5 Ways to Transfer the Family Business

The following article on business succession planning appeared in the February 10, 2014 issue of Northern Nevada Business Weekly:

JCM ProfileAs a business owner, you will have to decide when will be the right time to step out of the family business and how you will accomplish a successful transition. There are many estate planning tools you can use to transfer your business. Selecting the right tool will depend on whether you plan to retire from the business or keep it until you die.

The transfer can be an emotional minefield where some family members are participants in the business and others are non-participants.  Those participants may feel “obligated” to stay in the family business when they would rather do something else.  In addition, the transfer can be complicated due to estate taxes, gift taxes and capital gains taxes.

Moreover, sometimes the family business is only profitable enough to support one child, even though the non-participants may believe the business’ finances should support them. Or, only some or none of your children may have the abilities or skills to run the business.

Transfer of the family business is further complicated when – as is frequently the case – the family business represents all or nearly all of the parents’ wealth.  Passing the business on to one or more children, while treating all your children fairly, is not easy.

Transparency and communication are vitally important. To achieve the best result, the entire family should receive (1) an explanation of your plan and why you are undertaking a particular strategy; (2) sincere, personal discussions clarifying that you love them equally; and (3) a promise that you are doing your best to be fair to all, while ensuring the future viability of the business.

Here are the 2014 tax exclusion and exemption amounts to consider when analyzing the various alternatives available for the transfer of a family business:

  • The annual exclusion for gifts is $14,000 per donee (meaning husband and wife can each gift $14,000 to a recipient); and
  • The federal gift and estate tax exemption for transfers during life or at death is $5,340,000.

Business sale to the participating child through an installment sale.  This is considered one of the simplest methods of transferring the family business to a child or children.  You can sell shares or partnership interests to a family member.  The benefit of this method is that installments payments can be made over time, which provides an income for you after your retirement. Another benefit is that the purchasing child can better manage his or her cash flow and does not have to come up with a large sum of money at once. However, you will incur capital gains if the business sells for more than what you have invested.    

Gift the business to some children and give cash to the others. Gift taxes are likely to be incurred with this strategy. A more practical concern than paying gift taxes is the fact that you may not have sufficient cash to equalize the value of the business assets going to your other children. This dilemma can be solved with a sizeable life insurance policy which names the non-participant children as beneficiaries. There are various ways to handle the life insurance, including setting up an irrevocable life insurance trust so that the life insurance benefits are not included in your estate for estate tax purposes.

However, if you gift your business, your child will not benefit from the step-up in basis to the current fair market value that is allowed when the business is purchased or inherited. For capital gains tax purposes, your child will step into your shoes and own the business at the basis that you own the business. Assuming the business increases in value over time, your child’s capital gains taxes will be higher. Of course, if the business is never sold, capital gains taxes may not be a concern.

Divide the business: the participating children receive the operating company and the non-participants receive the land and/or buildings used by the business. You could retain the real estate but provide that your children who are not participating in the business inherit it. By retaining control of the real estate during your lifetime, you could collect rent from the operating business to provide income. Later, your children who inherit the facilities could charge rent to their siblings running the operating company. How well your children work together under this strategy depends on family dynamics.

GRAT or GRUT. A more sophisticated business succession tool is a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT). GRAT/GRUTs are irrevocable trusts to which you transfer appreciating assets while retaining an income payment for a set period of time. At either the end of the payment period or your death, the assets in the trust pass to the other trust beneficiaries (the remainder beneficiaries). The value of the retained income is subtracted from the value of the property transferred to the trust (i.e., a share of the business), so if you live beyond the specified income period, the business may be ultimately transferred to the next generation at a reduced value for estate tax or gift tax purposes.

Intentionally defective grantor trust.  Another sophisticated technique is use of an intentionally defective grantor trust (“IDGT”).  The trust is intentionally defective so the grantor pays the income tax on the assets that are no longer considered part of the estate.  You create the IDGT, lend the trust money to buy an asset (the business) you expect will appreciate significantly. In return for lending the trust money, you receive interest payments for a set number of years. The lower the interest rate, the less the trust must repay you — and the more your heirs stand to benefit.

Who Is Qualified to Serve as Administrator of an Estate?

Treasure ChestSome years ago a wealthy older man I’ll call “Boris” got married to a foreign national half his age. Boris was a Nevada resident. He brought “Natasha” to the U.S. after their marriage. She was intelligent but did not speak English well and was unfamiliar with American culture and basic business practices. Boris had two adult children from a prior marriage who both lived out of state. Three years after his marriage to Natasha, Boris died without any estate planning in place. At his death, who was qualified to be the administrator of his estate?

If Boris had made a will, he could have nominated whomever he wanted to act as executor of his estate. (As a note on vocabulary, the term “executor” refers to someone nominated in a will, whereas the term “administrator” refers to someone appointed by the court in a situation where there is no will.) If a Nevada resident dies without a will, that person’s estate may be administered by a qualified person. The Nevada probate code sets forth the priority in which the court will consider candidates; a surviving spouse has first priority, and a child (18 or older) has second priority.

Need I say that Boris’s adult children did not get along with Natasha all that well? They did not trust her at all, and they believed she did not speak English well enough nor understand basic survival skills nor basic obligations (e.g. that Boris’s death did not mean his bills didn’t have to be paid) to be the administrator of their father’s estate.

What qualifies someone to act as the administrator of an estate where there is no will? An administrator must be at least age 18 and not convicted of a felony, unless the court determines that such a conviction should not disqualify the person. Someone will be disqualified if upon proof, he or she is adjudged by the court to be disqualified by reason of conflict of interest, drunkenness, improvidence, or lack of integrity or understanding. Finally, the person must either be a Nevada resident or must associate as a co-administrator with someone who is a Nevada resident.

Boris’s children had two impediments to petitioning for appointment of themselves as administrator: they were not Nevada residents and they did not have priority over Natasha because she was Boris’s surviving spouse. In order to prevent Natasha from serving as administrator of the estate, it was necessary for them to prove in court that Natasha was disqualified by reason of improvidence or lack of integrity or understanding. In the end, however, neither Natasha nor the children were appointed administrator. Instead, Natasha invoked a statute that allowed her, as the person with first priority, to nominate someone else to act as administrator—and she nominated a local accountant who was perfectly qualified and did a great job.

Lesson learned? Do some estate planning—preferably while you are still well enough to think clearly and act independently. Choose a personal representative who is both competent and trustworthy. Boris could have avoided a fight among his relatives by executing a will naming someone to act as executor of his estate, and he could have better provided for disposition of his assets—which were significant.

You may be wondering what happened to Boris’s estate—who was entitled to receive his property? Stay tuned for the next installment of As the Probate World Turns.

Heggstad Petitions in Nevada: Or, How to Bypass Probate and Get an Asset into a Trust after Death

Washoe Co. Court House           It is unfortunately all too common that clients who set up a trust forget to transfer one or more assets into the trust; or they purchase a new home or other asset, and do not title it in the trust. In some cases, it is possible to avoid having to probate assets omitted from the trust if you can prove that the deceased intended to include that asset in his trust. In Nevada, this can be accomplished by way of filing a Heggstad petition with the probate court.

The name of the petition comes from a 1993 California case, In Re Estate of Heggstad, in which Mr. Heggstad created a trust but failed to execute the necessary paperwork to transfer his interest in certain real property into his trust. The successor trustee argued that Mr. Heggstad had intended that the asset be transferred to the trust by the fact that it was included in the schedule of assets attached to the trust. The court agreed, finding that that a written declaration of trust by the owner of real property, in which he names himself trustee, is sufficient to create a trust in that property; the law does not require a separate deed transferring the property to the trust.

In Nevada, the Heggstad case is not binding law, but a Heggstad type petition is provided for in the probate code, which allows a trustee or other interested person to petition the court to enter an order if the trustee has a claim to property and another holds title to or is in possession of the property. Pursuant to Nevada law, an omitted asset can be placed into the trust without a probate proceeding.

Under what circumstances will this be successful? You have to prove that the asset was intended to be in the trust. Inclusion of the asset on the schedule of assets was deemed sufficient in the Heggstad case. Another possibility is to show that the asset was in the trust but was inadvertently removed for some reason; for example, you had a bank account at First Bank titled in your trust and closed it and opened a new account with the money at Second Bank, but forgot to open the new account in the name of the trust. Each situation is different, but a knowledgeable probate attorney can help you evaluate your case.

In order to put the asset back in the trust, it is necessary to prepare and file a petition in the appropriate district court. The petition is set for a hearing and if approved, the court will issue an order transferring the assets into the trust without any further proceedings. This is a huge advantage over opening a probate estate as it cuts down significantly on the time required and on fees and costs.

Contact Woodburn and Wedge with your trust and estate issues. We can help you evaluate whether a Heggstad petition would work for your situation or whether another procedure is appropriate.

Why All Your Assets Should Be in Your Trust

Trust Jan. 2014           It happens all the time: People go to the trouble of setting up a trust, hoping to avoid the time and expense of a probate—but they either neglect to move all their assets into the trust, or they buy new assets and forget to take title in the name of the trust. Why is this a problem? If your assets are not in the trust, then the trust does not govern what happens to them at your death. Instead, they will be governed by your last will and testament, or by intestate succession if you don’t have a will, or your will cannot be located.

Depending on the value of the assets omitted from the trust, it may be necessary to open a probate proceeding with the court in order to get the assets to the intended beneficiaries. This involves spending time and money that could have been avoided if all assets had been titled in the trust.

Most estate planning attorneys have their clients execute a will “pouring over” any such assets into the trust—in other words, the trust is made the beneficiary of the will. In this case, the assets you left out of the trust will eventually get back into the trust, but only after an appropriate court proceeding. However, if your will cannot be found, or is invalid for some reason, the assets will go to your heirs according to the law, who may or may not be the beneficiaries of your trust.

What’s the best way to ensure your assets are properly titled in your trust? When you first set up a trust, make sure that the trust includes a schedule of assets intended to be transferred into the trust, and make sure that all of your assets are on that schedule. Next, you need to do some legwork: all real property should be transferred into the trust by means of a signed and recorded deed; and all titled personal property (cars, bank and brokerage accounts, etc.) should be transferred as well. Any time you purchase a new asset, make sure you take title in the name of the trust. If you refinance an asset, make sure the asset does not get bumped out of the trust in the process, and take steps to transfer it back in if this occurs. Finally, periodically review your assets to make sure they are titled in the name of the trust.

If you need assistance with this issue, you should contact a qualified Nevada estate planning and probate attorney.

Separate Assets, Joint Problems

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Some married couples enjoy living together while keeping their financial assets separate. Separate ownership of assets can be advantageous in some instances, but oftentimes loving couples misunderstand the results of holding separate assets.  The Wall Street Journal recently highlighted four potential pitfalls for couples maintaining separate accounts:

  1. The assets are not necessarily separate under Nevada law.

Simply having your name on an account does not mean the account is yours alone.  Under Nevada law, pursuant to community property principles, all of your earnings and wages after marriage are the property of both parties.   This is true even if you have your paycheck deposited into a separate account.

Nevada inheritance laws can surprise couples. If you die without a will and leave a surviving spouse, no children and surviving parents, your parents are entitled to a portion of your estate.  Many spouses intend for their entire estate to go to a surviving spouse.  However, unless that desire is set forth in a will or trust, the state may direct otherwise.

  1. Separate accounts most often mean lack of communication.

Communication between spouses is critical.  Many spouses have separate retirement accounts and manage those accounts in isolation.  This isolated planning can undermine the couple’s financial objectives and their combined risk tolerance.  Regularly, I meet with clients where both spouses are unaware of accounts or policies that one spouse possesses.  These omissions could cause the account proceeds to go missing or remain unclaimed for long periods of time.

In addition, holding similar investments in two separate accounts can be more costly.  Combining the separate holdings may result in lower advisory fees.

  1. Separately-owned property may be at greater risk in bankruptcy or a lawsuit.

Nevada has very liberal exemptions for bankruptcy purposes.  These protections can be utilized best by conferring with an attorney who focuses on asset protection planning.

Joint ownership can make your assets less appealing to creditors.  Creditors loathe joint assets in which they will hold only a one-half interest.  Separately-owned property is less-protected from creditors.  The home is the primary asset to hold jointly or through a trust. 

  1. Separate accounts are more difficult to administer.

The death of a loved one causes plenty of heartache.  Maintaining separate account causes needless headaches too.  The time delay in accessing separately-owned accounts can lead to draining financial stress.  Many financial institutions demand formal court orders before allowing access to financial accounts, even when such orders are not necessary.  At a minimum, couples should maintain a joint checking or savings account to make sure the day-to-day expenses can be satisfied.