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Business Issues
Placing Your Family Business in a Trust
Estate Planner May-Jun 2000
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How Your Children Fit Into Your Succession Plan

You've spent a lifetime growing a successful business. Now, as you near your retirement, is a good time to consider your company's future. Ask yourself these questions:

• What will happen to your business when you retire?
• How will your children divide their shares if some are active in the business and some are not?
• What is the best way to prevent the IRS from siphoning off more than its share of estate tax?
• How will conflicts among shareholders be resolved?
  You can control the outcome of these issues by placing your family business in a trust when the business is part of your estate. Let's take a closer look at issues to consider.

Choosing a Trustee

Your choice of a trustee is important because the trustee has ultimate control of your share of the business. Generally, selecting one of your children as the sole trustee may lead to problems down the line. Your children may have different ideas about your business than you. They may:

• Want to sell the company,
• Continue to aggressively grow it, or
• Use cash flow from the business to support their lifestyles.

For example, one child may want to retain a major part of the year's earnings for expansion or reserves, while children outside the business may want to distribute the profits as dividends.

To prevent dissension, consider choosing a professional trustee. But remember he or she ordinarily has a duty to minimize risk, and closely held businesses are risky by nature. Therefore, a professional trustee may be inclined to sell the business to reduce risk. But if you want your family business retained and have chosen a professional trustee, you can provide specific instructions about the circumstances under which you would permit the business to be sold, thus limiting the chances of liquidation.

On the other hand, some circumstances may lead you to choose one of your children as the trustee. If you feel comfortable that your children will be fair to each other after you're gone, it might be best to choose the child who is most active in your business. This way the trustee is the most qualified to make decisions about the trust as it pertains to the company's operation.

Allocating Profits

A critical question to consider when determining how the trust should allocate profits is: Should you leave it up to your children or should you address the issue in your estate plan? The children who continue with the family business deserve a salary and additional rewards for continuing to work to make the business successful. But the children outside the business whose inheritance is tied to the company's success should be rewarded accordingly.

For example, assume that the closely held business is a farm. A measurable reward for return on capital (cash rents) clearly belongs to shareholders. The balance of the profit belongs to the return on labor (which should go to the child in the business) and the return on bearing risk (which belongs to all the children).

Examining Tax Strategy

Don't overlook the importance of assessing your business structure and choosing the one that works best for your situation. Generally, a C corporation structure reduces after-tax returns because profits are taxed twice. The income is taxed once as corporate income, and again as a dividend to the individual investor. To prevent double taxation, consider another structure, such as S corporation, limited partnership or limited liability corporation (LLC). Profits from partnerships and LLCs have the advantage of being taxed only once, at the ownership level. But be careful! A partnership structure may expose the partners to liability they were protected from as corporate shareholders. A restructuring by your estate (after a step-up in basis) will minimize the tax cost of converting a C corporation to a new structure.

Making an Informed Decision

After you've considered the benefits and caveats, you can make an informed decision on how to best structure the trust to meet your particular needs. And after you consider issues such as who will be your trustee, the extent of the trustee's control and how to balance tax benefits with liability risk, your next step is to consult a professional. We can help you design your trust and focus your estate planning to best fit your needs.