Estate planning for business owners.Owning a Business in California


We assist clients starting a business in California in choosing which business entity (or entities) is best for their situation, not only from a tax perspective, but also from asset protection and estate planning perspectives. We also help business owners with the legal issues involved in transferring a business, whether through a sale or exchange or to the next generation of a family business. For family business owners, we also address the issues of coordinating the business and family estate plans and meeting the challenges of estate equalization while while ensuring family harmony and the ongoing health of the business.

Choosing a Business Entity

Business ownership can be a complicated process, filled with decisions for everything from choosing what types and shares of stock to issue for a corporation to choosing a business name and filing it with the State. All of these decisions must be made against the backdrop of both legal and practical considerations.

Choosing the business entity, or legal structure, can be complex. In addition to the legal aspects, there are practical considerations. Also, different filing and regulatory obligations accompany almost every form of business organization. We're here to help clients sort out all of these considerations, so they can get on with the business of running their business -- and making a profit!

Estate Planning for Business Owners

It would be an understatement to say that family businesses are the backbone of the American economy. Some 90 percent of all businesses in this country are either family-owned or family-controlled. They come in all shapes, sizes and colors, representing all sectors of our economy. From agriculture to services, technology and manufacturing, family businesses generate an estimated one-half of the U.S. Gross National Product and pay half of all wages earned in this country.

Not all family businesses are traditional small businesses either. In fact, about one-third of all businesses included in the Fortune 500 are family businesses. But not all of the family business statistics are rosy.

Family businesses tend not to outlive their founders. At any given moment, 40 percent of family businesses are in the process of transferring their ownership. Unfortunately, two-thirds of all initial transfers fail. Of the one-third that survives an initial transfer, only one-half will survive a second transfer.

Why Family Businesses Do Not Survive

Why such a dismal success rate? The reasons are as varied and unique as the businesses and business owners themselves. Nevertheless, many of the failed transfers can be traced to three causes: people, taxes and cash.

People: Family Business Owners & Estate Planning for the Family

The family element in every family business can mean the difference between its success or failure during the transfer process. The retirement, disability or death of the business owner are all common events that can trigger a business transfer.

Tough questions must be asked and answered. Otherwise, a business that took decades to build can be destroyed overnight.

For example, who will run the business after you? Will it be your spouse, one of your children or a non-family member key employee? If your spouse will not run the business, will he or she still be financially dependent on it ... or can you make arrangements to ensure they are financially independent of it?

What arrangements have you made for the inheritance of your children who are not active in the business? Have you in-law proofed your estate?

Thinking ahead to the second-generation transfer of your business, what provisions have you made to encourage thrift and industry among your grandchildren?

Taxes: Estate Tax Uncertainty

The only certainty about the federal estate is its uncertainty with each change in Congress and the White House. Additionally, many states now impose their own estate taxes, independent of any federal estate taxes.

Accordingly, careful monitoring of the economic, political and legal climate is required. Why? Without proper estate-liquidity planning, your family may have to sell the business just to meet an estate tax cash call.

Cash: Coordinating Financial and Estate Plans

If your financial and estate plans are not carefully coordinated, there may not be enough cash to fund your objectives. An appropriately-funded estate plan can meet all of your people-planning objectives and provide liquidity for estate taxes (and business debts). Life insurance, owned in the proper amount, type and manner, may be effectively used to fund such money matters.

The Business Buy-Sell Agreement (BSA)

A BSA is a lifetime contract providing for the transfer of a business interest upon the occurrence of one or more triggering events as defined in the contract itself. For example, common triggering events include the retirement, disability or death of the business owner. An interest in any form of business entity can be transferred under a BSA, to include a corporation, a partnership or a limited liability company. Also, a BSA is effective whether the business has one owner or multiple owners. As a contract, a BSA is binding on third parties such as the estate representatives and heirs of the business owner. This feature can be invaluable when the business owner wants to ensure a smooth transition of complete control and ownership to the party that will keep the business going. Subject to certain Family Attribution Rules under Internal Revenue Code 318, a BSA can help establish a value for the business that is binding on the IRS for federal estate tax purposes as provided under Internal Revenue Code 2703.

Entity Buy-Sell, Cross-Purchase Buy-Sell and Wait-and-See Buy-Sell Agreements

A BSA is commonly structured in one of three general formats: An Entity BSA, a Cross-Purchase BSA or a Wait-And-See BSA. Under an Entity BSA, the business entity itself agrees to purchase the interest of a business owner. Conversely, under a Cross-Purchase BSA, the business owners agree to purchase one another’s interests. The Wait-And-See BSA gives the entity a first option to purchase the interest before the remaining business owner(s).

In addition to these three general formats, a One-Way BSA may be used when there is one business owner and the purchaser is a third party. The selection of the appropriate BSA format is critical for a variety of tax and non-tax reasons beyond the scope of this discussion. However, no BSA is complete without a proper funding plan. Like a beautiful automobile without fuel in the tank, a BSA without cash to fund the purchase is going nowhere.

Funding a Buy-Sell Agreement

Some common options to fund the purchase obligation under a BSA include the use of personal funds, creating a sinking fund in the business itself, borrowing funds, installment payments and insurance. Of these options, only the insured option can guarantee complete financing of the purchase from the beginning. Accordingly, a proper BSA will include both disability buy-out insurance and life insurance. Since the health of the business owner determines their insurability, any delay in acquiring appropriate coverage could be fatal to the success of the BSA and, with it, the survival of the business itself.

Follow the link below to Business Owner Blues for an easy-to-understand presentation about business succession strategies. Feel free to use the integrated functions to print any page, bookmark it to return later, or forward a copy to your friends, family members or financial advisor.

Buy-Sell AgreementBusiness Owner Blues

Being a business owner today is both rewarding and challenging, especially if your business is a family business. For business owners facing the unique challenge of transferring ownership of the family business upon retirement, disability or death, a properly funded Buy-Sell Agreement may be the key to survival. Click here to learn more about business succession strategies.

Note: Nothing in this publication is intended or written to be used, and cannot be used by any person for the purpose of avoiding tax penalties regarding any transactions or matters addressed herein. You should always seek advice from independent tax advisors regarding the same. [See IRS Circular 230.]

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Tierney, Watson & Healy provides California probate administration, probate litigation, elder law and estate planning to clients throughout California and nationwide. Our California practice includes the entire San Francisco Bay Area, the cities of San Francisco, Alameda, Oakland, Santa Rosa, Sebastopol and Berkeley. With offices in San Francisco and Sonoma counties, we regularly represent and visit clients in San Francisco County, Alameda County, Contra Costa County, San Mateo County, Marin County and Sonoma County.

Martin J. Tierney  |  Dewey Watson  |  Brian S. Healy  |  Evelyn A. Low
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