Estate planning essential for small business owners

Having a will is not enough to ensure a spouse and children get the full benefit of business assets when you die.

From the pages of In Business magazine.

Estate planning is a broad practice area encompassing personal, family, and financial issues related to control and transfer of property and to end-of-life decision-making. It includes life planning and management of an individual’s property to satisfy their personal needs and the needs of their family or business — during their lives, during a period of disability, and after death.

As with the next feature in this issue on succession planning, estate planning is vitally important for business owners seeking to pass on their company or its assets to a spouse or children after their death, as well as to individuals who would like to make financial gifts to their children or grandchildren before or after their death that are exempt for federal estate taxes.

Estate planning goes far beyond just having a will, however. This brief guide will walk you through the basics of estate planning and provide more detailed information about what business owners, specifically, need to know when developing an estate plan.

Who should have an estate plan?

According to Roy Fine, an attorney and shareholder with Madison-based Murphy Desmond Lawyers s.c., any individual or couple with meaningful assets who wants to direct where those assets go upon death should have an estate plan.

The term “assets” can include a home, other real estate, investments, or other financial accounts. Assets can also include automobiles, jewelry or artwork, and other items of value. In Wisconsin, ticket holders can even list their Packers season tickets in their wills.

Essentially, anyone who answers “yes” to these three questions should have an estate plan:

• Do you have assets?
• Do you want to choose which individuals or charities receive your assets?
• Do you want to choose a trusted person to handle your estate when you pass?

It is especially important for individuals and couples with children or grandchildren to have an estate plan to ensure their intentions are properly communicated with regard to how and when their holdings are distributed.

An estate plan usually involves the preparation of five documents. Each one serves a special purpose in handling a person’s physical and financial affairs in the event of death or disability.

A will is a document that gives direction about how to distribute a deceased person’s property. It designates a person — referred to as the “personal representative” or executor” — who the will maker chooses to administer his or her estate. A will also designates a “guardian” or person chosen to raise minor children.

A trust is a document whose primary purpose is the avoidance of probate court proceedings. A trust outlines specifics such as when a person is to receive an asset. For example, the trust maker can choose to hold off on giving money to someone until he or she reaches a certain age. When assets are held in a trust, they are not subject to administration by a probate court.

A marital property agreement can be done prior to marriage or during marriage. It is a document which helps classify the ownership of a couple’s assets as “yours, mine, or ours.” Then, when one spouse passes, his or her property is handled separate from the surviving spouse’s property, so as to avoid mixing the two.

Most people think of marital property agreements in the context of a divorce, but they are highly useful for estate planning. They are especially important for couples with children from prior relationships. Without a marital property agreement, there can be much confusion as to what property should be administered by the deceased spouse’s estate.

A financial power of attorney is a document that enables a living person to designate another to manage his or her finances while he or she is still alive. The document can empower the designated person to handle the finances whenever the maker directs them to do so, or when the maker becomes incapacitated. After the person’s death, the financial power of attorney expires.

A health care power of attorney allows a person chosen by the maker of the health care power of attorney document to make medical decisions if the person is incapable of making decisions for himself or herself.

What happens if a person does not have a will or an estate plan when he or she passes?

When a person passes without a will, it is called “intestate,” according to Fine. The laws of intestacy will apply, which essentially create an estate plan for the deceased person. Without a will, the estate will move forward under these default probate laws.

This means the court will supervise the disposition of the person’s assets. The court will also determine who gets what, who can be the executor of the estate, among other matters, according to state law. This might not be what the deceased person may have wanted.

If a person is married and does not have a will or a trust, he or she cannot assume all assets will automatically go to the surviving spouse. For example, if the married person has children from a previous marriage, a family dispute could erupt over the handling of the estate’s assets.

Anyone with children or other heirs, or anyone with substantial assets who has a preference as to how those assets are to be distributed, should have an estate plan which ensures his or her wishes are carried out.

What is probate?

Probate court proceedings occur when a person passes — with or without a will — and the person’s assets cannot be distributed without the court’s assistance.

Fine notes probate will be required if the deceased has assets that exceed $50,000 total in value but no beneficiary has been designated for certain of those assets. Assets can include life insurance, retirement accounts, bank accounts, or other funds, as well as real estate or other physical property including vehicles, jewelry, and such.

Probate court is commonly considered the place where disputes get resolved among family members, heirs, and beneficiaries of an estate. It can include interested third parties and creditors. Guardianship of minors can be a part of the probate process as well.

How can probate be avoided in Wisconsin?

Probate can be avoided for many estates in Wisconsin. Well-recognized strategies can be employed to prevent heirs from having to invoke the probate court’s assistance to transfer the deceased’s assets.

Those strategies can include the following steps:

• Have a trust in place. A trust can hold assets while the trust owner continues to use and control them. Assets which can be held by a trust include financial accounts, a home, vehicles, and even a pet. An attorney can provide guidance about the pros and cons of having a trust.
• Name (and be sure to update as needed) the beneficiaries on payable-on-death accounts such as life insurance policies, bank accounts, or other financial accounts.
• Create transfer-on-death deeds for the home or other real estate.
• Have joint financial accounts that allow the surviving spouse to assume sole ownership when the first spouse dies.

What’s new in estate planning?

Over the past five to seven years, the most noticeable change in estate planning has come from the dramatic increase in the estate tax exemption amount, notes Cymbre Van Fossen, senior vice president – trust advisor and director of fiduciary services for First Business Bank in Madison.

“The Tax Cuts and Jobs Act of 2017 (2017 Tax Act) doubled the amount of money individuals could give free from estate tax,” explains Van Fossen. “Prior to the 2017 Tax Act, individuals could give away roughly $5 million, and couples could give $10 million, either during their lifetime or at death. The 2017 Tax Act doubled this lifetime exclusion amount and adjusted it for inflation annually. Today, in 2022, the exclusion is a whopping $12.06 million per person! This means that a married couple can currently transfer a $24 million family business to their heirs with no gift or estate tax. The current exemption amount, which will continue to adjust upward for current high inflation rates, shelters the value of the vast majority of small businesses from estate tax.”

But beware, Van Fossen advises. If Congress doesn’t act, the estate tax exemption reverts to $5 million per person, adjusted for inflation, as of Jan. 1, 2026. This means that the window for business owners to use the current high exclusion amount to its greatest impact is closing quickly. Of course, a sunset on the current tax law could be enacted sooner as a way to pay for projects or “reforms” by either political party.

At a more fundamental level, the pandemic of the last two years has brought core estate planning considerations into greater focus. For example, says Van Fossen, do business owners have a will or trust in place? Have they taken the time to do the hard work of business succession planning or map out a business exit strategy? Do they have durable powers of attorney for health care and finances? Have they thought how philanthropy may play a role in realizing a family legacy? From a practical standpoint, are the right fiduciaries named to deal with the complexities of their business, investments, and real estate?

“This is the time to reassess whether a spouse, children, or other individuals named as executor or trustee has the time and expertise to deal with such matters,” says Van Fossen. “Many families prefer to name a corporate trustee to deal with the complexities of tax planning, business continuity issues, and trust administration.

“At present, business owners have a great opportunity for effective planning,” Van Fossen continues. “Gift and estate tax exemption amounts are at historic highs, and income and capital gains tax rates have not been increased on wealthy taxpayers, despite much discussion about this possibility after the 2020 election. Sophisticated advanced planning techniques with grantor trusts are still viable and long-term ‘dynasty trusts’ can be created to pass wealth from generation to generation with no additional transfer tax. With smart planning, business owners can leverage valuation discounts to pass on minority interests in their business during their lifetime to heirs. These tools should be leveraged and used to their best advantage before this window closes.”

Comprehensive estate planning should consider how tax-deferred assets such as IRAs and 401(k)s are going to pass to beneficiaries in the most income tax-efficient way possible, according to Van Fossen. The previous ability to “stretch” an IRA over the life expectancy of a beneficiary is no longer an option. Following the passage of the SECURE Act in 2020, the “10-year rule” now applies, which requires distribution of all qualified retirement assets within 10 years of the account owner’s death. Such distributions are taxable to beneficiaries as ordinary income at their then-effective tax rate.

“So, instead of business owners leaving a large-balance IRA to children and creating an income tax problem for them, they may wish to consider making qualified charitable gifts of up to $100,000 a year during their lifetime, and then continue their charitable legacy by naming one or more tax-exempt entities as beneficiaries of the IRA,” explains Van Fossen. “The charity never has to pay tax on the IRA distribution, and the children can then inherit more tax-advantageous assets such as taxable investment portfolios or closely held business interests, both of which will get a step up in basis at the owner’s death.”

Inflation, interest rates are potential problems

Inflation is a concern from a number of perspectives and can have a direct impact on estate planning strategies to pass wealth on to heirs or charities. Some advanced estate planning techniques, such as installment sales to intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs), and charitable lead annuity trusts (CLTs), work better in a low interest rate environment and are less attractive as rates rise, states Van Fossen. On the other hand, charitable remainder trusts (CRTs) and qualified personal residence trusts (QPRTs) that have been out of favor for some years may become more beneficial as rates rise.

Rising rates can also negatively impact use of intrafamily loans, which are often used to assist with real estate purchases and business succession planning. When rates are low, family members may loan children money or assets rather than making gifts that erode the parents’ life-time gift tax exemption amount. Increased borrowing costs for related parties may make such debt arrangements less attractive than they were in recent years.

Finally, owners may not be able to exit the family business at what they consider to be a fair price if potential third-party buyers have trouble securing financing at attractive rates. A recession brings financial uncertainly to companies, impacts revenues, and may put even the best conceived business succession planning at risk. However, regardless of the short-term economic environment, everyone should take basic steps to get an estate plan in place now. The cost of doing nothing is enormous!

Estate planning best practices

When developing an estate plan, it is critical to gather a strong team that includes legal, tax, and investment experts. In many cases, a business valuation expert and experienced corporate trustee will be critical additions to the planning team. Look for advisors who will leave their egos at the door and work collaboratively to help you identify your personal, business, and philanthropic goals, and then come up with creative, tax-efficient solutions, recommends Van Fossen.

“From a practical perspective, don’t leave estate planning until the last minute,” Van Fossen states. “There is a three-year window before estate tax exemptions are slated to shrink. Don’t wait until November 2025 to contact your attorney and expect that they will have time to assist you, or that you’ll be able to get necessary tax planning and appraisal work done in time! It’s easy to stay too busy running your company rather than carving out the time to do planning work but know that this neglect can exact a significant cost!”

Van Fossen recommends involving your family and having honest conversations about your wishes and intentions, especially if business continuity issues are on the table. Charitable giving and legacy planning should be a consideration as well. Charitable giving through private foundations, donor-advised funds, and charitable trusts can be part of a comprehensive estate plan, and can help families avoid estate tax, transfer assets to heirs, and benefit the causes they believe in most deeply.

Transferring business assets

At the most basic level, an estate becomes the new owner of the business when the owner dies, notes Van Fossen. If the business is a sole proprietorship, it will terminate upon the owner’s death and its assets will become part of the owner’s estate. Many business owners wish to avoid having the delay and public disclosure of assets and debts that a probate estate brings. Therefore, they create a revocable trust during their lifetime and fund that trust with the business. Trusts may hold interests in LLCs or other business entities. The trustee then distributes the business to the named beneficiaries upon the owner’s death. Businesses are often held in trust for the benefit of future generations and are managed by a directing party or advisory board.

Common estate planning trends and strategies

According to Van Fossen, clients continue to look for ways to take advantage of the historically high gift and estate tax exemption amounts. Transfers during life “use up” the approximately $12 million exemption per person, thus locking in the benefit, even if subsequently that exemption reverts to lower levels in 2026 or Congress passes new legislation before then.

“Clients often make large gifts to irrevocable dynasty trusts created for the benefit of children, grandchildren, and even more remote generations,” says Van Fossen. “Spousal lifetime access trusts (SLATs) are popular as well. SLATs are irrevocable trusts created when one spouse makes a gift to another, thus using up as much of the federal transfer tax exclusion amount as desired. When the donor dies, the value of the assets that were gifted or sold to the SLAT are excluded from the donor’s estate.

“Smaller gifts of the annual exclusion amount in 2022 of $16,000 per individual recipient can be an effective way of reducing one’s taxable estate and simultaneously funding a trust or assisting children and grandchildren with outright gifts,” adds Van Fossen. “For example, a couple could together give each of their three children and seven grandchildren $32,000 per year, for a total of $320,000 in gifts in a single year. In addition, donors could pay for school tuition or medical expenses on an individual’s behalf without any limit.”

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