What Happens to Your Ownership Interest in an LLC When You Die?

By Lane V. Erickson, Idaho Business Attorney

In previous articles on our website, we have spent a good deal of time talking about the importance of creating a structure for your business. For most small businesses, the best choice is to create an LLC as the entity that operates the business. If you have questions about why we recommend an LLC for your small business, please go back and read our previous articles where we explain the main reasons, we recommend an LLC over most other entities. 

The purpose of today’s article is to focus on what happens to your ownership interest in an LLC when you die. Please keep in mind that this article is just a summary of the things that you should know. If you have questions that this article does not answer, we encourage you to contact us for a free 30-minute consultation where we can answer your specific questions. 

Most people are surprised to learn that their ownership interest in an LLC is property just the same as any other property they own. However, unlike tangible things like cars, jewelry, or a coin collection, your ownership interest in an LLC is intangible. This just means that you cannot really touch or hold your ownership interest in an LLC like you can those other items. Nevertheless, your ownership interest is still property that is part of your estate. 

Every adult has an estate. An estate consists of all the things that are “owned” by the individual which are assets, and all the things that are “owed” by the individual which are debts. Because of this, even though you cannot touch or hold it, your ownership interest in an LLC is an asset of your estate. 

When a person passes away the assets in their estate must be transferred to some person(s) who is alive. This is usually surviving family members such as a spouse or children. These are the deceased person’s heirs. If you do not have a written last will and testament then the statutes in the state of Idaho decide who your heirs will be. If you do have a written will then this document declares who your heirs are. In this instance, upon your death, your written will declares who is going to receive the assets of your estate including your ownership interest in an LLC. 

While there is nothing wrong with a person transferring their ownership interest in an LLC to their heirs when they die, this does create a problem for the original owners of the LLC. These people may never have contemplated being in business with your spouse or children. Because of this, all the owners of the LLC have an opportunity to use the operating agreement to control transfers of an ownership interest in an LLC when a member of the LLC dies. 

The operating agreement is a contract between the owners of the LLC that controls several things such as identifying who the owners of the LLC are, identifying the percentage of ownership each owner holds, and declaring how the LLC will be managed. In addition to this, because it is a contract, the operating agreement can also have language in it that controls transfer of an ownership interest in an LLC. 

To be clear, the operating agreement cannot strip an owner of their interest in the LLC, even if that owner is deceased. What the operating agreement can do is provide a way for the remaining owners to purchase the ownership interest from the heirs of the deceased owner. The operating agreement can create a formula for how that ownership interest will be priced. Additionally, the operating agreement can describe the terms for how that ownership interest will be purchased. 

For example, suppose there is a carwash business that is operating through an LLC and there are three owners in that business with each owning an equal share of the business. Now suppose that one of those owners passes away and their last will and testament says that everything they own goes to their spouse. In this instance, the deceased owner’s share of the business goes to their spouse who now becomes an equal owner with the other owners. 

If the operating agreement has terms and conditions about how ownership interest is transferred and whether it can be purchased by the business or the remaining owners, this will control the ownership interest of the deceased member. The remaining owners can elect to follow the terms in the operating agreement and buy the ownership interest from the deceased member’s spouse. If the operating agreement says they can make payments over five years to purchase the ownership interest this is what they can do. 

Another important way that the operating agreement can help the business to continue is by limiting the ability of someone who inherits an ownership interest in an LLC. In other words, the operating agreement can state that if an ownership interest is transferred by reason of death, the person who inherits the ownership interest has no management authority or voting rights concerning the operations of the LLC business. In fact, the operating agreement can state that an inherited ownership interest in the LLC acts as a silent partner who is only entitled to receive a portion of distributions when they are made. 

As you can see, the operating agreement is vitally important in controlling both the management and the ownership interests in an LLC business. If you do not have an operating agreement, or if your operating agreement was not created by a qualified and experienced business attorney, we encourage you to contact us today. We have assisted numerous business owners in creating well thought-out and helpful operating agreements for the operation of their LLC businesses. We are confident that we could help you too! 

Our team of Idaho business lawyers can help you with any of your business structure or operation needs. Whether you are seeking to create a new business or review a current business, we are available to discuss your options and answer your questions at an initial free 30-minute consultation. Call us toll free at 877-232-6101 or 208.232.6101 for a free consultation. You can also email us directly at lane@racineolson.com or stop by our office at 201 East Center Street, Pocatello, Idaho 83201. We will answer your questions and help you solve your Idaho business problems.