Business owners are well aware of how federal estate taxes can prevent the family business from passing to the next generation. With a maximum 45 percent tax rate on assets exceeding $2 million, upon death almost half of the company value is owed to the IRS. With a new President and Congress convening in January 2009, an uncertain estate tax environment will become even more uncertain. (Thankfully, Virginia has repealed its estate tax.)
Future posts will focus on methods business owners can employ to reduce or eliminate estate tax, whatever the tax rate and the exemption amount turn out to be. The focus of this post, however, is on the non-tax issues which can torpedo the business owner’s best intentions. As Keith Schiller, an attorney in Northern California has written in a wonderfully entertaining and informative article about Hollywood movies and their depiction of estate planning issues, "…non-tax issues often dwarf all tax considerations. Controversies within families, particularly over the family business, will continue to spawn novels, children’s stories, criminal cases and the news." See Schiller, 33 Tax Mgmt. Est., Gifts and Tr. J. 175, 177 (July/Aug. 2008).
Of course, most families will not suffer the same consequences as the Corleone family upon the "Godfather’s" death, and no business succession plan could have saved Vito’s family business, but for most business owners proactive planning can preserve the business for the next generation. Without claiming to identify all succession planning issues to consider, the following are reoccurring themes I have seen in my practice. Failure to address them can doom the business, with or without estate tax problems.
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If the company is to pass to the children, who will manage it? Will a power struggle arise because the children do not have well defined responsibilities and roles? Will jealousies arise if one child is granted more control than another? These issues can be further exacerbated if son-in-laws and daughter-in-laws are involved in the management. If the children inherit the stock equally, stalemates can arise that effectively shut down the company operations.
Often times the business owner exerts such control during his lifetime that these problems are ignored or bubble below the surface until his death or retirement. Without him, it is too late to remedy the ills that could have been treated with his involvement. The owner should strive during his active involvement in the company to define the children’s roles and foster a management structure that can continue when he is no longer present. It would be helpful to hold quarterly or semi-annual meetings with the owner and next generation present to inculcate the management structure. To formalize the relationships, the children should be parties to the same documents executed by unrelated parties, such as employment contracts and a shareholder agreement. Unfortunately, planning for the future is often easier said than done when a controlling owner lacks the interest to plan for the future.
Perhaps some of the children are not working in the company. In this case, should the company pass equally to all of the children or only to the children-employees? The children in the business do not want to answer to the passive, non-working children. The non-working children may not be pleased with real or perceived excessive salaries or perquisites enjoyed by the working children. There can also be disagreements involving dividend distributions versus reinvesting in the company, and whether or not to sell, borrow, merge and other major decisions. It may be preferable to leave the business to only the children working in it. However, that may not be possible if a goal is to divide all assets equally among the children.
Obtaining an appraisal to value the company and other assets can alert the family to the looming problem. Next, solutions can be discussed, such as life insurance to help allocate the family resources. Also, strategies such as purchasing stock and lifetime gifting can help divide the assets fairly.
These issues can appear overwhelming to the business owner already struggling to manage and operate the company. Finding the time, energy and interest to plan for the future is often put off until tomorrow. There also is no "one size fits all" solution that is easily discernible. Just as there are a myriad of issues to address, there will be a number of possible solutions. The solution reached may even be to sell the company. If so, this realization is healthy in that the decision is made on the owner’s terms, not a forced decision upon his death or retirement.
One thing is certain: the failure to plan will likely lead to the failure of the business’ continuation and the diminution of its value. Whatever may be the appropriate solution, business owners can take comfort in knowing they are not the first ones to face these difficult issues. With proper planning and effort, management and control issues can be identified and solved.
