Resting in Pieces - Part II: Why Family Harmony is a Frequent Casualty of Most Estate Plans, 0320 KSBJ, 89 J. Kan. Bar Assn 3, 20 (2020)

AuthorTim O’Sullivan, J.
Position89 J. Kan. Bar Assn 3, 20 (2020)

Resting in Pieces - Part II: Why Family Harmony is a Frequent Casualty of Most Estate Plans

No. 89 J. Kan. Bar Assn 3, 20 (2020)

Kansas Bar Journal

March, 2020

Tim O’Sullivan, J.

Part 2:

Planning Bequests to Children of Farms and Closely Held Businesses

Tis land is your land, this land is my land… Woody Guthrie

As the initial estate planning consideration involving a farm or other closely held business, a parent must determine whether the closely held business should be maintained following the parent’s death or whether market conditions and family considerations discussed below militate in favor of selling the business before or after the parent’s death. If it is determined that the business is to be continued by family members following the parent’s death and a business succession plan put in place, a parent must carefully consider which family members will receive business interests, how the business is to be maintained, when and how family members should receive the business interest, and how the estate is to be divided among family members, particularly if there are family members who are not active in the business.

In the decision-making process, it is of first importance that parents fully understand that closely held business interests are difficult to maintain from generation to generation. The stress on family harmony in the transition of the ownership of a family farm or business can adversely impact business operations due to the conflicting values and needs of a family versus a business. The focus on family values tends to be inward, whereas the focus of a business mandates a focus on external factors in the marketplace. Compensation in a successful business tends to be based upon performance and skill level, whereas the family tends to desire equality of remuneration irrespective of these factors. Such predilections need to be carefully addressed if the success of the business succession plan is to be enhanced and family harmony preserved in the process.

Part of the tension placed on family harmony when transferring a business to descendants is also due to emotional and psychological considerations. The older generation’s natural reluctance to “turn over the reins” of the business needs to be addressed. For business succession to be successful, the succeeding generation should gain practical experience in business operations prior to the death of the older generation. Additionally, sibling rivalries should be observed in the operational phases of the business by the parent so that they can be properly considered and addressed in the parent’s estate planning and business succession plan.

Improper or inattentive estate planning in the area of business succession can not only increase the risk of failure of a business succession plan, it can destroy family harmony and greatly increase operational costs. Te prominent issues which frequently arise in this context are the orderly transition of the management of the farm or closely held business to a child or children and the division of the estate between or among children who are active in the business with those who are not. From the outset, a parent must appreciate that there is a substantial risk of disagreements that will arise between active and non-active children (hereinafter also referenced as “active” and “passive” family members, respectively) regarding business decisions if both classes succeed to the ownership of a closely held business enterprise. Tis aspect results in an extremely high incidence of family disharmony, often leading to resentment, arguments, and not all that infrequently, costly litigation.

Although active children can be given voting control of the enterprise for continuity of business management purposes, from a family harmony standpoint this serves to aggravate such tensions. Te selection of a few family members to manage a business places risks on family harmony greater than that of naming children as financial fiduciaries of a parent’s estate. Te former situation, however perilous it may be to family harmony, is transitory in nature and does not place sibling fiduciaries in an on-going superior economic position.

Passive owners may “second guess” aspects of such management decisions, including the salaries of active owners and the amount of cash in the enterprise which should be distributed to them versus the amount to be retained for future business needs. In addition to disagreements among themselves in management decisions, active family members may overvalue their contributions to the business enterprise, their merited compensation, and view passive family members as being unappreciative of their efforts in the business. In short, neither faction is likely to be totally objective, and are often far from objective, about their respective positions and how they are viewed by the other faction.

With such axioms in mind, one of the most perplexing issues attendant to a parent’s transfer of an ownership interest in a closely held business to family members lies in the distribution of estate assets between active and passive family members. Frequently, active children are given a greater share of the total proportionate value of the estate, usually in the form of business interests, in consideration of their efforts. Tis disparity may be due to a parental view that such children have received below market compensation for their efforts during the parent’s lifetime or that their expertise or creativity has enhanced the value of the business enterprise. It also may be simply due to a child choosing to stay on the farm or in the family business enterprise. In such situation, if in conversations with clients it appears such child was paid the same approximate amount as would be paid to a third party possessed of the same experience, did not add significant economic value to the family enterprise than would otherwise have been expected from another individual performing the same duties, and did not give up better economic opportunities to assist a parent in the enterprise, it would be advisable for their estate planning counsel to inquire of the client the basis for such additional allocation to ensure that such decision was well thought out in the face of an apparent lack of economic undergirding.

Whatever the rationale for such additional allocation, it is at high risk of triggering resentment and disharmony between the active children receiving such additional allocation and passive children receiving a lesser share of the estate. Passive children tend to be less than objective in their assessments of the merits of any such additional share allocation and, as noted above, active children tend to overvalue their contributions to the business enterprise and feel they should be so compensated simply for assisting a parent in its management irrespective of any accompanying economic benefits. One way to help mollify such a situation is to place the parental reasons for such additional allocation in the testamentary instrument, preferably in a revocable trust, rather than a will, due to the former not being a matter of public record. An even better way is to avoid it altogether by adequately compensating active children for their efforts during the parents’ lifetime to avoid such disparity in the allocation of the parent’s estate.

Even if such allocation of business interests between active and passive children is proportional based on their respective percentage ownership interests in the business, the fact that active children have a controlling voting interest will substantially increase the personal value of their proportional interests over the proportional interests of passive children. It can also increase their fair market value as well, dependent upon whether the active children alone have voting interests, their percentage voting interest, and most particularly if an active child has a controlling voting interest in the enterprise. Tis realization also can result in significant additional family disharmony and dissension, for parents are unlikely to increase the proportional interests in the business interests going to passive family members in consideration of such increased value.

Because active and passive children owning a closely held business are at a very high risk of incurring family disharmony, a strategy to avoid such problems, yet provide for equal shares o f the estate passing among children, is to include provisions designed to balance out the equal shares of the non-business assets passing to passive children with the equal shares of the business interests passing to active family members. Nonetheless, a serious problem is presented if there are insufficient non-business assets to equalize shares of the estate going to passive children. Here, one such approach is for the parent to require active family members receiving a business interest to purchase any business interest in excess of their shares that otherwise would have been allocated to passive children, perhaps under a prescribed installment purchase method with a reasonably small interest rate so as to ease any economic burden that would otherwise by be imposed on active children. Another more family-harmony-friendly strategy not putting active and passive children into such debtor/creditor relationship is for the parent to purchase a life insurance policy on the parent, if economically feasible and not prohibited by the parent’s current state of health, to provide both estate liquidity and sufficient assets to balance the shares of the estate such that the business assets may all pass to the active children.

In situations when it is determined that there is no foregoing viable alternative but for a parent to give business...

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