What Happens to Your Small Business When You Die?

You’ve figured out what will happen to your personal wealth when you pass away. Hopefully, you’ve prepared a will or set up a living trust to spell out your wishes. Have you stopped to consider what will happen to your small business after you die, not only in terms of ownership but also in terms of management?

The first thing you want to do is make sure that you avoid probate. Probate court costs money, the process lasts for months, or sometimes years, and your business could lose a chunk of its value if the IRS collects an estate tax. The moment your company starts making a profit, you should make a plan for transitioning ownership in the event of your death.

Fortunately, you have a few different options for passing your small business to your heirs and preserving your hard-earned legacy. Let’s examine the advantages and disadvantages of each.

Gift the business to your successor

Best for young businesses that have just become profitable or companies only making a small profit.

Advantage: You’ll pass on your business without a tax penalty.

Disadvantage: If you fail to gift your company before you die or become incapacitated, or without giving someone power of attorney, you’ll have no chance to gift the company before you’re gone.

If your company is worth less than $14,000 (as of 2015) you can gift your business to a successor, and the IRS won’t tax the gift. As long as total lifetime gifting doesn’t exceed $5.34 million, your gifting won’t trigger a tax.

Unfortunately, gifting has to be done when you’re alive; once you’re gone, it’s too late to gift your business. Only gift your business if you’re ready to act immediately. Don’t make gifting your small business a long-term succession plan.

Create a living trust

A living trust works for almost any transition of ownership when there is a known successor.

Advantages: Trusts enable you to avoid probate costs and keep the transition private; they also offer certain tax advantages.

Disadvantage: It costs more initially to set up a living trust than it costs to execute the other methods.

Despite the initial cost, it makes the most sense to set up a living trust and transfer ownership of the business. Upon your death, the business transitions into a trust, and the successor trustee designated by you becomes the owner.

A living trust keeps your company out of probate and keeps your company’s financial performance private. It also keeps the estate tax at bay so it doesn’t take a bite out of your business. To keep legal fees down when creating a trust, try online tools that make it easy to set up a trust without an attorney. Also, unless you have significant personal wealth aside from your business, you don’t need to place your other assets in trust.

Form a partnership

A partnership is a great option if you are transitioning your business to someone who could buy you out.

Advantage: You can hand-pick and train a partner who will carry on your legacy.

Disadvantages: You could face potential conflict with your partner while you’re alive, and certain states have laws disadvantageous to partnerships.

Make your successor a business partner and set up a buy-sell agreement. Your agreement should set forth the events that would trigger a sale to a partner, such as death, divorce, bankruptcy, or retirement. It should also explain how and when partners can sell their shares, and it should spell out a share price. Before forming a partnership, verify your state’s laws. In some states, partnerships immediately end upon the death of a partner, which could throw your business into probate even with your buy-sell agreement in place.

Choosing your successor

Before choosing a successor to assume ownership of your company, it’s important to have a serious talk with the person you’ve chosen. If you leave your small business to someone who doesn’t want it, the business could end up being sold, poorly run, or driven into bankruptcy.

If you choose your minor children as trustees, select a responsible custodian who will take care of the business until they’re ready to assume ownership. Or, consider leaving the business to your spouse, if you want your children have the option to run your company someday, and you trust your spouse to take care of it until they’re ready.