Last posted by Steve Parrish | forbes.com
Probate is the legal process to establish the validity of a will. Probate court is where you go when there are disputes over a will’s validity. Probate judges make the final call. Simple enough, right?
If you’ve been in business for long, chances are you’ve heard at least a few tales of probate problems plaguing family members, would-be successors or remaining business partners.
Open court battles, lengthy delays and outrageous expenses – all part of the lore of the evil nature of probate. In many cases, however, the root cause is a messed up estate plan. In and of itself, probate doesn’t have to be contentious, lengthy or expensive. Problems arise when a decedent leaves a jumble of difficulties for the probate court to untangle.
Your business interest holds a number of tangible and intangible property rights, and these rights may be a mystery to a probate judge. Leaving the disposition of your business and its assets to the probate court is like leaving your kids with an unknown babysitter. You get what you get.
You’re a more trustworthy caretaker
While you still have a say, it’s wise to approach the issues of probate with two fundamental estate planning strategies:
- First, arrange to keep out of probate those assets which don’t need to be there in the first place. Real estate, life insurance and bank accounts are examples of assets that can pass to heirs without the middleman of probate.
- Second, for the assets and legal documents that will go through probate, structure their disposition ahead of time so they will efficiently flow through the probate process. For example, if you don’t have a will, the state is essentially writing one for you, and the probate court will execute the state’s bidding.
If you haven’t set up a buy-sell agreement for your company, whoever inherits your interest – whether involved in the business or not – gets to decide what to do with it.
Leaving the business equally to the kids? Think of what happens if:
- One of your children is the company’s vice president.
- One is its bookkeeper.
- And one isn’t involved in the business.
Equal ownership will mean equal dissatisfaction with your will.
Handling the business
There are ways to avoid a messy business outcome after you are gone. Below are five strategies to avoid having the business hung up, hurt or otherwise impaired by probate.
- Trusts – Despite the hype, putting your assets in a trust doesn’t solve all estate planning issues. If, however, you have your business interest correctly titled in a living trust, it’s true that the business will avoid probate. With corporate stock, the process is fairly simple. With a business interest such as an LLC membership or a partnership share, the planning is more elaborate – but manageable. In doing trust planning for your business, be sure to differentiate between a revocable trust and an irrevocable trust. Both can avoid probate, but they serve different purposes. With the former, you continue to manage the trust and its assets (including your business), but the trust doesn’t shield you from estate taxation. With an irrevocable trust, you potentially avoid estate taxation, but you do so by relinquishing control of the asset to a trustee – something few active business owners wish to do.
- Real estate – If your business is a separate legal entity and owns real property, it is an asset of the business and flows with the disposition of the business interest. In many cases, however, the real estate is owned separately, and the owner rents the property to the business. In this case, probate can be avoided by titling the real estate in joint ownership with right of survivorship, in a life estate or, in some states, with a transfer on death (TOD) deed. All three approaches avoid probate. And if the property passes quickly after death, it’s one less thing to potentially cause trouble for the business.
- Personal property and insurance – There are other assets related to the business which may be personally held. A business owner may license a patent to the company. Or business owners may take out life insurance policies on each other’s lives and own the policies personally. Even though these assets are personally held, if they get hung up in probate, it will be the business that suffers. For example, a dispute over a life insurance policy may delay execution of a buy-sell agreement. Attention to titling and beneficiary designations – in advance – is needed to expedite disposition of these assets.
- Wills, executors and powers of attorney – From a legal perspective, the probate court works with whatever the decedent leaves in terms of instructions. But these instructions must be properly and legally executed. A will is nothing more than its author telling the court, “This is what I want to happen to my assets.” Appointing an executor is saying, “This is who I want to handle these matters on my behalf.” When the business is the largest asset of the decedent’s estate, it is particularly important to make sure a legal process has been established which will make both the business and the probate process run smoothly. At the management level, the company needs someone identified in advance to run the business while probate proceeds. Arrangements for maintaining company cash flow and family income should be sorted through beforehand. Otherwise, the probate court is forced to determine spousal allowances, payment of debts and potentially even management of the company.Finally, there’s no guarantee the business owner will be able to run the business until he or she dies. A business owner can become incompetent and lose the legal capacity to make decisions. A power of attorney is a way to assure that if the owner loses capacity and then ultimately dies, there is a person of trust able to get the business interest to probate in an orderly fashion. The power of attorney can be limited to management of the business interest. It doesn’t have to interfere with the rest of the assets in the estate.
- Business continuation – The most important step a business owner can take regarding the disposition of the business at death is to have a predetermined business continuation plan. First, whether through a buy-sell agreement, joint property ownership of an LLC interest, a gift of stock, or myriad other techniques, the legal disposition of the business interest as an asset must be pre-set. Next, the ongoing management of the company must be known in advance. Salaries, rent and debts must be paid. Operations must continue. And finally, the funding of the plan must be in place. A buy-sell agreement can exist, a successor manager known and business plan established. But if there is no money to execute the plan, and if a probate judge has to order a liquidation of the business to pay debts, the business will not continue.
It’s sometimes said that a privately held business is most vulnerable six months before and six months after the death of its owner. Do you have a plan in place to make sure your business will continue? Have you taken the steps needed to make probate an efficient process rather than a business killer?