Arizona Estate Planning Lawyer & Attorney : Stephen Follett Law Firm : Probate Law and Trusts : Gilbert, Phoenix, Arizona

The Wall Street Journal has an online article about business succession planning for parents that own businesses.  The article is behind a firewall so you cannot read it without a subscription.  But the article starts with this probing question and answer.

It is one of the toughest questions that parents who own businesses confront -- how can they be equitable in their estate planning when one child works for the company but others don't?

The answer: It isn't easy. But the best way to preserve harmony and, possibly, the business is to communicate with family members and forge an ownership-transfer plan as far ahead as possible.

Because family businesses are so often integral to the family, they are harder to pass on successfully to the subsequent generation.  Small businesses are always more difficult to deal with because they are hard to operate.  They can also introduce tax liabilities that force the sale of the business.  Often, it is very difficult to divide the business between heirs so much of the value is lost due to the sale.

While the solution may be simple and elegant, getting there is the hard part.  There are many personal and family issues tied up in the business, in addition to the many legal and tax consequences.

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I often ask clients what would happen to their children if they did not return from their appointment.  Then we talk about making sure that there is an emergency response plan in place to assure their children are taken care of in the event they do not return home because minor children are unable to care for themselves.  They need a legal guardian.

Small businesses are often like minor children.  They need constant care and attention from their owners.  They need a legal guardian--the boss.

If you are a small business owner, consider that question?  What would happen to my small business if I didn't return to the office today?  What would happen to the value of the small business?

If you cannot answer that question, then you need business succession planning as part of your estate plan.  Here is an article that talks a little bit about succession planning.  It can prompt some questions.  If passing your business and/or its value to the next generation is important, then talk with a qualified estate planning attorney.  Statistically, you only have a three in ten shot at getting the business to the next generation.

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Family Owned Businesses were treated favorably under the IRS statutes, because of the high rate of failure of businesses upon the death of the owner.  Without this deduction, estate taxes could force a family to sell the business in an attempt to pay estate taxes.

Under section 2057, the IRS allowed a deduction of up to $675,000 for ownership interest in a family owned business.  In otherwords, if you are leaving a family owned business, you can pass up to $675,000 without taxes.  This helps alleviate the tax burden on the family so they can avoid selling the business.  A family will qualify only if the business is more than 50% of the estate of the decedent.

However, like so many of the IRS's rules, this is a complex rule that requires planning and preparation on the part of the business owner to ensure that the heirs will be able to claim the deduction.

The Tax Court recently disallowed what appeared to be a business owner's succession plan.  The business owner made personal loans to the business and then formed limited partnerships to hold the loans.  The decedend tried to use the amount of those loans to reach 50% threshhold necessary for the Qualified Family Owned Business Interest (QFOBI) deduction. 

The IRS stated that the loans to the business were not countable as an interest in a business under the QFOBI rule for purposes of §2057(b)(1)(C).

The result?  The deduction was disallowed and the family will have to pay hundreds of thousands of dollars in taxes.

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Estate planning often involves a specialty called "Business Succession Planning."  This term is meant to capture the planning necessary to ensure that a business can successfully pass to the family or to ensure that a business partner is able to purchase the business from the heirs of the deceased business partner.

Such planning is important because only 30% of businesses succeed to the second generation upon the death or disability of the first generation.  Here is an article from that gives an overview of business succession planning.  Failure to plan is a large reason that 70% that fail.

Arizona has many successful small businesses that beat the odds and have survived the first five years.  If your business beat those odds, make sure you have a business succession plan in place.  Otherwise, your business is very likely to be in the grim 70% of failed businesses.

I have a friend who was an attorney.  He had to quit his firm to take his father's formerly successful business out of bankruptcy.  Fortunately, the business is now thriving.  However, it is not a tribute to any planning, but rather it is a tribute to the son's remarkable efforts.

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