The Death of a Sole Proprietor

A sole proprietor is the “sole” or only owner of a business who is entitled to keep all of a business’s profits after all taxes have been paid.  However, unlike a corporation whose executives are exempt from liability, a sole proprietor is responsible or liable for all losses.  

Therefore, when a sole proprietor dies, all of the business assets and liabilities become part of the sole proprietor’s personal estate.  The executor of the estate has the responsibility to settle the estate, which includes the disposition of the sole proprietorship.  However, certain problems can arise upon the death of a sole proprietor.

Problems at a Sole Proprietor’s Death

A number of different problems that can occur when a sole proprietor dies, including:

  • Survivor Income – In what way will income to be continued to surviving family members?
  • Debts – Is there enough assets available to pay the sole proprietor’s personal and business debts?
  • Estate Settlement Costs – Is there proper cash to pay the estate taxes and the other estate administrative costs required to settle the estate?
  • Business Disposition – How is the value of the business interest best preserved for the heirs?

If advanced planning is not in place, unfortunately, often the only solution is to liquidate the assets of the sole proprietorship in order to pay estate settlement costs and debts.  If anything remains after the liquidation of the value of the assets, the heirs receive the remainder.

An alternative to this devastating scenario is life insurance.

The Life Insurance Solution

Rather than liquidate all of the sole proprietorships assets, a key employee, relative, or even a competitor may wish to purchase the business.  An insured buy-sell plan provides a means for an orderly transfer of ownership after the sole proprietor’s death.  There are several accomplishments to be found with advanced planning and an insured buy-sell plan:

  • The creation of a market for the sale of sole proprietorships.
  • The agreed upon buy and sell price of the sole proprietorship.
  • Upon the sole proprietor’s death, the full purchase price is available.
  • Losses associated with a forced liquidation is avoided due to the prompt sale of the business at full market value.
  • A fixed value for the sole proprietorship is available for federal estate tax purposes.
  • The prompt and efficient settlement of the estate is available due to the cash available with the quick transfer and sale of the sole proprietorship.

A Buy-Sell Agreement

Basically, a buy-sell agreement is an arrangement between business owners on buying and selling a business.  However, if the buy-sell agreement is not initially set up in the proper way, grief and headaches to business partners, family, and others could occur.  Only an experienced business law attorney or expert should arrange a buy-sell agreement.

Funding of a Buy-Sell Plan

The purchaser of a sole proprietorship can bund a buy-sell plan four different ways:

  • Loan Method – If the new owner is able to obtain a business loan, the purchase price can be borrowed if the income from the future business generates adequate income to repay the loan plus interest.
  • Installment Method – After the sole proprietor’s death, the purchase price may be paid in installments.  However, this may mean a drain on income generated by the business for years to come.  Additionally, this also means that any recipients are dependent on the performance of the business.
  • Cash Method – If the purchaser is able to accumulate enough cash to purchase the business upon the death of the sole proprietor, cash may be the best method.  Unfortunately, saving the necessary funds may take many years while the full purchase amount may be needed in a much shorter period of time.
  • Insured Method – If a purchaser is looking for a guaranteed amount needed to complete the sale of a sole proprietorship exactly when needed, life insurance is the best option.  The sole proprietorship must be accurately valued in order for this option to be viable.
Key Steps of a Buy-Sell Agreement Funded with Life Insurance

The first step of implementation in this type of agreement is a consultation with an experienced attorney who is an expert at the structure of a buy-sell agreement.  The size of a business typically determines the difficulty of a properly structured buy-sell agreement.

At the same time, the process of obtaining life insurance for the buy-sell agreement begins.  The reasoning behind this process is the time it takes to approve the life insurance, which can take from a quick few days to a few months depending on the proposed insured’s health and the size of the policy.

For those who need or want to be insured quickly, a no exam coverage policy can be written, albeit at a higher price.  If a purchaser is not satisfied with the coverage and price of the no exam policy, a fully underwritten policy can be applied for at a later date.  

No matter which method a person chooses to fund a buy-sell agreement, an experienced business law attorney or highly qualified business professional should be retained to explain the many different nuisances of the entire buy-sell process such as:

  • The steps needed to create a buy-sell agreement
  • Using life insurance to the best advantage in a buy-sell agreement
  • The different types of life insurance used to fund a buy-sell agreement
  • Finding the lowest premium for the highest amount of protection

Taking into consideration the many different choices involved in a buy-sell agreement, undertaking this process alone will most assuredly lead to confusion, higher costs, and costly mistakes.  

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