Family Business: How To Equalize Your Estate and Minimize Taxes in the Process

Doug Sherry, President of Arden Trust Company

Family businesses are closely-held assets that deserve the time and attention of a thorough estate plan. Building a succession plan for a family business can be complex when multiple descendants are involved, as these businesses are usually the most valuable asset transferred to the next generation. Often, one child is more involved and interested in the business than the others. This situation poses the question: How can you evenly distribute your estate to your heirs? 

One strategy to equalize the distribution among children is to place the family business into a partnership, creating general partnership shares and limited partnership shares.  

• Limited partners are passive investors with participation limited to profits and losses up to their invested amount.
• General partners oversee the business, receive management interest, and have unlimited debt liability for the business.

In this partnership structure, creating a buy-sell agreement is imperative to ensure shares are not sold to outside parties and can remain within the trusted family. Partnership interests can be a solution to equally divide the estate between heirs that have mixed interests in the family business, and can potentially provide the added benefit of discounted estate taxes. 

Estate taxes can run up to 40% of an estate if exceeding $11.7 million for an individual or $23.4 million for married couples. By utilizing partnership interest, grantors can provide lifetime gifts in the form of shares of the business to heirs up to the amount of the gift tax exclusion, currently at $16,000 annually, decreasing the value of the taxable estate each year. Caution: exceeding the annual gift tax exclusion threshold could trigger gift taxes. Additionally, skipping a generation and gifting shares to grandchildren may also trigger a taxable event.

To effectively utilize partnership interests as a tax strategy, it’s recommended to begin the process while the grantor is alive and competent. This will allow for a thoughtful transfer of management responsibilities over the family business as well as properly structuring the partnership interests. It will also allow for the ability to provide lifetime gifts. 

Another consideration to address estate taxes and create liquidity is an irrevocable life insurance trust (ILIT). Through this vehicle, the life insurance policy is usually the sole asset and is held outside of the Grantor’s estate. The proceeds of the policy can be used to either equalize the inheritances of the heirs or as an offset to estate taxes. However, it’s important to keep in mind, the larger the estate, the larger the policy premium, which can be unattainable for some family-run businesses. 

The result of failing to properly plan and implement an effective tax strategy is often having to sell parts of the estate to pay off high estate taxes. While you can apply to pay the taxes off over a set period of time, the amount owed each year will likely still be significant and oftentimes cash flow cannot cover it. 

The moment a family starts to consider succession planning, they should also consider the transfer of management responsibilities. If you wait until the death of the individual running the business, you’ve waited too long. Begin transferring responsibility to the next generation and guide them through situations, allowing them to make decisions. This will create an experienced successor and leave everyone with a sound mind and game plan. 

When it comes down to it, considering your options and creating a plan of action that works for your family business model is necessary for a smooth transition, whether it be a partnership structure, lifetime gifts, or an ILIT.

Arden Trust Company does not provide legal or tax advice. Please consult a legal or tax professional for advice specific to your circumstances.