Estate Planning for Small Business Owners

When you leave your pet for a weekend, you have a plan. You know who'll feed it and how much it will cost. So, what happens when you step away from your business for the weekend? More importantly, what will happen when you leave your business for much longer—as in, permanently?

If a business owner dies and there's no plan in place, it's the survivors who are left without direction. While your business might be humming along right now, how will it be if you're not around? Executing someone's affairs after death is a whole new, and potentially messy, ballgame. If you want to take care of business even after you're gone, you need to plan what will happen to your estate, and that includes your business. Communication with your family and business partners is the first step, documenting what you decide is the second.

Let's look at some estate planning strategies for you, the small business owner.

Minimizing taxes

If nothing else, one good reason for estate planning is to minimize the amount your estate will owe in taxes. You've worked hard to establish your business as a profitable entity. Don't lose the fruits of your labor to the IRS in estate taxes. This type of tax usually ranges from 35% to 50% of the business value and is due within nine months of your passing. But only very large estate will be required to pay these taxes.  You should consult with an attorney or tax professional to see whether you will be subject to these taxes and learn about your options for minimizing them.

Two IRS tax breaks, Section 303 and Section 6166, alleviate the tax burden for small business owners. Section 303 allows your estate to redeem your stock with very little tax cost. This is a one-time opportunity, and the stock value must be more than 35 percent of your estate. Heirs frequently take advantage of Section 303 to cover estate taxes.

Section 6166 offers estate tax deferral for small business owners. To take advantage of Section 6166, more than 35% of your adjusted gross estate must be from your business interests. If eligible, your executor can pay the estate tax in 10 annual installments. This alleviates the burden of having to generate one lump sum within nine months of your passing. Under 6166, the first installment isn't due for five years. This gives your business time to earn the money to cover the taxes.

Buy-sell agreements

A buy-sell agreement is a contract between shareholders or partners that establishes a plan for the business in case one of the owners dies or becomes incapacitated. The principal benefit of a buy-sell agreement is that it establishes a sale price for the business and your share of the business. A buy-sell lets you document whether or not you want your partners to buy out your share, if you want to block certain individuals from having a role in the business, or if you want your heirs to sell your portion. Since the business price has been established, family members know they are receiving a fair price.

As any good business plan anticipates the future, a buy-sell agreement is simply another aspect of good business. While creating a buy-sell agreement requires open communication with both your family and your business partners, which can be difficult to achieve, it will establish a solid path for the future, greatly reducing any potential for disaster.

Life insurance

If the business assets are not liquid, where do partners get the capital to buy out a deceased partner's shares? Very often, the necessary capital comes from life insurance. This is a common business practice, each partner takes out a life insurance policy that names the other owners as beneficiaries. This strategy gives surviving owners tax-free proceeds to purchase the deceased's portion of the business from his or her estate.

Family-run businesses: Considering the heirs

In a family-run enterprise, you may have some heirs who are involved in the business and others who are not—how do you divide your business assets? Many people choose to distribute assets based on a relative's contribution level. Let's say two of your children are going to take over the family business. Do you want your third, uninvolved child to have an equal share? Perhaps you want the two involved siblings to buy out the third. Regardless of what you decide, controlling these types of choices is critical. After all, the passing of a family member is hard enough to deal with on its own. Proper estate planning at least allows your business to have a smooth transition.