Tax & Business Insights

Ruling From the Grave?

Volume 10 Issue 2 -- March/April 1998

The final topic in our series of newsletters on business succession will, fittingly, be ruling from the grave. When planning for business succession, the first generation will, far too frequently, reflexively want the children or surviving spouse to assume control of the business. Often there is little reflection upon the ability of the family members to participate in business activities.

Few people do estate planning and, of those who have, many have given only cursory attention to whether those named in a will or trust have the training or ability to take over the duties of the decedent. While there are numerous instances of younger generations assuming control and "growing" a business (to use a phrase of President Clinton), there is considerable anecdotal evidence to the contrary. Expressed differently, what the departed envisioned happening to the business, and what will, or may, happen, can vary tremendously.

Certainly, making some mention of who succeeds to an ownership interest in a business is far better than no guidance at all, namely, dying without a will and trust. If the spouse and kids are to receive an interest in a business, questions should be asked such as, "Can Mildred and the kids really run the business as well as Bob (my partner and co-founder) and I have?" Alternatively, "How will Bob get along with my children, some of whom have many gold rings hanging from various parts of their bodies?"

In addition to the difficulties of dealing with the death or serious injury of a loved one, family members often "come to bat" with another strike against them -- they lack the experience of the founders of the business. Instead of forcing family members on the non-family business survivors, a buy-sell agreement funded with insurance is usually a better alternative. Why?

For starters, there is liquidity from the insurance proceeds. Many businesses do not have the cash to pay a deceased associate. Insurance can supplement the cash needed by a business that has recently had the misfortune of losing an important member. The associate's family, the sellers of the interest, will receive the cash to fund other interests should they choose to do so. The business will be missing a leader-founder, but at least it won't be forced to divert cash flow to the members of the decedent's family who may be producing no business receipts and could be demanding payments.

"But wait," you ask, "what about the surviving spouse and children who are dynamite? What if the survivors want the family members of the decedent to remain in the business? In this situation, one answer is to have the company ask the family members to waive the compulsory right to have the business buy the interest of the decedent. If the surviving business members want the decedent's family to remain and the family wants to do the same, then an accord can be reached between the purchasing business and the selling family members.

But what if only some family members are acceptable, and the disagreeable family members object to some family members staying in the business while they, the disagreeable ones, are forced to sell? In this sensitive situation, it is possible to buy all of the decedent's interest and then, later, sell some interest in the business back to selective members of the decedent's family. While there may be some friction over such a course of action, the offended individuals will probably be able to do little more than grumble about unfairness. This is preferable to dealing with family members who cannot, or will not, contribute to the activities of a business, in a meaningful manner.

Bear in mind that, while life insurance proceeds are generally income tax-free to individuals and some businesses (S corporations and LLCs), there can be income tax imposed on certain whole-life insurance proceeds to the extent of the internal build-up in some policies. How this special income tax works is too lengthy to discuss in this newsletter, but the concepts should be kept in mind for large policies owned by regular "C' corporations.

While it seems "fair" to split interests in businesses and other assets equally between family members, equality of control can lead to deadlocks. Despite the unsavory aura of favoritism, it is sometimes better to give one heir the authority to break deadlocks. Don't assume that family members who get along fine now will be harmonious in the future.

Some people believe in ruling from the grave in perpetuity by imposing restrictions such as "this land can never be used as a site to sell alcoholic beverages." Such fiats, often found in deeds, are ill advised and, more often than not, cause unpredictable problems. No matter how hard one peers at the horizon, the future is hard to envision, especially from under the ground.

Copyright 1998
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