Equitable distribution: Fair isn’t always equal

One of the more difficult estate-planning decisions pertains to the distribution of the business and assets from the owner’s estate, particularly how to make that distribution fair and/or equitable. The one hard truth about this judgment call is that when it comes to dividing up ownership in the family business, fair does not always mean equal.

The topic is one of six pillars identified in MassMutual’s 2018 Business Owner Perspectives study. It requires some creative thinking because one solution is crafting an estate equalization plan that equalizes the estates of those working in the business with those who are not working in the business by using other, non-business assets such as real property, cash, or a life insurance death benefit. According to MassMutual, key considerations include the following:

  • Should the business be divided equally between children working in the business and those not involved in the business?
  • If the children not involved in the business do not receive ownership, what other assets can they receive that are of equal value?

Nearly 60 percent of business owners who responded to the MassMutual survey say they plan to divide ownership in the business equally among all children, regardless of how much each child contributed to the business. This default position is where potential problems arise because it means children who are working in the business will have to share in the decision-making and the profits of the business with siblings who have no involvement. Is that equitable? Yes. Is that fair? Definitely not.

“I would say there is no right or wrong answer on this,” states Tim Powers, president and CEO of MassMutual Wisconsin. “There are business owners who will, as the study indicates, divide it up between all children whether they are active in the business or not. We’ve seen business owners, as they leave, give it to active children who have put the sweat equity into it, and they will buy insurance for the other kids. That’s one of the options we’ve seen.

“This is no different than you and me leaving our assets when we pass away to our kids or whoever our heirs are,” Powers adds. “Everybody, business owner or no business owner, needs to take a look at that sooner or later because we never know when we’re going to exit the earth.”

Joining Powers in this discussion about the distribution of assets are Andrew Klein, financial advisor and CEO of Focal Point Strategies; J.P. Aime, financial advisor and president, Focal Point Financial Strategies; and Nathan Brinkman, president of Triumph Wealth Management.

Family affairs

MassMutual encourages business owners it works with — a lot of family businesses and closely held businesses — to have a family meeting. When your children get a little bit older, you should make sure they know what mom and dad’s assets are, what your business is worth, and how the assets will be divided, Powers advises.

“That’s a lot easier than having mom and dad exit unexpectedly, and the kids are left and really don’t know much about what’s going on or what the business is worth,” he notes. “More so, what would mom and dad want for them after they are gone? So, a will and estate planning and also business planning go hand in hand — the individual finances and the business finances. You can’t do one without the other if you’re a business owner.”

In this aspect of estate planning, which causes no small measure of tension and stress, there might be no such thing as fairness in this context. A lot depends on the individual family situation, but the owners of family-run businesses have to gauge their comfort levels with children outside the business potentially receiving liquid assets versus those working in the business receiving an illiquid asset, and their level of comfort with those working in the business receiving their inheritances today in the form of ownership, especially when those not involved must wait for your death to receive their inheritance.

Complicating matters is that a husband-and-wife team might not agree on what’s fair or equitable. “In any marital relationship, there is going to be two people who don’t view the world in the same way,” Brinkman notes. “When you have siblings or step kids who are in and out of the business, it just creates a focal point of stress, and generally that’s where people start to avoid decisions.”

This is where it helps to involve an advisory team including an accountant, an attorney, and a financial advisor just to get multiple perspectives and help you think through various ways and methods of making the distribution of assets fair or equitable. “A lot of people think very linearly here, and there are a lot of creative solutions when you dig into it,” Brinkman notes, referring to non-business assets that can be deployed here. “Generally, people come to a good conclusion on it. They feel good about it, but generally it’s not where they thought they would end up in the beginning. That’s an intersection where experience really counts and having multiple heads in that thought process is very valuable.”

“If there is one thing that gives business owners more heartburn than anything else, it’s this particular pillar,” Klein states. “Their default is that since I’ve got four kids, all of them are going to get equal shares. A lot of times, that isn’t necessarily the best route, so we as advisors in the business planning really have to be diligent about having that conversation with them, understanding that you’ve got four kids. Does it make sense that all four of them have the same equity? Once we can understand the relationships in the family, we can help them develop that transition before something immediate happens like a death, disability, or retirement.”

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The thing that makes the decision so difficult is that even though one or more children are involved in the business, business owners might want to demonstrate that they love their children equally. “That’s where it gets hairy because if they look at it and say, ‘My net worth is $10 million, and x-amount of that is tied up in the business, and I’m going to give the business to Suzie who’s been working in the business, and then I’m going to give equal amounts of cash to Johnny who is not working in the business,’ well, what people tend to forget is that Suzie has been working in the business to help grow its value,” Aime notes. “So, that business grew in value, and her brother walked away with just cash-on-hand equivalent to the value that she spent her lifetime helping mom and dad build. So, it’s about understanding that.

“The other piece is understanding what everybody wants,” Aime adds. “The heartburn really comes down to the fact that every parent envisions the children getting along, right? They would like to have their children get along in perpetuity, and if they make a mistake in this phase of the planning process, their biggest fear is that their kids don’t get together for holidays. Their kids won’t talk to each other. There is something going on there that they didn’t know about. So, this is a piece where family meetings become very important because a lot of times, when they ask about what you want, sometimes the answers are very different than mom and dad expected.”

At that point, he says parents can be very intentional with their planning. Not everybody is going to get what they want or how they want to get it, but at least they can get closer to that equitable split that everybody is aware of before the fact. The alternative is that “mom and dad are gone, and they are no longer around to explain why they made the decision they made,” Aime states.

Don’t forget estate taxes

Even though federal tax reform raised the estate tax triggering threshold, paying estate taxes and fees is still an issue that might have to be addressed. According to MassMutual, only 55 percent of business owners have life insurance in place for estate tax purposes, but those who don’t would put their families in the unenviable position of having to liquidate business or personal assets to cover this obligation.

Under the new tax law, the federal estate tax exemption has temporarily doubled to $11,180,000, and unless another law is passed to change the threshold, it will remain there until 2026 when it is scheduled to revert to the 2017 limit of $5,490,000. “Right now, it puts a large chunk of the population outside of that estate tax threshold, but that being said, all of those tax laws will change over time,” Aime cautions. “So, if people just assume their business will never get above the exemption amount, and then all of the sudden things do change in the future, now they may be scrambling to deal with that because in most cases, life insurance typically is the most efficient way to have tax free dollars show up in the event of someone’s passing to cover estate tax liability.”

Life insurance, however, is a product you can’t just buy — you have to qualify for it. “When estate taxes are looking you in the face and there may be a reason why you can’t get life insurance coverage, you need to have a less efficient approach,” Aime notes. “Less efficient means it costs more for whoever will walk away with dollars.”

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