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Directions for the Family Business in a Will or Trust

Who gets the business? What does the will say? Many business owners make no special provisions in their wills for the business. They have so-called "simple" wills that create a complicated mess when the business owner dies.

Let's say Number One Son has been running Dad's carpentry business while Dad is ill. Dad dies and his will says that his estate goes to the 4 kids in equal shares. Does Number one Son only get 1/4 of the business? Yes. Is that what Dad intended? Probably not.

What if Dad's will says "I leave my carpentry business to my son"? Dad has always operated as a sole proprietor. Does the "business" include the real estate on which the shop is located? Does it include the two trucks that were titled in Dad's name? Does it include the business checking account which has a $25,000 balance? Is that what Dad intended? Probably not.

The assets of a sole proprietorship need to be specifically identified. Partnership interests present other problems. For instance, the partnership agreement itself must be reviewed to make sure it doesn't prohibit the disposition directed by the will. Corporations bring their own problems.

Many businesses are incorporated and, because of the favorable income tax treatment, are S Corporations. There are strict limitations on how long an estate can be a shareholder of an S corporation. If the business interest is to be held in trust, the trusts must be specially drafted in order to qualify as shareholders, otherwise the corporation will lose its S election. These problems can be solved with appropriate planning and drafting. How are the beneficiaries of the trust to get any benefit? Must the corporation pay dividends?

If the estate is being left in trust to the heirs: beware! A business is not well-suited to being a trust investment. The law of trust investments directs a trustee to invest in "prudent" investments. Investing in a family business is much less prudent than investing in publicly traded large capitalization securities. Any small business venture has a high risk. Trustees are also required to diversify to eliminate unreasonable risk. A large concentration in the trust portfolio consisting of a closely-held business is not good diversification.

Further, trustees may not delegate their management responsibilities. When a trustee owns a controlling interest in the stock of a company, it has a duty, absent provisions in the governing instrument to the contrary, to exercise management responsibility over the business by placing one or more representatives on the board of directors. A Trustee who owns a controlling interest in a business may find herself caught between conflicting fiduciary duties to trust beneficiaries and the minority owners of the business. It may be in the best interest of the trust beneficiaries to sell the business but this may hurt the minority shareholders.

Dad also needs to also give thought to whom he chooses as his executor. An executor for any will is more of a responsibility than a privilege; it's even more of a responsibility when the will includes a business. Many persons chosen as executors because of their family relationship to the deceased are ill-equipped to handle these types of business and financial matters.

For an executor, being responsible for an estate which owns a business can be very burdensome. The executor is responsible for safeguarding and preserving the value of the business. Often this means stepping in and taking an active role in management.

An executor also has substantial personal risk. Estate and inheritance taxes are imposed on the date of death value of the decedent's assets. At the moment of death, the value of the decedent's business might be $1 million. If the executor continues the business and cannot, or chooses not to, sell the business, and the business runs into severe financial trouble, the business may be worth very little 9 months from the date of death when taxes are due. The amount of the tax remains the same (although some relief may be afforded by the 6 month alternate valuation date) and the executor is personally liable for the amount of the tax even if the estate's assets have declined radically in value. (This is why most prudent executors want to liquidate assets as soon as possible - they do not want to take investment risk, which can become their personal risk.) Business interests require special handling by executors and trustees.

Many professional fiduciaries will refuse to serve as executor and trustee when the estate includes a business unless the documents are drafted to take care of all the problems and liabilities that might arise. Care must be taken in drafting to make sure that an executor or trustee has sufficient authority and power to deal with a business interest, but is also protected from the many liabilities that may arise. This requires more than boilerplate. If you are a business owner, make sure you get professional advice on planning your estate.

-Patti Spencer 

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Spencer Law Firm LLC
320 Race Ave
Lancaster, PA 17603

Toll Free: 866-639-5451
Phone: 717-207-7935
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