As business owners reach their golden years, many wonder about how their business should be structured to prepare the company for future estate taxes and other forms of inheritance. To answer this question, we must focus less on how the business should be structured and more on what structures a business owner needs to have in place so that the business can continue to operate long after the owner is gone.
The easiest answer to this question is that every business owner should have an estate plan in place. An estate plan is not just about creating tax savings -- it's also about managing and protecting your assets against future creditors, both for you and for your loved ones.
As you can imagine, there is no one-size-fits-all estate plan, and working with a competent advisor is the best strategy for success. While this is the case, here are a few strategies that any real estate business owner can utilize.
Create a living will
Drafting a will is an important step to ensuring that your business is able to transfer to an appointed person with ease. We have all heard of multimillion-dollar estates that are contested because the original owner died without a will, like real estate mogul Roman Blum, who died without a will or any heirs to claim his $40 million estate. The late Roman Blum is not the only multimillionaire to die without a will; the list is endless: Prince, Aretha Franklin, etc.
So to get your affairs in order, the first step is to create a living will. You can either work with an attorney, or you can draft one by yourself. If you choose to draft the will yourself, you should contact the Register of Wills in your state to ensure your will complies with local rules.
Create a business succession plan
After drafting your and filing it with the Register of Wills in your state, you should also create a basic business succession plan. A business succession plan is a plan that many owners create so that the business can continue to operate long after they're gone. Much like a will, each succession plan will be unique to each individual, but here are some key elements your succession plan should include.
Name a successor
One of the most important components of a succession plan is to have a named successor. The successor does not have to be a family member; it could be a long-trusted business associate, or you can be like Warren Buffett, who named Berkshire Hathaway's vice chairman Greg Abel as his successor. No matter who you choose, your successor should be a trusted advisor and someone who knows all the business rules -- someone who will keep the business running as you would have if you were still alive.
Another great element that must be included in every succession plan is a buy-sell agreement. A buy-sell agreement is a contract that determines what happens to the owner's ownership interest in the event of disability, death, or retirement.
Get a valuation of the business
This might be one of the most important steps in your succession plan. To prepare for the future of your business, you will need to determine its value by getting a business valuation done by an expert. To find an appraiser in your area, you can contact the American Society of Appraisers.
It is important to have a proper valuation done because the IRS or a living family member can challenge the value of your business.
As you can see, creating a succession plan is important for the vitality and longevity of your legacy. Leave a lasting legacy by keeping your family out of court by developing a business succession plan. As John C. Maxwell says, "a leader's lasting value is measured by succession."
Purchase life insurance
Another important step in your succession plan is to purchase life insurance. The type of life insurance that should be purchased depends on the needs of the owner. Deciding between a permanent life insurance plan and a whole life plan can be a quite difficult decision to make on your own. Working with an agent will be helpful in determining your needs.
Additionally, after you have purchased life insurance, it is wise to look into establishing an irrevocable life insurance trust, with the assistance of an advisor, of course.
No matter what you decide, purchasing a life insurance policy is a great financial decision. When the policy pays out upon death, the death benefits are generally excluded from income for the purpose of taxation.
Irrevocable life insurance trust
As you may be aware, most business assets pass through probate. You can get around this rule by using an irrevocable life insurance trust (ILIT), a grantor-created trust with a life insurance policy as its primary asset. To create an ILIT, you will need to work with a competent advisor. An advisor is essential for this process because once you establish an irrevocable trust, it cannot be altered or amended by the grantor.
You will also want to reap all the benefits associated with the trust. One of the benefits associated with an ILIT is that death benefits paid to the ILIT will not be included in the gross estate, and those will not be exposed to estate taxes.
A grantor trust is a type of living trust in which the owner retains control over the trust while alive or directs the assets of the trust. If you want to utilize a grantor trust and fund the trust with your real estate while you are alive, you should contact an attorney to assist you with this process.
If you choose to create a grantor trust, you should include a spendthrift clause. A spendthrift clause restricts a beneficiary's ability to transfer rights to future payments of income or capital under the trust to a third party. Having this type of clause in your trust agreement will help to ensure your hard earned assets are protected.
Family limited partnership trust
If your business is family-owned, creating a family limited partnership trust (FLPT) may be the right thing to do. A FLPT is a partnership amongst family members that allows joint ownership of the assets within the trust. The structure of a family limited partnership helps to reduce estate taxes because the assets within the trust can be transferred to other members of the family. Also, the FLPT is eligible for the annual gift tax exclusion.
If you have a family business with significant assets, creating a family limited partnership may be the correct choice for you, but before you dive in headfirst, be sure to consult with an attorney.
The Millionacres bottom line
As you can see, there are a number of options real estate business owners can use to protect their assets and limit their exposure to taxation. While death is inevitable, losing control of your investment portfolio is not; proper estate planning can help you to protect your legacy.
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