Creating a Legacy

How estate and tax planningstarted earlycan protect your family and your business

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In the beginning, throwing all your profits back into the business makes a lot of sense. Growth is what matters. But as your business matures and your life changes, your priorities will likely shift, too. Maybe it's time to free up some cash, or perhaps you're thinking of passing the business on to your far-flung children. But how can you increase liquidity or transfer wealth without getting hit by onerous taxes or damaging your company?

The simple answer is to think ahead. It's true that estate planning appears to be first and foremost about death and taxes. But a good plan is much more than that: It's really a strategy to keep your business going. An estate plan will protect your company—and family—if you or your partner die or get divorced. It will allow you to indulge your philanthropic streak and can smooth any bumps that may arise when passing your company to the next generation. "A big chunk of this is transition management," says Paul Vogel, president and CEO of the trust division for Enterprise Bank & Trust in Clayton, Mo.

Estate planning starts with two basic premises. First, don't exceed the lifetime gifting exemption of $1 million ($2 million for married couples). Second, you must not fall prey to the estate tax, which can eat up 45% or more of your assets. Although most entrepreneurs won't be hit by the estate tax—it kicks in if assets total more than $2 million ($4 million for a couple)—those who know they're likely to be affected should start planning. "To a large extent, the estate tax is voluntary," says Allan Paterson, head of the estate and trust group at San Antonio law firm Cox Smith Matthews. "If you don't do anything about it, you will be taxed at the maximum amount. But with planning, you can use strategies and techniques to minimize the burden."

Beyond those basics, things can get pretty complex. Trust and estate planning can resemble a chess game with a finite number of pieces and nearly infinite possibilities. Preparing an estate plan with an eye to selling your business is difficult enough, but preparing to pass a business down through your family is far trickier and likely to get more complicated with each successive generation.

No two scenarios are exactly alike, and estate lawyers are likely to try many variations on a few basic themes.But most experts agree it's best to stick with the tried and true. Estate tax law is thorny and complex, and you don't want to wind up lost in a judicial labyrinth with the IRS breathing down your neck. "Start with planning that is not new," says William Forsyth, senior fiduciary counsel for Bessemer Trust in New York. "Chances are no one plan will solve whatever the issue is, but you don't want to be a tax court case."

Once you determine your goals, you'll need to work with your advisers—including a lawyer, financial planner, and accountant—to devise a strategy that uses an array of financial vehicles. Among them: insurance, gifting, trusts, family limited partnerships, and grantor retained annuity trusts.

What's important is that you don't wait until your AARP membership card arrives to get going. "Very few privately owned businesses make it down through several generations, and one reason is the failure of the senior generation to do any planning at all until it is too late in the game, or too difficult," says Forsyth.


When you're launching a company, it may seem a bit morbid to think about what could happen when you are no longer at the helm. But the unexpected does happen, as Debi Butler can attest. In the 1930s, Debi's father, John, founded Butler Gas Products, a New Brighton (Pa.) company that manufactures and distributes specialty gases for industrial and medical uses. John died of cancer in 1977, and although he had put 30% of the company stock in an irrevocable trust, protecting those shares from estate taxes, the business still owed about $200,000 on other shares. "That sounded like a lot of money to me and my sister," says Butler, then 21.

The family considered selling the company, but Debi's brother, Jack, who was also in his 20s and had been working at Butler Gas for a few years, decided to take the reins. He bought company stock from the trust and paid the estate tax bill with a combination of his own savings and the company's revenues. Today, John, Debi, and sister Barbara jointly own the 30-employee, $10 million business.

Ideally, a business owner should no longer have a controlling interest in the company when he or she dies. That ensures that the value of the business remains outside the estate. Both revocable and irrevocable trusts can be used to shelter shares in the business. And an insurance policy owned by an irrevocable trust can go along way toward easing cash needs if an owner dies unexpectedly. Another option some entrepreneurs use is to divest themselves of a controlling interest by transferring more shares in the business to a spouse.

Today the Butlers are planning aggressively to make sure the transfer to the next generation goes smoothly. Since business owners, like other people, can give any number of individuals $12,000 tax-free each year, the Butlers make annual gifts of nonvoting stock to their children. They have also set up additional irrevocable trusts for company shares. They hold life insurance policies to pay off estate taxes that might arise should any of them die unexpectedly.


Insurance policies were an important facet of the plan Junab Ali and Jay Uribe made when they started Möbius Partners, a 17-employee, $25 million info-tech consultancy and computer hardware reseller. Ali, 34, and Uribe, 35, wanted to be sure that their families would be provided for if one of them died. They purchased insurance policies valued at $5 million. Each partner named the other as his beneficiary, enabling the surviving partner to buy the other's shares. In the event of Ali's death, for example, the insurance payouts would flow to his wife or to an irrevocable trust for Ali's two girls, now age 7 and 2, to fund their educations. Ali says he and Uribe also structured their buy-sell agreement so that the surviving partner would buy the other man's shares. That prevents family members who are not involved in the business from becoming partners, but ensures they get the money from the asset. Says Ali: "When you are running your day-to-day business, you tend to forget all about wills and life insurance, and it is doubly important as a small business owner, because you are responsible for all your employees and business partners and your family."


As your business thrives, you may want to unlock some of its cash, for anything from a college tuition bill to income for an aging parent, or a philanthropic cause. You may just want to reduce the value the business contributes to your overall estate. That requires juggling the cash needs of the company with those of its principals. "It is very important to establish a situation where you have the right balance between your payroll and distributions," says Brenda Newberry, the 53-year-old chairman and CEO of Newberry Group, a 135-employee IT outsourcing company in St. Charles, Mo.

Newberry and her husband, Maurice, 55, who is president and chief operating officer, support several charities, including the United Way and Boys & Girls Clubs of America, and want to do more. One option is setting up a charitable remainder unified trust, which would provide Newberry with an annuity based on the amount of assets in the trust. After a predetermined number of years, the remainder plus any increase in value passes tax-free to the designated charities. Says Newberry: "A charitable trust would be one way to help protect some of the assets from the impact the heirs would have."

Ken Van Tuinen, CEO of West Michigan Uniform in Holland, Mich., faced the challenge of providing for his father's retirement while keeping enough cash in the business. "The cash needs of the company have to be met during that time, keeping the business growing with cash to buy equipment, attract the right employees, and to make other improvements," says Van Tuinen. His father, Gordon, founded the company in 1963 and recapitalized the company stock just before he retired in 1983. Gordon divided the company stock into voting and nonvoting shares. Then he and his wife began giving a combined $20,000 in shares annually to each of their five children, but just two—Tom, the executive vice-president, and Ken, the only other sibling working in the company—received voting rights. To provide retirement income for his father, Ken arranged a deferred compensation plan for him. He also personally purchased the two buildings the company owned, paying for them over a 10-year period. That gave his father another source of retirement income and lowered the value of the estate.


As the Butlers have found, succession planning gets more complicated with each generation. If a family-owned business is run by siblings, they are more likely to have common goals, probably based on their shared upbringing. But often by the next generation, cousins, spouses, and other relatives have different visions for the company.

Debi Butler says that because she and her brother and sister grew up in the same house, what they want for the business seems to be the same. "We knew what to expect because we were together on Easter and Christmas and for summer vacation," she says. "With the [subsequent] generations, there are a lot of different cultures and people think differently." Between them, the three Butlers have six children, two of whom have expressed interest in joining the company.

Distributing wealth among siblings can be fraught with tension, especially if some children work in the company and others do not. You may have to find a way to share your assets with multiple children in a way that everyone is comfortable with. "On the one hand, you have someone who might say: 'My sibling will receive a business interest and is worth more.' And on the other hand, the person who gets the business interest may say, 'My sibling got cash and securities, and I got a job,'" says Charles Aulino, first vice-president and director of financial planning at Glenmede Trust Co. in Philadelphia.


The Van Tuinens are now working on a plan to pass the company to the third generation, while continuing to balance the $6.5 million, 78-employee company's needs with those of the two owners. Ken owns 66% of the company, and Tom owns 14%. To fund Tom's impending retirement, the company will purchase about 6,000 of his shares during the next seven years. Tom will gift an equivalent amount to his children, Steve, vice-president of operations, and Mitch, vice-president of sales, increasing their ownership stakes. When he's 59, Ken expects a similar buyout arrangement to kick in, moving shares into the hands of his son, Patrick, currently vice-president of finance.

To transfer still more wealth from the business to his heirs (besides Patrick, Ken has two daughters, Emily and Elise), Ken set up three family limited partnerships, or FLPs. These trusts hold the company real estate, which Ken owns and the company rents from him. The FLP structure lets Ken retain 80% control while gifting 20% to his children, who get a tax break on their ownership since it is a minority stake. Explains John Barone, a wealth-planning strategist for Wells Fargo Bank: "It allows you to have a discount in transferring the ownership interest in the FLP, as opposed to the value that would be imposed if you were to transfer the ownership interest in the real estate itself." Right now, Tom's children own 9% of the company each, while Patrick owns 2%.

Once a month, Ken and Tom take time to have frank discussions with Mitch, Patrick, and Steve about the progress they are making in the business. All three sons are required to meet performance goals and to complete self-assessments. "What the final result will look like—whether Steve, Mitch, and Patrick will own one-third, or whether Steve and Mitch will own 49% and Patrick 51%, we are just not sure," says Ken Van Tuinen.

Over the years, what has become clear is that an estate plan isn't done once and filed away. Aulino at Glenmede recommends a checkup with your planner at least every three to five years, and sooner if there is a significant life change or a business opportunity arises, such as the prospect of a sale that is too good to pass up.

Meanwhile, the ongoing education of all family members is important. Every Tuesday from 7:30 a.m. to 9, the Van Tuinens hold a family meeting where they discuss succession issues. It's also their forum for creating a family covenant which elaborates the values they want the business, and those who own it, to embody. "We all agree we want to work together and enjoy this, so we want to know what will it take to be successful, for ourselves and the next generation," says Ken Van Tuinen. "My goal is to be able to see my two nephews and son be more successful than I was. And not just financially, but by continuing the values my dad taught me."

By Jeremy Quittner

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