How to Create a Successful Estate Plan for Your Small Business

Stone Harbor, New Jersey - July 25, 2014: 3rd Avenue Stone Harbor. The charming row of shops along 3rd Avenue in downtown Stone Harbor. Anyone who has visited the iconic New Jersey beach town has strolled past this strip of Third Avenue between Springer’s Ice Cream and 96th St.

Did you know that only 30% of family-run businesses survive into a 2nd generation? We strongly believe that the reason so many small businesses fall apart after the initial owner passes away is a lack of estate planning. Estate planning for small business owners is a hugely important responsibility! Find out why you need to start planning now, and what estate planning components you should utilize.

Why Do You Need an Estate Plan?

Establishing an estate plan before you need it is one of the most important tasks you can do for your business. It has some major benefits like:

  • Maximizing your inheritable assets
  • Minimizing taxes and probate fees
  • Ensuring your business won’t be shut down due to lack of a plan
  • Helping you to establish long-term business goals
  • Taking care of your family after your passing

You have quite a few options for a successful estate plan. We’re going to cover six major components including wills, life insurance, tax breaks, buy-sell agreements, an heir succession plan, and a power of attorney.

6 Components of a Successful Estate Plan

1. Will or Living Trust

QuickBooks defines a formal will as “signed by the individual and is often prepared by an attorney. The act of signing is officially witnessed by two observers, neither of whom may be a beneficiary or the spouse of a beneficiary. Most formal wills are drafted by legal professionals.”

However, a will requires your assets go through probate. If you want to bypass probate, a living trust is a great option. It still determines how your business is divvied up but operates as a separate legal entity. Since it is its own entity, it can hold your assets without extra legal fees and estate taxes, as well as keep your estate private.

Tip from the experts:

Always include a provision that gives the executor access to your assets. This could include your bank accounts, email accounts, and all passwords.

2. Life Insurance Beneficiaries

Where does the capital come from for partners to buy out your business shares? If the business assets are not easily accessible, it can be a smart strategy to use the payout from a life insurance policy. If you name your business partner as the beneficiary for your life insurance, they can use that payout to buy your remaining shares. The life insurance payout is actually tax-free too!

Another beneficiary to consider is your family. If your business was their main source of income, life insurance can help them remain on solid financial footing. You can buy a separate term life insurance policy for your family in addition to your business partner.

3. Estate Tax Break

If you die, the IRS can collect an estate tax on your business. This can range from 35-50% of the business value! Since it is usually due within 9 months of your passing, selling the business is often the only way to afford this tax. Plus, a tight deadline forces many businesses to sell below their actual value.

If you plan ahead, there are two IRS tax break strategies you can use to lessen this burden.

Section 303

You can use this if your stock value is more than 35% of your estate. The strategy lets heirs redeem the stock without the large estate tax. But you can only do this once!

Section 6166

You can use this if more than 35% of your adjusted gross estate is from your business interests. If you qualify, the estate tax can be paid in ten installments vs. one single payment. Plus, you can defer the first payment for five years.

4. Buy-Sell Agreement

If you have business partners or shareholders, this agreement will help plan for how the business is handled after your passing. The buy-sell agreement will determine a sale price and what your share of the business is. It can also help you decide if you want your partners to buy out your share, if you want to prohibit specific individuals from taking ownership, or if your heirs should sell your shares. Since the business sale price was established with your help, your heirs will know that they are getting a fair price in the agreement.

We recommend setting up this agreement when all business owners are healthy and cash flow is positive. If you wait until one owner is sick, they will have very different motivations for the agreement.

5. Succession Plan for an Heir

Is your business family-run? If you want it to remain in the family, you have to create a succession plan for your heirs before you pass away. This succession plan will determine how to divide your business assets if you have multiple heirs. For example, if you have three children but only two want to be involved in the business after your death, should your third child get the same share as the others?

Beyond dividing business assets, you also need to prepare your heirs for how to run the business without you. You need to lay out all of the vital information they need to know and set aside time to physically teach them.

6. Power of Attorney

Even if you are still alive, you may not be able to carry out your normal business affairs. A power of attorney document will pick a specific person to handle these business affairs if you are unable. Don’t let the court decide who becomes the guardian of your affairs – start planning now!

Remember, most small businesses will need more than one of these components to be successful. But certain components may not be applicable to your situation. We always recommend consulting a CPA to create a plan.

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