If you’re a business owner, the thought may have crossed your mind: “What will happen to my business when I’m no longer here?”
To answer this question, begin by examining the issues of a closely held business in your estate. Planning generally involves three areas: administration of your business during the estate settlement period; continuation of your business after your estate has been settled; and taxes and related estate settlement costs.
In general, there are three forms of business organization favored by solo business owners:
sole proprietorship, partnership, or corporation.
Let’s take a look at the possible advantages and disadvantages, as well as planning opportunities, of the sole proprietorship.
The Pros and Cons
A sole proprietorship is a business entity owned and managed by one person. Simplicity is one of the major advantages of this form of business. No completed articles of incorporation need to be prepared, and there are few administrative costs associated with starting the business. However, if the business is conducted in a name other than that of the owner, most states require that the name of the business and owner be filed as a matter of public record.
Another advantage of the sole proprietorship is the flexibility and freedom of action enjoyed by the owner. There are no associates to consult when making business decisions. Unlike a corporation, the owner’s activities are not limited by statutes, corporate charters, or bylaws. In addition, the owner of a sole proprietorship is entitled to all profits generated by the business.
On the other hand, there may be a distinct disadvantage to the sole proprietorship when trying to continue the business after the death of the owner. In the absence of specific arrangements for continuation, the business ends and its assets and liabilities become the assets and liabilities of the owner’s estate. Many states have enacted statutes that authorize the executor or administrator to continue the business temporarily, in order to avoid loss to the heirs. However, an application must be made to the court for continuing the operation of the business. Anyone who does so without authority may be liable for any losses or expenses, even if she was acting in good faith.
Providing for the Future
If a sole proprietor does not want to change the form of his or her business, but does want the business to continue after his or her death, planning concerns involving the administration of the business both during and after the estate settlement period need to be addressed. The proprietor’s will may give the executor certain powers during the period of estate administration:
- the power to retain the business interest indefinitely;
- the power to do everything possible to operate the business successfully;
- the power to reorganize the business, incorporate it, or merge it with another business; and
- the power to borrow money, if necessary, to help the estate meet its liquidity needs.
In addition to these discretionary powers, the will may also include a provision that relieves the executor of personal liability where duties are exercised in good faith. In order to help minimize potential problems, the assets and accounts of the sole proprietorship may be placed in a trust with the trustee granted authority to continue the business during the applicable period.
Regardless of the form of business organization, there is often the need for adequate cash to pay funeral and administration expenses, personal and business debts, and possible estate taxes. It is important to remember that directions in the will permitting continuation of the business will not be allowed to interfere with the right of existing creditors and tax collectors to settle their accounts when the proprietor dies.
One tool to help ensure the estate has the cash needed to settle its affairs is life insurance. The proceeds of a life insurance policy can help provide liquidity to pay bills, supplement income for family members, and facilitate the continuation of the business. The insurance policy may be owned by an irrevocable trust to protect the proceeds from taxation as part of the business owner’s estate.
As a sole proprietor, the continuation of your business may be of prime importance to you. Your qualified financial, tax, and legal professionals can help you develop estate planning strategies to allow your business to continue in the event of your death.