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Death of a Sole Proprietor: Does Your Agency Have a Plan?

Small ad agency owners tend to get jumpy when anyone talks about the possibility that they might not return from their weekend jaunt to Las Vegas, or Bermuda, or their two-week visit to a Tuscany cooking school. A case in point: a principal told us recently that, as he and his wife were about to go on vacation, an employee asked him who would sign the paychecks if he didn’t come back. His response?

“Hey! Look over there!” he exclaimed, then turned and ran out the front door.

He didn’t have a response because he didn’t have a continuity plan. With no plan in place, your business could die with you, or because you are incapacitated by accident or illness. What steps have you taken to ensure the business will survive, and your family and employees can continue if you are suddenly not around? For most agency owners, this is not just a business decision. Our agencies are our babies, and it hurts to think that they could die in our absence.

Mortality and Estate Planning Are Scary

No one likes to think about one’s own passing. But business owners have a responsibility to do so, if only to ensure their family is not saddled with debt and taxes upon the owner’s death. A sole proprietorship is especially vulnerable, since the business is not viewed as separate from the individual under the law. That is why so many smaller ad agencies have incorporated, or function under partnership agreements enabling sale of owner interests to a surviving partner.

Sole proprietors should make wills that address how the business will be handled in event of the individual’s death. This may include designating a family member to oversee selling the business to a third party or to a designated successor, or liquidating the business. Ideally, you should have life insurance to cover operations until the sale or liquidation can be completed. But state estate probate takes time, and it is generally easier for everyone if the business is incorporated. All taxes and debt rest with the sole proprietor… or his heirs. The death tax can amount to between 35 and 50% of business value, due within nine months of your passing. Make a will and save everyone a lot of hassle and expense.

Estate Planning and Corporations

Corporations do not die with the owner, and debt, taxes and stocks can be sold or transferred under terms of the estate plan. Incorporating can ensure the business has a chance to go on after you are gone. IRS estate tax breaks for small businesses allow redemption of stock at minimum tax cost (Section 303), or deferral of estate tax combined with a 10-year payment schedule (Section 6166). Some requirements must be met to claim these tax breaks.

In partnerships, formal partner agreements (limited partnerships [LPs] or limited liability partnerships [LLPs]) will provide for the sale or purchase of the deceased partner’s interest, set a price and provide life insurance for tax-free funding of the purchase, ensuring business continuity. Typically, each partner names the other as beneficiary.

When Family Are Involved

Succession planning can help your business avoid the perils of high estate taxes or lack of leadership should an agency owner die suddenly or be incapacitated. Make sure the wills of agency owners/partners dictate the transfer of business ownership to a specified heir or heirs, and in what proportions in case of multiple heirs. That said, there are better ways to transfer a business to successors; wills leave a business vulnerable to high estate taxes. A trust or buy/sell agreement in case of the death of a proprietor or partner may be in order.

Where family members may be the preferred successors, make sure you name a controlling heir (the decision maker or largest stockholder), and levels of involvement for any other heirs. Some heirs may elect not to be involved in the business, and wish to sell to the primary heir; make sure buy/sell options are included in your succession plan. And if the heirs decide to sell the business, some guidelines for apportioning the assets may be useful.

The best way to leave your business to the next generation is to start the transfer while you are still living and leading the agency. The IRS allows lifetime gifts, or transfer of business interests within your lifetime. Some taxes may apply if you exceed designated gifting levels. Gifts may even apply toward a future buyout.

Buy-sell agreements can also be set up with trigger events (death, disability or retirement) to spur sale of the business. These agreements establish a selling price or price mechanism to be used, and name those who may be involved in the sale. Under such agreements, lifetime gifts cannot occur, nor can you sell to another buyer.

Talk to an estate planner or tax attorney about business succession plans. It is never too early to think about how your business will transfer to the next generation. (Cue Celine Dion’s “My Heart Will Go On”…)

The 2017 Tax Cuts and Jobs Act (which actually goes into the Congressional record as “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018,” due to a parliamentary technicality) may alter tax planning for small businesses structured as sole proprietorships, S corporations, partnerships and LLCs—a.k.a., “pass-through”businesses. Initiate contact with your tax planner now to start discussions about how to address changes that may come into force with the new bill.

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