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Nov 13, 2024

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Estate Planning for Business Owners: Strategies and Solutions for Wealth Advisors

There are over 33 million small businesses in the United States, employing over 60 million people. In many ways, private businesses are the heart and soul of the country’s economy, and—unsurprisingly—business owners often feel passionately about what happens to their share when they pass away. 

Wealth advisors should be prepared to help their business-owning clients create a thoughtful succession plan, regardless of the size or value of their business. 

In a recent webinar, estate planning experts Steve Lockshin and Patrick Carlson sat down to discuss everything from foundational concepts to advanced strategies wealth advisors should consider for clients who own businesses. 

Read on to learn the key takeaways from Steve and Patrick’s conversation, including why estate planning is critical for business owners, different business continuity strategies to know, an overview of advanced estate planning techniques, and more. 

Why estate planning is important for business owners

Just like in estate planning for personal assets, estate planning for businesses is an important proactive measure for protecting wealth. 

Put simply, there are three primary benefits of estate planning for clients who own businesses: 

• Business continuity: Small businesses may be heavily reliant on a few individuals.
• Family protection and security: Liquidity is important when there’s a death or disability of a key person or owner. Proper planning can assist in alleviating these issues.
• Tax Minimization: Proper estate planning, including charitable planning, can help move money out of taxable estates and lower estate taxes.

Business continuity strategies

Business owners—and, by extension, their wealth advisors—need to consider how owners or family members enter and exit the business, how shares transfer between owners or generations, and how to ensure the business can carry on if an owner leaves or passes away. 

Here are a few common business continuity strategies to discuss with your clients who own businesses and key considerations for each. 

Succession planning

In addition to having a documented plan for ownership transfer in the event of a death or disability, it’s important to lay the foundation for succession planning so that a plan can be successfully implemented:

• Consider timing of transfers during lifetime versus at death
• Development and training of successors and future leadership
• Provisions for ownership family
• Consider if your partners want to be partners with your spouse or children

Key person insurance

Key person insurance, also called key man insurance, is a life insurance policy purchased by a business to cover the death of a key employee. The goal is that the insurance protects the business from the financial loss it would sustain if a key employee passes away. 

For example, when Steve Lockshin founded AdvicePeriod, many of the first wave of clients came with him from a previous firm. This meant a significant portion of AdvicePeriod’s portfolio was linked to Steve, making him the “key person.” The business took out key person insurance on Steve, so that the firm would be protected from the potential loss of clients and AUM if Steve were to pass away unexpectedly. 

Determining how much key person insurance a business should purchase can be complicated, but an advisor can start by asking the client the question: What is the impact to the business if the key person dies, and how long will it take to find a replacement for the key person’s contributions?

Buy-sell agreements

A buy-sell agreement is a contract that describes what happens to each owner’s share of the company if they leave the business, whether due to death, disability, retirement, or other reasons.

There are two types of buy-sell agreements advisors and business-owning clients should know: 

• Cross-purchase: The remaining owners will buy the departing owner’s share of the business.
• Entity purchase: The business entity buys the departing owner’s interest. The business entity then retires or redistributes the purchased interest among the remaining owners.

A key component of a buy-sell agreement is how the business’s value will be determined in the event that the agreement is carried out. Though the business owners can put essentially any valuation arrangement they want into the agreement, there are two common methods: 

• Fixed price/formula-based, using multiples of earnings or book value
• Independent appraisal, with a third-party assessing the fair market value

Advanced estate planning techniques for business-owning clients

The strategies we’ve covered so far are foundational concepts that any business owner should consider when estate planning. For more complex businesses, estates, or partnerships, more nuanced planning strategies may be needed. Let’s look at two. 

Intentionally defective grantor trust (IDGT)

Essentially, an IDGT is an irrevocable trust structured to allow certain assets to be passed on without being subject to estate taxes, while still retaining the settlor’s liability for income taxes generated within the trust.

In other words, an IDGT allows assets to grow and escape future estate or generation skipping transfer taxes.

IDGTs can be a powerful planning tool for cash flowing assets because they can allow assets that are rapidly appreciating and not tax efficient to avoid estate taxes. 

There are several ways to fund an IDGT, including through gifts, discounts, sales, private annuities, and grantor retained annuity trusts (GRATs). 

Charitable planning

When advising business-owning clients on their estate, wealth managers should learn whether clients are charitably inclined, to what extent, and for what purpose. With this information, the advisor can point to the most appropriate and efficient vehicle to accomplish the client’s goals. 

For example, if a client wants to use charitable gifting to reduce the size of their estate, they can gift directly to a qualified charitable organization. This enables the donor to receive an income tax deduction while reducing their taxable estate. 

A client who wants to defer taxes might set up a charitable remainder trust, which allows the donor and/or their family to draw an annual payment over the lifetime of the trust. When the trust term ends or the last income beneficiary dies, the remaining assets in the trust are given to the designated charity or charities. 

Finally, a client who wants to accomplish both of these outcomes could use a charitable lead trust. A CLT is a type of trust established by an individual (in this case a business owner) to provide regular payments to one or more charities for a specified period. At the end of that period, the remaining assets in the trust either revert to the settlor or pass to non-charitable beneficiaries, such as family members or other individuals named by the donor. 

Like many elements of wealth advisory, estate planning for business owners is complex and nuanced. This is just an introduction to the strategies and concepts that can come into play. 

For more educational resources and CE-eligible courses, create a free Vanilla Academy account today. 

Curious how Vanilla can empower you to have more effective conversations with business-owning clients? Get in touch with our team. 

The information provided here does not constitute legal, financial, or tax advice. It is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with an estate attorney, financial advisor, or tax professional who can advise as to your particular situation.