The family business is often the parents’ legacy to one or more of their children. It represents a lifetime, or sometimes several generations, of struggle and success. Without special estate planning by the parents, a child who has devoted himself to the family business can easily lose the fruits of his labors. Tax planning is also vital in this instance.
When a family business is owned by the parent, the value of the business at the death of the parent will be subject to distribution under the parent’s Will, or in the absence of a Will, under state law. Suppose a father owns a manufacturing firm; he has three children, two of whom have other careers. One child, a daughter, is employed by the father. For fifteen years, daughter devotes her work and energy to building up the business. Suddenly the father dies. He leaves a Will dated 1982 which leaves his entire estate to his three children equally. His estate consists of his bank account of $10,000 and his business worth $200,000. Daughter has just lost two-thirds of her life’s work. Additionally, the $210,000 is subject to state Inheritance Tax of 4.5% and legal and administrative costs and the business must be sold to settle the estate, as each of the other two children is entitled to a one-third share. This problem is even greater in cases of higher value which may be subject to Federal Estate Tax, as this tax begins at 37% and quickly rises to 45%.
Father could have prevented this result by planning. If he were unwilling to give up any control during life, he could have willed the business to the daughter who worked with him. While the taxes and expenses would have been the same, daughter, as sole owner, could have borrowed against the business to pay these items and saved the firm for herself and her children. The daughter could have purchased life insurance on her father to provide cash to pay the taxes and to get the business through the rough transition of the loss of her rather.
If Father were willing to part with control to some degree, he could gradually, over a ten- or fifteen-year period, have sold (or gifted) shares in a business corporation or limited liability company over to daughter. With the funds from a stock sale, he could have purchased life insurance so that his other two children would receive a fair inheritance, and the life insurance proceeds are free of Pennsylvania Inheritance Tax. His Will or a shareholder agreement could provide for daughter to obtain any shares still in father’s name at his death. Only his small date-of-death ownership of the business would be subject to Inheritance Tax, and/or Federal Estate Tax.
If Father holds onto a controlling or even a 100% ownership, there is also a terrible risk of loss if he suffers a long-lasting illness such as Alzheimer’s. If he must have nursing care, the business may have to be sold to pay for his care. His daughter may have caused the business to succeed and to grow by her labors, and then may have to buy the whole business or worse yet, if she is unable to buy, it may have to be sold to a stranger. Careful advance planning could prevent this terrible result.
Children often find it difficult to discuss estate planning with a parent, due to emotions. Also, a child may fear the parent will perceive his inquiries into estate planning as evidence of greed on the child’s part. However, failure to address these concerns can leave the child not only grieving but without employment and income, costing the child the business in which she worked so hard.
The above example may seem harsh. In reality, the manufacturing firm of the example could be the family farm, or the home where the family has lived for three generations. In any of these instances, failure to plan translates into risking the heritage of descendants.