If you are operating a small business as a sole proprietor, you may feel as though it is the simplest way to proceed. You can claim profits and losses on your personal income tax returns, so you have a turnkey situation.
All this is well and good until you are hit with a business-related lawsuit. Asset protection is important for small businesspeople, and there are some relatively straightforward ways to go about it.
Limited Liability Company
A limited liability company (LLC) is a structure that is very commonly used by businesspeople that are looking for an asset protection solution. When you establish an LLC, you are creating separation between your personal finances and actions that are taken on behalf of your business.
If a business creditor or another type of litigant files a lawsuit, the assets that were in your personal possession would be out of their reach in most instances. An exception may be made if you directly cause damages while you are doing your job.
This asset protection is a two-way street because the business would be protected if you are targeted by a litigant seeking redress. However, if a court issues a charging order, payments that are made to you by the limited liability company would not be protected.
You do not lose the pass-through taxation that you get when you are a sole proprietor, so you can still claim your profits and losses on your personal returns.
Family Limited Partnership
As the name would indicate, a family limited partnership (FLP) is comprised of members of the same family. The person that establishes the partnership would be the general partner with total decision-making authority, and the others would be limited partners.
Personal property that is owned by the partners would be protected if a partnership that is holding a business or an investment property is sued.
Let’s say that you own a construction company and three apartment buildings. You could convey each building into a separate family limited partnership, and the construction company can be held by its own partnership. If a party is injured in one of the buildings, the other apartment buildings would be protected along with the construction company.
If a legal action is filed against any partner as an individual, all the property that is held by the partnerships would be protected. In addition to asset protection, family limited partnerships can be used to mitigate estate tax exposure.
This tax is applicable on transfers that exceed $12.92 million in value in 2023, so most people do not have to worry about the tax. It is going down to $5.49 million in 2026 if there are no legislative changes in the meantime, so this is something to keep in mind.
Succession for Small Business Partners
A buy-sell agreement can be used to make small business succession for business partners possible. The cross-purchase plan is a simple arrangement, and if you implement this strategy for estate planning purposes, it involves the use of life insurance.
Each partner would take out a policy with a payout that is equal to a business ownership share. When one partner dies, the proceeds would be utilized to purchase the share that was owned by the deceased partner from their estate.
There is also an equity purchase buy-sell agreement, and with this approach, the business as an entity will carry the life insurance.
A buy-sell agreement can be used for general succession purposes that are not necessarily estate related. Someone may want to step aside to pursue a new opportunity, or a person with an ownership interest may want to retire.
Under these circumstances, a buyout agreement can be drawn up that does not necessarily involve the use of life insurance.
Take Action Today!
Today is the day for action if you are going through life without a plan. You can schedule a consultation appointment at our Westport or Glastonbury, CT estate planning offices if you call us at 860-548-1000, and you can use our contact form to send us a message.
- Take Precautions to Protect Your Legacy - September 12, 2023
- Regular Reviews and Updates of Your Estate Plan Are Essential - August 24, 2023
- Estate Planning Tips to Help You Protect Your Family - August 8, 2023