Commencing the Inheritance Discussion

In estate planning, silence is never golden

by Herbert K. Daroff, J.D., CFP

Mr. Daroff, a contributing editor for L&H Advisor Magazine, is affiliated with Baystate Financial Planning, in Boston. Connect with him through e-mail: [email protected].
Visit www.baystatefinancialplanning.com.

Have you every listened to a business owner talk about the future ownership of his or her business? “If I die,” this is what I want to happen. “IF?” Is there a choice?

No one wants to face their own mortality. So, as a result, we have the stories of famous high net worth individuals who die without a will, without a trust, without a plan.

Everyone has an estate plan: by design or by default. “By default” means that every state has laws that govern where your assets go if you die without a will (laws of intestate succession). But, some people who have died with a will, still had an estate plan by default. The will was written without a real focus on what would happen after they were gone.

I like asking clients these four questions:

  • How much of your estate will HELP your heirs?
  • How much of your estate will HURT your heirs?
  • How much of your estate do you want to HELP the government?
  • How much of your estate do you want to HELP charities that you select?

How much of your estate will HELP/HURT your heirs?

The worst family business case I ever worked on involved parents who left each of their five children an equal 20% of each and every asset. That’s what was stated in their documents. Not ‘an equal share of the value of the assets’. Not ‘you get Boardwalk with houses, I get Park Place with a hotel, you get the railroads and utilities, etc.’ Why? The parents and the lawyer did not want to make the decision for their children. They did not want to involve the children in their estate planning. They remained silent.

Two of the five worked in the family business started by their grandfather (third generation). They now owned a 40% minority interest and their siblings who were not actively involved in the management of the business owned the majority 60%. The non-active siblings wanted the same income as their siblings who were working in the business. The non-active siblings didn’t want to share their individual incomes with their active siblings, did they?

We tried to negotiate a swapping of assets among the siblings. “I’ll trade my non-business assets for your family business assets.” The non-active siblings could not agree on the value. They kept increasing the value, thus increasing the taxes that needed to be paid on the estate. We looked to outside buyers to set the price. The 60% decided to sell the business to an outsider and split the cash. Fortunately, the two active siblings went to work for the new owner. However, they are now employees, not owners. The family name is no longer associated with the business.

Instead of silence, the family could have met, discussed the values for estate tax purposes, and the values for “equitable sharing” purposes. The parents could have passed the business to the two active children and other assets to the other children.

What’s “fair” may be that you don’t treat your children equally

Allocating the business to the two siblings who were actively working there would have been “fair”, provided a plan could be established to provide “equitable sharing” by the others. But, one frequent “mistake” (* “inconsistency, see below) is to leave the operating business to one or more children and the business real estate to others. Have you ever met a landlord and tenant that got along? We see family business continuity as the continuity of the family as well as the continuity of the business. We want Thanksgiving to still be civil. * I have never found a “mistake” in a will, trust, buy/sell agreement, etc. I have found provisions that seem “inconsistent” with the current planning objectives. I refer to this as learning diplomacy from Henry Kissinger, “How to step on someone’s toes without scoffing their shoes.”

If the parents had asked the children, “Would you rather have a 20% interest in a large asset or a 100% interest in a smaller asset that you would control by yourself, that had equal value?” What do you think each child would answer?

Everyone has an estate plan: by design or by default

Parents don’t have to discuss numbers with their children. Pie charts work. As long as you get a fair share of my assets, are you ok? Are there any specific assets that you want? We’re talking about a vacation home, for example, not a Hummel figurine. Are there any specific assets that you don’t want to share with your siblings, or their spouse?

We have a client whose parents left their three children a beautiful vacation home here in New England. The problem is that one sibling lives in the Midwest and another lives in the Northwest. Only one lives in New England. Only one gets to use the vacation home with any regularity. What do you think happens when the property needs a new roof? Do the others, who own two-thirds, want to pay for it? What did they really inherit from their parents? It might have been more “fair” to allocate the vacation home to the one child and other assets to the other two.

And then there is the local case of the DeMoulis family and the Market Basket supermarkets. Grandfather left the business to two sons. The two brothers left the business to their sons, first cousins, Arthur T. and Arthur S. They simply don’t get along. Arthur T. ran the business until last year when Arthur S. convinced other stockholders to elect directors favorable to him. When Arthur S. got control of the Board, they fired Arthur T. Employees walked out. Some key managers have been fired. Customers are boycotting the stores. Suppliers are not making deliveries. Store shelves are empty. As I am submitting this article, the Board is meeting later today to discuss Arthur T.’s offer to buy the company. Had the two cousins’ parents (brothers) discussed the realities of what could happen, given the feuding between the cousins, all of this might have been avoided.

Many clients fear leaving their children too much? There is no calculation that can determine how much is enough?

  • Grace Kelly’s parents wrote this very famous provision in their estate plan (paraphrasing), “We gave the family business to our son. Our daughter is a famous movie star and real life princess. Being of sound mind, we spent the rest. Good luck, kids.”
  • Warren Buffett says, “I want to leave my children enough that they can do anything, but not so much that they can do nothing.” He is leaving them 1% of his vast fortune. He gave the rest to the Bill and Melinda Gates Foundation.

Most of my clients are “control-freaks”. Frequently, they want to “rule from the grave”, as well. That’s ok. I tell them to tell their children, “It’s not that I don’t trust you. I just want to continue protecting you.” Properly designed and communicated plans allow heirs to benefit from inherited assets while protecting those assets from creditors, including, but not limited to divorces (but, having a pre-nuptial agreement, too, is ok) and estate taxes (generation skipping).

How much of your estate will help the GOVERNMENT/CHARITIES?

I believe that the government (local, state, and federal) needs the money. I just want that money funded by other people’s clients, not mine.

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” — by Judge Learned Hand in Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).

Are you a voluntary philanthropist or an involuntary philanthropist (over-paying your taxes)?
Have you ever made a cash gift to charity during lifetime in the same year you incurred a capital gain on the sale of an asset? You could have given that low basis highly appreciated asset to the charity instead.

Do you include a charitable bequest in your will? If so, then why are you giving assets to charity that would have passed free of income taxes to your heirs, and then giving your heirs your retirement accounts, subject to income taxes? Instead, consider setting up a separate IRA for charitable beneficiaries. Don’t comingle IRAs for people with IRAs for charities. Otherwise you lose the opportunity to “stretch” the income over longer than 5-years from date of death.

Talk with your children. Talk with your professional advisors. Discuss with friends whose opinions your respect. Once completed, keep in current. Don’t just put it in a drawer and forget about it. Tax laws change. Economic conditions change. Your financial position changes. Your personal situation and that of your heirs changes. Trying to anticipate what may happen in the future is not easy. Discuss the possibilities.