Estate planning is complex at the best of times. When you own a small business, the complexities are multiplied because your estate plan must double as a succession plan in the event of your death.
You’ll find a number of tips and tools contained within this article that can help you plan your estate. It’s important to keep in mind that these tools are just that – tools. They’re not a strategy.
To create a strategy, you’ll need to consult other people. This can include experts (your legal team, your financial planning team), stakeholders (your family, partners in your business) and a number of other individuals (spiritual counsellors, life coaches). This humble guide was merely created to get you thinking about how to start planning your estate.
Succession Planning
The methods used for succession planning will vary depending on the structure of your small business. Here, we’ll focus on two types of small businesses – sole proprietorships and partnerships.
Sole proprietorships are an interesting case, as they, unlike most other business structures, are not their own legal entity. When you’re operating a sole proprietorship, you remain liable for all the activities undertaken by the business. When you pass away, then, you can’t actually pass along the sole proprietorship – it’s intrinsically tied to you as an individual.
What you can do is designate an heir (or heirs) to be given all the assets of the business. This can include intellectual property rights, contracts, and any other number of assets. The business would need to be run under a new sole proprietorship (or any other business structure your heir deems appropriate).
When it comes to partnerships, you’re going to want to look at a buy-sell agreement. These agreements can be quite complex, but in simple terms, they determine three things:
- Conditions under which the agreement is triggered (a partner’s death is one common trigger)
- Who is to buy that partner’s shares when the agreement is triggered
- The value of those shares
While partners will typically buy each other’s shares, the business entity itself can also buy shares. This agreement decreases the risk of the business being taken over by outside interests. In other words, it’s to every partner’s advantage.
In order to ensure that every partner has the assets to purchase shares should the buy-sell agreement be triggered, it’s common to see partners take out life insurance policies on each other. The funds from these policies are then used to buy the deceased partner’s shares. The business entity may do the same.
Ensuring that the tangible assets from your business are incorporated in your estate is easy enough, but it’s equally important to ensure that intangible assets are made available. You may have relationships with suppliers and key stakeholders that no one else does. You may have knowledge about procedures that others don’t share. Business planning is not a one-time event. You should constantly be updating your plan so that your successor will be able to operate the business with relative ease once you’re gone. Details are important!
Estate Planning Tools
Trusts are one of the most important estate planning tools small business owners have at their disposal. They provide a high degree of customizability – you’ll get to choose who receives assets once you’ve passed away and how those assets are distributed to beneficiaries. You can put a number of conditions on trusts – far too many to list here.
Life insurance is another excellent tool to incorporate in your estate strategy. The payout from life insurance is generally not taxable – numerous exceptions do apply. The biggest one is that if you have any incidences of ownership over a life insurance policy, the proceeds from that policy may be considered as a part of your estate for the purposes of calculating estate tax.
Estate tax is not something that’s important to consider for the vast majority of North Americans. It only applies (as of the writing of this article) to Americans with estates valued over 11 million dollars. Those who are worried about life insurance contributing to estate tax might consider an irrevocable life insurance trust (ILIT). There is no estate tax or inheritance tax in Canada.
Another tool you can use is gift giving. You can, as of the writing of this article, give each of your children up to $15,000 each year without having to pay a gift tax in the USA. This reduces the overall value of your estate, which can reduce your tax burden. Canada has no gift tax so you can give your children any amount of cash while you’re alive without it being considered taxable income.
You might also benefit from creating a Family Limited Partnership (FLP) or Family Limited Liability Corporation (FLLC). These business arrangements can act to reduce your tax burden. You’ll assign your children as partners in the FLP or FLLC, but their roles in the business will be limited. Chiefly, they won’t have control or marketability. This effectively reduces the value of your share of the business, which reduces your tax liability.
It’s worth repeating that everything mentioned in this section is a tool, and not a strategy. These tools won’t work for everyone, and they can be incorporated together in different ways in order to create a strategy for your estate.
You should also note that the IRS heavily frowns on tax evasion strategies – they’re illegal. So does Canada’s taxation arm, the CRA. The reasons behind this are obvious, and it makes it important to have legal counsel as well as financial advice when planning your estate.
Lawyers are an essential component of your estate planning team, and they can work with accountants, financial planners, insurance brokers, and other professionals to ensure your estate grants the most money possible to its beneficiaries – legally.
Business planning is not a one-time event, as your business grows and develops, and your circumstances change, so too must your planning. You should view estate planning in the same light. Your financial situation may change, and your personal and familial situations may change as well; adjust your estate plans accordingly.