The Right Mix

Planning for the orderly distribution of a client’s assets, balancing the need for control and income while minimizing taxes to be paid to Uncle Sam are fundamental objectives of any estate plan. If the client is also a business owner, then the estate plan has to be married to a succession plan for the firm; drafting them independently of one another, experts caution, only courts trouble.

“The business is often the largest asset in the client’s estate,” says Daniel Prisciotta, a certified financial planner and managing partner of Equity Strategies Group, a Rochelle Park, N.J.-based firm affiliated with Sagemark Private Wealth Services and Lincoln Financial Advisors. “The success or failure of the business often comes down to how well the two plans are developed, coordinated, and executed. To me, they’re inseparable.”

Uncoordinated planning, sources tell National Underwriter, can produce such unintended consequences as legal battles over the control of a business upon an owner’s death because of the naming of different beneficiaries in succession and estate planning documents; an unfair distribution of assets to heirs; a lack of liquidity to pay off estate taxes; inadequate income for a surviving spouse and children; and, ultimately, a collapse of the business.

Among the most common mistakes is the failure to plan adequately for a spouse and children when an owner dies, leaving them dependent on remaining owners for income from the business’s cash flow. Often, for example, business partners will establish a below fair market price for their company to more easily facilitate the buyout of a surviving spouse’s interest upon the death of one or the other partner. This may be fine for the surviving partners, but not necessarily for the surviving spouse, who may wish to sue to recover the lost value and provide for an adequate income.

The likelihood of a lawsuit increases when the spouse is left out of exit planning discussions, an all-too-common occurrence, says Gregory Anderson a chartered financial consultant and principal of Estate Design Group, Scottsdale, Ariz. “This is potentially malpractice for the insurance agent or attorney who spearheads the plan. You absolutely have to do a formal business appraisal at the time of death or when the buy-sell agreement is triggered.”

Also tailor-made for conflict are situations involving “blended families” where a surviving step-parent requires support from a child by a first marriage who inherits the business, and parent owners who set up a plan to distribute estate assets equally–rather than fairly–to surviving children.

Nate Sachs, founder and president of Blueprints for Tomorrow, Scottsdale, Ariz., cites an instance where parents left assets of roughly equal value to their 4 kids: an auto dealership they owned going to two sons; and the property on which the dealership was located to two daughters. Within two years of the parents’ deaths, the 4 siblings had a falling out and the sons moved their dealership across the street, leaving the daughters with an empty lot they were unable to maintain.

“It was a train wreck waiting to happen,” says Sachs. “The 4 siblings should never financially have been in bed together. In retrospect, the parents could have been fair by bequeathing other assets to the girls, such as stock, bonds or the house.”

They could also have equalized the estate by purchasing life insurance, a favored vehicle, experts say, for funding succession and estate planning objectives, in part because of the product’s tax efficiency. Cash values of permanent policies grow tax-deferred. Death benefits go to designated beneficiaries income tax-free. And, when the policy is owned by an irrevocable life insurance trust, proceeds escape estate taxes.

To be sure, other tax-savvy options are available to facilitate a smooth transfer of the business to the next generation. Jeffrey Condon, an attorney and principal of Condon & Condon, Santa Monica, Calif., says he often advises parents to sell a business while they’re alive to an adult child using an installment (or promissory) note. Typically, the financial instrument assigns a fair market value to the business and yields an interest payout equal to the salary the parents would otherwise draw from the firm.

One benefit: The note “freezes” the value of the business for estate tax purposes. So if the company grows in value to $20 million at the time of the parents’ death from $10 million at the time of sale, only $10 million will be subject to tax. If parents don’t need full value for the firm, they can also sell, for example, one half and gift the other half to child, making gifts tax-free using their $13,000 annual exclusion amounts.

Often, however, owners are unwilling to give up control of the business while alive, particularly in cases where they consider a sale premature; hence, the value of life insurance. For pennies on the dollar, sources say, a business owner can purchase a policy to provide the necessary liquidity to cover the estate tax.