Surprise! Your Buy-Sell Agreement Could Result in Denial of a Marital Tax Deduction When a Business Owner Dies.

By: Greg Condra, Condra Law Firm, PLLC

It’s critical that business owners leaving a large estate behind devise a plan. Beyond the typical estate planning documents, a well-crafted Buy-Sell Agreement is an excellent place to begin.

If your business has, or anticipates having, multiple owners, then a Buy-Sell Agreement is essential to protect you. It can take the form of a standalone Buy-Sell Agreement, a Shareholders’ Agreement, or detailed provisions within a limited liability company’s Operating Agreement or a partnership’s Partnership Agreement. Chances are you are fine being in business with your partner(s), but you would rather not be in business with their ex-spouse(s) or widow(s). Perhaps the spouses are active in other businesses or professions, or have never worked in the family business, or there could be other reasons. Often, families wish to retain ownership within familial blood lines by prohibiting transfers to spouses.

Most Buy-Sell Agreements prevent transfers to a spouse of an owner, either during lifetime or at death. But beware, this prohibition on transfers to, or for the benefit of, a spouse will accelerate the payment of death tax which could have been delayed until the death of the surviving spouse if a marital transfer had been permitted by the Buy-Sell Agreement after all. Because federal and state death tax laws change often, you should put off as long as possible paying any death tax. Why pay a deferrable tax years sooner than you have to when the family business owner dies?

To eliminate this problem, your Buy-Sell Agreement could be updated to permit transfers to an irrevocable QTIP trust for the benefit of the surviving spouse when an owner dies. So, instead of the ownership interest going to the surviving spouse outright, ownership is placed in trustfor the lifetime benefit of the surviving spouse. It is a good idea to include the following rules in the Buy-Sell Agreement update: (1) the ultimate beneficiaries upon the surviving spouse’s death must be permissible transferees (such as descendants of the deceased owner), (2) prohibit discretionary distributions of stock to the surviving spouse and (3) the trustee must be either a bank trust company or a permissible transferee himself or herself (such as a descendant of the owner, for example).

When deciding if this approach is right for you, keep in mind that the surviving spouse must be given the power to force the trustee to make the trust assets income producing. This could be a problem if those assets consist of stock in a family business which has never declared a dividend. But really, the whole point of this, besides deferring tax (!), is that the widow has a retirement income. So, you might also want to revisit your operating agreement or bylaws to spell out a dividend-payout policy.

Furthermore, the surviving spouse must receive all the net income earned by the trust assets for life in order to qualify for the federal estate tax marital deduction. In other words, no one else can be a beneficiary during the lifetime of the surviving spouse. It is helpful to include instructions reminding the executor of the deceased owner’s estate to file the necessary election along with the federal estate tax return.

Attorney Greg Condra helps small business owners with transactions and litigation including starting, buying, and selling businesses, business “divorces”, commercial/rental real estate, and the generational transfer of the family business. Greg Condra also practices probate & estate planning (wills, trusts, powers of attorney) helping people manage even complicated situations including unmarried couples, second marriages, senior citizens, and spouses or children with unique needs.

This article was written in partnership with the Southern Indiana Estate Planning Council. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship. The law sometimes changes. Documents persist on the internet indefinitely. Information may not constitute the most up-to-date legal or other information. The author does not undertake responsibility to update the information. Article written by: