February 27, 2024
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Inheritance Equalization Strategies for Business Owners

A unique challenge and/or opportunity for small business owners is what happens when one or more of their children are brought into the business. The combination of family dynamics and day-to-day business can be explosive, both positively and negatively, and long lasting.

One of the more sensitive aspects of involving children in a business is the terms of inheritance when the business owner passes, especially if the children’s participation in the business has been unequal. For example, if one child has become the company CEO, while the others have pursued careers in other fields, how should the business’s value be distributed?

Most owners/parents say, “I love my kids equally, so I want to share my assets equally,” wrote Steve Parrish, a regular Forbes contributor, in a January 16, 2013, blog post. But a simple division of the business ignores both the past contributions made by children who have been part of the business, and the incentives they may have to either sell or continue operating it. As Parrish writes, the estate plan should result in “not only an equal transfer, but an equitable transfer.”

For many small business owners, the task of equalizing inheritance is complicated because the types of assets that comprise the business are illiquid. Land, buildings and equipment may represent much of the business’s value, but forced, piecemeal sales will probably mean a discounted inheritance. Further, even a partial sale (one of three trucks, or a third of the farm’s acreage) to satisfy non-involved heirs may result in unemployment for the child who’s stayed in the business and helped build its value.

Although these issues can apply to a wide range of small businesses, family farms are particularly susceptible to these inheritance dilemmas. The May 2014 issue of Progressive Cattleman provides an example of the challenge of equalizing inheritance, along with some possible solutions.

John and Mary, both 65, own a central Montana ranch valued at $8 million, along with cash assets of $200,000. They have three adult children, Steve, Mark and Sue. Steve, who has lived and worked on the ranch for his entire life, earns a modest $30,000 salary. Mark and Sue have established careers off the farm, and have no interest in returning, even in a management capacity.

John and Mary want Steve to have the ranch, but also want to provide a “fair” inheritance to Mark and Sue. They decide a fair inheritance would be giving half the farm to Steve (reflecting his long-term involvement) while dividing the remaining $4 million between Mark and Sue. But with only $200,000 in liquid assets, how can this be accomplished? John and Mary have three plausible options.

Option 1: Accumulate liquid assets. With a life expectancy of 20 years (to 85), John and Mary could save and invest approximately $110,000 for 20 years at 6 percent to produce approximately $4 million to leave to Mark and Sue. As the Progressive Cattleman says tersely: “Option 1 won’t work.”

Option 2: Borrow. John and Mary inquire about the cost of a $4 million loan, initiated at their death, and to be repaid by Steve. At 6 percent for 20 years, the monthly payments are $26,398, for a total cost of $6.3 million. That’s an unequal burden on Steve’s inheritance; he pays interest while his siblings get a lump sum.

Option 3: Use life insurance. John and Mary obtain a survivorship life insurance policy. When John and Mary have both passed, the insurance benefit will be paid. This scenario provides an immediate inheritance payment to Mark and Sue, without further encumbering Steve for inheriting the ranch. This solution is not only more effective than saving, but also ensures the estate plan will be workable regardless of when John and Mary die.

The type of life insurance used for equalizing inheritance will vary depending on the age(s) and circumstances of the owner(s), and the format of the estate plan. The insurance benefit is the funding mechanism, while the legal arrangement determines the method of inheritance distribution. Common arrangements include a policy owned by (1) an irrevocable life insurance trust (ILIT), (2) the children, (3) the business owner.

Similar inheritance equalization strategies using life insurance can be applied to any situation where it is deemed desirable for one heir to inherit a unique asset (like a home, or a work of art), yet still treat all heirs equally in terms of total value received.

See www.wagroupllc.com/epreil for full disclosures and disclaimers.

Guardian, its subsidiaries, agents or employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.

By Elozor M. Preil

 Elozor Preil, RICP®, CLTC is Managing Director at Wealth Advisory Group and Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). He can be reached at [email protected].


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