Friday, April 4, 2014

Passing the Buck - Business Interest Transfers

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, or through my other websites,, or for Fred Begun.