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Succession Planning for a Business

Adequate planning can ensure your business will be preserved as you want it to be.

If you have your own business, you may wish to keep the business within your family or sell it, before or after you pass away. Regardless of which option you choose, careful planning will ensure the business can stay up and running and be protected from large, unexpected tax liabilities.

Does a business you own go through probate?

YES, all assets, including business assets, generally must go through probate (unless the assets allow for the naming of beneficiaries).

However, certain trusts (GRATs or GRUTs) can be established during your lifetime that will allow any subsequent growth of the trust assets to pass outside of your taxable estate. It is important to consult with an attorney and/or tax advisor about your specific circumstances.

It is advisable to consult an attorney or tax advisor with expertise in this area.

Special tax considerations

It’s important to understand that the value of your business may continue to grow between the time you plan your estate and when you pass away, and that the taxable estate will include the value as of your date of death.

Leaving a business to co-owners

If your business has one or more co-owners, you might consider establishing an agreement that upon the death of any owner, their interest is automatically purchased by the other owner(s). Known as a buy-sell agreement, this arrangement can ensure that beneficiaries of the deceased owner (including spouses or other family members) don’t unintentionally become owners. Life insurance can be purchased or an irrevocable life insurance trust (ILIT) can be established to cover these buy-sell agreements and provide necessary liquidity.

Creating a succession plan

At a minimum, a business succession plan should address the systematic transfer of the management and ownership of a business.

Management succession planning may include:

  • Development, training, and support of successors.
  • Delegation of responsibility and authority to successors.
  • Outside directors/advisors to bring objectivity to the process (when necessary).
  • Maximizing retention of key employees through equitable compensation planning for management, family/non-family employees, and active/inactive shareholders.

Ownership transfer planning considerations may include:

  • Coordination between who will own the business and who will manage the business.
  • Consideration of the best interests of the business and the owner’s family.
  • Timing of a transfer of the business during your lifetime. This may provide you with the opportunity to consult with the successor(s), and generally reduces the risk of a discounted sale of the business.

Steps to help minimize taxes and avoid probate

The gap between what your business is worth while you plan your estate and what it is worth when you pass away, as well as other liquidity problems, may be managed by creating an ILIT. If the ILIT is structured correctly, the benefits paid from the underlying insurance policy do not pass through probate and are available immediately, providing cash for estate taxes and other needs.

You may be able to transfer your business assets to your children and retain a source of income for yourself by establishing a grantor retained annuity trust (GRAT) or grantor retained unitrust (GRUT). If the assets grow over the terms of the trust, the appreciation will not be subject to estate taxes, so these trusts can be effective tools for passing on a rapidly growing business.

To achieve the estate tax benefits of this type of trust, the trust must be structured precisely and you must outlive the terms of the trust. You may mitigate this risk by structuring an ILIT for wealth replacement to help offset the potential tax liability that would occur if you die before the trust expires.

Another approach is the family limited partnership or a family limited liability company. For example, you can form a limited partnership to hold the business assets. Some of the limited partnership units can be transferred to your successors, potentially eliminating the units from your taxable estate. Because limited partnership interests do not carry control of the partnership, the value of the transferred assets may be discounted for gift tax purposes. As with GRATs and GRUTs, family limited partnerships are subject to complex rules and it is advisable to consult with experienced tax and estate planning professionals.

Next step

Reviewing & updating your estate plan
Keeping your estate plan up to date is just as important as creating it.

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grantor retained annuity trust (GRAT)

irrevocable trust that pays a fixed annuity to the grantor for a defined term, with the remainder of the trust passing to a noncharitable beneficiary

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grantor retained unitrust (GRUT)

trust that pays a fixed percentage back to the donor for a period of time; designed for the transfer of business or property assets and shifts future appreciation to children through the use of gift tax rather than estate tax

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buy-sell agreement

for business with multiple owners; legal contract that stipulates the terms for remaining owners to purchase the interest of one that is departing

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irrevocable life insurance trust (ILIT)

irrevocable trust funded with a life insurance policy and designed to exclude life insurance proceeds from the taxable estate while providing liquidity to the estate and/or the trust's beneficiaries; it generally cannot be changed once it is created

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family limited partnership

partnership arrangement designed for the transfer of business, property, or other assets between family members, often from parents to children, in an effort to minimize estate tax liability and possibly provide protection from creditors

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family limited liability company

entity designed for the transfer of a business, property, or other assets from parents to children to minimize estate tax liability and possibly provide protection from creditors

Questions?

What we offer

The tax information and estate planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws which may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

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