust is either inter vivos (established during the grantor’s lifetime) or testamentary (established upon death via the grantor’s Last Will and Testament). An inter vivos trust may be revocable or irrevocable. If revocable, the transfer is not considered a completed gift. If irrevocable, the transfer is a completed gift and the property may be subject to gift tax. The same gift tax exclusion applies unless the beneficiaries have a right to withdraw property from the trust under certain circumstances.
    • Corporate entities. The Family Limited Partnership (FLP) is formed with a general partner and limited partners. Typically, the general partner is the older family member and the limited partners his heirs. The general partner can transfer up to 99 percent of the business to limited partners without surrendering control. Transfers of FLP interests are taxable as gifts and subject to the same rules regarding gift taxes.
  • Is a buy-sell agreement necessary? A buy-sell agreement stipulates how an owner’s interest in a partnership will be distributed upon certain events, such as death, retirement or disability. When several unrelated parties own an interest in a business, a buy-sell agreement becomes essential to the transfer of ownership upon an owner’s death. The agreement may permit remaining partners or the business to purchase the outstanding shares. The most cost-effective method of transfer usually takes into account the value of the business, the relationship between the parties, who is eligible to purchase the shares, and the appropriate time for the transfer.
  • Is life insurance necessary to cover the costs related to the transfer of interests? The proceeds from a life insurance policy can be used to pay estate taxes or fund a purchase of the outstanding shares of a business. Generally, often partners in a business take out life insurance on each other to fund a buy-sell agreement.

A closely-held business is a unique enterprise. An estate plan that addresses the issues discussed above will protect the current owner(s), as well as those who may become owners in the future. No closely-held business can be transferred without legal consequences. That’s why it’s best to consult an estate planning attorney for more information.

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