9015 / What issues arise when a family partnership is considering its small business succession strategy?

The preferred solution to the problem of transferring family partnership interests at death depends upon the particular type of family partnership and the circumstances surrounding it. A family partnership may be between two spouses, a parent and his or her adult child or children, the entire family, or the parent and a trustee or trustees, the latter acting for minor children. In some instances, disposition of the partnership interests by will may be a satisfactory solution. In most instances, a buy-sell agreement will be the preferred solution. Except in the case of two spouses, the income tax savings that result from the family partnership, by reason of spreading the business income, will more than pay the premiums on the life insurance used to finance the agreement.

When a family partnership has been formed by two spouses, it is sometimes assumed that there is no need for a buy-sell agreement to take effect at death. The spouse-partners may take the position that a buy-sell agreement is unnecessary because the survivor (assuming there are no children or other heirs) will take the interest in the business from the first-to-die under the intestacy laws of the state in the absence of a will. Moreover, in most states, each has a statutory right to one-third of the property owned at death by the other, and this right cannot be eliminated even by a will to the contrary.

Notwithstanding the circumstances that exist so far as inheritance is concerned between the spouses, a buy-sell agreement is practical and in some instances may be necessary in order to avoid serious problems upon the death of the first-to-die. See Q 9016 for a detailed discussion of the use of buy-sell agreements in the context of a family partnership.

Where two spouses are partners in a partnership business, they may execute wills leaving their interests in the business to each other. This procedure will sometimes eliminate any liquidation problems at death because the surviving spouse will own the entire business by virtue of the duly executed will, and it eliminates any doubts or problems so far as the surviving spouse’s rights are concerned.

There are several major problems, however, that require serious consideration, even though the spouses have executed wills leaving their business interests to each other. The decedent may have personal creditors pressing claims against the estate. Such claims must be satisfied before the surviving spouse can take over the decedent’s business interest.

Aside from personal creditors of the decedent, the business itself may be faced with substantial liabilities. Any such claims, if pressed for settlement, will need to be satisfied by the surviving spouse.

There is always the chance that the decedent’s will may be contested by other potential heirs, and if set aside will leave the surviving spouse in the same position as if no will had ever been executed. Consequently, if the will is set aside for one reason or another, the surviving spouse will then take under the intestacy laws of the particular state involved, which may give a large portion of the decedent’s business interest to heirs other than the surviving spouse. And if any of these heirs are minors, liquidation of the business could become necessary.¹