Estate equalization for business owners: How to do it

By Thomas Charla
Thomas Charla is director of business markets at MassMutual.
Posted on Jun 28, 2018

We’ve all heard stories of contested wills and disinherited ne’er-do-wells among the rich and famous. Hollywood has used this storyline countless times, creating a motive for the bad guy or a righteous quest for good. It makes for great theater and even better supermarket tabloid headlines, but for the rest of us, it’s something we actively seek to avoid.

In theory, providing equal shares of your estate to your children is a case of simple math. Add up the assets and divide by the number of kids. But the problem for business owners is that the business, often the estate’s largest asset, is illiquid. There’s no cash to divvy up. And if the business is to be passed down to the next generation — specifically to those actively involved in the business — how do you make the others "whole" while keeping the business in one piece?

All good estate plans that involve ownership of a business start with a company succession plan. A succession plan details who will own the business, who will manage it, and how the business will continue once you are gone. The foundation of both the succession plan and your estate plan is the value of the business. Once you know the business’s worth, you can then anticipate estate taxes due, determine the ownership value for your successor(s), and identify any shortfalls among heirs who are not involved in the business.

Estate equalization

For business owners who find themselves in this situation — passing company ownership down to one or more children, but not others — a combination of life insurance and unequal distribution of non-business assets can be a practical way to help address a shortfall. Let’s look at a hypothetical scenario:

Bob is a successful business owner with four children. Two children, Tom and Carol, are actively involved in the business while the other two, Bill and Trish, are not. Bob’s business is valued at $3,000,000 and he has $1,000,000 in personal assets. Bob purchases a $2,000,000 life insurance policy and names Bill and Trish as beneficiaries. Upon Bob’s death, Tom and Carol take full, equal ownership of the business ($1,500,000 value for each), while Bill and Trish share the policy death benefits and personal assets ($1,500,000 value for each).

Another consideration for the business owner may be to establish an Irrevocable Life Insurance Trust (ILIT). By creating a trust that owns the life insurance policy the proceeds from the policy (which would be payable to the trust) would not be considered part of the estate and would pass through to the named beneficiaries upon the business owner’s death. In the above scenario, if the insurance policy was owned by the ILIT, the total value of the estate would remain at $4,000,000, well below estate tax exclusion limits (based on 2018 IRS guidelines). If the life insurance policy was not included in an ILIT, it would be considered part of the estate, making the total value of the estate $6,000,000.

Equal may not mean equitable

The business owner may also seek to ensure not just an equal distribution of the estate, but an equitable one as well. To consider: Since the value of the business is always changing (hopefully on an upward trajectory), is the future value of shares in the business really the same as an equal value of cash? Or perhaps the owner wants to reward the active children for their hard work on behalf of the business or infuse monies into the business (via the successors) to give them a leg up? There are many options and factors to evaluate.

Whatever your choice, your goals should be twofold: 1) protect the business and 2) ensure family harmony. Speak with your Financial Professional about the options available to you for equal and equitable distribution of your estate. Once you know the future of your business, and how you want each heir to be treated, you can then create both a succession plan and an estate plan that meets your needs.

Learn more from MassMutual…

Your business and the odds of liquidation

Understanding voluntary benefits

Insurance products issued by Massachusetts Mutual Life Insurance Company (MassMutual) (Springfield, MA 01111) and its subsidiaries, C.M. Life Insurance Co. and MML Bay State Life Insurance Co. (Enfield, CT 06082).

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own, and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.