Passing the Buck - Business Interest Transfers
A special concern in Estate Planning, and for that
matter Financial Planning, Tax Management and all aspects of wealth transfer is
the handing of business interests.
Whether we are talking about Mom & Pop’s Restaurant or
Entrepreneur’s Tech Corp., our society has long valued and respected the
ability to create a business, and the wealth related thereto. Unfortunately, the passing of that
value has been both attacked and praised over the years. These businesses can be held in various
formats, most notably as a sole proprietorship, a general partnership, a
limited partnership, a limited liability partnership, or various corporation
formats, such as a limited liability company, an S corp or C corp. The various formats provide different
options, traps and opportunities.
First off, lets consider the sole proprietorship,
which is typically the small business with a single owner, and which is most
commonly seen. Sometimes this is
simply the DBA, reported on someone’s Schedule C tax returns, and is frequently
not severable from the person himself or herself. This lack of separation between business and person is a
prime reason for the early and careful planning for transition. In most cases, these businesses die
with their creator/owner.
Frequently, the plan is more for the liquidation of any asset value and
the passing of money. As this is a
very common business interaction for the Estate Planner, the attorney and the
client must figure out early on, what is the client’s real desire for the
business and make sure that desire is realistic. After a thorough planning discussion, sometimes these views
change. If the real business is
the personal knowledge, expertise, technique and connection of the client, then
it may be not be transferable at death or retirement. However, if there are others that could transition in, then
there are options. Maybe there is
a trusted manager or employee.
Maybe that is a family member.
If so, planning options might include: 1) Reorganization of the business into a more readily
transferable format, like a corporation, so that ownership can be bought or
transferred over time, allowing a vesting transition. 2) Sale of the business during the owner’s lifetime. Not only does this remove your client
from the business, hopefully with cash value to invest or live on, but if done
while a vital going concern, it may maximize value, rather than an after death
fire sale. 3) Devise the business
and assets upon death. You can
pass your business in your Will, but this is less desirable, in part due to
players and readiness to take on the business, but also due to taxes and
liquidity issues for the recipient.
Also, some businesses may require licensed or certified individuals, such
as accountants, doctors and lawyers, so the practical aspects of operation
pending devise are simply not present.
4) Sale at Death is an option.
However, this usually means charging your executor with the task of
finding a buyer after your death or if no buyer is viable, liquidating the
business. Unless there is a plan
for operation during transition, it is possible that the business would be
treated as marginal and discounted buy aggressive buyers.
A general partnership is an association formed by 2
or more persons to carry on a business, as co-owners, for profit. A partnership is a very personal
business arrangement, dealing as much with personalities as it is with rights
of control and management. A death
of a partner does not automatically dissolve a partnership, but will
disassociate the deceased partner.
The surviving partners have the right to continue the partnership
business, but there will be an obligation to buy out the deceased partner’s
interest. The manner and method of
determining the value of the deceased partners interest, and the method of
paying out that value to the estate, survivors or heirs may be delineated in
the partnership agreement or buy law.
It should go without saying that in preparing the Estate Plan, the
review of the Partnership Agreement is crucial. As with sole proprietorships, the same issues of liquidity,
taxes, valuation and buy out. So
too with partnerships, if the partner seeking the Estate Planning has a desire
for the business to continue on, there may be issues of changing format of the
business, perhaps even to incorporate, as that will be a more durable
entity. Finally, there may be
other issues relative the devise of the interest, execution of a buy out
agreement, or even sale or liquidation, all of which may have to be monitored
by the executor.
A limited partnership has at least one general
partner and one or more limited partners.
The business of the limited partnership is under the management and
control of the general partner. As
such, the limited partner has no right to participate in management or
control. An interest in a limited
partnership is essentially personal property of the investor. There should be a limited partnership
agreement, which will define the terms and conditions for the transfer of such
interest. It may provide for the
liquidation to or through the general partner, or some other format of buy
out. Death of the general partner,
who has management rights and obligations is treated differently from the death
of a limited partner. As with
general partnerships, the same issues of liquidity, taxes, valuation and buy
out.
A limited liability company is an unincorporated
business entity that combines certain attributes of a partnership and a
corporation. On one hand they may
have less formalities than a corporation and more flexible structures and
participations. On the other hand,
they are not uniformly used throughout the US, they may have different
treatments state to state and may have unusual tax treatment. Like a limited partnership,
participation in an LLC is treated lie personal property or other
investments. You can share in
gains or losses, but not in management or control. Like a partnership with an agreement, the LLC should have
its controlling documents, including the Articles of Organization and the
Operating Agreement, which will give guidance. There may be buy sell agreements to consider in the Estate
Planning process. There may also
be issues of the number of members in the LLC. Therefore it may be interests in the LLC that are devised by
a Will or simple the liquidated value, after your executor has been directed
accordingly.
More common is the limited liability partnership,
which is treated like a general partnership, but has taxes generally imposed
upon corporations. LLPs differ
from general partnerships in that only the general partner has control, whereas
all of the partners in the LLP share in the control of the LLP. Otherwise death and planning for an LLP
will be treated much the same as that of the general partnership noted
above. Again, in the Estate
Planning process, access to and review of the partnership agreement is a
necessity, if for no other reason than to identify and fully understand the
buy-sell or buyout arrangements.
Finally, on to corporations or corporate
securities. Shares of publicly
traded corporations are freely transferable, so this presents little
concern. In some instances, there
may be some restrictions on the transfer of stock, but this would be more for
significant blocks of publicly traded corporations or if the stock is in a
closely held corporation, such as the S Corp. These restricted or closely held stock, frequently have some
trust or voting restriction. For
the closely held C Corp or S Corp, you need to be aware of tax considerations
and other concerns if the stock is to be held by a trust. Tax planning can be crucial here. Transfers of stock in publicly traded
corporations rarely offer these same concerns.
As I caution throughout my blogs, you must consider
each case on its own. Your unique
facts and variables will offer something different every time. You may fall into a simple general
application, but you may have some little item that makes your situation
special, so always have complete disclosure, full show and tell, with your
Estate Planner and the rest of your “A” Team of advisors, so that we can work
in concert to create the results you want.
As for these considerations during or after a divorce, it is very likely that a family business could be the biggest asset of a family. Obviously, ownership usually goes to the party that runs the business or holds the licenses. Even so, value is usually allocated accordingly. For a partnership format, we typically see some struggle with value and buy out. In a stock situation, we usually see the same thing, but sometimes, there may be a stock transfer. We need to be aware of any limitation on transfers in case diluting ownership raises red flags. While we have a hard time looking a day ahead, especially when mired in a divorce, the foresight to consider long ranging issues for eventual passage of this value and wealth, may impact how you value and fight over an asset in the present.
When we meet next, we are going to enter the wrap up
phase on Wills, with some assorted issues, such as Charitable Devises and
Residual Devises and after that, I hope to have special discussions on
taxes. In the meantime, I hope you will review your Estate Plan with
you're “A” Team, or at least begin to seek out an Estate Planning Attorney to
start this process. Stay tuned for future blogs. However, if you have
any questions, feel free to respond below, or if you are interested in learning
more about an Estate Plan, Wills, Trusts, Advanced Healthcare Directives, or
Divorce, Custody, Visitation, Child Support, Spousal Support, Property
Division, Modifications, Remarriage, or Pre-Nuptial Agreements, please contact
me at please contact me at fbegun@gmail.com, or through my other websites, www.fcbegun.com,
or www.linkedin.com
for Fred Begun.
