Deciding how to pass on the family business is a complicated issue. Each person is in a unique situation. For example, Henry Durrell was equally fond of each of his three nephews. But, he wanted to keep his holdings together. So, his Will provided that his nephews should decide who would get the holdings using a game of dice. Upon his death in 1921, they did just that.
Today, an estate planning attorney could help Henry achieve his goal, while providing a more equitable distribution. For example, the business could be given to one nephew and other assets could be given to the remaining nephews. If there were no other assets available, life insurance could be utilized to provide liquidity to fund the shares for the other nephews.
In the alternative, if Henry did not mind tying all three nephews’ fortunes to the business, he could have put the business in an S Corporation with voting and non-voting shares or in a Family Limited Partnership or Family Limited Liability Company. He could then give each nephew a share in the business, either during life or at his death. This has the advantage of being able to have one or more of the nephews have control of the operations while allowing the remaining nephew(s) to participate in the growth of the business to the extent desired.
Family Limited Partnerships and Family Limited Liability Companies have added advantages. Because of certain restrictions that can be drafted into the partnership or operating agreement, Henry can get a valuation discount on the assets placed into the entity. In order to qualify for such discounts, Henry would have to be willing to give up control over distributions and dissolution. However, he could have control over day to day operations. Henry could get valuation discounts of 25% or 40% below true value.
Why would Henry care about valuation discounts? Estate and gift taxes are determined from the value of the property. If Henry had $3,000,000 of assets and he put them into an entity qualifying for a 1/3 discount, his estate would be valued at $2,000,000. So, by employing this strategy, Henry would save $800,000 in estate taxes, if he died in 2022.
While the use of S Corporations, Family Limited Partnerships and Family Limited Liability Companies continue to be important strategies, the Internal Revenue Service has been scrutinizing these entities more carefully. Accordingly, it is essential to consult with an estate planning attorney who is knowledgeable in the use of these advanced planning strategies. Such an attorney can help you secure substantial valuation discounts while helping you achieve your business succession goals.
Compliments of the McGee Law Firm, Attorney Brandon McGee
Written By: The American Academy of Estate Planning Attorneys