For startup founders, there are a number of special considerations involved in putting together a cohesive and effective estate plan. From tax considerations for transfers of restricted stock and self-directed IRAs to planning for the future of your business in your absence, when it comes to planning your estate as a company founder, it is critical to make informed decisions that serve your needs during your lifetime while also adequately protecting your loved ones’ financial future.
Unique Estate Planning Considerations for Company Founders
As a startup founder, here are five unique considerations you are likely to encounter when putting together your estate plan:
1. Restricted Stock
As part of the process of seeking outside investment, company founders will often acquire ownership shares in the form of restricted stock. The term “restricted stock” refers to shares in a corporation that can only be transferred subject to satisfaction of certain conditions.
Restricted stock ownership presents an obvious challenge for estate planning: What if you die before all of the necessary conditions have been met (i.e., before the stock has “vested”)? Fortunately, federal securities laws account for this by allowing for transfers of non-vested restricted shares upon the owner’s death – subject of course, to certain alternate conditions.
Ideally, your company’s governing documents will address the issue of transferring restricted shares in the event of a founder’s death. If not, satisfying the securities laws may present slightly more of a challenge. In either case, you will want to be sure to name a beneficiary to receive your restricted stock, and you will need to appropriately address the tax consequences of transferring restricted stock in your estate plan.
2. Stock Options
Transferring stock options upon death potentially implicates federal securities laws as well, but once again founders have a number of options for effectuating a desirable estate plan. First, as a general principle, both nonqualified options and incentive stock options can be transferred upon death. Keep in mind, however, that each of these types of options receives different tax treatment (e.g., realized gains from nonqualified options are taxable, while exercising an incentive stock option is not automatically a taxable event), with varying rules and special treatment applying under different circumstances.
For stock options in privately held companies, federal securities laws are less of an issue. But, if you have taken your company public, transferring your unexercised stock options will likely require compliance with the SEC rules (including Rules 16b-3 and 16b-5), and your chosen beneficiary may be subject to time-limited transfer restrictions.
3. Section 83(b) Elections
Let’s go back, for a minute, to your restricted stock. Did you pay income tax to the IRS when you received it? If you did, you likely filed what is known as a Section 83(b) election.
When you receive restricted stock without paying for it (as is generally the case with company founders), that receipt qualifies as taxable income. However, under the default IRS rules, this income is taxed when the stock vests – at its vesting value. This defers your obligation to pay income tax, but it can ultimately increase your income tax bill (perhaps substantially) if your shares appreciate over time.
Filing a Section 83(b) election allows you to pay income tax when you receive the shares at their then-current value. If the value of your restricted shares is nominal, making the Section 83(b) election will almost always make sense, since your tax bill will be quite low. However, if the shares are worth something when you receive them, you will need to assess whether you are willing (and financially able) to pay tax without any actual income coming in the door.
What does this have to do with estate planning? In addition to income tax resulting from receipt of the shares themselves, you will also owe capital gains tax when you eventually sell your vested shares (assuming you held them for longer than a year).
4. Self-Directed IRAs
When it comes to planning for retirement, since startup founders typically lack access to traditional employment-based retirement accounts, many choose to invest through what is known as a self-directed IRA. With a self-directed IRA, you, the investor, retain control over how you structure your retirement portfolio. This affords greater flexibility (self-directed IRAs can invest in stock, bonds, mutual funds, real estate, gold, limited partnerships, and other speculative ventures), but of course, it presents some unique challenges as well.
With regard to estate planning, the risks inherent in a self-managed IRA (or any other investment account) require careful consideration. How long should you continue to invest? How risky can (and should) your investment portfolio be? Should you move assets out of your IRA and into a less-volatile account to ensure that you will be able to leave money to your loved ones? These are just a few of the questions you will need to keep in mind.
5. Grantor Retained Annuity Trusts
The grantor retained annuity trust (GRAT) is an important estate planning tool for many startup founders. They are designed to achieve tax savings by anticipating significant appreciation in the value of certain assets (such as stock in a growth-stage company) over time. With a GRAT, the company founder transfers the relevant assets into the trust, and receives an annuity from the trust during his or her lifetime. At death, the trust’s assets transfer to the founder’s chosen beneficiaries without triggering gift or estate tax.
Structuring a GRAT to minimize tax liability is complicated, and it requires a clear understanding of the relevant provisions of the Internal Revenue Code. But, for company founders expecting to build significant wealth through their business endeavors, they can produce substantial tax savings that far, far exceed the modest up-front costs involved.
Business Succession and Asset Protection Planning
For business owners, estate planning is just one part of the bigger picture of preserving your wealth for generations to come. Business succession planning is critical, and company founders should be sure to understand the benefits of asset protection planning, as well.
More Estate Planning Resources for Entrepreneurs
If you are an entrepreneur or startup founder and you have questions about estate planning, we encourage you to review the following additional resources from Jiah Kim & Associates:
- Are you single? Learn why you still need an estate plan in: Do You Need an Estate Plan if You Are Single?
- Still not sure if you need an estate plan? Read: Why Everyone Needs an Estate Plan.
- Have philanthropic aspirations? Read: How to Do Good and Maximize Tax Savings with a Charitable Remainder Trust.
- Already have an estate plan in place? Read: Why You Might Want to Update Your Estate Plan.
- Are you a foreign national? Learn about protecting your US-based assets in: Can Non-US Citizens Use US Trusts in Their Estate Plans?
Schedule an Initial Estate Planning Consultation at Jiah Kim & Associates
To get started on your estate plan, schedule an initial consultation at Jiah Kim & Associates. Call (646) 389-5065 worldwide or submit an inquiry online today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.