If you own a business, you should not overlook it in your estate planning. Business entities require that certain legal formalities be observed. Creating a business entity is relatively inexpensive, but maintaining it can be expensive. It can be even more expensive if it is not done right.
There are four major uses of and reasons for creating a business entity:
- Limiting your personal liability from legal problems of the business, also called “limited liability.” This feature usually prevents debts and liabilities of the business from being collected from the owners and officers personally (though there are some exceptions).
- To provide a simple method of dividing ownership interests among multiple owners.
- To provide a centralized management system when there are multiple owners.
- To take advantage of business tax breaks which are only allowed to legal entities. The most common entities are: the corporation, the partnership, the limited liability company (LLC), and the sole proprietorship. There are also many variances of each, such as the subchapter S corporation, Series LLC’s, and the family limited partnership, just to name a few. It is also important that you choose the right entity for your particular business. Depending on the size, nature, and overall goal of your business, certain entities can offer you the structure you desire more than others.
In addition to using business entities to structure your business, they are also used as an effective estate planning tool. In the situation where the beneficiaries are compatible and have an interest in maintaining the assets of the family, particularly real estate or a family business, significant estate, gift, (and, in some cases, income) tax benefits may be secured using a family business structure. The most common ones for this purpose are the family limited partnership and the limited liability company, principally because they permit the donor(s), usually the older generation, to retain management control of the assets that are given during his, her, or their life to the younger generation, and have significant operational flexibility compared to a corporate structure.
The principle on which the estate tax reduction is based is that a minority interest has a disproportionately lower value than a majority interest in the whole. For example, suppose a partnership’s business could be sold as a whole for $1,000,000. An investor outside the family might only be willing to pay about $150,000 for a 25 and up have been defended for partnership/membership interests where there was a lack of control and a lack of marketability.