Business Estate Planning
How to preserve your life's work
You've spent a lifetime building your business. Take a moment to make sure that your hard work will survive the death of you or one of your partners.
As the owner of a closely-held business, much of your wealth is probably tied up in the business. While returning earned income back into the business helps finance growth, it can cause severe liquidity problems for your estate when you die. After paying probate and estate taxes, your estate and surviving family members also may encounter liabilities that become payable upon your death. They may also face the potential of decreased business earnings, due to your absence.
There are ways to overcome these liquidity problems. Business-oriented strategy tools can help reduce estate taxes and make the best use of the cash available. The most common business estate-planning tools are buy-sell agreements and Section 303 stock redemptions. Business-owned life insurance is one method that can be used to fund each of these strategies.
Buy-sell agreements can establish the value of your business for estate-tax purposes and improve your estate's liquidity by assuring a ready market for your business upon your death. These agreements also protect business partners from sharing ownership with a deceased stockholder's family.
There are two main forms of buy-sell agreements: cross-purchase and stock redemption. In an insurance-funded cross-purchase arrangement, each business owner buys an insurance policy on the other, naming themselves as beneficiary. At the death of one of the owners, the surviving owner receives tax-free insurance proceeds to use in purchasing the deceased owner's stock from his or her estate.
In an insurance-funded stock-redemption arrangement, the corporation purchases the stock of a deceased shareholder. Here the business is the owner and beneficiary of life insurance policies on each shareholder. A partnership looking for a business continuation plan may use a similar arrangement called an entity purchase.
A buy-sell agreement that is funded with life insurance will benefit:
- Prevents conflict with surviving owners
- Ensures that your family receives a fair price for your business
- May set the value of your business for estate-tax purposes
- Provides needed cash
- Keeps new and/or unwanted owners out of the business
- Prevents disputes
- Ensures continuity and orderly transfer of ownership
- May provide tax-free cash to purchase stock
Section 303 Redemptions
Section 303 of the Internal Revenue Code gives your estate a one-time opportunity to remove cash or other property from your business, at little or no tax cost, through a partial redemption of your stock. This can provide the liquidity your survivors need to pay funeral costs, estate and administrative expenses, and state and federal death taxes.
To be eligible for a Section 303 redemption, the stock value must exceed 35 percent of your estate. The maximum amount that can be paid under such a plan equals the total amount of the federal estate tax, state death taxes, funeral and administrative expenses. Corporate-owned life insurance can be used to fund the redemption. Under this arrangement, your business purchases an insurance policy on your life and at your death uses the tax-free proceeds to buy enough stock from your estate to cover death expenses and taxes.
Business Valuation for Estate Planning
No matter what technique you select for your company, determining the value of the business is a key step in the estate planning process. Why? First, in the case of a buy-sell agreement, you need to know the value of the business to determine the price and fund the agreement. Second, because the business is part of your estate, the valuation is needed to estimate the estate taxes; this helps you calculate the cash or liquidity needed to administer the estate. Finally, the value of the business must be reported on the estate tax return when the owner dies.
Life insurance products contain fees, such as mortality and expense charges (which may increase over time), and may contain restrictions, such as surrender periods. Please keep in mind that the primary reason to purchase a life insurance product is the death benefit. Financial Advisors do not provide specific tax/legal advice and this information should not be considered as such. You should always consult your tax/legal advisor regarding your own specific tax/legal situation.