A Director/Partner dies.

How do you protect against crippling tax liabilities?

You’ve spent years running and building up your business.  You may have done this single handedly or with partner(s).  Have you thought what might happen in the event you or one of the directors or partners die?  In this guest blog post Tim Mullock of Adept Asset Solutions discusses the options available to you and how you can protect those left behind from crippling tax liabilities.

It’s a sorry tale – one I’ve heard countless times. A founding business Director or Partner dies. His colleagues find themselves under pressure from the beneficiary of their deceased colleague’s Will. The latter might demand an unreasonably high continuing stream of dividend income regardless of profitability. Or, they might push to sell their shares in the business. Either scenario, sadly, too often leads to the failure of the company.

However, there’s good news. There can be a happy resolution to the situation. All it takes is careful, expert planning and the implementation of what we call a Cross Option Agreement. Let’s take a closer look.

To keep things simple, we’ll use the terms ‘Limited Company’ and ‘Director’, although what we cover applies equally to Partners and Partnerships. For the same reason, we’ll use an example of a company comprising just two Directors, even though they apply equally to multiple shareholders/partners.

The problem

Let’s start with the regrettable scenario where Director A dies with a conventional Will in place. His wife inherits his shares in the business.

The downsides for Director A’s widow?
  1. She now owns part of a company that she may not want to run.
  2. The shares form part of her estate and are at risk from situations arising from re-marriage, divorce, bankruptcy and long-term care.
  3. If she decides to sell her shares, the proceeds will create a potential Inheritance Tax liability.
The downsides for Director B?
  1. He may not wish to share the running of the business with Director A’s widow.
  2. He may not have the necessary funds to buy out Director A’s widow’s share of the business.
The solution – A Cross Option Agreement
Each Director leaves their share of the Business to their beneficiaries via their Will.

A Cross Option Agreement is set up to enable one Director to purchase the other Director’s shares in the event of his death.

The Directors plan ahead by each taking out a Family Life Assurance Policy under Trust, which, in the event of the death of one Director, funds the purchase of his shares by the other.

Director A dies, following which his shares pass on to his widow. The Life Assurance Policy then pays out, enabling Director B to purchase Director A’s shares. So all’s well. Or is it? Let’s take a closer look.

Consequences for Director A’s widow

√ She now has the funds from the sale of her late husband’s shares

× As part of her estate, these funds will count towards her inheritance tax threshold when she dies.

× The funds are also at risk from claims arising from re-marriage, divorce, bankruptcy and long
term care.

Consequences for Director B

√ He now has full control of the company

× His increased shareholding is now at risk from claims arising from re-marriage, divorce,
bankruptcy and long-term care.

× Whilst trading, Business Relief applies. But – if he sells the business, the cash proceeds
will be part of his estate and will be assessable for Inheritance Tax when he dies.

× With the growth in Director B’s shareholding, making him subject to more Capital Gains Tax.

Overall, it’s clear that the Cross Option Agreement, which is used in most circumstances, above will be generally beneficial for all concerned. There’s potential for some financial ‘pain’, especially in terms of swelling the value of the beneficiaries’ estates to potentially high levels. But surely, the peace of mind generated by a Cross Option Agreement outweighs the potential negative consequences. Using the Agreement means that all parties can be clear about the security of the futures – both personal and for the business.

Importantly, for more sophisticated businesses there is an alternative that offers a higher level of protection for both the Widow(er) and the surviving Director Shareholder(s).

 

The Cross Option Expert
Tim Mullock is a leading expert on all matters concerning Wills, Estates and Asset Management. He enjoys many years’ experience in helping people to manage their assets for the best interests of those who, one day, they leave behind.  For further details visit   Adeptassetsolutions.co.uk  or email  Tim.Mullock@AdeptAssetSolutions.co.uk