Trust Administration for Business Owners: Handling Business Interests in California

When a trust holds interests in a business—whether a sole proprietorship, partnership, LLC, or corporation—trust administration becomes significantly more complex. Business interests require specialized knowledge about valuation, operating agreements, buy-sell provisions, ongoing management, and tax implications.

This guide helps trustees navigate the unique challenges of administering business interests held in California trusts.

Types of Business Interests in Trusts

Sole Proprietorships

What it is: Unincorporated business owned by individual, not a separate legal entity.

Trust administration challenges:

• Business dies with owner (no continuing entity)
• Assets must be liquidated or transferred
• Ongoing operations difficult
• Personal liability concerns
• No formal valuation mechanism

Typical actions:

• Close business and liquidate assets
• Sell business as going concern
• Transfer assets to beneficiary to continue operating

Partnerships (General and Limited)

General Partnership:

• Two or more owners sharing profits, losses, and management
• Partnership agreement governs transfer rights
• Partners have personal liability

Limited Partnership:

• General partners (manage, liable)
• Limited partners (passive investors, limited liability)
• Trust typically holds limited partnership interest

Key issues:

• Partnership agreement may restrict transfers
• May require partner consent for transfer
• Ongoing management decisions
• Valuation complexities
• Income distributions during administration

Limited Liability Companies (LLCs)

Most common structure for family businesses

Single-member LLC:

• Trust owns 100% of LLC
• Easier to manage and transfer
• Operating agreement still governs

Multi-member LLC:

• Trust owns percentage interest
• Other members may have rights
• Operating agreement controls transfer rights
• May have buy-sell provisions triggered by death

Key advantages:

• Liability protection continues
• Business operations continue uninterrupted
• Separate legal entity
• Flexible management structure

Corporations (C-Corp and S-Corp)

C-Corporation:

• Separate taxpayer
• Double taxation (corporate + individual)
• Shares freely transferable (unless restricted)
• May have shareholder agreements

S-Corporation:

• Pass-through taxation
• Stricter ownership requirements
• Trust must be eligible shareholder
• May lose S-election if improper trust type

Key issues:

• Shareholder agreements may restrict transfers
• Buy-sell provisions often triggered by death
• Valuation for estate tax purposes
• Corporate formalities must continue

Step 1: Identify and Secure Business Interests

Immediate Actions

Within first week:

1. Locate all business documents:

   • Operating agreements / partnership agreements / bylaws
   • Shareholder agreements / buy-sell agreements
   • Tax returns (last 3 years)
   • Financial statements
   • Business bank account information
   • Membership certificates or stock certificates

2. Notify business partners/co-owners:

   • Inform of settlor's death
   • Confirm your authority as trustee
   • Request copies of operating documents
   • Discuss transition plan

3. Secure business assets:

   • Change locks if necessary
   • Update bank signature cards
   • Protect intellectual property
   • Secure inventory and equipment
   • Maintain insurance coverage

4. Review cash flow needs:

   • Immediate operating expenses
   • Payroll obligations
   • Accounts payable
   • Loan payments

Review Governing Documents

Operating Agreement / Partnership Agreement:

Critical provisions to identify:

Provision	What to Look For
Transfer restrictions	Can you transfer membership interest?
Buy-sell triggers	Is death a triggering event?
Valuation method	How is business valued?
Right of first refusal	Must you offer to other members first?
Mandatory purchase	Are other members required to buy?
Payment terms	Lump sum or installments?
Management succession	Who manages after death?
Voting rights	Does trust have voting rights?

Shareholder Agreements:

Similar issues for corporations:

• Restrictions on stock transfer
• Buy-sell provisions
• Valuation formulas
• Right of first refusal
• Drag-along / tag-along rights

Step 2: Determine Trustee's Authority

Review Trust Document

Questions to answer:

1. Can you continue operating the business?

   • Some trusts require liquidation
   • Others allow continued operation
   • May have time limits

2. Do you have management authority?

   • Can you make business decisions?
   • Are you limited to passive ownership?
   • Must you appoint professional management?

3. Can you sell or transfer the business?

   • Does trust require distribution to specific beneficiary?
   • Must you obtain beneficiary consent?
   • Are there restrictions on sale?

California Statutory Authority

Probate Code §16200-16249 grants trustees broad powers over trust property, including:

• Operating a business (§16249)
• Continuing existing business
• Incorporating, dissolving, or reorganizing business
• Voting shares
• Entering contracts on behalf of business

However: Trust document controls. Explicit restrictions in trust override statutory authority.

Operating Agreement Restrictions

Even if trust document allows business operations, the operating agreement may:

• Prohibit management by non-members
• Require unanimous consent for certain actions
• Trigger mandatory buyout upon member's death
• Restrict trustee's authority

Step 3: Obtain Professional Business Valuation

Why Valuation Is Critical

You need accurate valuation for:

1. Estate tax purposes (if estate over $13.61M)
2. Capital gains basis for future sale
3. Equal distribution among beneficiaries
4. Buy-sell transactions if agreement triggered
5. Financial planning for trust administration
6. Defending against beneficiary disputes

Valuation Methods

Asset-based valuation:

• Business value = assets minus liabilities
• Used for asset-heavy businesses
• Ignores earning potential

Income-based valuation:

• Discounted cash flow analysis
• Capitalization of earnings
• Used for profitable, ongoing businesses

Market-based valuation:

• Comparable company analysis
• Comparable transaction multiples
• Used when comparables exist

Valuation Discounts

Minority interest discount: If trust owns less than 50%:

• No control over business decisions
• Cannot force sale or distributions
• Discount typically 20-40%

Lack of marketability discount: Private company interests are hard to sell:

• No public market
• Transfer restrictions
• Limited buyers
• Discount typically 20-35%

Example:

• Pro-rata value of 30% interest: $1,000,000
• Minus minority discount (25%): -$250,000
• Minus marketability discount (30%): -$225,000
• Fair market value: $525,000

These discounts can significantly reduce estate tax.

Hire Qualified Appraiser

Qualifications to look for:

• Accredited Senior Appraiser (ASA)
• Certified Valuation Analyst (CVA)
• Accredited in Business Valuation (ABV)
• Experience with your industry
• Experience with estate/gift tax valuations

Cost:

• Small businesses: $5,000-$15,000
• Complex businesses: $15,000-$50,000+
• Litigation-quality valuations: $25,000-$100,000+

Timeline: Expect 4-8 weeks for comprehensive valuation.

Step 4: Handle Buy-Sell Agreements

Types of Buy-Sell Agreements

Cross-purchase agreement:

• Other owners buy deceased owner's interest
• Personally, not through business entity
• Common in partnerships and small LLCs

Entity redemption:

• Business entity buys deceased owner's interest
• LLC or corporation becomes sole buyer
• Simpler than cross-purchase

Hybrid (wait-and-see):

• Business entity has first option
• If entity doesn't buy, other owners must buy
• Flexibility for tax planning

Triggering Events

Common triggers:

• Death
• Disability
• Retirement
• Termination of employment
• Bankruptcy
• Divorce
• Voluntary sale

Death almost always triggers buy-sell provisions.

Valuation Under Buy-Sell

Fixed price:

• Agreement states specific dollar amount
• Often outdated if not regularly updated
• Binds IRS for estate tax if legitimate

Formula:

• Book value
• Multiple of earnings (3x-5x EBITDA)
• Revenue multiple
• Must apply formula as of date of death

Appraisal:

• Independent appraiser determines value
• Most accurate but most expensive
• May specify appraiser selection process

Payment Terms

Lump sum:

• Buyers pay full amount at closing
• Requires financing or insurance proceeds
• Clean and final

Installment sale:

• Payments over time (typically 5-10 years)
• Interest required (AFR rates)
• Trust receives payments during administration
• Creates note receivable

Life insurance funded:

• Business or owners maintained life insurance
• Insurance proceeds fund purchase
• Most common and cleanest method
• Verify policies are current and adequate

Enforcing Buy-Sell Terms

If agreement is triggered:

1. Notify other parties of death and triggering event
2. Provide required documentation (death certificate, trust documents)
3. Initiate valuation process per agreement terms
4. Negotiate closing (timing, payment method, transition)
5. Prepare purchase documents (assignment, bill of sale)
6. Close transaction and transfer ownership

If other parties won't comply:

• Send formal demand letter
• Consult business litigation attorney
• File lawsuit for specific performance
• Seek damages for breach of contract

Step 5: Manage Business During Administration

Decision: Continue or Liquidate?

Factors to consider:

Continue operating if:

• Business is profitable and stable
• Competent management is in place
• Beneficiary intends to take over
• Buy-sell process will take time
• Trust authorizes continuation

Liquidate if:

• Business dependent on deceased's skills
• No qualified management available
• Business is unprofitable
• Trust requires liquidation
• High liability risk
• Beneficiaries want cash, not business

Ongoing Management Decisions

If continuing operations:

Financial management:

• Review financial statements monthly
• Monitor cash flow carefully
• Ensure bills and payroll are paid
• Maintain adequate insurance
• File all required tax returns

Operational oversight:

• Ensure competent management in place
• Make major decisions (new contracts, major purchases)
• Protect business assets
• Maintain customer relationships
• Preserve goodwill

Legal compliance:

• File annual reports with California Secretary of State
• Maintain good standing
• Comply with employment laws
• Renew licenses and permits
• Maintain required insurance

Delegating Management

You're not required to personally manage the business.

Options:

1. Existing management continues:

   • Manager, president, or GM stays in place
   • You oversee from governance level
   • Review financial reports

2. Hire professional management:

   • Recruit qualified manager
   • Set compensation
   • Monitor performance

3. Appoint special trustee:

   • Co-trustee with business expertise
   • Handles only business decisions
   • You handle other trust matters

4. Family member takes over:

   • If qualified and trust allows
   • Must pay reasonable compensation
   • Avoid conflicts of interest

Step 6: Address Tax Issues

Entity-Level Taxes

Partnership/LLC (pass-through):

• File Form 1065 (partnership return)
• Issue K-1s to trust
• Trust reports income on Form 1041
• Income may be distributed to beneficiaries

C-Corporation:

• File Form 1120 (corporate return)
• Corporation pays its own taxes
• Dividends to trust are taxable income

S-Corporation:

• File Form 1120-S
• Pass-through taxation
• Critical: Ensure trust is eligible S-corp shareholder

S-Corporation Trust Rules

Eligible trust types:

After death, trust typically qualifies as:

1. Qualified Subchapter S Trust (QSST) - If single beneficiary, all income distributed
2. Electing Small Business Trust (ESBT) - More flexible, but higher tax rates

Election must be filed:

• QSST: Beneficiary files Form 2553 within 2 months and 16 days
• ESBT: Trustee files Form 2553 within same timeframe

Missing deadline = Loss of S-election = Corporate double tax

Estate Tax

Business included in gross estate:

• Fair market value as of date of death
• Valuation discounts apply
• Buy-sell agreement may establish value

Special valuation rules:

• IRC §2032A - Special use valuation for family farms/businesses
• IRC §6166 - Deferred estate tax payments for business interests

Income During Administration

Business income received by trust:

• Reported on Form 1041
• Taxed at trust rates (reach 37% quickly)
• Consider distributing income to beneficiaries (lower tax rates)

Deductions:

• Trust administration expenses
• Business losses (if any)
• Depreciation

Step 7: Transfer to Beneficiaries

Distribution Options

Distribute business interest in-kind:

• Transfer membership interest/shares to beneficiary
• Beneficiary takes stepped-up basis
• Beneficiary continues or sells business

Sell business and distribute proceeds:

• Liquidate business interest
• Distribute cash to beneficiaries
• Cleaner if multiple beneficiaries want different things

Partial distribution:

• Distribute percentage interests to multiple beneficiaries
• Creates co-ownership
• May lead to future disputes

Transfer Mechanics

LLC/Partnership:

1. Prepare assignment of membership interest
2. Amend operating agreement (if required)
3. Update company records
4. File amended annual reports if ownership changes
5. Update EIN if necessary

Corporation:

1. Endorse and deliver stock certificates
2. Update stock ledger
3. Issue new certificates in beneficiary names
4. Update bylaws if required
5. File amended annual reports

Sole proprietorship:

1. Transfer individual assets (equipment, inventory, contracts)
2. Transfer business name registration
3. Transfer licenses and permits (if transferable)
4. Close business accounts in trust's name
5. Open new accounts in beneficiary's name

Co-Ownership Issues

If distributing to multiple beneficiaries:

Consider:

• How will they make decisions?
• What if one wants to sell and others don't?
• Who will manage operations?
• How will profits be distributed?
• Exit strategy if relationship deteriorates?

Options:

1. Force sale and distribute cash
2. One beneficiary buys out others
3. Create new LLC with operating agreement
4. Establish management buy-sell agreement

Special Considerations

Professional Practices

Medical, dental, legal, accounting practices:

Challenges:

• May not be transferable
• Value tied to professional's reputation
• May have ethical restrictions
• Partnership may dissolve upon death

Typical resolution:

• Collect accounts receivable
• Distribute or sell equipment
• Transfer client files (if permitted)
• Close practice

Family Businesses

Emotional issues:

• Not all children work in business
• Disputes over who should inherit
• Different valuations placed by family members
• Legacy and family identity concerns

Solutions:

• Life insurance to equalize inheritances
• Transfer business to active child, other assets to others
• Clear communication during estate planning

Franchise Businesses

Special rules:

• Franchise agreement may restrict transfer
• Franchisor approval often required
• May have first right of refusal
• May require training/qualification of successor

Process:

1. Review franchise agreement
2. Notify franchisor
3. Request consent to transfer
4. Provide beneficiary information
5. Meet franchisor requirements

Common Mistakes

1. Ignoring Buy-Sell Agreements

Failing to enforce agreement terms:

• Missing valuation deadlines
• Not notifying other parties
• Assuming agreement doesn't apply

2. Poor Interim Management

Letting business deteriorate:

• No oversight of operations
• Bills unpaid
• Customers lost
• Employees leave
• Value destroyed

3. S-Corporation Election Failure

Missing QSST/ESBT election deadline:

• Corporation loses S-election
• Double taxation triggered
• Massive tax liability

4. Commingling Business and Trust Funds

Mixing trust and business assets:

• Using business account for trust expenses
• Using trust account for business expenses
• Confusion about what belongs where

5. Unauthorized Business Decisions

Acting outside your authority:

• Making major decisions without reviewing operating agreement
• Binding business to contracts you can't authorize
• Personal liability risk

Conclusion

Administering business interests in a trust requires specialized knowledge about business law, valuation, tax rules, and operational management. The stakes are high—businesses can be the most valuable trust asset and the most vulnerable to mismanagement.

Key takeaways:

• Secure business immediately after death
• Review all governing documents carefully
• Obtain professional business valuation
• Understand and enforce buy-sell agreements
• Maintain business operations or liquidate prudently
• Address S-corporation elections immediately
• Work with CPAs and business attorneys
• Consider beneficiaries' goals and capabilities
• Document all business decisions
• Transfer ownership properly

Business interests require more time, expertise, and professional help than most trust assets, but proper administration preserves value and protects beneficiaries' inheritance.

Related Articles

Learn more about complex trust assets:

• Form 1041 Trust Tax Return Guide - How to report business income, K-1s from pass-through entities, and distributable net income with business assets.

• Capital Gains Tax on Trust Property Sales - Tax implications of selling business interests, valuation for basis purposes, and minimizing capital gains.

• Income vs. Principal Trust Administration - Allocating business income, retained earnings, and sale proceeds between income and remainder beneficiaries.

• Generation-Skipping Transfer Tax California - GST planning for multi-generational family businesses and dynasty trusts holding business interests.

• Real Estate in Trust Administration California - When business owns real estate, coordinating property transfers with business succession planning.

Need Help With Business Interests in a Trust?

If you're administering a trust that holds business interests, our experienced trust administration attorneys can help you navigate the complexities of business valuation, buy-sell agreements, and transfer to beneficiaries.

Contact us for a consultation to discuss your trust administration needs.

This article is for informational purposes only and does not constitute legal, tax, or business advice. Business interests in trust administration involve complex legal, tax, and valuation issues. Consult with qualified legal, tax, and business professionals about your specific situation.