A common estate planning questions that arises is “What happens to my business when I am gone?” As part of the answer to this question you will need to consider, among other things, the form of the business entity, your goals, the size and nature of your business, and more.
The type of business entity you have dictates a large part of this answer. This blog will focus on the type of entity you have and how that is affected when you pass away.
Sole Proprietorships – If you own a sole proprietorship, then you personally own all the assets of the business, and all the liabilities. Upon your death, all the interests in your sole proprietorship company will pass to your estate or Trust (if you prepared a trust prior to your passing or provided for a testamentary trust in your Last Will) and will pass to your heirs/devisees/distributes. For the most part, sole proprietorships will end up terminating at the owner’s passing – but not always. The ability to keep your company going depends on the ability of the person or persons inheriting your business and the speed with which they can step in after your passing. In certain instances, they may need to obtain credentialing to keep the business going (for example, if the person who passed was a licensed contractor, you will need to obtain a contractor’s license, or hire someone who is already licensed). Even if no credentialing is required, there is still the question of whether or not the persons inheriting the sole proprietorship are capable of handling the business, or even want to. There will likely also be the need to open up probate proceedings in order to gain appointment as a Personal Representative to handle the business in the interim, and ultimately to arrange to have the business transferred to your heirs or to sell the business.
Partnerships – If you own an interest in a partnership then the terms of the partnership agreement, if there is one, may determine what happens to your share of the partnership. For instance, the partnership agreement could provide that the remaining partners are required to buy out the deceased partner’s interest, or provide for some kind of insurance policy that would buyout the deceased partner’s interests in the business. This keeps the remaining partners from “inheriting” a new partner or partners, any of which may not understand the business model or get along with the remaining partners. Absent a written partnership agreement, statutory rules or common law may dictate your heirs/devisees/distributees rights in your partnership interest. Further, the deceased partner’s interest passes to his estate or trust, to be distributed according to the terms thereof. This may result in an heir/devisee/distribute becoming a partner in the business. This may not be optimal if the person receiving the interest is a minor, a young adult with little business experience, or a person having no interest in operating or running the business.
LLCs – Limited Liability Companies are designed to exist indefinitely, and as such are good vehicles for continuing the operation of your company after your passing. Care should be taken to draft an Operating Agreement which will sufficiently spell out how your interest in the LLC will be treated upon your passing – this is especially critical where there are multiple owners. If you do have multiple owners you need to strongly consider use of a buy-sell agreement which spells out in advance, what will happen when one member passes.
Corporations – Corporations issue stock as evidence of their ownership. Your ownership interest will be larger or small depending on the total number of shares issued by the corporation. A few corporations will grow very large, issue thousands or millions of shares of stock, and will be taken public. Many more corporations are closely held meaning that they are wholly owned by one individual, or by just a few individuals. This blog deals more with the closely-held corporation scenario because it is more likely to be “your business.
As with LLCs, corporations exist indefinitely allowing the business to continue operating regardless of the owner’s death. This trait makes it an excellent tool for continuing the operation of the business post-mortem. If the corporation is large enough, you will have people in place who can carry on with the company’s business. If your corporation is small, you will need to plan much like you would with a sole proprietorship,, partnership or LLC. The sudden loss of an owner in a small corporation who is also the key person in the business can be devastating.
Upon your passing, your heirs/devisees/distributees will not directly receive the assets and liabilities of the company. Instead, they will receive the stock certificates, and with that, ownership rights in the company. This provides liability protection to your heirs from the company’s creditors, and gives them the right to collect on dividends and distributions, and even vote at the annual business meeting.
Use of a Trust – Each of these these types of businesses can benefit from the use of a trust. The sole proprietorship will benefit by having a successor trustee who can easily and seamlessly take control of the business without the necessity of probate proceedings, and make the important decisions of whether to continue running the business or selling it. Your trustee can hire qualified people that will enable the business to continue, and can distribute the income from the business to the persons you direct. This will also avoid the issue of having the persons whom you wish to benefit of becoming direct owners of the business.
Similarly, with LLCs, you can direct your shares or membership interest into a trust. This may be treated like an assignment under the LLC operating agreement which could result in non-voting status upon your passing, but that would likely be the same result if the shares in the LLC passed directly to your heirs. The trust will have the authority to receive the income from the LLC and to distribute in a manner that you prescribe in the Trust. This is helpful if, for instance, your child is young. The trust can accumulate the income from the LCC over a period of time and then distribute it to her when she is old enough to wisely handle the money. Or, the trustee can choose to allocate some of the income while your daughter is still a minor to assist with her education, healthcare or general support. The trust may also insulate your heirs from potential tax issues that would arise were they to directly inherit your interests in the LLC. You will also avoid the necessity of probate proceedings.
Like with an LLC, you can direct your partnership interest into a trust. If there is a formalized partnership agreement, such a transfer might be treated as an assignment (much like an assignment of an LLC interest). The advantages here are that you avoid probate proceedings, the persons you intend to benefit do not become direct owners of the partnership interest and yet can still collect the income from the continuing operation of the business or collect the proceeds from the sale of your interest, and you retain the flexibility of determining how those funds will be distributed to your devisees.
Finally, with a corporation, you can transfer title to your shares in the corporation to the Trust. Unlike an LLC or partnership, this should not affect your rights in the company because you can vote them in your capacity as trustee of the trust. It also permits the successor Trustee of the trust to vote the shares of your stock until such time as it is appropriate to transfer those shares to your devisees, and protects those shares from creditors of your devisees. And, again, use of a trust avoids probate and the inherent delays in getting a Personal Representative appointed.
In sum, you should consider an appropriate structure for your business. Sole proprietorships are not advisable because of the liability risk to all your personal assets. You should also consider the use of a trust is the cornerstone of your estate planning to maximize the chances that your company will continue to operate for the benefit of your loved ones after your passing. Consult a knowledgeable attorney to discuss the particulars of your situation further.