How business owners should plan their estates

Business owners and the self-employed are naturally focused on growing their enterprise but as one ages, estate planning is vital to ensure their business lives on or provides financial support to their family long after they have gone.

A valid, up-to-date will, which sets out who will receive the assets from a business is very important for ensuring it passes to who you wish. Christine Ross, client director at Handelsbanken Wealth & Asset Management, says: "It is essential that it is reviewed regularly to keep up with changing family and business circumstances."

Also, consider what might happen to your company if you die unexpectedly. If there are other directors of your company, it can carry on but you need to decide how that will happen in practice. Lauren Peters, managing director of Valkyrie Financial Advice, an appointed representative of St James Place Wealth Management, says: “For example, will your spouse, partner or child take your place in the business or will a replacement have to be found? If you have a limited company, ensure the rules for closing the company or selling shares are clearly set out in the Articles of Association, and the Shareholder Agreement properly reflects the ownership and any shareholder agreements.”

Kate Aitchison, tax director at RSM, adds that you should ask family members if they want to take over the business and, if not, plan so they can exit at the right price.

Even if you are the sole director and intend to end the company after your death, still document what should happen so that it is more likely to be able to be wound up without complications. Informing a financial adviser or accountant of your plans for the business if you die unexpectedly, or become incapacitated, is helpful to your family who are “already in a distressing situation”, advises Peters.

One option is to start handing over control and or shares in your business to an adult child over a number of years whereby they eventually take control. Or you could sell off parts of the business in stages to existing shareholders or third parties.

Sole traders are often 'the business', so there is no entity to pass on. But Ross warns that creditors can claim against estates so it's wise to buy "insurance that covers this risk".

Shareholder protection, meanwhile, can safeguard the interests of remaining directors. For example, if a business owner dies and leaves their shares to beneficiaries who do not want to be involved in the business, they may sell their stake. But the remaining shareholders may not want that stake to go to a third party in which case they need to buy it. “However, finding the funds, particularly at short notice, to buy the shares back from the beneficiaries may be extremely challenging,” says Peters.

Shareholder protection insurance could provide a cash payout to do this without the business having to save, find or borrow money to purchase the deceased shareholder’s shares. The remaining business owners can keep control of the company, so there is a smooth transition for both the business and the surviving family.

However, there is a cost for shareholder protection and the policy needs to be reviewed at least every five years to make sure the cover reflects the share value.

Tax efficiency

Limited company owners, partnerships and sole trader businesses may be able to get Business Relief (BR) which exempts companies from inheritance tax (IHT) once they have been held for at least two years, if they meet certain conditions. These include that they are not quoted on a main stock exchange and less than 50 per cent of the business’s activity is investment such as buying land or buildings, holding investments, or purchasing stocks and shares.

If the business qualifies, BR is available at 100 per cent on unquoted shares. It may also be available at 50 per cent on assets such as land, buildings and machinery owned directly by the individual but used in a business they control or are a partner in, so that tax is payable at half the death rate. “An example of this is where a property is owned personally but used as the premises by the shareholder’s company,” explains Aitchison.

But if investment becomes the majority activity or asset, the business could lose relief from IHT. For example, if “a residential property developer decides to retain a number of properties to create a rental business [and] that rental business outweighs the main development business in value, turnover or time devoted to running it, the business [might] be regarded as pursuing investment and not trading,” says Ross.

If a business holds large amounts of cash that are not regarded as working capital it could also lose its trading status.

When making a claim for BR you normally complete form IHT400 and supplementary schedule IHT413.

BR can also apply as a relief for IHT on gifts of a business or an interest in a business during the donor’s lifetime, provided that it has been held for two years.

Businesses passed onto surviving spouses or civil partners, as with all other assets, are automatically IHT-free. However, when the second member of the couple dies there could be IHT due if their increased estate uses up all their allowances. So in such cases “consider implementing trust structures too, since assets held within a trust don’t count towards a person’s estate for IHT purposes”, adds Peters.

If a beneficiary doesn’t want to receive shares in a business, they could enter into a deed of variation which would redirect them to someone else. They have two years from the date of the death to do this. For example, if a father leaves shares in a business to a child but they are well off and receiving them increases the value of their own estate and its IHT liability, they could enter into a deed of variation to pass the assets to their own children – the original business owner's grandchildren.

Owners of limited companies can also give the option during their lifetime or in their will to co-shareholders who aren’t family members to have a first option over buying their shares. “This can provide comfort to the remaining shareholders that they will be able to continue to run the business as per their agreed strategy,” says Ross. “However, it is important that the option is not binding, otherwise the IHT relief on the business assets is lost. Having binding contracts, rights to buy shares and or interests in businesses leads to a loss of the 100 per cent BR.”

A gift of business assets in a lifetime can be subject to capital gains tax (CGT). “So, for example, if a parent gifts shares in the family business to a child this is a disposal for CGT purposes,” explains Aitchison. “Where the individuals are connected, tax is calculated based on the market value of the asset at the date of the gift, deducting the original purchase price. The difference is subject to tax at either 10 or 20 per cent. [But if] the asset being gifted is business assets or shares, gift holdover relief may enable the beneficiary to defer a gain till sold in future. The donor and donee jointly elect to defer the gain, and the donee in effect inherits the base cost of the donor.”

If the asset being gifted is shares, the company must be unlisted and the donor’s personal company. HM Revenue & Customs (HMRC) guidelines state that only 20 per cent of its activities can relate to investment activity.

What beneficiaries need to do

When a business owner or sole trader dies the executors of their will – or personal representatives if they died intestate – have to register the death, and obtain death certificates and copies of any will. Beneficiaries or other individuals can be executors or personal representatives.

Executors or personal representatives have to value the estate and notify financial institutions of the death so that assets and liabilities can be determined, taxes paid and grant of probate given, making it possible for the estate to be distributed in accordance with the will of the deceased. If there is no will, representatives need to apply for letters of administration and the estate will pass in accordance with the rules of intestacy.

HMRC and other government departments have to be notified of the business owner’s death which you can do via the Tell Us Once service at www.gov.uk/after-a-death/organisations-you-need-to-contact-and-tell-us-once.

If there are other directors of a limited company and they want to continue it they need to ensure that tax is paid and returns are filed.

When a sole trader dies their business's assets and liabilities become part of their estate. Final accounts have to be completed and filed, income up to date of death needs to be reported and outstanding tax due needs to be paid. The executor or administrator of the estate is responsible for submitting a tax return for the deceased person from the start of the relevant tax year to the date of death, and making any tax payments due by the normal deadlines.

There may be a requirement for an IHT return in respect of the estate. The executor is responsible for making the IHT return and settling any tax due. IHT is payable by the end of the sixth month after the individual has died, and you have a year to complete and submit the IHT return.

When a sole director dies, a new director might need to be appointed as a company cannot exist without at least one director. “If the intention is for the surviving shareholders to appoint a new director in order to keep the company running or simply so that the bank account can be accessed for paying creditors and completing tax returns, you need to appoint a new director using Form AP01,” says Peters.

The executor of the estate can appoint a new director if the company’s Articles of Association allow for this. “The new director will be expected to continue running the company and file tax returns as required,” says Peters. “Otherwise, the company will need to be wound up so that any remaining business assets can be paid to the estate and distributed as per the will.”

Companies House has to be notified of a director's death within 14 days of it happening via form TM01. Only certain people can sign form TM01 such as another director, company secretary, liquidator or receiver. Someone who is just a shareholder, and not also in one of these roles, is not permitted to sign the form. “This does not give grieving family or friends long to act,” says Peters.

Those dealing with the inherited business need to quickly appoint a liquidator or, if the Articles of Association allow and there is at least one shareholder, hold a shareholder meeting to make them a director. This “can often be the case where a spouse is named as a shareholder but not director,” says Peters. They should then complete form AP01 to appoint a new director and form TM01 to terminate a director one day later.

Executors of a deceased’s will or personal representatives have to notify institutions, with which the deceased has accounts, by sending a copy of the death certificate to each one. A sole trader business account is typically frozen at this point and often probate has to be granted before the account funds can be distributed to beneficiaries.

If there aren't other directors, the account can be frozen until a new director has been appointed. The new director has to present proof of their director status to the bank to reopen the account. “This can take several weeks which can be an issue if there are invoices to settle or taxes to pay in the meantime,” says Peters.

It is also very important that limited company bank accounts are emptied before a company is struck off or dissolved at Companies House. This is because at the point of dissolution, the bank account is frozen and any monies in it pass to the Crown. “In order to get this money back, the company would need to be restored which is not an easy task,” warns Peters.

A way to avoid these problems is for a company to have more than one director so that if one dies unexpectedly, another can continue to access the bank accounts. Also keep a record of passwords to get into necessary accounts and pass these on to your accountant or the person who will take over if you pass away such as your spouse or other family members.

If beneficiaries decide to wind up the company, a cheap way to do this is to apply to get it struck off the Companies House Register via form DS01. Or you could start a member’s voluntary liquidation.

If the company is deemed insolvent its creditors' interests legally come before those of directors or shareholders. “Options usually include putting the company into administration or arranging a creditors’ voluntary liquidation,” says Peters. “The company could be forced into compulsory liquidation if you cannot pay creditors. In such cases, it’s advisable to seek assistance from professional liquidator and insolvency practitioners.”