Business owners face unique estate-planning challenges that require specialized strategies to protect accumulated wealth, minimize tax exposure and ensure the successful transition of the business to future generations. With proper planning, business owners can leverage strategies to achieve their personal and financial objectives while maintaining control during their lifetime.
Estate-Planning Landscape
Business owners typically hold the majority of their wealth in their business interests, creating concentration risk and liquidity challenges. According to available data, approximately 90% of the 14 million businesses in the United States are family-owned and managed, with family businesses responsible for nearly half the gross national product.
The Small Business Administration reported that 90% of the 21 million U.S. businesses are family-owned, yet 80% of family businesses don’t pass successfully to the second generation, and of the 20% that do, 80% never make it to the third generation.
These sobering statistics underscore the critical importance of comprehensive estate planning for business owners. Challenges include: liquidity constraints, as business interests are typically illiquid and difficult to value; increased estate tax exposure due to concentrated wealth in a single asset; and business succession difficulties when no clear successor is in place. Further complications arise when owners mistakenly assume their children or relatives are willing and able to run the business. Lastly, without proper planning, owners risk having to share ownership with unwanted parties.
Essential Estate-Planning Documents
Every business owner should maintain current estate planning documents that address both personal and business-specific concerns:
Revocable trust: A revocable trust provides the foundation for comprehensive estate planning. Essentially, it’s a vehicle to own legal title to property instead of having it in an individual’s personal name. A revocable trust offers several key advantages, including probate avoidance, privacy protection, disability planning and flexibility.
Durable financial power of attorney: This document enables trusted individuals to manage business and personal affairs during incapacity, avoiding court-appointed guardianships.
Buy-sell agreement: A properly structured buy-sell agreement is essential for any business with multiple owners or key employees who would run the business in the event of an owner’s disability or death. Provisions should address: triggering events, valuation methodology, purchase obligations, payment terms, source of liquidity for purchase and transfer restrictions.
Planning for Incapacity and Survivor Liquidity
Cash flow for the surviving spouse represents one of the most critical issues in family business succession planning, especially when the surviving spouse is unable to continue running the business.
If the business owner has been taking cash out of the business in the form of compensation, the surviving spouse faces immediate concerns when, on the business owner’s death, the paycheck stops.
Ways to address this issue include earmarking life insurance proceeds for income replacement, setting up deferred compensation plans payable to the business owner on retirement and continuing for the surviving spouse’s lifetime, implementing written dividend policies to apply after the owner’s death and using buy-sell agreement proceeds if ownership interests are to be purchased.
The business owner who believes the business will continue earning uninterrupted by death must determine how those earnings will reach the surviving spouse. Without proper planning, there may be no mechanism to compel distributions, particularly if voting interests pass to active family members who prioritize business reinvestment over distributions to inactive owners.
Advanced Estate Planning Strategies
Many business owners are rightly concerned about creditor protection or mitigating the risks of estate taxes. Here’s a brief overview of common trust structures that business owners will consider.
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Beneficiary defective irrevocable trusts (BDITs) shift appreciation outside the estate while maintaining control, though they’re complex and lack Internal Revenue Service precedent.
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Spousal lifetime access trusts (SLATs) allow indirect access through a spouse and lock in gift exemptions, but risk loss of access on divorce.
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Intentionally defective grantor trusts (IDGTs) transfer business interests while minimizing transfer taxes, though they require loss of control over assets.
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Intentionally defective grantor trusts (IDGTs) transfer business interests while minimizing transfer taxes, though they require loss of control over assets.
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Grantor retained annuity trusts (GRATs) minimize gift taxes on appreciating assets, especially in low-interest environments, but are less effective if assets lose value.
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Irrevocable life insurance trusts (ILITs) keep insurance proceeds estate tax-free and provide liquidity, although they’re irrevocable, and premiums can be costly.
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Irrevocable life insurance trusts (ILITs) keep insurance proceeds estate tax-free and provide liquidity, although they’re irrevocable, and premiums can be costly.
Trustee Selection and Conflict Considerations
The selection of appropriate trustees requires careful consideration of potential conflicts of interest. Corporate fiduciaries may be unwilling to act as trustees when trust assets consist of ownership interests in a family business due to management responsibilities and fiduciary exposure associated with such roles. If the trust holds a controlling interest, corporate fiduciaries are naturally aware of the fiduciary responsibilities that accompany control.
Individual trustees present different challenges. A child managing the family business may struggle between fiduciary duties and business loyalties. Additionally, a spouse-trustee’s need for income may conflict with obligations to other beneficiaries, especially regarding trust-owned business dividends.
To address some of these conflicts, estate-planning documents may acknowledge and waive conflicts of interest, authorizing individual trustees to act despite self-dealing prohibitions, provided they don’t exercise powers resulting in general power of appointment problems. Furthermore, many business owners incorporate a business trustee to manage business assets and a general trustee to administer non-business assets.
Early Action
Successful planning requires early action, as many strategies become less effective as business values increase and owners’ age. Advisors should work with business owners to develop comprehensive plans addressing tax minimization, asset protection, liquidity needs and succession objectives. With proper planning, business owners can preserve their life’s work for future generations while achieving their personal and charitable goals.
