New Tax Regulations Attack Family Business Planning

by ShuffieldLowman | Aug 17, 2016 | Blog, Estate Planning & Probate, Planning for High Net Worth Families with Closely Held Business | 0 comments

As you know, the Internal Revenue Service closely scrutinizes transfers between family members of stock, units, and partnership interests (“Stock”) in any corporation, limited liability company, or partnership that is family-owned (a “Family Business”).  The Service has announced proposed regulations that eliminates the use of valuation discounts that would otherwise decrease the estate and gift tax value of such Stock when transferred by sale or gift to family members.  If you are considering a gift or sale of Stock in a Family Business, you may want to consider taking action right away to implement your planning.

When Stock in a Family Business is transferred between family members, valuation discounts are commonly applied for, among other things, lack of marketability and lack of control.  The lack of marketability discount is based on the fact that a Family Business cannot easily be sold on the open market and is not publicly traded; so, the true value of the Stock is actually worth less than a pro rata portion of the total value of the underlying assets.  The lack of control discount is based on the fact that a non-voting interest or a minority interest that does entitle the owner to a vote (but not unilateral control of the entity) is worth less to an arm’s length purchaser than if they could control the entity.  These discounts are designed to reflect the true economics of a Family Business from the view point of a third party purchaser.

Valuation discounts have been an effective tool to reduce or eliminate federal estate and gift taxes on transfers of Stock in Family Businesses for many years.  The Service, however, has long sought to limit the benefit of this tool.  This has been especially true when the Service determines that the Family Business in question has no legitimate “business purposes.”  The proposed regulations address the Service’s concerns by eliminating all discounts.  We expect attorneys, accountants, appraisal experts, and other planners to comment in the next ninety (90) days about the validity and public policy implications of the proposed regulations.  However, the very real possibility is that the proposed regulations will be effective when the final version is published, which might occur in as little as one hundred and twenty (120) days.

The new regulations do basically two (2) things.  First, when valuing Stock in a Family Business certain restrictions on liquidation rights are disregarded when such rights lapse after a transfer (for instance if the General Partner of a partnership dies) or if after a transfer the restrictions may later be removed by the transferor or the transferor’s family.  Second, any lapse of voting or liquidation rights is deemed to be a transfer to the other family member/owners in the Family Business.  Both rules only apply if one (1) or more members of the family has control of the Family Business both before and after the transfer or lapse.  Control may occur when certain voting or equity thresholds are met; furthermore, ownership by a particular family member will be attributed to related family members, making it hard not to pass the threshold of control.  In plain English, this means that valuation discounts will no longer be available for transfers of Stock in a Family Business to family members.

Existing Family Businesses would not be “grandfathered” under the proposed regulations.  Only gifts or sales completed prior to thirty (30) days after the effective date of the final regulations would be exempt from the new rules.  It is also very likely that regardless of how broad or narrow the final regulations may be, the ultimate validity of the regulations will be determined through taxpayers litigating this issue in the Tax and Federal Courts.  Therefore, once the new regulations are made final, we may not have any certainty in this area for the next several years while legal battles are fought with the Service.

Because of the uncertainty of the new proposed regulations, we recommend that our clients who may be inclined to transfer Stock in a Family Business, whether by gift, sale, or both, consider all of their planning options as soon as possible to determine if they should go ahead with some transfers prior to the issuance of the final regulations.  We would be happy to sit down with you and discuss all of your planning options.

Choose Wisely When You Consider Your Fiduciary and Your Estate Plan

by Alexander Douglas | Dec 23, 2013 | Blog, Estate Planning & Probate, Planning for High Net Worth Families with Closely Held Business

One of the most common errors parents can make when doing their estate planning is not making the hard choice as to who they want to serve as their fiduciary.  Specifically, parents make the mistake of choosing among their children to serve as their fiduciary instead of choosing a bank or brokerage company with trust powers, or other non-family member.

Parents naturally do not want to show favoritism with regard to their children or indicate they lack any confidence in any particular child.  Often, the parent kicks the can down the road by simply choosing both of their kids, or even multiple siblings as co-fiduciaries, even knowing that they may have great difficulty working together.  This is a disastrous road to take.  Parents should not set their children up for failure if they know their children are not likely to be able to work together.

The following is the most common scenario.  Mother, being the last to die, changes her will to make her two daughters co-personal representatives of her estate and co-trustees (replacing her deceased husband who she had named in her prior will).  One daughter is strong-willed, the other is mild mannered. The daughters often had problems working together and even routinely fought as youngsters.  The mother, however, simply cannot bring herself to choose between her daughters.  As such, she wants to “recognize” both by making both daughters co-fiduciaries of her estate or trust.  The result?  The daughters, predictably, cannot work together and worse, actively take action to hamper and frustrate the other when they need to work together the most.  After the mother dies, all gloves are off and the daughters start litigating.   The result?  Tens of thousands of dollars of the mother’s estate intended to go to the benefit of her daughters is squandered in legal fees—all because the daughters were set up for failure by the mother in her estate plan.

What is the solution?  If your estate exceeds $1,000,000, a bank or brokerage company with trust powers is a good solution.  A professional fiduciary such as a bank or brokerage company can offer professional fiduciaries familiar with Florida law and who know how to navigate an estate administration and/or trust administration.  Having lost a parent is difficult enough, but having to administer an estate or a trust by a person unfamiliar with fiduciary responsibilities can be a burden that may not be appropriate for your children.  Moreover, by picking a bank or brokerage company, the parent avoids having to choose between their children so that no one is upset.  In essence, you will have given your kids a final gift of having a professional navigate the administration of your estate plan.

If your estate is less than $1,000,000, there are many smaller trust companies and/or certified public accountants that are willing to act as your trustee and/or personal representative.  Family harmony can be an important legacy that you leave by considering the simple realities of your family dynamics.  If in doubt, choose a third party fiduciary, not your family.

The Importance of Shareholder Agreements in the Succession of a Family Business

by Daniel Harris | Dec 3, 2013 | Blog, Estate Planning & Probate, Planning for High Net Worth Families with Closely Held Business

Orlando, FL – Often when a closely-held business (i.e. a non-publicly traded LLC, Partnership, or Corporation, hereinafter “Family Business”) is created there is a single shareholder who owns 100% of the voting units and thus makes all of the decisions concerning the business (hereinafter the “Founder”). As time goes on and this person ages, they will begin to think about their goals for estate planning, as well as what they would like to happen with the business when they are gone.

Generally people tend to favor splitting up all of their assets equally among their descendants. However, when the largest asset is the Family Business, resolving these matters may become very complicated. For instance, it is common that certain children will be involved in the Family Business, while others have nothing to do with it. Further, between the children who are involved in the Family Business, there will often be different degrees of involvement, skill, and dedication. Other issues that frequently arise involve children who have substance abuse problems, or mental health issues. Additionally, there is always the possibility that one or more children will go through a divorce, which could create the risk of ownership of the company being transferred to an ex-spouse. It is also not uncommon for a non-family member to be involved in the Family Business. The Founder may wish to reward their hard work and dedication with partial ownership and/or control of the company.

The purpose of creating a unified Estate and Succession Plan, including a Shareholder Agreement (or Operating Agreement or Partnership Agreement, as the case may be), is to avoid as many of these issues as possible on the front end. Doing so is both good for the family and good for the business. By and large the most important issue for the continued success of the Family Business comes down to who controls the company. Therefore, it is often advisable for the Founder to recapitalize the Family Business into voting and non-voting units. This helps to facilitate the goal of the children having “equal” inheritances in terms of value, while ensuring the Family Business will continue to operate and prosper by allowing control of the company to be separated from the right to income generated by it.

The Shareholder’s Agreement is important because it creates the rulebook for governing the company and will be the foundation moving forward. Dividing control of the Family Business will depend on a variety of factors including the nature of the business, and the experience, age, education, and responsibility of the family members. There are many different ways to define control. On one end of the spectrum, one child will have total control of the Family Business (i.e. control of day-to-day business operations, and the right to do anything with the business that they please). This model works as a continuation of the one created by the Founder. However, the success of the company will depend solely on that one child, and this situation is very likely to create disharmony and friction among the family members. When voting power is shared among family members there can be many different arrangements.

Toward the middle of the spectrum, one child may have a majority of voting power, and thus that child will have control of day-to-day business operations. Other issues may be left to a majority vote, which that child would solely determine, giving them an additional level of control but not total control. And, certain “Issues of Major Importance” will require a “super majority” vote, so that at least one other child joins and agrees with the majority holder.

At the other end of the spectrum, one child may be given 50% or less voting power, and have control of day-to-day business operations as president or director, but other items will be put to a majority or super majority vote, depending on the particular issue.

There can be many Issues of Major Importance, depending on the nature of the business and how the voting control is divided, but often the issues that will be put to a majority or super majority vote include the following:

• Sale or disposition of substantially all of the company’s property, or of any property in excess of a certain value;
• Entering into a lease;
• Creating, modifying , or terminating any agreement affecting compensation of an officer or manager of the company;
• Incurring or refinancing debt;
• Mergers and joint ventures;
• Amendments to the Operating Agreement;
• Filing bankruptcy;
• Dissolution or Liquidation of the company;
• Issuing additional units in the company;
• Hiring of family members;
• Changing the nature of the business;
• Purchasing property in excess of a certain amount; and
• Making distributions or payments to owners or employees of the company in excess of a certain amount, or percentage of book value.

Other issues that the Shareholders Agreement addresses include what events trigger rights to a put or call on voting and/or non-voting units. These can include:

• The permanent mental disability of a shareholder;
• The death of a shareholder (the terms can vary depending on whether life insurance was purchased to facilitate a buyout or not;
• Divorce or separation of a shareholder;
• Retirement of a shareholder;
• Involuntary transfers of units; and
• Transfers of units in breach of the Agreement.

Additionally, the Shareholders Agreement may contain provisions known as “Drag Along / Come Along” rights. The former allows the majority holder to force the minority holder(s) to agree to a sale even if they do not wish to sell. While the latter allows a minority holder who does want to sell to benefit from the same terms that the majority holder has agreed to, even if the buyer is otherwise uninterested in purchasing the minority interest.

The Shareholders Agreement is important due to the wide variety of issues it addresses and because it has the ability to act as a referee among the family members. Thus, no one family member has to “be the bad cop;” the rules are simply the rules and the whole family must follow and respect them. In addition to creating the Shareholders Agreement, it is often advisable for the Founder of the business to begin transitioning control and/or decision making authority away from themselves while they are still alive. This method will allow the people succeeding to control of the company to have a safety net, as well as to allow suppliers, contractors, employees, and clients to get to know the new players in the game. The ultimate goal is for a seamless transition of the Family Business upon the death of the Founder and for its continued success thereafter.