A proper estate plan can help protect your assets from excessive taxes and creditors, control how your assets should be distributed, to whom and when, and so much more. The same is true for small businesses, as your business planning attorney can tell you. Understanding how small businesses can benefit from business planning will help you organize your business and plan for succession of that business to your heirs.
Planning for the estate tax consequences for business owners
If you are a sole proprietor, you know that your business assets are essentially your assets, as the business owner. For that reason, your business assets will be lumped together with your personal assets after your death, even if some assets are in the name of your business. If you owned non-liquid assets, such as property, vehicles, machinery, the fair market value of that property will also be included with your personal assets for federal estate tax purposes. This is an issue that your business planning attorney can help you address ahead of time in order to reduce or even eliminate those taxes.
Consider establishing limited liability entities
There are basically two business entities created specifically for the purpose of limiting personal liability for certain business owners: Limited Liability Companies (LLCs) and Corporations. Owners of these entities can elect to be taxed as “passes through” entities, which allows them to avoid double taxation. The flexibility of a limited liability entity also permits the business owners to assign income and losses in the most tax-friendly way possible.
Other business planning options for small businesses
Your attorney can explain some of the other types of business structures available, as well as the advantages and disadvantages of each. By discussing your options with your planning attorney, you can choose from different strategies that will maximize the growth of your assets throughout your lifetime and ensure proper distribution of those assets after your death.
The benefits of a business succession plan
Some clients actually intend for their businesses to be passed on to their heirs intact so their loved ones can continue the family business. If this is the case, you should specifically discuss a business succession plan with your business planning attorney. There will eventually come a time when you will be ready to retire from running the family business. However, resigning is not as easy as you may think – not if you want the business to continue running smoothly. You need to pass on the reigns properly. That is where a business succession plan comes in. Although most business owners would prefer to pass on the management of the business to the next generation, less than 30% of owners actually have a succession plan in place.
Why you need a business succession plan
The principal goal of a business succession plan is to ensure a smooth transition of ownership and management. Without these two components, your continuation of your business is not assured. A proper succession plan can address the two most common issues that prevent family-owned businesses from surviving: inadequate tax planning and family disputes.
What you should include in your succession plan
Each business succession plan needs to address three key issues: ownership, management and taxes. A common misconception is that ownership and management of a business are essentially the same, but they are not. For example, you can transfer ownership of your business to all four of your children, but typically only one child will be named to take over management of the company. The reality is not all of your children will be capable, or even interested, in managing the business or being active in its operation. Your plan should take all of this into consideration.
How to minimize taxes during transfer of your business
There are different methods available for transferring a business, including an outright sale, installment sale, buy-sell agreements, or outright gifts. Each of these methods has its own tax consequences which must be carefully considered when you establishing your business succession plan. Some useful strategies that business owners can use to minimize transfer taxes are valuation discounts, irrevocable life insurance trusts and the election to defer payment of estate taxes with respect to closely-held businesses. Ask your business planning attorney about the different strategies available to you.
If you have questions regarding your estate planning needs, contact us at the Northern California Center for Estate Planning and Elder Law for a consultation, either online or by calling us at (916) 437-3500.