How to Include Your Small Business in Your Estate Plan

Introduction: Don’t Leave Your Business’s Future to Chance

You’ve worked hard to build up your small business. Now you need to protect it. Many owners don’t realize that not having an estate plan can mean their business falls apart upon their death. Proper estate planning ensures your family and employees won’t have to deal with legal disputes and financial loss.

In this guide, we will go over how to include your small business in your estate plan to protect and preserve your legacy for future generations, from ownership transitions to tax strategies.

Why Your Small Business Needs an Estate Plan

You invest your time and efforts into your business. In return, it becomes your most valuable asset, providing income and meaning to your life. Asset being a key word. Like your car and stocks, your business needs to be handled within your estate plan.

Risks of not planning

After you pass away, your assets need to go through probate court. Business operations may freeze during the probate process, which is a huge problem because probate can take months, if not years.

Disputes among family or co-owners can also occur if you didn’t specify what should happen to your business after your death.

Due to frozen business operations, most businesses will incur a severe loss of customers, employees, and contracts.

Benefits of planning ahead

You can ensure a smooth transition of leadership or ownership if you plan ahead.

Proper estate planning also minimizes taxes and legal complications. A reduced tax burden on your business can save a lot of money.

In addition, you can maintain financial security for your family and employees. This is particularly meaningful for small businesses because the income stream of your business is likely significant for your loved ones and workers.

Step 1: Consider How Your Business Is Owned

Sole Proprietorship

In a sole proprietorship, you own an unincorporated business by yourself. The business and owner are legally the same. One-person businesses default as sole proprietorships unless you legally change it to a separate business entity.

Without proper estate planning, a sole proprietorship business may dissolve at your death. The solution is to create a will or trust to designate who inherits or continues operations, though of course it needs to be properly structured to function as desired.

Partnership

In a partnership, ownership is possessed by two or more people (or entities). There is a legal agreement that determines the business operations and ownership. Typically, owners will incorporate a buy-sell agreement to specify what will happen next if one owner dies, becomes incapacitated, or otherwise leaves the business.

Buy-sell provisions control how shares transfer. You can detail who is allowed to buy your business shares, at what price, under what conditions, and more. You can also say who is not allowed to control the business. Small business owners who are a part of a partnership need to determine their buy-sell agreement to avoid interrupting the business if they pass away.

Buy-sell agreements offer a lot of flexibility. They can be updated as needed while you’re alive, and it can also provide a source of cash that may be used to settle your estate.

LLC or Corporation

In an LLC or other corporation, ownership is represented by membership interests or shares. You need to include these in your will or trust to ensure proper succession.

Corporate bylaws or operating agreements should complement your estate plan. Since these can be complicated, an estate expert, attorney, and tax professional are highly recommended.

Important: Ownership structure determines how your business assets pass on and how taxes will apply.

Step 2: Create a Business Succession Plan

Your business succession plan defines who will take over management or ownership when you retire, become incapacitated, or pass away.

Identify a successor

The most important step is to identify a successor to your business. This can be anyone—a family member, co-owner, or even an outside professional. The successor should be someone capable and trusted.

Establish a timeline and training process

Leadership transfer requires training. You cannot simply shove someone to the forefront of a business without preparation. Whether you know your end is coming or not, it is important to start training your successor well in advance.

Outline contingency plan

Sometimes, the successor cannot or refuses to serve. You need a contingent successor who can manage the business instead of your primary successor.

Pro tip: Document everything related to your business succession plan. Verbal promises won’t hold up legally!

Step 3: Use a Buy-Sell Agreement to Protect Ownership

A buy-sell agreement is a legally binding contract that protects business ownership. It defines what happens to an owner’s share of the business upon their death, disability, or departure.

Common types of buy-sell agreements

Cross-purchase agreement: Lets co-owners buy out the deceased’s share.

Entity-purchase agreement: The business itself buys back the shares.

Funding options

For a smoother business transition, many funding mechanisms can be used. Popular options include life insurance for buy-sell agreements, SBA loans, and other internal or external funding options. Business savings can also be used to fund the transition.

Life insurance policies on owners, such as through Ethos, can offer a lot of value in buy-sell agreements.

Without an appropriate buy-sell agreement, outsiders or unqualified heirs could end up taking control of the business.

Step 4: Include Your Business in Your Will or Trust

Wills and trusts both let you protect and transfer ownership of your business. Wills are the default way to plan asset distribution, whereas trusts are more complex but can offer better features. Let’s go over each option.

In a Will

In your will, you can designate who inherits your business assets and interests. You can also add a letter that explains your intentions.

Beware: Assets that are listed in a will go through probate court, which is public and can expose your financial details to strangers. The probate process can also delay transfers and freeze your business operations.

In a Trust

You can transfer the ownership of the business to an irrevocable trust or business trust to avoid probate and maintain privacy. There are many types of trusts that can benefit your business continuity and liquidity.

The trustee you choose can manage or transfer business operations immediately after your death. Make sure they are someone you have full confidence in.

Pro tip: Services like LegalZoom can help establish business or family trusts to hold ownership interests. Consult with an expert to ensure the trust is properly structured. It allows for a faster, smoother business continuity than a standalone will.

Step 5: Plan for Taxes and Liquidity

Estate taxes

Your business entity’s value counts toward your taxable estate, so it may trigger federal or estate tax obligations. Federal estate taxes can reach up to 40% of the value. That is a significant amount, making it a huge pain for small business owners with sizable estates.

Liquidity challenges

If your wealth is tied up in your business ownership and it may need to be taxed or go through probate, this can pose a liquidity challenge. You might not be able to obtain cash to pay taxes or debts.

Solutions

There are some strategies that can help you reduce your taxable estate, such as if you give your ownership to a trust. However, the trust needs to be irrevocable and properly structured. A revocable trust’s assets will not be excluded from your taxable estate. A grantor-retained annuity trust (GRAT) or a family limited partnership can be a good choice for tax-efficient transfers.

You can also purchase life insurance via Ethos to provide immediate liquidity for estate expenses or buyouts. The life insurance proceeds provide a predictable death benefit to your beneficiaries.

If you gift your business shares during your lifetime, it can also help reduce taxable estate value. Just be sure you are aware of gift-related tax obligations and limitations, though they are quite generous.

Step 6: Address Key Operational Concerns

Document access

Always store your digital logins, passwords, and key contracts securely. Multi-factor authentication services can add additional layers of digital security. Online will creation platforms like LegalZoom can facilitate document access.

As for physical copies, keep them in a fireproof safe and provide copies to your attorney’s office.

Tell your trusted people and agents how to access key documents if you become incapacitated or pass away. For example, your executor, trustee, and successor should know how to retrieve critical files surrounding your estate plan and business operations.

Authorize decision-making

Power of attorney lets you give someone the legal authority to handle your business finances (or other major decisions) if you’re incapacitated.

Update beneficiary designations

For retirement accounts, insurance, company-owned policies, and anything else with beneficiaries, make sure that you keep the designations up-to-date. Not having updated beneficiaries can mean the wrong person gets ownership of your small business. Beneficiary designations typically override the instructions in your wills and trusts, so if they’re incorrect, your wishes would not be carried out properly. Inconsistencies can also cause asset distribution delays and confusion.

Maintain continuity

Imagine you pass away suddenly without an estate plan. Your employees wouldn’t know what to do. Who would your clients contact? Business opportunities could fall through if there is an issue with ownership transfers.

In your will, you can address what should happen to your business after your death. Include who becomes the leader, who should be contacted for major decisions, how you hope the business can be operated, and other important details.

Step 7: Review and Update Regularly

Review your estate and succession plans every 2 to 3 years or after major life changes. Relationship changes can greatly impact how you want your share of the business to be transferred.

It is recommended to review and update your entire estate plan if there is a marriage, divorce, major business changes, or new family members. If you relocate, you will also need to discern if the new state laws will impact your business. For example, dynasty trusts are not allowed in all states.

Pro tip: Keep your estate planning attorney, accountant, and business attorney aligned on all updates. Incongruencies can cause confusion later down the line.

Step 8: Communicate Your Plan

After preparing and securely storing your plan, make sure you actually discuss your intentions with key people, such as:

• Family members
• Co-owners and partners
• Successors
• Employees

Communication ahead of time prevents disputes later on. If you have co-owners or partners, you need to coordinate buy-sell agreements or there may be mistakes made. People within your business should get a heads-up on what will happen if you pass away, which builds confidence and ensures everyone knows their roles.

Common Mistakes to Avoid

Failing to update ownership or beneficiary documents is actually a crucial step that many small business owners overlook.

Succession planning can be stressful. Many people also assume that family members will “figure it out.” You need to think about succession and ownership transfers to ensure your loved ones will be able to deal with everything in case you pass away.

Many small business owners fail to fund buy-sell agreements properly. Whether you’re using a life insurance policy or other method, make sure the agreement complies with any requirements and works for your business.

Don’t forget about tax and liquidity needs. Taxes, debt, and other obligations can impact your liquidity, and potentially stall your business operations.

Lastly, remember you have digital business assets. Most businesses these days have online domains, stores, and other digital properties. Include these in your estate plan.

Conclusion: Protect Your Business, Protect Your Legacy

Estate plans are essential for protecting your legacy. Businesses can get into hot water if you don’t set up a legitimate estate and succession plan for your small business. With thoughtful estate planning, you can ensure your company thrives long after you’re gone.

If you’re looking to fund a buy-sell agreement or secure immediate liquidity for your loved ones, check out Ethos life insurance for affordable, fast life insurance.