Generational planning:  take care of the non-tax issues first

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John P. Dedon

Business owners are well aware of how federal estate taxes can prevent the family business from passing to the next generation. With a maximum 45 percent tax rate on assets exceeding $2 million, almost half of the company value is owed to the IRS. With a new president and Congress convening in January 2009, the federal estate tax environment will become even more uncertain. (Thankfully, Virginia has repealed its estate tax.) 

Future columns will focus on methods business owners can employ to reduce or eliminate estate tax, whatever the tax rate and the exemption amount turn out to be. The focus of this column, however, is on the non-tax issues which can torpedo the business owner’s best intentions. As Keith Schiller, an attorney in Northern California has written in an entertaining and informative article about Hollywood movies and their depiction of estate planning issues, “…non-tax issues often dwarf all tax considerations. Controversies within families, particularly over the family business, will continue to spawn novels, children’s stories, criminal cases and the news.” 

Of course, most families will not suffer the same consequences as the Corleone family upon the “Godfather’s” death, and no business succession plan could have saved Vito’s family business, but for most business owners proactive planning can preserve the business for the next generation. Without claiming to identify all succession planning issues to consider, the following are reoccurring themes I have seen in my practice.  Failure to address them can doom the business, with or without estate tax problems.   

-  If the company is to pass to the children, who will manage it?  Will a power struggle arise because the children do not have well-defined responsibilities and roles?  Will jealousies arise if one child is granted more control than another?  These issues can be further exacerbated if son-in-laws and daughter-in-laws are involved in the management. If the children inherit the stock equally, stalemates can arise that effectively shut down the company operations. 

Often times the business owner exerts such control during his lifetime that these problems are ignored or bubble below the surface until his death or retirement.  Without him, it is too late to remedy the ills that could have been treated with his involvement.  The owner should strive during his active involvement in the company to define the children’s roles and foster a management structure that can continue when he is no longer present.  It would be helpful to hold quarterly or semi-annual meetings with the owner and next generation present to instill the management structure. To formalize the relationships, the children should be parties to the same documents executed by unrelated parties, such as employment contracts and a shareholder agreement. Unfortunately, planning for the future is often easier said than done when a controlling owner lacks the interest to plan for the future.

-  Perhaps some of the children are not working in the company.  In this case, should the company pass equally to all of the children or only to the children-employees?  The children in the business do not want to answer to the passive, non-working children.  The non-working children may not be pleased with real or perceived excessive salaries or perquisites enjoyed by the working children.  There can also be disagreements involving dividend distributions versus reinvesting in the company, and whether or not to sell, borrow, merge, and other major decisions.  It may be preferable to leave the business to only the children working in it.  However, that may not be possible if a goal is to divide all assets equally among the children.

Obtaining an appraisal to value the company and other assets can alert the family to the looming problem. Next, solutions can be discussed, such as life insurance to help allocate the family resources. Also, strategies such as purchasing stock and lifetime gifting can help divide the assets fairly.

-  What if the business is inherited by the children but they are not capable of operating it? Often times the children are pursuing their own interests. They have no interest or involvement in the business, other than receiving their quarterly distributions. Or, the company may have reached a growth stage where its continuing prosperity is dependent on abilities or experience beyond the children’s capabilities. Only if successful talent is hired and retained can the company continue. In this model, the children are merely shareholders. However, they should also act as the company’s directors, with enough interest and oversight to provide direction and input. If the children can recognize their limitations, the company can still succeed with unrelated employees and outside counsel.

-  What if there is a step-parent involved?  The recent poster-case for this problem is the relationship — or failed relationship — between NASCAR driver Dale Earnhardt Jr., and his step-mother, Teresa.  In 2007, Junior left the company his father had founded in 1998, Dale Earnhardt Inc.  Junior and Teresa, DEI’s owner, could no longer peacefully coexist.  Junior said in May 10, 2007 ESPN article that his relationship with Teresa “ain’t a bed of roses.”  Money was not the issue: at the time of his departure Junior was the highest paid NASCAR driver. But according to the same ESPN article, Junior wanted at least 51 percent ownership so he could control DEI’s destiny.

Therein lies the rub: Apparently Dale Senior left the controlling interest in DEI to Teresa. Without knowing how this was done, we can only speculate whether Teresa owns the controlling interest directly, free to do whatever she wants with the company during her lifetime and upon her death, or whether it was left in trust for her during her lifetime and then passes to Junior upon her death. Either way, without control, Junior’s paycheck alone did not make him happy.

It is easy to see this situation develop among a child and a step-parent.  Unfortunately, emotions can run even higher among blood relatives when ownership and control of the business are divided among various family members. 

These issues can appear overwhelming to the business owner already struggling to manage and operate the company.  Finding the time, energy and interest to plan for the future is often put off until tomorrow.  There also is no “one size fits all” solution that is easily discernable. Just as there are a myriad of issues to address, there will be a number of possible solutions. The solution reached may even be to sell the company. If so, this realization is healthy in that the decision is made on the owner’s terms, not a forced decision upon his death or retirement.

One thing is certain: the failure to plan will likely lead to the failure of the business’ continuation and the diminution of its value. Whatever may be the appropriate solution, business owners can take comfort in knowing they are not the first ones to face these difficult issues. With proper planning and effort, management and control issues can be identified and solved. 

John P. Dedon is a principal in the firm with the Trust, Estate & Tax Planning practice group of Odin, Feldman & Pittleman. Dedon blogs about estate planning issues for Virginians and U.S. citizens at www.dedononestateplanning.typepad.com.

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