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Transferring the Family Business

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The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (hereinafter referred to as the Act) presents various planning opportunities and the limited two-year window should prompt clients to act and to begin to take control of their estates.

The Act presents a unique opportunity for owners of closely held businesses to review their business succession plans with their tax and legal advisors and to consider using some or all of their $5 million gift tax exemption to transfer interests in the family business (or family real estate) to their children. This article addresses the primary objectives that typically need to be addressed before developing a plan to transfer the family business to the next generation.

Primary Objectives

The first question that should be asked is whether the business should remain in the family or should it be sold. As simple as this question sounds, it is too often not asked or answered until it is too late. Often, this question is not asked because it requires the business owner to make an objective assessment of a child’s ability to manage the business.

The owner needs to think carefully about the talent and experience required to carry on a successful business, and whether or not these qualities exist inside the family. Failure to address this issue can result in a business being retained in the family when it would be better for the family, as well as for the business, if it were sold and the proceeds distributed to the heirs.

Once the decision is made to retain a business within the family, three primary objectives need to be addressed in order to have a successful transfer to the next generation. In many situations, the success of the business succession plan will be judged by how well these three objectives are met.

(1) Transfer Control to the Children Who Are Active in the Business

Once the decision is made that a business will remain in the family at the retirement, disability, death or withdrawal of an owner, a formal succession plan can be developed. The main objective of planning for business continuity for the family business is to transfer the ownership to the active members of the next generation with the least amount of estate transfer costs.

If a successful business owner waits until his or her death to transfer the business, his or her estate may lack sufficient cash to meet these tax obligations, forcing the estate to liquidate the business. This failure to plan could result in an undue financial burden on the business and may jeopardize its future viability.

Transferring the business to the surviving spouse is often the simplest approach. This approach may appear attractive initially because all estate taxes are deferred until the second death. However, leaving the business to a spouse who has no working knowledge of the business could jeopardize its ongoing success, and even threaten the spouse’s financial well being.

Another problem with this approach is that family friction may arise if the spouse begins to assume a management role formerly performed by the children. Also, the fact that control of the business will not shift until the death of the surviving spouse may act as a disincentive for the children who are active in the business. Even if all of these obstacles are overcome and the business remains successful, the future growth of the business will be included in the surviving spouse’s estate. This will add to the costs of transferring ownership to the next generation.

(2) Equitable Treatment of Inactive Children

The business should not be used to equalize the estate with inactive children. Rather, the business should pass to the active children and non-business assets should be used to treat the inactive children equitably. Equitable does not necessarily mean equal value. It could be argued that a cash gift is worth more than a bequest of an equal value of closely held stock, since the stock carries greater risk and will generally require the child’s active involvement in the business.

In many cases where the business is the primary asset, it may be necessary to purchase life insurance in order to provide additional non-business assets to meet this objective. This insurance could be owned by an irrevocable trust designed for the benefit of the inactive children. The death benefit could remain in the trust and could be used to purchase non-business assets from the surviving spouse’s estate or via arms-length loans to the estate, provide cash to pay estate taxes. In this way, the children active in the business should receive the business interest and the inactive children receive other property of comparable (or at least equitable) value.

(3) Financially Independent of the Business

Owners are often reluctant to release control of the business because their professional egos and financial well being are so closely aligned with the business. When a senior family member’s retirement and financial security are too closely tied to the continued success of the business, it is difficult for that older family member to trust the leadership skills of the new generation.

Not enough attention is given to planning for the owner’s financial security separate and apart from the business. More focus should be placed on creating an estate for the owner that is independent from the business. In addition, greater use of retirement vehicles, both qualified and nonqualified, as well as establishment of sound investment programs outside the business would help assure a smoother ownership transition when the children are ready to assume control of the business.


A business succession plan is a crucial part of any business owner’s estate plan. Failure to properly arrange an orderly transition to the next generation can generate unnecessary conflict, result in needless estate transfer costs and even jeopardize the very survival of the business. These consequences are even more likely in a family situation where emotions and unresolved family issues create even more complexity.

Assuming the business is to remain in the family, the first step is to address the three primary objectives of (1) passing control to the active children; (2) equitably providing for the inactive children; and (3) creating financial independence for the owner and his spouse. If the transition is to be successful, these issues should be addressed early in the process.

Kenneth M. Cymbal, J.D., LL.M., CLU, is assistant vice-president, Practice Development Group-Advanced Markets, at MetLife, New York.