Last updated on April 20th, 2022 at 02:15 am
Business owners spend a lifetime building a legacy only to risk having it swiped away because of a failure to plan. That’s why estate planning, especially in an uncertain economy, is essential for business owners. The problems that businesses face upon an owner’s death include lack of a succession plan or a market for the company. Even worse, the business may be the asset that triggers estate tax exposure. As a result, the business is all too often sold in a fire sale for less than full consideration because the estate needs funds to pay taxes on the business itself. The IRS will value the company at full fair market value the instant before the business owner passed away.
Irrevocable Life Insurance Trusts (ILITs) offer a straightforward option to avoid this trap. An ILIT is an irrevocable trust that functions as both the owner and beneficiary of one or more life insurance policies. Upon the death of the insured, the trustee administers the trust for one or more beneficiaries. For business owners, the life insurance will be on that person’s life. The trust will own that life insurance and the business owner will make annual gifts into the trust to pay the policy premiums. Upon death, the life insurance policy will pay the trust, making it flush with cash that is income tax free and outside of the business owner’s taxable estate.
This simple concept is ripe with benefits. It is a tax efficient strategy for both income tax and wealth transfer tax. Also, the trust can buy assets from the estate of the business owner on death, up to and including the business itself. The trust will manufacture a market and, with careful planning, can inject liquid assets into a taxable estate, avoiding the need for a fire sale. The trust can then either continue to run the business on behalf of the beneficiaries, or it can sell the business without undue outside pressures.
To boot, life insurance is never sold for its face value. As a result, the liquidity added to the trust is done so at a discount. Even if the trust assets are not needed to pay taxes or buy the business, this strategy still provides significant benefit for trust beneficiaries – usually the business owner’s children. Structured properly, this trust can be dynastic (meaning that it will continue for generations to come) and provide future generations with benefits such as tax efficiency and creditor protection. This benefit can be multiplied if these successor trusts also purchase life insurance on their beneficiaries. Over several generations, these trusts can generate tens of millions – even billions of dollars for the heirs of the business owner.
A little work now can go a long way to creating a true legacy for the business owner that plans properly with the help of an estate planning attorney.