Estate planning is a daunting and downbeat task for most anyone, but estate planning for the family business owner is usually twice as difficult. The estate plan must not only address an equitable or fair division of assets among the heirs and minimization of the impact of estate, gift and income taxes, but also deal with succession of business leadership, and frequently conflicting goals of inheriting family members. This process is further complicated by emotional and psychological burdens of personal relationships and the perceived message that financial favor carries regarding parental love, approval and acceptance.
Most family business owners would rate family harmony as far more important than their assets. Most have confidence that the strength of their family ties will ultimately overcome any conflict or dissatisfaction arising from the administration of their estate. Reliance on the strength of the family sadly underestimates the strain financial matters can place on relationships. This is particularly true when the unifying force of parental guidance has been lost owing to illness, incapacity or death.
Tax and probate law are precise and well-defined disciplines. Likewise, the mathematics of projecting estate tax liabilities and planning for the cash flow needs of a business are relatively exact sciences. Balancing the practical needs of business and estate administration with family harmony, however, is largely an art.
Put yourself in the place of the offspring in this example: You are the child of successful businesspeople. While one or more of your siblings have followed in your parents’ footsteps and joined the family firm, you have chosen to blaze your own trail and have built a successful career of your own. Through the years, a driving force in your quest for success was likely a desire to please and impress your entrepreneurial parents.
Like many business owners, your parents invested all their energy and efforts into building their enterprise. As a result, the majority of their wealth is tied up in the business and the real estate or other assets used by the business. In their will, the business is left to the children active in the company. There are life insurance policies in place to help defray the impact of estate tax on the business, so the active children bear little cost for the transfer of wealth. Your share of the inheritance amounts to the net proceeds from the sale of their residence, and a small balance in an IRA account—on which you must pay income tax. Compared with the multimillion-dollar enterprise your siblings received, it seems paltry.
In preparing their estate plan, the parents tried to protect the livelihood of the active children. They likely felt this was a fair division of the assets because it recognized the sweat equity of their children working in the business. They were proud of the successes of the non-active child and probably felt confident that this child was financially secure. But they failed to consider the emotional impact of the smaller inheritance. Many such parents add insult to injury by failing to inform the non-active child of their plans prior to their death, leading to an unpleasant surprise as their estate is administered.
Parents attempting to divide their assets equally among their children often also set the scene for discord by not taking into account their children’s different needs. Consider the scenario discussed earlier, except in this instance the parents leave you, the non-active child, an equal share of their total estate. In order to avoid a costly division of the assets and to maintain the stability of the business, they have bequeathed to you real estate under a long-term lease to the family business, at very favorable terms, and a minority share in the company.
Under this scenario, you have received an equal share of your parents’ wealth, but because of the needs of the business, your ability to enjoy this wealth is seriously limited. You may also be treated as a “silent partner” by your siblings, unable to take an active role in managing your assets because they feel you lack the experience or understanding to make a meaningful contribution.
The active children may also feel shortchanged. They have spent years devoted to the family firm only to see the fruits of their labor given to a less engaged sibling.
Experience shows that cases like these are the basic models for most family business owners’ estate plans and are often the beginnings of the demise of either family relationships or the family business—or both.
Planning to preserve harmony
By acknowledging the emotional impact of inheritance and planning appropriately, the family business owner can leave both active and non-active heirs satisfied with their share and minimize the possibility for rivalries to emerge. Family business owners should keep in mind the following principles as they consider their estate plan.
• Plan early and often. The transfer of wealth from one generation to the next is such a huge factor in a closely held business’s ongoing viability that succession and the attendant estate tax issues should be an integral part of the business owners’ strategic plan. Planning for the transfer of the business should begin as soon as there is a business to transfer. Once the plan is in place it is also crucial that it be revisited to reflect changes in the business as well as changes in family circumstances and in estate tax, income tax and probate law.
• Communicate openly. Many business owners avoid discussing inheritance with their children out of fear that it will negatively affect the child’s work ethic. On the contrary, if done properly, open and frank discussions can prepare heirs for the responsibility of inheritance and manage their expectations regarding the future. Parents can explain their goals for their business and their motivations for making decisions. If hard feelings arise, the smart step is to address the issues directly. If necessary, seek out trusted advisers or other objective parties to help frame the discussions and settle controversies.
• Don’t wait until you are dead. As life expectancies grow longer, it is more common for children not to receive their inheritance until they are in their 50s or 60s. Lifetime gifting, particularly gifts made at crucial milestone moments, can have a profound effect on a family’s financial and personal life. Likewise, transfer of ownership in a family business—whether through sales, gifts or equity compensation—rewards sweat equity in a timely fashion and can help ensure a smoother transition of management to the next generation. As part of this process, proper documentation of the character and motivation for transfers is crucial. This helps avoid disputes regarding your intent at the time a gift is made.
• Be creative. Every family and every business has its own special set of needs. Cookie-cutter wills and trusts are a recipe for disaster. Having clear goals for the administration of your business and estate is crucial. There are many different ways to provide fairness to each heir.
There are so many positive reasons that family businesses are started and nurtured in the first place. Why not invest the same level of time and thought into estate planning, to carry the legacy of both the family and the business far into the future?
Joel C. Susco, principal, and Eric Fletcher, manager, are Certified Public Accountants and business advisers in the Family Business Practice of Bond Beebe, Accountants & Advisors (www.bbcpa.com). Bond Beebe is the founding member of the Greater Washington, D.C., Family Business Alliance (www.dcfamilybusiness.com).