Most people don't like thinking about their own demise. Even fewer want to think about what will happen to their business postmortem, and absolutely nobody wants to take on the jargon and paperwork involved in setting up an estate plan.
"The hardest thing to get people to embark on is the estate-planning process," says Patrick Smith, vice president and director of
The Hartford Financial Services Group's
estate and business-planning department. Business owners that start in their early 50s are ahead of the curve, he says.
More than 40% of small-business owners say their top concern is how to leave their business and realize the monetary benefits of their hard work, according to the Hartford's Business Owner survey. However, crippling taxes and poor planning too often put businesses to rest alongside their founders.
A Fate Worse Than Death
Besides their death, business owners are increasingly worried about surrendering a large chunk of their assets to federal estate taxes, says the Hartford Study on Consumer Attitudes and Perceptions Regarding Estate Tax released last month.
With national elections 14 months away, a growing federal budget deficit that might imperil tax cuts and a current law that calls for the federal estate tax to be repealed in 2010 and then reinstated in 2011 at a whopping 55 cents to the dollar has small business owners feeling their mortality.
"Federal estate tax rates are scheduled to go up and personal exemptions are scheduled to go down, which means individuals who plan to pass
on more than $1 million in assets will have to take the estate tax into account," says Smith.
Timely Planning for the Untimely
Before you pull out your business terms dictionary, start off on solid footing by nailing down the value of your company. "Even though people say businesses are the principal source of retirement security, less than half of them are appraised," says Smith.
Then round up your experts, who should be varied and specialized. "Very often the CPA can act as a quarterback to provide the attorney with financial information," says Mitchell Lapidus, partner at Propp, Lubell & Lapidus, LLP in New York City. "But the attorney has more detailed knowledge of the law. No single person can
or should do everything."
And just like you wouldn't go to a general practitioner for a root canal, says Smith, use an estates and trusts attorney that has experience with your kind of business. Be sure to let your attorney know if you have a Subchapter S or C corporation under the internal revenue code, adds attorney James Siegel, member of law firm
James E. Siegel & Associates PLLC, a distinction that becomes particularly important in estate planning.
Most importantly, start the process while you're still breathing, warns Siegel. "If you have no will or trust,
upon your death your assets will be distributed according to descent and distribution." If the sole proprietor of a business dies without a succession plan in place, the business terminates.
Kill the Taxman
If you've never ventured into estate planning, the jargon alone can scare you to death, but "people grasp it quickly," says Lapidus of the terminology and complex rules. "The question is how to play within these rules."
Unfortunately, less straightforward planning solutions are most effective for protecting assets and avoiding looming estate-tax issues, says Smith. Passing your business on to anyone other than your spouse, particularly if they're not in the family, "screams for some form of funded buyout," he continues.
Renee White Fraser's company
Fraser Communications, for instance, is 15 years old. In the last three years she has started thinking about succession planning. Her three daughters aren't interested in the business, so she created a plan with her tax attorney and CPA for the business ownership to be transferred to senior employees who would eventually pay out her husband. "The reason my business is successful is because of my entire team," says Fraser. "I respect that they know better than my family."
Still, a buyout is often expensive for a business partner and spouses are notorious for causing conflict. The best way to keep your business alive after your death, says Smith, is to keep everyone happy and avoid the federal estate tax which can take as much as 60% of your estate.
While all situations are different, Smith recommends life insurance. "I can't think of a better way to increase cost basis," he says. "It's the right way to do a business buyout."
Getting complicated is really the most effective way to avoid tax if your business is passed to anyone besides your spouse. Here's a quick and demystifying explanation of how life insurance works to rid you of estate tax:
Say your business is worth $2 million. You and your business partner take out a $1 million life insurance policy on each other, so if one person dies, the other gets $1 million income tax-free. The surviving partner's cost basis in that business is increased by $1 million and he or she becomes the sole owner.
But before you run to your local
, know the terms of another highly effective, but unfortunately less-utilized succession plan: the Irrevocable Life Insurance Trust (ILIT). According to the Hartford study, only 22% of small-business owners surveyed used this solution, largely because they opt for simpler but less powerful methods like wills and living trusts.
In the ILIT, the trustee (who is not the insured) is the applicant and owner of the policy. Because the insured does not have ownership in the policy, when he or she dies, the proceeds belong to the trust and are therefore not subject to estate tax.
Keep in mind that an irrevocable trust cannot be changed or dissolved, but its opposite -- a revocable trust -- won't give you a tax shelter. Some business owners don't want to impair their standard of living now to ensure their business after death. In this case, talk to your attorney about setting up an access provision in which one of the trustees (usually the spouse) has access to the money in the trust while alive. "It gives a level of comfort to folks," says Smith. "They are still in control of their financial destiny."
In addition, the ILIT comforts the family of the insured, as the spouse has privileges such as the ability to decide who gets the assets of the trust upon subsequent death.
Whatever your method, plan for your business's survival while you're still living, and remember one of life's greatest lessons: the easy way isn't always the best.