Estate Planning for Business Owners: Trusts and Beyond

Most business owners would agree that proper estate planning is critical, yet complex for those with ownership stakes.

With the right strategies, business owners can effectively plan their estate while minimizing tax burdens and ensuring smooth succession planning.

This article provides an in-depth guide to key tools like trusts, buy-sell agreements, gifting assets, and more to empower business owners to make informed decisions for their future.

Introduction to Estate Planning for Business Owners

Estate planning is an important consideration for business owners to protect their assets and ensure continuity of their business. Proper planning can minimize taxes, avoid probate, and facilitate the transfer of the business to heirs or a successor.

Overview of Business Owner Estate Planning Challenges

Business owners face unique estate planning challenges, including:

Protecting business assets from creditors and lawsuits
Ensuring a smooth transfer of business ownership and management
Minimizing estate taxes to avoid forced liquidation of the business
Treating all heirs fairly, especially those not involved in the business

Proper planning is essential to address these challenges.

Importance of Proper Estate Planning for Business Owners

Without an estate plan, a business owner's assets may be tied up in probate court after their death. This can disrupt business operations and lead to disputes between heirs over control and ownership. Proper planning ensures:

Clear plan for transfer of ownership and management
Minimization of estate taxes to avoid forced sale of business
Protection of business assets from creditors of heirs

Role of Estate Planning Advisors

Key advisors who can help business owners with estate planning include:

Attorneys - Draft legal documents like wills, trusts, buy-sell agreements
CPAs - Evaluate tax implications of various planning strategies
Financial planners - Assess life insurance, succession funding needs

These advisors help create customized plans addressing the business owner's goals.

Top Estate Planning Goals and Objectives

Key goals business owners should consider include:

Minimizing estate taxes - To avoid forced liquidation of business
Business continuity - Smooth transfer to heirs or successors
Asset protection - Shield assets from creditors, lawsuits
Wealth transfer - Transfer business and assets in a fair manner

Proper estate planning can help effectively achieve these objectives.

What type of trust is best for business owners?

A living trust can be an effective estate planning tool for business owners. Here are some key benefits of using a living trust:

Avoids probate. Assets transferred to a living trust avoid the costly and time-consuming probate process after death. This allows your business to continue operating without disruption.
Privacy. Trusts are not public records like wills, so details about your assets remain private. This prevents customers, vendors, and competitors from gaining insight into your finances.
Control. You can still fully control assets in your living trust while alive and competent. If you become incapacitated, your handpicked trustees take over according to your directives.
Tax savings. Properly structured, a living trust allows you to shift income to beneficiaries in lower tax brackets. This can provide substantial tax savings over time.

The best trust structure depends on your specific business, succession plan, and estate planning goals. Key options include credit shelter trusts, qualified terminable interest property (QTIP) trusts, and generation skipping trusts. An estate planning attorney can advise you on the optimal trust strategies and terminology for your situation.

Overall, living trusts offer business owners robust control, privacy, probate avoidance, and tax minimization. Consult an attorney to implement the ideal trust structure aligned with your business succession plans.

What type of trust is best for estate planning?

A revocable living trust is often the best option for estate planning purposes. Here's why:

You maintain control. With a revocable living trust, you can continue to manage the assets in the trust, add or remove assets as needed, change beneficiaries, or even revoke the trust entirely. This flexibility is useful for changing life circumstances.
It avoids probate. Unlike assets that pass by will, a properly funded revocable trust allows your assets to transfer directly to beneficiaries after your death, avoiding the time-consuming and costly probate process.
It's private. Unlike wills, trusts are not public records, so your asset and distribution details remain private.
It plans for incapacity. Your revocable trust can outline what happens to trust assets if you become mentally incapacitated, helping your family avoid a court-supervised guardianship.
It coordinates with wills. You still need a will to transfer any assets not in your revocable trust. Your will can contain backup provisions for trust assets and nominate guardians for minor children.

The bottom line is that a revocable living trust is a flexible estate planning vehicle that keeps you in control while avoiding probate and planning for contingencies. It works hand-in-hand with your will as part of a coordinated estate plan.

Why might a business owner use a trust in their succession planning?

A trust can be a useful tool for business owners looking to plan for the future transfer of their company. Here are some key reasons a business owner may choose to use a trust:

Avoids probate: Assets placed into a properly structured trust can avoid the probate process upon the business owner's death. This allows for a smoother, more efficient transfer of the business to the trust beneficiaries.
Privacy: Trusts are not public documents like wills in probate court. This allows business owners to keep the details of their succession plans private.
Control: Properly structured trusts allow business owners to place restrictions and instructions on how and when trust assets are distributed. This ensures their succession wishes are carried out.
Tax planning: Certain types of trusts may help minimize estate taxes when assets are transferred. This helps preserve more of the value of the business for the beneficiaries.
Avoids conflict: By clearly spelling out an organized transfer plan in the trust, business owners can avoid potential conflict between heirs over the business succession.

In summary, trusts can facilitate an orderly, private business transfer upon death while allowing business owners to maintain control over the process. Consulting with an attorney experienced in business succession planning is highly recommended when considering using trusts.

Can estate planning be a business expense?

Some estate planning fees were previously eligible as an itemized deduction under IRS rules, but the Tax Cuts and Jobs Act changed that. However, succession planning remains deductible for small business owners as it is considered an ordinary and necessary business expense.

Succession planning involves developing a strategy to transfer ownership and management of a business to key employees or family members. This ensures business continuity when the current owner retires, becomes disabled, or passes away.

The costs involved in developing a succession plan are deductible expenses because this planning is directly related to the operation of the business. This can include attorney fees to draft buy-sell agreements, consultant fees to evaluate leadership candidates, and other professional services required to design and implement the succession process.

Therefore, while personal estate planning fees are no longer deductible for individual taxpayers, business-related succession planning and transfer costs remain deductible for business owners as ordinary operational expenses required to sustain the company's future operations.

Overview of Key Estate Planning Tools and Strategies

This section provides an introduction to essential estate planning strategies business owners utilize like wills, trusts, buy-sell agreements, gifting, and more.

Last Wills and Testaments

Wills allow business owners to designate beneficiaries for assets and appoint an executor to carry out the distribution of assets upon death. However, wills must go through probate, which can be costly and time consuming. Business assets in a will may also be subject to estate taxes.

Best practices for business owners include:

Having a separate will for personal assets and business assets. This allows for more control over distribution.
Setting up a living trust to avoid probate and ensure privacy. Assets in a living trust can be distributed quickly per the trust terms.
Using entities like LLCs and incorporating to better protect assets.

Revocable Living Trusts

A living trust allows business owners to avoid probate and reduce estate taxes by transferring assets into the trust during life. The trust names beneficiaries who inherit assets per the trust terms privately and quickly upon death.

Key benefits include:

Avoiding probate delays and costs
Preserving privacy compared to a public will
Designating a successor trustee to manage assets if disabled
Setting conditions for distributions to beneficiaries

Living trusts are a vital component of a business owner's estate plan.

Irrevocable Life Insurance Trusts (ILITs)

ILITs allow business owners to own life insurance policies outside of their taxable estate. The ILIT owns the policy and is named beneficiary. This removes the death benefit from estate value calculations.

Benefits of ILITs:

Avoid estate taxes on insurance proceeds
Make premium gifts to the ILIT to further reduce estate value
Set conditions for insurance payouts to beneficiaries

ILITs play a key role in leveraging life insurance in estate plans.

Gifting Assets

Gifting business assets or interests during life is an effective way to reduce estate value for tax purposes. Annual exclusion gifts up to $16,000 per recipient do not use up lifetime exemption.

Strategies like gifting ownership units, real estate, or other assets to irrevocable trusts can reduce estate value while allowing some control. It is vital to work with legal and tax professionals when gifting business assets.

Business Succession Planning Considerations

Business succession planning is vital for business owners to ensure continuity of operations and a smooth transfer of ownership. This involves analyzing exit strategy options, preparing successors, and developing contingency plans.

Options for Transferring Ownership and Control

There are several approaches business owners can consider to transfer ownership interests:

Gifting ownership interests gradually over time to successors. This can help reduce gift and estate taxes.
Management buyouts (MBOs) where existing managers purchase some or all of the business. This rewards and retains key personnel.
Employee stock ownership plans (ESOPs) to sell shares tax-efficiently to employees over time. Business owners can sell part or all of their shares into an ESOP.
Private sales to internal successors or external buyers. This allows owners to negotiate their own deal terms.

Funding Buy-Sell Agreements

Owners should fund buy-sell agreements to guarantee a market for a departing owner's shares:

Self-funding through business earnings and cash reserves.
Loans or promissory notes to successors to finance a buyout.
Disability buyout policies to fund the purchase in case of owner disability.
Life insurance to ensure funds are available if an owner dies.

Key Person Life Insurance

Key person life insurance protects against financial losses from the death of an important owner or leader. It provides cash proceeds to:

Fund a buyout of the key person's shares
Pay off business debts tied to that key executive
Hire and train a replacement

Successor Readiness Planning

It takes years to groom successors on:

Financial management - reviewing systems, controls, and performance
Leadership development - coaching skills in areas like strategy, communication, and relationship-building
Mentorship activities - providing increasing responsibilities to successors

Starting early allows successors to ramp up skills before transition.

Estate and Gift Tax Planning Strategies

This section explores estate tax costs business owners face and techniques like trusts, valuation discounts and gifting to minimize tax liability.

Overview of Estate and Gift Tax System

The federal estate and gift tax system imposes taxes on transfers of assets during life or at death. Here is a brief overview:

The federal estate tax applies to the transfer of assets at death. There is a basic exclusion amount that allows a certain value to pass tax-free. For 2023, this amount is $12.92 million per individual.
The federal gift tax applies when you transfer assets during your lifetime. There is an annual exclusion amount ($16,000 for 2023) per donor that does not count towards your lifetime exemption amount.
Generation-skipping transfer tax closes loopholes around estate tax by taxing transfers to recipients who are two or more generations younger.

As a business owner, understanding these complex rules is key to smart estate planning. Proper planning can help minimize taxes that could force heirs to liquidate the business.

Leveraging Tax Exemptions and Exceptions

There are planning techniques centered on fully using gift, estate and other tax exemptions:

Lifetime gifts up to the annual exclusion amount to children or grandchildren do not reduce your estate or use up any lifetime exemption.
Portability election allows a surviving spouse to use any unused exemption of deceased spouse.
Qualified Personal Residence Trusts (QPRTs) remove future appreciation on residences from taxable estate.

Maximizing use of all available exemptions and exceptions helps reduce future estate tax exposure.

Family Limited Partnerships (FLPs)

Family Limited Partnerships (FLPs) are a way to gain valuation discounts and reduce the taxable value of assets in your estate. Here’s how they work:

FLPs are limited partnerships where you transfer business interests as gifts to family members.
Minority discounts apply as limited partners lack control compared to general partners.
Other discounts like lack of marketability can further reduce value of LP interests.

Properly structured FLPs can potentially reduce estate value by 30-50%.

Charitable Trust Planning

Charitable trusts allow you to fulfill philanthropic objectives while also gaining estate tax advantages:

Charitable Lead Trusts provide income to charity while assets pass tax-free to beneficiaries.
Charitable Remainder Trusts pay income to you before the remainder goes to charity.
You get an income tax deduction for the charitable gift. The assets also leave your taxable estate.

Charitable trusts enable business owners to realize estate planning goals alongside charitable priorities.

Probate Avoidance Strategies

This section discusses tactics business owners can use to avoid the lengthy and public probate process when they pass away. By planning ahead, business owners can ensure a smoother transition of assets to their desired beneficiaries.

Titling Assets Properly

Joint tenancy allows for automatic transfer of assets to the surviving owner upon death, avoiding probate. Business owners can also title assets directly into trusts, keeping them out of probate. It's critical to properly title assets like real estate, vehicles, investments, and bank accounts.

Using Transfer-on-Death Provisions

Transfer-on-death deeds for real estate, payable-on-death designations for bank/brokerage accounts, and transfer-on-death registrations for vehicles and investments pass assets directly to named beneficiaries. These provisions avoid probate and allow a smooth transition of ownership.

Establishing Living Trusts

Revocable living trusts are a key component of probate avoidance. Business owners can transfer assets like ownership interests, real estate, and investments into the trust during life. The trust dictates distribution of assets upon death, avoiding court intervention.

Lifetime Gifting of Ownership Interests

Gifting part or all of a business during life removes those assets from the estate. This not only avoids probate, but can reduce estate taxes. Lifetime gifting requires careful planning to ensure continuity of business operations.

Post-Death Transition Planning

This section explores administrative considerations following an owner's death like obtaining date-of-death valuations, filing tax returns, and managing tax payments.

Settling the Estate

Settling an estate after a business owner's passing involves several key steps for the executor. These include:

Obtaining date-of-death valuations of the business, assets, and liabilities to establish the taxable value of the estate. This provides the basis for estate tax calculations.
Filing any outstanding tax returns for the deceased from before their death, such as final individual income tax returns.
Paying any taxes owed by the estate within 9 months of death to avoid interest and penalties. This includes making estate tax payments if applicable.
Managing business operations, liquidity, debts payment during the transition. An executor may need to sell assets to cover estate expenses.
Transferring ownership and titles of business assets and accounts to beneficiaries as designated in the will or trust.

Filing Final Tax Returns

Several tax filing requirements come into play after a business owner dies:

A final individual income tax return is due by April 15 of the year after death. This covers any income they earned before death.
Estate income tax returns for income the estate earns after death. These are due within 9 months after death.
Federal estate tax returns within 9 months of death for estates over $12.06 million (in 2022). Below this threshold, no federal estate tax is owed.
State estate tax and inheritance tax filings may also be required within 6-12 months of death depending on state law.

Court Supervised Estate Administration

If the estate goes through probate, the court oversees addressing claims against the estate by creditors before distributing assets. The timeline varies but can take 6-12 months.

Key aspects of court supervised estate administration include:

The executor inventories assets, pays debts and taxes owed, and manages claims. Creditors have a limited time, often 3-6 months, to make claims against the estate.
Once claims are settled, remaining assets are distributed to heirs and beneficiaries according to the will or state law if no will exists. For trusts, distributions occur per the trust terms.
The executor petitions the court for formal approval of asset distributions and estate closure once administration is complete, often taking 12-18 months.

Closing the Estate

Closing an estate formally wraps up the administration process. The executor's remaining tasks include:

Preparing a final financial account of estate administration for the probate court.
Distributing remaining assets to beneficiaries per the estate plan or laws on intestacy if no will exists.
Ensuring all beneficiaries receive an itemized list of assets distributed to them for tax purposes.
Filing a final estate tax return to pay any taxes still owed.
Petitioning the court for permission to close the estate once all tasks are complete.