Estate Planning for Business Owners in the Midst of COVID-19
Estate planning is important for everyone, but business owners have unique needs. Planning is especially important with the uncertainty of the current pandemic. Having an inadequate plan, or no plan, can be costly and wreak havoc with the business. Common issues that arise include:
- The owner becomes ill or temporarily incapacitated without a plan for decision-making and control.
- The owner’s illness is permanently incapacitating, but without legal documents, business succession is a “free-for-all.”
- The owner dies, but the owner’s family hasn’t been informed of the owner’s wishes. Each family member has a different view of what the owner “would have wanted.”
- The business falls into the hands of family members who don’t get along or don’t have a shared vision of the future of the business.
- Because the owner had no estate plan, the business passes to “heirs” instead of family members or others of the owner’s choice.
- The family may be forced to sell the business in a “fire sale” to pay estate tax.
- The owner leaves the business to a spouse or child with no interest in running it. This rarely turns out well.
Fortunately, many of these issues can be addressed through basic planning.
The owner’s verbal expression of estate planning wishes during lifetime, or at death, is not legally enforceable. Nor is an unsigned Will or Trust. Even if the owner’s wishes have been clearly communicated verbally (“I want my daughter to have the business because she has been running it with me for years”), if the verbal expression isn’t put into a legally enforceable written document, it is unlikely to govern the disposition of the business, at least not without the risk of costly litigation. State law governs the disposition of property at death in the absence of a Will or other legally enforceable writing. Family members do not have legal authority to change the requirements of state law, even if the owner’s intent has been clearly expressed verbally.
If an estate plan is already in place, this may be a good time to review it. Have there been any changes in the family since the documents were prepared (births, deaths, marriages, divorces)? Are the persons named to fulfill roles such as Personal Representative, Trustee, Power of Attorney, or Health Care Agent still alive and appropriate for the job? Where are originals stored? Is there easy access?
The best place to begin with estate planning is with basic documents. Putting the basic tools in place will go a long way to ensuring the proper handling of the owner’s property if the owner becomes incapacitated or dies. Here are the concepts and legal documents to be considered in estate planning.
A. State law. In the absence of legal documents containing specific wishes, state law governs what happens to property at death and how decision-making occurs in the event of incapacity.
1. Protections for spouse and children at death. State law protects spouses and children at death, granting the automatic rights described below. Some of these rights can be altered in a valid Will, and all of these rights can be waived in a valid antenuptial agreement.
a. Elective share. The surviving spouse has the right to elect up to 50% of the deceased spouse’s “augmented estate” at death, regardless of what the deceased spouse’s Will, Trust, or beneficiary designations provide. The augmented estate is broadly defined to include all property owned by the deceased spouse at death and even property transferred during their lifetime.
b. Rights in the event that the deceased person has no Will (intestate share). In the absence of a Will, the surviving spouse will inherit the deceased person’s probate property (except in a blended family situation – see below). If there is no spouse, the children will inherit probate property. The exception to these rules however, is a blended family situation. If the deceased person or the surviving spouse have children from a prior relationship, the spouse is entitled only to the first $225,000 of the deceased spouse’s probate property, plus one-half of the balance. The deceased person’s heirs receive the remaining probate property.
If a person dies without a Will and has no spouse or children, the estate will be distributed first to the deceased person’s parents, if they are living, next to surviving siblings and the descendants of any deceased siblings, or if none of these survive, to the deceased person’s grandparents or their descendants (aunts, uncles, etc.).
c. Homestead rights. The surviving spouse is entitled to live in the marital homestead for the rest of his or her life, regardless of which spouse owns the home, or what the deceased spouse’s Will provides.
d. Executor/Personal Representative. In the absence of a Will appointing a Personal Representative (also sometimes called the “Executor”), the surviving spouse has first priority to serve as Personal Representative, followed by all of the deceased person’s children serving together. This can be modified in a valid Will.
e. There are other provisions allowing the spouse and dependent children to receive monthly maintenance payments from the estate, automobiles, and sentimental property.
2. Provisions in the event of divorce. State law prescribes a process for determining whether property is marital or non-marital in the event of a marital dissolution, and how property is to be divided by the parties. It also allows for an award of maintenance or alimony payments of maintenance to a spouse. These rights can be waived in a valid antenuptial agreement.
3. Provisions in the event of incapacity. If the proper legal documents are not in place to govern decision-making in the event of incapacity, state law requires a legal proceeding to appoint a substituted decision-maker. Please note that a person’s spouse does not have an automatic legal right to make these decisions without a legal document appointing the spouse.
i. Guardianship. If no one has been named in a legal document to make decisions about a person’s health care, personal needs, or living situation, a guardianship proceeding can be brought in state court. If all requirements are met and a hearing is held, the court will appoint the legal guardian. The guardian typically has the authority to make decisions concerning:
- Medical care and other professional health care, counsel, or treatment,
- Place of residence,
- Comfort and maintenance needs including food, clothing, shelter, social and recreational requirements, and
- Clothing, furniture, vehicles and personal effects.
ii. Conservatorship. If no one has been named in a legal document to make decisions about a person’s finances and property, a conservatorship proceeding can be brought in state court. If all requirements are met and a hearing is held, the court will appoint the legal conservator. The conservator typically has authority to make decisions concerning:
- Providing for the person’s support, maintenance, and education,
- Paying expenses,
- Managing finances,
- Making contracts, and
- Applying for insurance or other assistance.
Of course, it is usually preferable to have valid legal documents in place identifying who will be filling these roles, rather than incur the time and cost of a court proceeding.
B. Review of Assets. An important step in estate planning is to review how assets are owned, and beneficiary designations are structured. Is the business in the name of one person? If the owner is married, is the spouse a co-owner? Review bank accounts, investment accounts, retirement accounts and life insurance to ensure that ownership and beneficiary designations are in order. If a divorce has occurred since an account was opened, be sure the ex-spouse’s name has been removed from beneficiary designations as appropriate. If a marriage has occurred, be sure the new spouse has been added if desired. If a beneficiary has died, prepare a new beneficiary designation if appropriate.
C. Legal documents. Proper planning includes the following estate planning documents, these should be adopted before death to ensure the owner’s wishes are honored.
1. Will. It is advisable for everyone to have at least a Will. The Will contains guidance on how property subject to probate should pass, and who should manage the estate. Property subject to probate is property that (a) is not owned with someone else as joint tenants, (b) does not have a beneficiary designation, and (c) is not owned by a trust. As indicated above, the person named to manage the estate is called a Personal Representative. If no Will exists, state law will determine who receives the deceased person’s probate property and who will serve as Personal Representative. This may or may not be consistent with what the deceased person would have chosen. Probate is a public proceeding, all probate filings are on file with the county probate court where the proceeding is commenced, and available to the public.
2. Revocable Trust. Many people prefer to avoid probate at death. This can be done in a number of ways, but a Revocable Trust is often a preferred method of avoiding probate because of the ability to detail how property should pass in multiple situations.
There are many types of trusts. There are trusts created during lifetime, called “inter vivos” trusts, and there are trusts that arise at death, called “testamentary” trusts. Trusts can be either revocable or irrevocable. A Revocable Trust is a form of inter vivos, or lifetime, trust. Revocable trusts are often called “living trusts.” Revocable trusts allow for the management of property both while the creator of the trust is alive, and after death. Typically, the maker of the trust controls and enjoys the benefit of the trust during lifetime. If the creator becomes incapacitated or dies, a successor trustee, named in the document, assumes control of the trust assets. With a revocable trust, there are generally no court filings and nothing is available for public access.
3. Beneficiary designation. Designating someone as a beneficiary on an account or real property is another method of passing property at death. Beneficiary designations are helpful ways of passing property for assets such as IRAs and retirement assets, life insurance, annuities, bank and brokerage accounts. It is advisable to name a primary beneficiary of the asset and at least one contingent or secondary beneficiary in case the primary beneficiary doesn’t survive you.
Real estate may be transferred at death without probate using a Transfer on Death Deed (TODD). The TODD functions as a beneficiary designation for real property. Stock and LLC interests can also be transferred at death without probate using a TOD designation.
4. Joint ownership. Property owned jointly with someone else with right of survivorship will pass to the joint owner at death without probate. This is called joint tenancy property. Examples of jointly-owned non-probate property include:
- real estate held in joint tenancy,
- real estate with life estate/remainder interest ownership, and
- joint bank accounts.
At death, most jointly-owned property will pass directly to the surviving joint owner, without a probate proceeding. (See the exception below, however, for real property held as tenants in common.) For example, if the home is owned with a spouse as joint tenants, and the spouse dies, the surviving spouse will become the owner of the home without probate. (However, the spouse must file an Affidavit of Survivorship with the county recorder’s office to place title into the spouse’s own name.)
Note, however, that real estate can be owned in joint tenancy or as tenants in common. Real estate owned with someone else as tenants in common is subject to probate at the death of a tenant in common. To determine how real estate is held, the deed to the property or certificate of title should be examined. If it states “joint tenants” or “joint tenancy”, it is joint tenancy property. If it does not state joint tenancy, the property is held as “tenants in common” and is subject to probate at death. In other words, tenancy in common is the default under Minnesota law.
There is no right or wrong way to jointly hold real estate. Sometimes probate is the preferred method of passing the property at death. For example, if farmland is inherited by the owner’s children and one of the children dies, the deceased child would often prefer that the farmland pass to the deceased child’s children rather than to the remaining siblings. It is important, however, to understand what happens to real estate at the death of the owner. It is easy to change real estate ownership when the owner is alive; but much more difficult, if not impossible, after the owner has died.
5. Power of Attorney. As indicated above, a power of attorney authorizes the attorney-in-fact to handle property and finances. It is important to note that spouses and children do not have an automatic legal right to handle each other’s finances if someone becomes incapacitated. Even if the spouses jointly own most property, they cannot co-own IRAs or retirement benefits, and except for second-to-die policies, do not co-own life insurance, so cannot access these assets during the incapacity of the owner. A Power of Attorney is necessary to provide access. In addition, the Power of Attorney provides access to financial information such as insurance coverage, employee benefits, and even contracts such as cell phone bills. It is advisable to have a Power of Attorney in place to provide access to financial matters if the principal is incapacitated. At least one successor should also be named on the Power of Attorney if the person’s first choice is unable to serve.
If a business owner adopts a Power of Attorney for business decision-making, this must be coordinated with a personal Power of Attorney to eliminate confusion over who is authorized to make business decisions.
6. Health Care Directive. A Health Care Directive can serve two purposes: appoint an agent (Health Care Agent) to make health care decisions if the maker of the Health Care Directive is unable to express health care wishes, and/or express the maker’s wishes about specific Health Care Instructions. As with the Power of Attorney, a spouse or children have no legal right to make health care decisions without a written Health Care Directive so it is important to consider adopting a signed Health Care Directive. There is no required form for the Health Care Directive in Minnesota, so any form will be honored if it (a) appoints a Health Care Agent, or (b) provides health care instructions, and (c) it is signed in the manner required by law. Consider if there are any changes to be made to an existing Health Care Directive in light of the situation with COVID-19.
While it may be tempting to try “do it yourself” sites for estate planning, it is highly encouraged to call on professionals for the job. DIY documents can be disastrous and lead to unintentional consequences. Worse yet, it can result in costly probate or Will contests. Legal services and end-of-life planning are “essential” services under Minnesota’s current stay-at-home order. Attorneys remain in business and are continuing to serve client needs.
D. Estate Taxes. Estate planning also includes planning for potential estate and other taxes. Currently, Minnesota’s estate tax exemption is $3 million per person. There is a special deduction for estates that include a qualified small business or farm, allowing for a total exemption of up to $5 million. For a business owner who is married, provisions should be included in the Will or Revocable Trust to ensure that each spouse’s exemption can be maximized.
The federal estate tax exemption in 2020 is $11.58 million per person, adjusted annually for inflation through the year 2025. In 2026, the exemption is scheduled to revert to $5 million per person, adjusted for inflation. Under federal law, a surviving spouse is automatically entitled to the unused federal exemption of the first spouse to die. Known as “portability,” this allows a married couple to maximize the federal exemption. There is a special opportunity under federal estate tax laws that may allow a stock redemption from the estate on a tax-favored basis, and lifetime gifting strategies to children or trusts may also reduce tax at death.
Failure to plan for estate taxes, either to minimize them or plan for funding payment through life insurance or other liquid assets, can result in an estate where the primary value lies with the business. If there are insufficient assets in the estate to pay estate tax, all or portions of the business may have to be sold – relatively quickly – to raise funds to pay taxes when due. This “fire sale” scenario can be disastrous to the business and surviving family members.