Challenges of estate planning often amplified when family-owned businesses are involved
Family businesses benefit from having family members do estate planning together and have everyone in line with the vision for keeping the business operating well into the future. courtneyk via getty images
Estate planning is a critical undertaking, requiring intricate decisions and strategies as well as clarity in communications with loved ones to accomplish your wealth-distribution goals.
For family-business owners, the task is all the more essential – and complicated. With a generational enterprise at stake, myriad tax issues to consider and often challenging interpersonal relationships involved, it’s important for entrepreneurs to ensure the plan is structured to implement their wishes as well as to keep the business thriving.
“You really have to think about what you’re leaving behind,” says Steve Ivacko, a partner at MNP, a national accounting, tax and business-consulting firm dedicated to private companies, especially family enterprises.
Mr. Ivacko, a member of MNP’s Family Office Services team, says estate planning has wide implications for the family business and all those associated with it. One challenge is that many company founders are “a bit headstrong” and want to control their affairs and company succession issues, Mr. Ivacko cautions. “You need to include others in the conversation, because the likelihood of the transition being successful diminishes with that sort of iron fist.”
“A business is a going concern, and it should survive someone’s death. But if that person doesn’t communicate what the plan is, or doesn’t even have a plan, then the company is really at risk of not being a going concern anymore.”
One major factor is that while a company owner may want to pass the business on to children, there is a “deemed disposition on death” of all of the owner’s assets, which can create a hefty tax bill for the estate. “So if someone doesn’t plan well enough in advance, or doesn’t plan appropriately, there may be a liquidity issue and the heirs may have to sell something, even the business,” he says. So it’s important to work out how to finance that tax liability well ahead of time.
Mr. Ivacko says an estate freeze – locking in the value of your business in favour of a trust – can offer certainty, deferral of tax on any gain in value accrued to when the freeze takes place and provide a mechanism to transition a family business and its future value to children, other family members or third parties.
Whether and how you do such a freeze and manage it over time are important considerations, he says. In an estate freeze, a business owner typically exchanges common shares in the company for fixed-value preferred shares. This freezes the value of his or her participation in the company at that moment in time. A trust may be set up where the trustees subscribe to new common shares, usually for the benefit of second- or third-generation family members. These shares start with minimal value, but future growth – and related capital gains – accrue to them.
He continues with saying that a freeze allows the company owner to begin transferring control and to have financial stability in retirement. It also helps establish the tax liability at the owner’s death, which could be covered by a life-insurance policy. If the business is eventually sold, any gain may be allocated to family members who are beneficiaries of the trust and who are in lower tax brackets. With proper planning, they could also utilize their lifetime capital gains exemption to achieve greater tax savings.
Mr. Ivacko says it’s important to consider the long-term effects for the family using strategies such as estate freezes. He warns that some structures are put in place for tax reasons “without looking at what it actually means for the family.” For example, an estate freeze is “great tax strategy, but a lot of people don’t realize you’re effectively putting your kids in business together in 20 years. Is that a good idea? Do they want to be in business together?”
“It goes to investments, it goes to insurance, it goes to tax, it goes to legal documents and shareholder agreements. It’s understanding that there is a bigger picture for a family that’s got an operating business. ”
It’s important to consider such “hard solutions” with a broad lens, which could show they “may not be the best soft solution for the interpersonal dynamics in a family,” he says.
Kerry Smith, MNP’s national leader of Family Office Services, says such issues are best examined in collaboration with trusted family advisers with a wide range of specialties and capabilities. Having such third-party expertise can help ensure that estate-planning decisions “are effective for the individual, the family and the business,” he says.
Such planning requires a tailored approach, Mr. Smith says, examining everything from wills and trust agreements to the company organizational structure and the choice of executors. “It goes to investments, it goes to insurance, it goes to tax, it goes to legal documents and shareholder agreements,” he says. “It’s understanding that there is a bigger picture for a family that’s got an operating business.”
Mr. Ivacko says it’s critical to develop a strong relationship with a group of advisers like those at MNP who can connect with the broader family. It’s also important to keep the estate plan up to date and to communicate your intentions to your heirs.
Attaching a “letter of wishes” to a will can avoid guesswork and resentment, while having a frank conversation about your estate plan before your death can stop tensions down the road. “You don’t have to talk dollars and cents,” he explains. “You can say, ‘Look, here’s what it is,’ or ‘These are the percentages,’ or ‘We’re equalizing the non-business siblings with an insurance policy.’”
It’s never too early to benefit from professional advice, says Mr. Ivacko, who points out that estate planning is important for family companies, both small and large.
“A business is a going concern, and it should survive someone’s death,” he adds. “But if that person doesn’t communicate what the plan is, or doesn’t even have a plan, then the company is really at risk of not being a going concern anymore.”
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