When individuals are deciding how best to structure their estate plans, the question often comes up as to how to treat their children fairly. Unfortunately, in estate planning, depending on the types of assets involved, treating all children fairly may not always mean treating them equally.
Take the example of an individual who owns a family business, has some taxable investments, and a few retirement accounts. The family has three children, and only one of whom is involved in the family business. What approach is fair here?
Should the child who is involved in the business receive only that business as part of their share, while the siblings receive the remainder of the estate? What if the business is not doing well financially? Or the flipside, what if the business is the largest asset in the estate—far in excess of the other estate assets—what will the children not involved in the business receive? What if the child who is involved in the business no longer wants to be involved after Mom and Dad pass away?
What is the best way to treat each child fairly? With family business assets, there are several approaches.
One approach, if the business is the largest asset in the estate and the child wants to stay in the business after their parents’ death, it might make sense for the child to receive the business as part of his or her share of the estate. He or she can then “buy out” the siblings’ shares over time for any amount over and above what the siblings may receive from other assets in the estate. The child receiving the business then can receive the future profits of the business, but also has to continue to manage the business over time and suffer the losses on his own, while continuing to make payments to his or her siblings.
Sometimes with this approach, individuals will purchase life insurance and name the other children not involved in the business as the beneficiaries. This allows them to receive a chunk of money at the parent’s death while also somewhat diminishing the amount the child continuing the business might have to pay to his or her siblings.
Another approach, if the business were a small part of the estate, could be to pass the business to the child and make up the difference from other assets of the estate. This allows the child operating the business to receive some liquid funds from the estate (like his or her siblings) in addition to the business itself, to possibly offset the cost of continuing to operate the business. With either approach, the business’ value comes into question. Some wills include a provision requiring a number of appraisals be done of the business with an average being taken of those valuations in determining the final value. Other families may instead have an agreement in place between the parent/business owner and the business (or the child working in the business) that values the business based on a certain methodology chosen when the owner is alive. No one valuation method must be used, and no method is wrong as long as there is some methodology used for the valuation.
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Family Vacation Home
The family vacation home is another asset which may lead to fair, but unequal treatment among the children. Often, we see individuals pass the family vacation home to all of their children, or at least allow all of the children a right to purchase the vacation home based on property appraisals.
The questions that generally arise here are: Who will pay the upkeep, property taxes, utilities, etc., for the property? Who decides what upkeep is necessary, and who is allowed to stay at the property at any given time? What about the child who lives thousands of miles away and would never use the vacation home? Sometimes, that child may receive something else from the estate in lieu of the property.
To assist with the expenses related to the property, an individual may provide for a sum of money to be held in trust to pay the expenses, tax, and upkeep of the property. The struggle with this approach is how to know there is enough money in the trust, and what happens when the money in the trust is exhausted. Who pays the bills then? When you have children of different financial means, which is commonly the case, this is often a very difficult question to answer, and it can ultimately lead to the need to sell the property as a result that no one wants it.
There is no right or wrong rule for how to handle the vacation home. Each situation is unique. Members of the family know who will use the property, who can pay to keep the property if any trust funds run out, and which children get no interest in the property. If that situation exists, the most fair and equitable method may be to allow each child the right to purchase the property or, if no one can do that, to authorize the sale of the property.
In a different scenario, there may be family property that two out of three children want to sell (or cannot afford to keep), and one child that wants to keep in the family. Generally, this may only be resolved with some court action, unless the children can ultimately come to an agreement. For these reasons, it is very important to have a discussion with your children about how the property will be managed after your deaths to ensure that everyone is on board and has the financial means, if necessary. In some cases, the only alternative may be to sell the property if the children cannot work out how to keep the vacation home.
Not everyone wants Mom’s fine china and crystal or Dad’s coin collection. When any personal property item has a substantial value associated with it, the value must be considered in dividing personal property among your children.
Most often, individuals either provide for the property to pass “in equal shares” or allow the children to choose items they may want and make up any dollar difference with other estate assets. This is generally fair, although it may be unequal. If two children want the same item, then the question becomes how to resolve the fairness issue.
“Fairness” can be resolved by an executor, but what if the executor is one of the children who wants the item? Now what happens? Every estate attorney has stories of families who’ve feuded over personal property. We’ve seen one involving five children who could not agree on the distribution of the property, leading to an estate sale and ensuing arguments about the true value of items. Ultimately, family relationships were broken. The best plan to ensure your estate does not devolve into infighting is to first decide who is to receive what specific items. Giving items to your children early or making a list to be used in conjunction with your will, can help ensure everyone understands the intended recipient. Having tough conversations with your children about which child may receive specific items may avoid a dispute altogether.
Fair Is Not Always Equal
In addition to considering the different approaches for how certain items in your estate may be distributed, there are other factors to consider.
Dependent on the asset, there may also be income tax consequences. For example, if one child receives the family business and the other receives the retirement accounts, the transfer of the business to the child would generally not incur income tax if transferred at the parent’s death, since the business would receive a step up in basis to the date of death value. Taxes would then be incurred on any future sale of the business if the sale price exceeded that date of death value.
Alternatively, the child who receives the retirement accounts will pay income tax every time he or she withdraws funds from the retirement accounts. What is initially fair in dollar amount may not result in equality because of the income tax burden.
There are several factors for consideration when determining how to best transfer assets to your children, including potentially weighing the income tax consequence. For that reason, it is important to give significant thought to the transfer of these assets and the impact on not only the individual receiving them, but also the overall family dynamic that will result.
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Please consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this article is not intended as legal or tax advice.
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