Estate Planning for Small Business Owners

If you are a small business owner, putting a plan in place in the event of your incapacity or death can ensure that your business survives, your family can continue to be supported, and your assets will pass to your family efficiently. Without a plan, your business could be interrupted, have fewer tax saving options, and be subject to probate. By taking the time to establish a plan now, small business owners can be assured their goals and desires are put into action.

One of the first considerations with business estate planning is reviewing the existing buy-sell agreement or putting one in place. A buy-sell agreement is a legal document that is put in place by two or more business partners that covers all the situations by which a partner may leave the business. This would include whether a partner leaves because of death, disability, wanting to sell, or other reasons set forth in the agreement that might compel an owner to leave the business such as bankruptcy or divorce. Some buy-sell agreements will require or give the option to the surviving owners to purchase the interest of a deceased owner. Knowing how your buy-sell agreement impacts your business interest on your death is vital to effective planning.

Depending on your type of business and the terms of your buy-sell agreement, life insurance might be appropriate. Life insurance owned by the business or the other partners can help fund a buy-out of a deceased owner's interest in the company. If the business will continue with the business owner's family, life insurance can help the family and the business remain solvent during a time of change. Whether life insurance is appropriate to your business estate plan is unique to your situation.

Once we know whether your business interest will be affected by a buy-sell agreement, the next step is to determine the manner in which your interest should pass. Generally, your estate can pass either through a will or a revocable trust. Both wills and trusts are documents that set forth your wishes as to where your assets should go when you are gone. However, unlike a will, a revocable trust is not subject to probate. A Minnesota probate is court process by which a personal representative is appointed to carry out the terms of your will. Since probate is a court process, it is part of public record. Recent changes in Minnesota law will make it so that court records can be accessed via the internet from a remote location, which many people find discomforting. See Coming soon to a computer near you: Minnesota Court Records. For many small business owners, a revocable trust makes sense instead of a will. By using a revocable trust, business owners can avoid the public exposure involved with probate and allow assets to pass more efficiently.

Finally, all Minnesota business owners should consider whether they are impacted by the Minnesota estate tax. The estate tax is a tax assessed upon the death of an individual when the total value of all the assets less liabilities exceeds the estate tax exemption in the year of death. In Minnesota, the estate tax exemption is $1.6 million for decedents dying in 2016, which is set to rise to $2 million in 2018 and beyond. The federal estate tax exemption is a higher $5.45 million per individual, set to increase with inflation. See Estate and Gift Tax Update for 2016. By including a plan for potential estate taxes in an estate plan, business owners can minimize the impact. Both the federal and Minnesota estate tax codes also give business owners some options for reducing or delaying payment of estate taxes.

One option available for federal estate tax is found in Section 6166 of the Internal Revenue Code which gives the family of a business owner the option of paying estate taxes over 10 annual installments rather than all at once. To qualify for this estate tax deferral the business interest must be more than 35% of the decedent's adjusted gross estate.

For Minnesota business owners, one way to reduce Minnesota estate taxes is to utilize the qualified small business property deduction. Like the qualified farm property deduction, this deduction allows the value of a small business to be deducted from the Minnesota gross estate. The amount that may be deducted is the difference between $5 million and the exemption amount in the year of death. For instance, a business owner dying in 2016 may be able to deduct up to $3.4 million of the value of a small business. Qualified small business property must meet all of the following requirements to be deductible:

  1. The value of the property is included in the decedent's federal adjusted taxable estate, which is after deductions, including debts, expenses and bequests to a surviving spouse;
  2. The property consists of small business property (i.e. not traded publicly);
  3. The decedent or the decedent's spouse materially participated in the business during the taxable year that ended before the decedent's death.
  4. The business had gross annual sales of $10 million or less during the last taxable year that ended before the decedent's death;
  5. The property does not consist of cash or other assets not used in the operation of the business;
  6. The decedent continuously owned the property for the three-year period ending at the decedent's death;
  7. A family member materially participates in the business for the three years after the decedent's death.
  8. The estate and qualified heirs agree to pay the recapture tax, if applicable.

Though the qualified small business deduction is generally only available to family businesses in which the business owner was active at the time of death, the deduction is a huge tax savings for those business owners and their families that meet the requirements.

Whether you are a sole proprietor just starting out or an established business with multiple partners, all Minnesota business owners should take the time to put a plan in place to ensure that the enterprise they've put together passes according to their wishes when they are gone.

The attorneys at Ward & Oehler are experienced in providing legal services to business owners and their families. For more information or to schedule an appointment, call (507) 288-5567 or send us an email on our contact page.

Interested in staying up-to-date on Minnesota estate planning, business law, farm law, probate, and real estate law? Sign up for our quarterly newsletter here.