Estate Planning for Business Owners in Minnesota

Estate planning for a business owner is fundamentally more complex than planning for someone whose wealth consists primarily of a home, retirement accounts, and savings. A business is often the most valuable asset in the estate — and unlike a brokerage account, it cannot simply be divided equally among heirs without potentially destroying its value.

Minnesota business owners face additional considerations because the state imposes its own estate tax on estates exceeding $3 million (Minn. Stat. Section 291.03), a threshold that many successful business owners exceed when the value of their company is included. Without careful planning, the estate tax bill alone can force the sale of a business that took decades to build.

This guide covers the key estate planning strategies that business owners should consider, from succession planning and buy-sell agreements to entity structure decisions and trust-based strategies.

Business Succession Planning

Succession planning answers the question: what happens to the business when the owner can no longer run it — whether due to death, disability, or retirement?

For family businesses, this often means identifying and preparing the next generation of leadership. For businesses without a family successor, it may mean planning for a sale to employees, a management team, or an outside buyer.

Key Succession Questions

• Who will run the business? If one child is active in the business and three others are not, how should ownership and management be divided?
• When does the transition happen? A gradual transition during the owner’s lifetime is almost always smoother than an abrupt transfer at death.
• How will non-business heirs be treated fairly? Leaving the business to one child and other assets to the remaining children requires careful valuation and balancing.
• What happens if the successor fails? Contingency provisions protect the family and the business.

The most effective succession plans are developed over years, not weeks. They involve training successors, gradually transferring responsibilities, and creating legal structures that support the transition.

Buy-Sell Agreements

A buy-sell agreement is one of the most critical documents a business owner can have. It governs what happens to an owner’s interest in the business when a triggering event occurs — typically death, disability, divorce, retirement, or voluntary departure.

Cross-Purchase Agreements

In a cross-purchase arrangement, the remaining owners agree to purchase the departing owner’s interest. Each owner (or their estate) sells directly to the other owners.

Advantages:

• Purchasing owners receive a stepped-up basis in the acquired interest, which can reduce future capital gains tax
• Simpler structure for businesses with two or three owners

Disadvantages:

• Becomes unwieldy with many owners — five owners require twenty separate insurance policies if funded with life insurance
• Requires each owner to have the financial capacity (or insurance) to fund the purchase

Entity Redemption Agreements

In an entity redemption, the business itself purchases the departing owner’s interest. The ownership stake is retired rather than redistributed.

Advantages:

• Only one insurance policy per owner is needed (owned by the entity)
• Administratively simpler for businesses with multiple owners

Disadvantages:

• No basis step-up for remaining owners
• Insurance proceeds owned by the entity may increase the entity’s value for estate tax purposes
• Potential corporate-level tax implications depending on entity structure

Funding the Buy-Sell Agreement

A buy-sell agreement is only as reliable as its funding mechanism. The three most common approaches are:

1. Life insurance — The most common method. Provides immediate liquidity at exactly the moment it is needed.
2. Installment payments — The estate receives payments over time. Less ideal because it ties the estate’s liquidity to the business’s ongoing performance.
3. Sinking fund — The business sets aside money over time. Rarely sufficient on its own for unexpected events.

For most business owners, life insurance is the foundation. The policy amount should be regularly reviewed against updated business valuations.

Key Person Insurance

Key person insurance protects the business against the financial impact of losing a critical individual — whether the owner, a top salesperson, or someone with irreplaceable technical knowledge. The business owns the policy and is the beneficiary.

The proceeds can be used to recruit a replacement, cover lost revenue during the transition, or fund a buy-sell obligation. For estate planning purposes, key person insurance ensures the business can survive the owner’s death long enough to execute the succession plan.

Entity Structure Considerations

The legal structure of the business affects estate planning options significantly. Each entity type presents different opportunities and constraints.

Limited Liability Companies (LLCs)

LLCs offer the most flexibility for estate planning. Membership interests can be divided into different classes — for example, voting and non-voting interests — allowing the owner to transfer economic value to heirs while retaining management control.

Under Minnesota’s Revised Uniform Limited Liability Company Act (Minn. Stat. Chapter 322C), an LLC’s operating agreement can include detailed provisions governing what happens upon a member’s death, including:

• Restrictions on transfer of membership interests
• Rights of first refusal for remaining members
• Valuation methods for buyouts
• Management succession provisions

S Corporations

S corporations are widely used by Minnesota business owners, but they impose significant estate planning constraints:

• Only certain types of trusts can hold S corporation stock without terminating the S election (Qualified Subchapter S Trusts and Electing Small Business Trusts)
• The 100-shareholder limit can become relevant as ownership passes through generations
• Differences in shareholder classes are restricted to voting rights only

Planning for S corporation succession requires careful coordination between the estate plan and the corporate structure to avoid inadvertently terminating the tax election.

C Corporations

C corporations face double taxation issues that make estate transfers more complex. However, the ability to use stock recapitalization — creating voting and non-voting shares — provides flexibility for transferring value while maintaining control.

Business Valuation for Estate Tax

When a business owner dies, the IRS and the Minnesota Department of Revenue both need to determine the value of the business for estate tax purposes. A proper valuation is essential for both Minnesota estate tax and federal estate tax calculations.

Common Valuation Methods

• Income approach — Values the business based on its expected future earnings, typically using a capitalization of earnings or discounted cash flow model
• Market approach — Compares the business to similar companies that have been sold
• Asset approach — Values the business based on the net value of its tangible and intangible assets

Valuation Discounts

For closely held businesses, two types of discounts may reduce the taxable value:

• Lack of marketability discount — A minority interest in a private company is worth less than a proportional share of the total value because there is no public market for it
• Minority interest discount — A non-controlling interest is worth less than a controlling interest because the holder cannot direct business decisions

These discounts can be significant — often 15% to 35% — and are a legitimate part of estate tax planning. However, they require a qualified appraisal and are subject to IRS scrutiny.

Family Business Transfers

Transferring a family business to the next generation involves balancing tax efficiency, fairness to all heirs, and business continuity.

Lifetime Gifting Strategies

Gradual gifting of business interests during the owner’s lifetime can reduce the taxable estate. Under current federal law, each person can gift up to $19,000 per recipient per year without using any of their lifetime gift tax exemption. For business interests with applicable valuation discounts, the actual economic value transferred can be substantially higher than the gift tax value.

Grantor Retained Annuity Trusts (GRATs)

A GRAT allows the business owner to transfer business interests to an irrevocable trust while retaining an annuity payment for a set number of years. If the business appreciates faster than the IRS assumed interest rate, the excess growth passes to the beneficiaries free of gift and estate tax.

Installment Sales to Intentionally Defective Grantor Trusts

This advanced technique involves selling business interests to a specially designed trust in exchange for an installment note. Because the trust is a “grantor trust” for income tax purposes, the sale does not trigger capital gains tax. The business interest and all future appreciation are removed from the owner’s estate.

Family Limited Partnerships and LLCs

Creating a family limited partnership or LLC to hold business (and sometimes non-business) assets is a well-established planning strategy. The senior generation retains control as general partners or managers while transferring limited partnership interests or non-voting membership interests to the next generation at discounted values.

Trusts for Business Interests

Several types of trusts serve specific purposes in business estate planning.

Revocable Living Trusts

A revocable living trust can hold business interests and provide for seamless management succession. Upon the owner’s death, the successor trustee can manage or transition the business without court involvement — a significant advantage over probate, which can delay business decisions for months.

Irrevocable Life Insurance Trusts (ILITs)

An ILIT holds life insurance outside the owner’s taxable estate. This is particularly valuable for business owners because the insurance proceeds can provide liquidity to pay estate taxes without forcing a sale of the business. The trust, not the owner, applies for and owns the policy.

Qualified Personal Residence Trusts and Other Specialized Vehicles

Depending on the owner’s overall wealth and goals, additional trust structures may be appropriate. Each involves trade-offs between control, tax savings, and complexity.

Operating Agreement and Corporate Provisions

The business’s governing documents — operating agreement, bylaws, or partnership agreement — should be coordinated with the owner’s estate plan. Key provisions to review include:

• Transfer restrictions — Do they prohibit or limit transfers to heirs or trusts?
• Valuation provisions — Is there a formula or process for determining the value of an interest upon death?
• Management succession — Who takes over management if the owner dies or becomes incapacitated?
• Distribution policies — Will the business generate enough distributions for heirs to pay estate taxes on their inherited interests?
• Drag-along and tag-along rights — These become relevant if some heirs want to sell and others do not.

Conflicts between the estate plan and the operating agreement can create expensive litigation and business disruption. These documents should be reviewed together and updated simultaneously.

The Importance of Professional Guidance

Estate planning for business owners sits at the intersection of tax law, business law, family dynamics, and financial planning. The strategies described here are powerful, but each involves technical requirements and potential pitfalls. A buy-sell agreement with the wrong valuation formula can shortchange a surviving family. An improperly structured trust can terminate an S election. A succession plan that ignores family dynamics can tear the business apart.

Working with an attorney who understands both estate planning and business law is essential. The cost of proper planning is a fraction of what poorly coordinated or absent planning costs in taxes, legal fees, and lost business value.

Minnesota business owners who invest in thoughtful, well-structured estate planning protect not only their families but the businesses they worked a lifetime to build.