The Limited Liability Company is unique in that it is treated in part as both a corporation and sole proprietorship (or general partnership) at the same time. In short, as a owner/member you can be taxed for your portion of the business like a sole proprietor would be, while maintaining the limited legal liability associated with corporations. These attributes make the LLC structure one of the most popular in the nation.

In the State of Maryland when a owner passes away the business interest vested with that owner passes immediately to the estate. The beneficiary of the estate can elect to assume control of that portion of the business or to liquidate the assets to receive proportionate cash consideration. Receiving consideration in either the form of ownership or cash for ownership is the legal right of the estate of the deceased. This leaves the surviving owners with the threat of liquidating some (or all) of the business or losing control of the ownership structure. In addition, the beneficiary of the estate needs to decide if they want to assume ownership and operation of said business or attempt to piece-meal liquidate it’s assets for cash. These are outcomes usually un-desirable to all involved parties.

The aforementioned outcomes are the result of improper (or non-existent) Operating Agreements that should include the stipulations for succession. A well written OA will include what is to happen to the portion of interest of each individual owner upon their departure. If the surviving owners want to maintain control of their business they need to buy out the interest from the estate. If the beneficiary of the estate wants cash consideration for the business without ownership responsibilities, they need a buyer of those assets. The natural remedy here is for the existing owners to purchase the deceased partner’s portion from the estate. This is called a Buy-Sell agreement.

Funding a Buy-Sell agreement

Where do the existing owners get the cash to buy back these shares of ownership? If we look at the sources of financing for such a transaction we see limited options. Retirement plans (qualified or non-qualified) would require penalties and income tax liabilities to be satisfied. Investment accounts would spur capital gains taxation. The amounts of all of these funds would also vary at any given time, with no guarantee that enough money would be there when the time comes. The only method for a tax-free and guaranteed lump some of money to be paid out upon the death of an owner is Life Insurance. Using Life Insurance as the funding vehicle for a Buy-Sell agreement is the most widely accepted method for this type of planning. Beneficiaries of the estate have a ready made buyer for the business interest and because a life insurance contract has been used can be assured to avoid the time and money suck of probate. Existing owners likewise are assured of the continued control and operation of their business.