Family Business Succession
October 11, 2011
Succession Planning and Estate Planning for Family Businesses
Succession planning is as important in a family business as in a public corporation. According to the Family Business Institute, 97% of family businesses do not survive past the third generation. Succession planning and estate planning can help determine what to do if a family member who is next in line is performing poorly.
There are numerous high profile examples of failed family businesses. Perhaps the most glaring is the Busch family, founders of Anheuser-Busch. Adolphous Busch joined the struggling company in 1864, and through four generations it thrived, generating nearly $17 billion in revenue in 2008. But personal problems and failure to adapt to the market led to the company’s hostile takeover by Belgian-Brazilian conglomerate InBev.
With successful family businesses, the generation that created the wealth tends to be highly productive. The creator is frequently a larger-than-life type A personality who enjoys enormous control over the company and undertakes extreme effort for wealth creation, which can be detrimental to family relationships. The founder often does not share control or ideas about the company with his family while he is alive.
The next generation doesn’t learn about saving or wise spending, becoming accustomed to a lavish lifestyle. Subsequent generations lack the incentive to become strong, resourceful leaders and to strike out on their own to make more money. They develop a completely different ethic about spending than the previous generation. Since the founder put himself over his family, adversarial relationships develop between spouses and children, often leading to conflicts and alcohol and drug abuse.
The failure of wealth to survive to the third or fourth generation is usually not because of estate taxes or the inability to transfer the wealth, but because the knowledge of how to create wealth and then to keep it is not passed on. When the children are not integrally involved in the company before the founder’s death, they lack wisdom and experience. They also may feel they have something to prove once they take over, which can lead to reckless decision-making.
Children in the second and subsequent generations also may not be as intelligent or shrewd as the founder and find themselves taken advantage of. This is especially the case for children with a famous name. The name attracts hangers-on who do not have the children’s best interests at heart. Detailed estate planning using trusts can help mitigate this problem by not allowing the children unfettered access to inherited money.
Estate planning is also important because of the danger of drug and alcohol abuse. The World Health Organization states that the more money someone has, the more likely they are to abuse drugs and alcohol. Substance abuse is one of the most common reasons wealthy families see their fortunes squandered. Trusts can be used to help encourage entry into a recovery program or keep substance abusers away from the family fortune.
A successful family business created through dedication and hard work by one generation can be preserved through careful succession planning and estate planning by qualified professionals.
photo credit: Tumbleweed:-)
A Child’s Inheritance
September 28, 2011
Inheritance Planning for Children
Parents often worry that their children will spend their inheritance recklessly. There are a number of steps that can be taken to ease their concerns. Select financial training, carefully chosen trustees, and creatively written trusts can be used to develop a plan that gives children room to mature financially while still respecting their independence.
Parents need to make an honest determination of their children’s financial knowledge. Often, simply allowing children to sit in on meetings with financial advisors can help teach them how to be an owner of wealth. Another method is to create a family investment firm that can give children some experience. They sit on the company’s board, interview investment advisors, and hold quarterly strategy calls where the parents listen, but don’t talk. The company can even pay for financial education programs for the children. Such methods often yield surprising results.
Picking the right trustees can also be important. One approach is to have a corporate trustee who controls cash disbursement and a co-trustee who knows the child, like a longtime family friend. The co-trustee can periodically report to the corporate trustee on the beneficiary’s financial development. Alternatively, the heir could serve as the co-trustee in a sort of apprenticeship role.
Creatively written trusts are the most common way parents try to protect their assets from reckless spending. A delicate balance must be achieved between honoring the parents’ goals for their children, respecting the children’s independence, and not putting too much of a burden on the trustee.
Some parents depend on extremely specific trust language describing how their children can access inherited money, but most experts advise against this. Such language constrains both the children and the trustee and can be very hurtful to a child. Clauses that hold money back if an heir is not behaving should include generic language instead of singling out an individual by name. The goal is to find a middle ground where the parents make clear that the trust should not be the sole means of support for a child in good health.
Parents with children who are demonstrably reckless spenders or other problem heirs have several ways to use trust language to protect their assets. For example, having a trustee from outside the family can be essential for children with substance abuse problems. Trust language can give a trustee the ability to pay bills like rent or medical costs, if necessary. In addition, a trust can be structured so that a spendthrift child cannot get title to the family home, allowing the trust to buy real estate on behalf of the heir. A trust can also be set up so a child’s creditors cannot access the inheritance.
Parents must realize that a trust can continue for more than one hundred years, so clauses should not be too narrow or specific. Trustees should be permitted to adapt to changed circumstances. A great approach is to include a letter with the trust documents which can expand on the legal language to explain the parents’ decisions.
photo credit: quinn.anya
Student / Dependent
August 9, 2010
Joe,
My daughter is entering her third year at the University of Minnesota this fall. Up until now we have been claiming her as a dependent, but I am hearing that rules for claiming a dependent are more complicated than verifying that they are your child and in school. What are the rules for this?
Percy, St. Paul
Percy,
Thanks for your question. You are absolutely right in saying that there are more qualifications to claiming someone as a dependent than they are your child and attending school. And given the soaring costs of tuition, room and board, and other “related” expenses, the ability to claim a child as a dependent come tax time is a vital wealth-management strategy.
The good news is that, unlike many IRS laws, the rules regarding dependency are relatively simple. Well, sort of.
A dependent is defined under IRS § 152(a) as either a qualifying child or a qualifying relative. Well, what is a qualifying child or relative?
To determine that, the individual must meet the qualifying general dependency test under IRS § 152(b). Namely the child must:
• Not be married. Unless, if married, the couple did not file a joint return for the past year or if the couple did file jointly, they did so only to claim a refund.
• Be a citizen, resident, or national of the United States or a resident of Canada or Mexico.
If the student in question meets the requirements of IRS § 152(b), then you move on to IRS § 152(c). That says a student must also meet these four tests:
• Relationship Test. The child must be either the taxpayer’s: child, stepchild (by blood or adoption), foster child, sibling, stepsibiling. Or a descendant of any of those.
• Age Test. The student must either be under 19 years old, or a full-time student under 24 years old. What constitutes a full-time student varies from school to school.
• Residency Test. The student must live with the taxpayer for half of the year. However, a student is considered “living with” an individual even if away due to a host of factors such as school or military service.
• Support Test. The student cannot provide more than half of college-related expenses himself.
So be careful in how much your child contributes to his education or be unable to claim your child as a dependent.
Seems simple enough, right? Well there are more complicated rules on things such as how divorced parents can claim dependencies. For those your best bet would be to contact a qualified CPA for more detailed advice.
Hope this answers some of your questions, Percy. If you have more questions feel free to give me a call and we can discuss further. Best of luck to you and your daughter.
Best,
Joe Rapacki
photo credit: chris.corwin
College Planning
June 2, 2010
Joe,
My oldest daughter is two years away from college, and my youngest is a freshman in high school. My husband and I had put some money aside over the years, but it has taken a real hit in the past two years. I want my kids to go to a good school, but I just don’t know how we can afford it. Do you have any tips?
Miranda, St. Paul
Thanks for your question. First, don’t panic. You’re in the same situation many parents find themselves in. Parents with college-ready kids are facing a perfect economic storm. First, the accounts they have spent years contributing to are taking a beating. Even families who planned ahead for their kids to attend college are seeing their accounts dwindle.Hope these tips help, Miranda. If you have further questions please don’t hesitate to contact me.
Not only are accounts dwindling, but college expenses are increasing. College tuition and living expenses rise, on average, 5-6% per year—far out pacing inflation. Colleges have become businesses who must recruit for the best students. And the things that attract students—new academic buildings, trendy student lounges, and “free” iPods and laptops all cost money. Guess who gets stuck with the bill?
But even as costs continue to skyrocket, parents continue to trot their kids off to college in record numbers. The U.S. Census Bureau notes that college attendance rose some three million students in the last six years—with 29.3 million students trotting through ivy-shrouded academic buildings and living on a diet of cold pizza for a year. Parents are OK with one less meal out a week or selling the family boat, but struggle to tell their kids they can’t attend college. And there’s a good reason for that: Most jobs now require at least an undergraduate degree—and many an advanced or specialized degree—for employment.
So what do you do?
First. Keep saving. You hear about parents who start applying to top-notch schools before their kids are born? They sound over zealous? Maybe. But start saving when your kids are young, contribute to a 529 Savings Plan.
If you want to estimate what a school will cost look at their current tuition and room and board expenses for 2010-11. Then add 5-6% for each year away from college your kid is. That means if a schools currently has a fee structure of 25,000 dollars (a mid-level state school), it will cost about 28,940 dollars by the time your current 10th grade kid attends her first year. Scared yet? That is just the first year—remember to plan on a 5-6% increase yearly.
Next, sit down and have a frank conversation about the realities of college. Too many parents fall in to the sentimental trap of giving in to whatever their kids want for college, regardless of finances. This is both dangerous and foolish. With your kid, sit down and make a list with three categories: dream schools if finances are not an issue, mid-level schools that you see as realistic, and safety-schools if your financial situation gets worse (yes, that can still happen).
Next, keep saving. Remember: 5-6% increase a year.
Here’s the secret most people don’t know: Almost no one pays the full sticker price of a college. Most schools, especially private schools, offer generous financial aid packages. The only way to find out what money your kid is eligible for is to apply to a school and see. Also, make sure to fill out the FAFSA. That is the document that will determine the amount in loans and grants your student qualifies for. There are subsidized loans and un-subsidized loans. Subsidized loans are preferable because the interest on them does not start accruing until the student is not in school full-time anymore.
In addition, here are some other general tips in funding college.
Do: Encourage academic performance. One of the most overlooked college financing options rests with your kid. Students who perform well academically and score high on the ACT/SAT are eligible for a host of scholarships—both at the school and privately. There are many private scholarships that go unawarded each year for lack of applicants. Have your student talk with his or her guidance counselor for advice where to look and apply.
Don’t: Bank on athletic scholarships. You have a better chance of winning the lottery.
Do: Consult the numerous resources that rank college. The US News and World Report and Princeton Review are two of the better ones. They rank schools by everything from academic reputation to cafeterias to value. But be advised: The term value applies to more than tuition and what the student is afforded in terms of opportunities at the college. For instance, St. Olaf and its 45,300 dollar comprehensive fee is listed as a best value.
Don’t: Take the rankings as an end all be all. There is a lot of debate amongst colleges as to the utility of such ranking services. Many schools are ranked on past numbers and, if you are cynic, on the money they contribute to the publications. Still, they are a guide.
Do: Consider all schools—both public and private. As state earlier, many private colleges, even though they carry a higher comprehensive price tag, end up being the same price or cheaper based on the private scholarships they can offer.
Don’t: Give up on a public school because it is out of state. Many states have reciprocity agreements with other states to encourage cross-state matriculation of students.
Do: Consider loans. Almost all college students have them, and their low interest rates usually make them comfortable to repay with a typical post-college job. Also, knowing that the student will be paying for the education later often makes him more invested in school while there.
Don’t: Be tempted by the low interest rates of home equity loans to finance college expenses. Yes, the interest rate is low, but home equity loans cannot go into forbearance if the student goes on to graduate school or is unable to afford the payments the way other education-related loans can.
Best,
Joe
Noncustodial Parent
November 1, 2008
Joe
My accounting question to you is:
For how long can I claim my children as dependents? I currently claim 2 of my children on my tax returns. My son (21) and daughter (18). They both are attending college. I also have another son (15) who is claimed on his dad’s return. Can we exchange children on our claims or is it best to keep consistent?
J. H.
Hello J. H.
The general rule is that your son and daughter can be dependents if they are under 24 at the end of a tax year, and a student. Your children cannot provide more that one-half of their own support. Your children may work during the year, but keep in mind that they should not claim themselves as an exemption if and when they file their personal tax returns.
As far as the 15 year old son, the general rule for the custodial parent to claim the child as a dependent. In order for the noncustodial parent to claim the child as a dependent, the custodial parent should sign a Form 8332 Release of Claim to Exemption for Child of Divorced or Separated Parents). The form may indicate that the custodial parent releases the claim for a single year. For a number of specific years (e.g. alternate years), or for all future years. The form is attached to the noncustodial parent’s return. If the form is for more than one year, the original Form 8332 is attached to the return for the first year, and a copy is attached to each subsequent return on which the noncustodial parent claims the exemption.
Joe Rapacki
Photo Credit: Louisiana Tech Homecoming 2005 by Jason Gulledge, on Flickr
