All in the Family: Harmonizing Inheritance around a Multi-Generational Business Transfer

By: Randy Fox
Firm Name: InKnowVision
Contact: Randy@inknowvision.com
Location: Naperville, IL
Industry: Tax Consulting

Quick Read
Jane Jaffe is 82, has four grown children, and has a net worth of about $8M. Currently $6.7M of her net worth is in the stock of Jaffe Corp., the S Corp that she and her husband founded early in her marriage. Jane's son, Gerald, has been successfully running the business for the last 15 years and owns almost all of the balance of the outstanding shares, currently valued at around $8M. Jane would like to transfer all of the company stock to Gerald upon her death but that leaves no significant inheritance for her three daughters. Gerald's son has come into the business and would likely be the next in line to take control when Gerald retires. With the company in the final stages of buying out its only outside shareholder, the note payments are utilizing most of the Jaffe Corp.'s excess cash flow.  

Challenge
The estate does not have enough liquidity to make the large estate tax payments on Jane's death, and son Gerald will face the same problem in the next generation, once the balance of the company's outstanding shares are transferred to his estate. There is currently no way to leave an inheritance for the other heirs, and most of the company's excess cash flow is tied up in note payments.

Design
Because there has been no advanced estate planning completed we wanted to devote our full attention to the current state of affairs and interpret how that would affect the family if no further actions were taken. Fortunately our use of the Family Wealth Diagnostic and the Family Wealth Goal Achiever effectively illustrates the risks and opportunities, and uses those outcomes to develop a strategy that helps the client achieve specific financial goals. While this most certainly has a positive impact on the client, it also reflects well on that of the attorney who elected to work alongside our team.

As we discovered utilizing the Family Wealth Diagnostic, there are several areas of risk. There is not enough liquidity in the estate to pay the estate taxes at Jane's death whether it is now or at her normal life expectancy. In addition, Jane's current will leaves all of the company stock to Gerald, thereby disinheriting her daughters.  Upon his death, Gerald will have the same problem that Jane has now.  In order to create a desirable outcome for the family we developed a sophisticated structure for:

·         Increasing liquidity

·         Establishing a tax-free business transfer

·         Maximizing inheritance to other heirs

Using the Family Wealth Goal Achiever we were able to develop a successful strategy which helped the client to establish a means of achieving all of her goals and more:

1. Re-capitalized Jaffe Corp. shares into voting and non-voting shares
2. Appraised shares, resulting in a 35% reduction in value
3. Sold non-voting shares to Grantor Deemed Owner Trust (GDOT) in exchange for note
4. Determined the note will accrue interest until Jaffe Corp. completes the purchase of the       other shareholder's interests and then commence interest-only payments to Jane
5. Structured GDOT as a Dynasty Trust, keeping shares in the trust and out of Gerald's taxable estate
6. Positioned Dynasty Trust as a multi-generational tool to preserve ownership of family business
7. Purchased life insurance on Jane through GDOT by borrowing premiums from an outside source, creating a private premium financing transaction
8. Designated policy proceeds as security to pay back borrowed premium upon death, due to the cash flow

Results
With this advanced plan there is adequate liquidity to pay the estate taxes. Gerald will receive full control of Jaffe Corp. without compromising his estate, and the other children will each receive anywhere between $2M and $3M. Considering that Jane is currently 82 and has not done any planning until now, the family is more than pleased with the results. Equally important is the satisfaction of the attorney on this case.  As a sole practitioner, it was difficult for him to see the areas of greatest opportunity for Jane and her family. Working with us through this case has given him the confidence to work with other high net worth clients without fear of failure.

Lessons Learned

·         Create a program that capitalizes on large share balances for tax purposes

·         Use Dynasty Trusts to transfer ownership without adding value to taxable estates

·         Advanced planning creates a win-win situation for everyone

Randy Fox, CFO, InKnowVision, LLC

www.InKnowVision.com

randy@inknowvision.com

LinkedIn: Randy Fox 

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