鈥嬧�媁hat Happens To a Business When the Owner Dies?

When a sole proprietor dies, the business鈥檚 assets and accounts receivable become a part of the owner鈥檚 estate. With or without a Will, the Surrogate鈥檚 Court must appoint a representative of the estate before anyone can wind up the sole proprietorship, which can take months. During those months, if no one has access to company funds, the bills will go unpaid and contracts unfulfilled.

If the sole proprietor鈥檚 heirs are minors, determining what is next for the business and its assets is even more difficult and time consuming. Who owns the business is crucial for determining next steps. You can transfer your ownership interest to a trust to alleviate the need for Court intervention. Whoever you choose as your successor trustee can handle your business affairs immediately. Choose that individual wisely.

Corporations and LLCs can have multiple members which may reduce the impact of a decedent’s death, but depending on the role the owner plays, it can still be devastating. For LLCs, an operating agreement is a valuable tool for outlining the responsibilities and rules members must follow and what happens if one of them cannot. For corporations, bylaws or shareholder agreements ease the business succession process with guidelines for ownership, voting rights, and transfer of shares.

The Role of Buy-Sell Agreements

Developing a buy-sell agreement should be considered by all those with an interest in a partnership, LLC, or corporation. A buy-sell agreement allows co-owners to purchase and sell interests in the business at an agreed upon price and procedure in the event of certain future circumstances like another owner鈥檚 death, disability, or incapacity.

Buy-sell agreements are protective for both the business and the owner鈥檚 family. The agreement terms can restrict the sale of business interests to certain parties or create re-sale options for other existing co-owners. The buy-sell agreement can provide the owner and family with compensation which can be used to offset the loss of income.

Life Insurance as a Succession Tool

Insurance is another important business succession tool. For partnerships, a buy-sell agreement allows each co-owner to get life insurance on the life of the other owner. The surviving owner receives the death benefit and to fund a 鈥渂uy out鈥� of the deceased owner鈥檚 interest.

In New York, unless a partnership agreement indicates otherwise, a partner鈥檚 death causes the partnership to dissolve. Dissolution may also be a reality if the sole member of an LLC passes away or becomes disabled. Key person insurance is a life insurance policy utilized to compensate a business for the loss of a crucial team member. The business pays the premium and is the beneficiary of proceeds if anything happens to their key player 鈥� whether it be disability or death. The benefit can be used to recruit, hire, and train someone to replace the key person or make up for the profit loss incurred.

Succession Planning is Key for Both Family-Owned and Large Businesses

Without a succession plan, a business owner鈥檚 family and/or co-owners are forced to make quick and stressful decisions. Having a procedure in place is invaluable. For family-owned businesses, disputes may occur when there is a shift in power. Even in larger companies, the unexpected loss of a leader may cause employees to depart for fear of what lies ahead. An estate planning attorney with business experience can give you peace of mind and help steady the longevity of your business.

By Nancy Burner, Esq. and Erin Cullen, Esq.

Nancy Burner, Esq. is the Founding Partner, and Erin Cullen, Esq. is an Associate Attorney at 明星黑料, P.C. 明星黑料, P.C. serves clients from New York City to the east end of Long Island with offices located in East Setauket, Westhampton Beach, Manhattan, and East Hampton.

An S-Corporation is not a Business Entity but a Tax Classification聽

People are always surprised to learn that an S-corporation is not a business entity, but a tax classification. Both LLCs and C-corporations can choose to be taxed as an S-corp. An S-corp doesn鈥檛 pay corporate income tax like a traditional C-corp 鈥� avoiding the dreaded double taxation. Double taxation stems from the corporation paying tax on all profit generated and the owners being separately taxed on income they received from the company. An S-Corp designation, like an LLC partnership, is a pass-through tax election with income, losses, deductions, and credits reported on the owner鈥檚 personal tax returns.

Choosing a Business Entity

奥丑别苍听, the founder must first choose between a sole proprietorship, LLC or Corporation. The second choice is how you want the business taxed. Since most small business owners prefer the simplicity of an LLC, let鈥檚 focus on why an LLC might want to elect S-corp status.

S-Corp Requirements

Not all LLCs qualify to be taxed as S-corps.聽 The聽聽to qualify for S-Corporation status. An S-corp must be a US business with only US citizens/residents as owners. Neither LLCs, partnerships, or C-corps can be owners 鈥� and only certain types of trusts qualify. Additionally, an S-corp can have no more than 100 shareholders and only one class of stock/ownership.

In contrast, LLCs taxed as partnerships can have an unlimited number of members and different financial rights. Additionally, owners can include non-citizens/residents, corporations, partnerships, LLCs, and trusts.

S-Corp Benefits

One benefit of S-corp status is that it allows an LLC owner to be an employee, which could save money on taxes. When an LLC is taxed as a sole proprietorship or partnership, the owners must file as self-employed and thus subject to self-employment tax.聽 The self-employment tax rate is 15.3% in 2022. An S-corp owner can be an employee of the LLC and get paid using a W2. This means only their salary is still subject to Medicare and Social Security taxes 鈥� not the entire business profit. To leverage this benefit, S-corp owners keep their salary low and let the additional profits pass to them at the corporate tax rate of 21%. The salary cannot be too low, as the IRS requires the salary be 鈥渞easonable.鈥�

Cons of an S-corp

The downside is that there are more fees involved with an S-corp.聽 The S-corp must manage the withholding and reporting requirements of an employer. If the LLC has employees other than the owner, this is not an issue. But if the only employees are owners of the LLC, a complicated payroll is unnecessary. Accounting fees will also be more expensive since two returns will have to be filed.

Navigating entity formation and the tax landscape is tricky and depends on the needs of the particular business. Consult an attorney or accountant before making such a far reaching decision. Always alert your estate planning attorney when starting a closely held business. An attorney can make sure your interests pass to your beneficiaries聽without interrupting the business.聽It is crucial that small businesses pass to a partner or family seamlessly and avoid probate in Surrogate鈥檚 Court. Too many small businesses fail because they had no business succession plan in place.