How Can a Sole Proprietorship Be Passed On?

By John Cromwell

A sole proprietorship is a business with one owner-employee who holds assets and is directly responsible for all business obligations. He also has sole control over the business. The phrase “passed on” suggests that the owner is transferring his business to another. How you transfer a sole proprietorship will depend on your personal preferences and tax concerns. You can transform the business into another type of organization, transfer the business through your will or assign the business assets to a trust.

Transferring Issues

How you transfer a sole proprietorship is influenced by several factors. The first issue is whether you want to want retain sole control, share ownership with another or transfer the business immediately. Then you’ll need to determine who will receive the business. Finally, you need to consider whether you will be transferring the business to another without compensation. An example of when you might transfer a business without payment is if you were to give it as a gift to a family member or friend.

Tax Concerns

Many asset transfers are taxable, so you may want to consider how your business assets can be transferred in a way that minimizes your overall tax liability. The two major taxes applied to exchanges are gift and estate. The federal gift tax is levied on the donor who transfers property to another. How much the donor pays in taxes is based on the total amount the donor gives the recipient during a given tax year. The estate tax is paid out of the property left behind by the decedent. How much the estate will owe is based on the value of the decedent’s property at the time of his death.

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Convert to Alternate Organization

If you wish to bring on another owner and retain some control over the business, various options are available. The sole proprietorship can be reformed as a corporation, a limited liability company (LLC) or as a partnership. By bringing in more owners, you can transfer some of your ownership to other parties immediately while retaining some ownership and managerial control. If you reorganize as a corporation or LLC, the business can continue after your death. If you reorganize as a partnership with you as a general partner, the business will be dissolved when you pass away. If the new owners buy their way into the business, there are no immediate tax consequences. If you give a portion of the business away for free, the gift tax applies.

Last Will and Testament

If you want to retain control of the business and transfer the sole proprietorship after your death, drafting a will is one way to go. A will is a legal document that specifies the decedent’s wishes as to how his property should be distributed when he dies. The legal requirements for drafting a valid will vary from state to state. By drafting a valid will, you can transfer the assets of the sole proprietorship to another individual after your death. Transferring the business this way would make the business’s assets subject to the estate tax.

Revocable Living Trust

Another way to retain control of the business during your life and transfer the assets after your death is through a revocable living trust. A revocable living trust is a legally distinct entity comprised of property managed subject to specific terms by a trustee. The trustee ensures that the assets are maintained for the benefit of a specific individual or individuals. By being revocable, the person who donates the property to the trust retains the right to change the terms of the trust as he sees fit. The trust can be created so that when the donor dies, the trust property is distributed to the beneficiaries. The transfer into the living trust is not subject to gift taxes, but the donated property will be included in the donor’s estate for tax purposes when he passes away.

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