“Business succession planning” deals with your eventual exit from the business, both intended and unexpected. In the case of your death, succession planning includes how to handle legal ownership of the business, how to ensure business can legally be conducted, and how to designate who can legally managing the business after your death, (Of course, everyone’s circumstances are different, and no single strategy is appropriate for everyone. So, it’s important to consult with your legal, tax and business advisory professionals before choosing a particular solution for your own family and business.)
There very good benefits and reasons for using a Living Trust as part of your family estate planning in any event, even if you do not own any businesses. We have already explored that in a separate article. But, if you own a business, there are also a number business succession problems that a Living Trust can minimize, while at the same time accomplishing your general needs for estate planning.
Reasons to have a Living Trust especially if you are a business owner
If you own your business as an individual sole proprietor (which for a whole host of other critical reasons we do not recommend), you individually own all your business assets (including accounts receivable, bank accounts, inventory, equipment, etc.). You also individually owe all your business liabilities (loans, lease obligations, accounts payable, employee obligations, employment tax obligations, sales tax obligations, contract obligations to customers, etc.) When you die, and unless or until a probate court appoints and authorizes a personal representative to act on your behalf, there is no other person who can legally do anything with your business assets, and no person who can legally pay your obligations (including your rent, your employees); no one can sign tax documents, enter or fulfill contract obligations with your customers, vendors, etc.; and no person has the legal right or power to even sell the inventory (including to customers), receive revenue, or deposit checks from customers. The business operation not only stops, but no one can do anything with the business, its assets, or bills, unless or until a probate court appoints a personal representative and authorizes the personal representative on behalf of your estate to pay bills, and sell or dispose any inventory, equipment, etc.; the business cannot even be sold to some other entrepreneur unless or until a probate court orders that to occur.
If you as an individual own a portion of your business through a partnership (which for a whole host of other critical reasons we do not recommend, and even strongly recommend against), your partnership interest in the business is your individual intangible property. When you die, the partnership legally terminates, and unless or until a probate court appoints and authorizes a personal representative to act on your behalf, there is no other person who can sign tax documents, sign on your behalf any contracts or documents relating to the partnership, or perform on your behalf any of the obligations you owed to the partnership. There is no one on your behalf who can receive any income from the partnership, including any distribution or share of partnership equity. Any equity you had in the partnership is now the property of your estate, and cannot be collected or disposed of without probate court approval as part of your estate. Moreover, any creditor claims against the partnership can create claims against your own probate estate.
If you as an individual own an interest (either the whole interest or a partial interest) as a Member of a limited liability company (LLC), your ownership of your Member interest in the business is your individual intangible property. When you die, the LLC legally terminates (unless you have an operating agreement that states otherwise). Further, at your death, your Member interest in the business is now the property of your probate estate. Unless or until a probate court appoints and authorizes a personal representative to act on your behalf, there is no other person who can even exercise your vote as a Member of your LLC; no decision that requires your vote or signature as a Member can be made; no one can sign on your behalf any tax documents, contracts or documents relating to the LLC, or on behalf of the LLC if it would have required your individual signature. No one can perform on your behalf any of the obligations you owed to the LLC. There is no one on your behalf who can receive any income from the LLC, including any distribution or share of LLC profits or any division of equity. Any equity you had in the LLC is now the property of your estate, and cannot be collected or disposed of without probate court approval as part of your estate.
If you as an individual are a Shareholder that owns (either in the entirety or a portion) shares of stock in a corporation: Your ownership of shares of stock in the business is your individual intangible property. When you die, your stock in the corporation and your interest as a Shareholder is now the property of your probate estate. The corporation, by law, normally continues to exist as a legal entity. But, unless or until a probate court appoints and authorizes a personal representative to act on your behalf, there is no other person who can exercise your vote as a Shareholder of the corporation. If you are the sole Shareholder or the majority Shareholder, there is no one who can hold Shareholder meetings, elect the Board of Directors, or approve things that require a vote of the Shareholders; no decision that requires your vote as a Shareholder can be made; if you are the sole Director, there may be no way to elect officers; and if you hold one or more positions as a corporate officer, there may be no way to elect a replacement officer, the corporation may be left without anyone who can act on behalf of the corporation, or appoint someone who can; no one may be able to sign any tax documents, contracts or documents relating to the corporation, or on behalf of the corporation. No one can perform on your behalf any of the obligations you owed to the corporation. There is no one on your behalf who can receive any income from the corporation, including any dividends or Shareholder distributions, or any compensation (such as wages) that you were entitled to receive from the corporation, or any share of Shareholder equity. Any equity you had in the corporation is now the property of your estate. Your stock in the corporation may not be capable of being redeemed, sold, liquidated or transferred without probate court approval as part of your estate.
Advantages of a Living Trust
- Given the above dilemmas, and depending on the circumstances of your business and your family, it may make sense for you to consider (a) having a Living Trust (which we would frequently recommend you have anyway for other estate planning purposes) and (b) having your Living Trust designated as the actual owner of your business ownership interest (whether as an LLC Member or as a corporate Shareholder). If you do this, then:
- Your Trustee (presumably yourself if you are the current Trustee) would then be the LCC Member or the corporate Shareholder.
- If you die, the Trustee of your trust (normally an successor who by the terms of the Trust automatically takes over if you are initial Trustee) continues to be the LLC Member or the corporate Shareholder.
- That successor Trustee continues to exercise voting power as the LLC Member, or as the corporate Shareholder. If your business is a corporation, that means there is always someone (your Trustee) as a Shareholder who can elect a person to fill your vacancy on the Board of Directors, and the Board of Directors can then fill your vacancy in any officer position.
- LLC profits can still be legally paid to the Trustee as the Member, for the benefit of your Trust Beneficiaries. And corporate dividends or distributions can still be legally paid to the Trustee as Shareholder, for the benefit of your Trust Beneficiaries.
- This accomplishes business succession in the event of untimely death of a business owner without opening a probate estate and without any intervention of a probate court. It allows:
- Handling legal title of the business ownership interest
- Continued legal ability of the business to enter, perform and complete contracts, collect customer revenue, sign tax documents, pay loans, rent, employees, vendors and other obligations, and distribute income and other owner compensation
- Continuity of management and decision-making in the business
- These same features may also help in the case of legal disability of the owner (not just death).
If your corporation or LLC has elected subchapter-S taxation, you will need to confirm with your attorney and CPA that ownership by your trust would not disqualify the entity from sub-S treatment. (Internal Revenue Code §1361 limits what kinds of trusts can be owners of a sub-S entity.) As always, each business and each business owner has its own unique circumstances, goals and needs. No one method of business succession planning is a “cookie cutter” solution to every scenario. It’s essential to have an informed, and coordinated, discussion with (a) your trusted legal professional, (b) your tax and accounting professional, and (c) your business management advisor or mentor to put in place the business succession strategies that make the most sense for you.