If you own a small business, you’ve got a lot to think about: attracting customers, holding down expenses, keeping up with trends and competitors — the list goes on and on. In short, you do everything possible to make sure your business can support your family. But if you want to keep the business in the family after you’re gone, you’ll need to prepare a strategy — and the sooner you start, the better.
Of course, you could simply transfer your business to family members through the use of a will. However, the value of your business could help contribute to a considerable estate tax burden for your heirs. (The future of estate taxes is unclear. In 2010, the estate tax is scheduled to disappear — for one year only. Unless Congress changes the laws before then, in 2011 the exemption amount - the amount you can pass to your heirs, free of estate taxes — will revert to $1 million, with a maximum estate tax rate of 55 percent.)
So, other than bequeathing your business to family members, how else might you transfer it? You can choose any of several alternatives. Let’s look at two of them.
Suppose you have a child who has shown a great aptitude for your business. You’d be delighted if your child took it over when you were gone, but there’s one problem: Your child can’t afford to buy you out.
To help your child purchase the company, you might want to establish a buy-sell agreement — a legally binding contract stipulating that, upon your death, the business will be sold to your child, at an established price. To fund the sale of the business, you take out an insurance policy on your life, with your child as a beneficiary. You could choose term insurance, which will be fairly inexpensive, but you also might want to consider “whole life,” which has higher premiums but offers the potential to build increasing cash value.
Family limited partnerships
You could also transfer ownership of your business through a family limited partnership. Here’s how it works: Well before you retire, you decide to transfer interests in your business to a family limited partnership, creating general partnership shares and limited partnership shares. You hold on to the general partnership shares and give the limited shares to your child. At this point, you are still responsible for managing the company. And, at the same time, you are reducing your family’s estate tax liability because you are removing assets (the limited partnership shares) from your estate. Furthermore, for gift tax purposes, you’ll get a “discount” on the value of the limited partnership shares because, as “noncontrolling” interests, they are theoretically worth less to the recipients.
When you die, only the value of your ownership interest will be included in your taxable estate. And your child can then take formal responsibility for running the business.
Get professional help
Both a buy-sell agreement and a family limited partnership are considerably more complex than described here, so you will need to work with an estate-planning attorney before you launch either of these arrangements. Your attorney can also advise you on other business-succession alternatives. Start your preparations soon. Even if you are many years from retirement, it’s nice to know you — and your family — will be ready.
Edward Jones, its employees and financial advisors do not offer tax or estate planning advice. You should consult with a competent tax or legal advisor for your particular situation.