A Sole Proprietorship When Someone Dies

By John Cromwell

A sole proprietorship is a type of business organization that has a single owner. This type of organization is popular due to how easy and comparatively cheap it is to form. The sole proprietor is personally responsible for the business’s liabilities, so if the business lacks the resources to settle its debts, the owner must pay off the liabilities using his personal assets. When a sole proprietor dies, the business usually terminates as well, since a sole proprietorship is so closely tied to its owner. However, if the sole proprietor carefully plans his estate, his business can survive in some form after his death, either in the hands of his heirs or through a third-party purchaser.

A sole proprietorship is a type of business organization that has a single owner. This type of organization is popular due to how easy and comparatively cheap it is to form. The sole proprietor is personally responsible for the business’s liabilities, so if the business lacks the resources to settle its debts, the owner must pay off the liabilities using his personal assets. When a sole proprietor dies, the business usually terminates as well, since a sole proprietorship is so closely tied to its owner. However, if the sole proprietor carefully plans his estate, his business can survive in some form after his death, either in the hands of his heirs or through a third-party purchaser.

Liquidation

Liquidation of a sole proprietorship is the process of selling business assets to individuals. The assets of a sole proprietorship are generally considered probate property, so the sale of these items will have to go through the probate process. Since the probate process can be quite lengthy, it may be a while before the decedent’s heirs get their share of the sale of the asset. The estate may also not receive full market price for the proprietorship’s assets, since it is trying to sell everything quickly. Finally, since the proprietorship’s assets are included in the owner’s estate, the owner’s creditors may claim proceeds from the sale of the proprietorship's assets to settle the owner’s personal and business debts.

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Transfer to Heirs

Another option is for a decedent's heirs to take over the business, which poses some challenges. If the business is transferred after the original sole proprietor dies, all of the business’s assets must still pass through probate. To protect the business’s assets from creditor claims, the new owners of the business may have to settle the outstanding debts. Settling debts and restarting the business may require significant amounts of money the new owners do not have. In addition, the new owners must create a new business since a sole proprietorship is non-transferable. Therefore, the new owners would need to create a new business then transfer all of the former proprietorship’s assets into that organization.

Life Insurance and New Heir Owners

If the owner wants to transfer his business to family, he may consider taking out a life insurance policy on himself. The proceeds from a life insurance policy can be used to settle all of his and the business’s debts so the business’s assets are protected. The policy proceeds could also provide capital for the new owners to help restart the business. An additional benefit is that the proceeds from life insurance are exempt from probate, so the beneficiaries of the policy can receive the benefits relatively quickly.

Business Sale to Third Party

Another option is selling the business to a third party. Depending on the size of the business and the timing of the sale, a third party may be unable to purchase the business outright with a lump sum. If the purchaser needs to borrow money to buy the business, the interest expense may make the transaction impossible. If the purchaser decides to purchase the business through an installment plan, the deceased’s beneficiaries may have to wait for a prolonged period to receive the funds.

Buy-Sell Agreement

If the owner wants to sell the business to a third party, he can execute a buy-sell agreement. Otherwise known as a business continuation agreement, the buyer and proprietor agree to the sale of the business prior to the proprietor’s death. The buyer takes out a policy on the proprietor for the agreed price of the business. When the proprietor dies, the buyer uses the proceeds of the policy to pay the full price for the business to the proprietor’s heirs.

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How to Transfer Ownership of a Sole Proprietorship

References

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Ways to Protect a Sole Proprietor From Being Sued

It is especially important for sole proprietors to avoid lawsuits because they are personally liable to pay for all of their business’s liabilities and claims. This means that they may have to pay for any business debt using their personal assets, not just the business's assets. There are two ways to protect a sole proprietor from being sued. The first is to ensure that the business does not participate in conduct that creates a high risk of a lawsuit. The second option is to protect the sole proprietor’s assets from a lawsuit.

Does an Estate Cover Sole Proprietorships?

A sole proprietorship is operated under the name and personal responsibility of the owner, and unlike other business forms, it is not legally separate from the owner. If the owner does not take special precautions to transfer the business assets, the business will be included in the owner’s estate upon his death.

Can a Startup LLC Assume Sole Propiertor Debts & Assets?

A sole proprietor who wants to transfer assets and debts to a newly-formed limited liability company, or LLC, can ordinarily do so, but only under certain circumstances. The transactions will be governed by the state law that authorized the formation of the LLC and any agreements between owners restricting capital contributions or withdrawals that change ownership interests. If you are converting a sole proprietor business into a single-owner LLC, you have a lot of leeway to determine how you capitalize your interest in the new company, but you must account for asset transfers properly for state and federal income tax purposes.

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