This is the fourth part of a six-part series focused on planning and implementing a successful succession strategy. The series focuses on a business-owning couple—William, 63 and Susan, 60—along with their three children: Nancy, 28; John, 25 and Amanda, 20.
While this family is fictionalized, its members represent the clients and issues I have worked with extensively over the course of the last two decades.
The first part told William and Susan’s origin story. The second focused on building a governance plan that insures the right people are making the right business decisions. The third part covered the financial planning process.
Now this fourth part explores William and Susan’s legacy plan—and the business’ role in it.
What Is Legacy Planning
The first question is what, exactly, is legacy planning and how is it different from estate planning?
Similar to a financial plan, legacy starts with a definition of purpose. The legacy purpose statement answers the following question: What story do I want my assets to tell when I am not here to tell it myself?
Answering that question, and crafting that purpose, means clarifying the intersection between people, purpose and property. For example, if the people are your children, the purpose is economic safety and the property is your stock portfolio, your statement of legacy purpose might provide that your assets can be used to help your children avoid financial hardship.
Or, if your purpose is education and the people are your descendants, you may decide to create a “multi-generational bank” with your assets funding their education costs into perpetuity.
Connecting Legacy And Estate Planning
While William and Susan’s statement of financial purpose and legacy statement should be incredibly similar (same values, same loved ones, similar property), there is a material distinction between them. The statement of financial purpose is intended to be executed by William and Susan themselves.
It is a document designed to create clarity (who and what matters to them) and alignment of resources. By contrast, the legacy statement is meant to be executed by others; it is only acted upon when William and Susan have passed.
Therefore, not only does the legacy statement need to be thoughtful about governance (see part 2) but also needs to be implemented through formal legal documents such as trusts, wills and powers of attorney. In other words, the legacy statement covers the whys and hows, while the estate planning documents lay out the whats.
For example, when William and Susan pass away, their legacy statement might indicate that they want to have Jackson owned and run only by their descendants. If that ownership structure is important to them, then leaving the Jackson stock outright to their children might be inconsistent with that intent, given that their children’s intentions might be different than theirs.
In that situation, they might decide that the best way to effectuate their legacy is to have Jackson owned by a trust that incorporates those intentions into multi-generational rules.
Or if their legacy creates a family education funding bank, the assets should not be left outright, because there is no guarantee that the children will use the property to educate their descendants.
The legal estate planning documents will be dictated by the legacy statement. If William and Susan want to implement their purpose and values, they will need to leave the property in a trust designed to do so. On the other hand, if they want to implement their children’s values, they could leave the assets outright to the children. Could…but not should.
Creditors, Predators And Divorcing Spouses
Let’s assume for a moment that William and Susan’s legacy statement makes it clear that they want to leave their assets to their three children to do with as they please (a pretty common legacy). As mentioned above, they could accomplish that goal by leaving the assets, including Jackson stock, to their children outright. But that is not what a good advisor would recommend.
The best plan to accomplish those goals would be to leave those assets to a trust. A trust is the best tool to accomplish different objectives. One such objective was mentioned above: wanting to separate decision-making authority from enjoyment. Another objective that is well served by a trust is to remove the detriments of outright ownership.
For example, if someone owns property, their creditors can seize it. Predators could steal it. And divorcing spouses can split it. But if property is instead owned by a trust created for their benefit by another, none of those detriments of ownership exist.
If William and Susan want to protect the children from creditors, predators and divorcing spouses, they will leave their assets, including Jackson, not to their children, but rather to trusts for their benefit. Each child can have decision-making control over his or her trust, and if the trust is well designed, still have those protections.
Moving From Defense To Offense
What we have learned so far is that there are compelling reasons to leaving our assets, for the people we care about, in trust. But there are also reasons that William and Susan might want to create trusts, and transfer their property to those trusts, during their lifetimes.
First, I want to point out that there is a legal distinction between the protections of a trust created by someone else for you and a trust you create for yourself. Under the asset protection laws of most states, when you transfer your assets to a trust you have created for yourself, those assets are not protected from creditors, predators and divorcing spouses. Further, those transferred assets will be subject to estate taxes at your death.
The estate tax is a tax collected on certain property that you (1) own or (2) have certain “disqualifying rights to” when you die. Without getting into a deep dissertation on the nuances of the estate tax, if you transfer property to a trust wherein you are either a beneficiary (you have the possibility of enjoying the property) or a trustee (you have the right to control the property), that trust’s property is estate taxable to you.
If, on the other hand, property is transferred by another to a trust in which you have those rights, it is simple to constrain those rights “just enough” to avoid estate inclusion.
The estate tax is collected on the value of all assets that are in excess of the lifetime exemption. Under current law, if William were to pass away in 2022, his exemption would be around $12 million. However, if he were to pass away after 2025, that exemption is cut in half.
For example, assuming no growth in the exemption (it increases annually by the CPI), and assuming William has $8 million that does not grow in value, if he died in 2025, he would owe no estate taxes. But if he died a year later, he would owe taxes on $2 million ($8 million of assets less a $6 million exemption). And given the flat estate tax rate of 40%, his estate would owe $800,000 to the IRS within nine months of his death.
A couple of additional comments about the operation of the estate tax:
- There is no estate tax due on the transfer of property to one’s spouse.
- Second, married couples can use their exemptions collectively, so in 2022, the surviving spouse can pass $24 million to their children without estate taxes.
- Third, the same rules apply to lifetime gifts (taxed based on value given, $12 million exemption, no limit on tax-free gifts to spouses) as apply to bequests. The tax is called the gift tax for lifetime transfers; the estate tax for transfers at death.
- Fourth, the assumptions used above of no growth in asset values and the exemption are impractical.
- And finally, the tax needs to be paid in cash within nine months of the date of death.
So let’s go back to William and Susan. Let’s assume Jackson is worth $30 million and the rest of their assets are worth another $10 million. If they were to pass away before 2026, they would owe approximately $6.4 million in estate taxes. But given their ages, the chances of them both passing away in the next four years is incredibly low.
And if they pass away after 2025, the tax bill, with no asset growth, increases to $11.2 million. Now presume that Jackson is growing at 20%, a fairly typical growth rate for a successful, closely held business. And assume that they live another 35 years. The estate tax bill could be upwards of $30-40 million.
While that is an incredibly large number regardless, it is particularly problematic for William and Susan. Their value is not in assets that can be converted to cash in nine months to pay the tax. It is in Jackson—an asset that cannot be sold that fast, and, for many business owners, an asset that they do not want to sell at all. Stated another way, if William and Susan’s advisors are telling them to do nothing, that is awful advice.
Before we go into what to do, a couple of observations. One, while William and Susan would have an estate tax liability if they died today ($2 million) that problem becomes unmanageable for two primary reasons: (1) the 2026 reduction in the exemption and (2) the appreciation in the value of Jackson. Two, some of the appreciation in the value of William and Susan’s assets is being reduced by annual income tax payments.
To solve their future estate tax problem, William and Susan can use their current higher exemption to give away Jackson stock to trusts. Because trusts can allow for better control or enjoyment if created by another, William would create a trust for Susan and she would create a separate trust for him.
Those trusts can be designed to be excluded from William and Susan’s estates. Making the gift now allows them to lock in the higher $24 million worth of exemptions, and it gets the appreciation in the gifted stock out of their estates.
Also, the assets they keep can be used to pay the income tax liability due on the trust property, decreasing the estate taxable assets and accelerating the growth of the trust’s tax-free assets.
After a few years, this type of planning will eliminate William and Susan’s estate tax burden and allow Jackson to pass to future generations without any additional estate tax burden…ever…
And finally, William and Susan have the flexibility to move assets, without income taxation, into and out of the trust allowing the right assets to be in the right place for the legacy they are building.
Legacy involves heart and head—how do we maximize the impact of our assets to care for the people we care about consistent with our beliefs and values. Sometimes the planning is simple; other times, it’s incredibly complex.
In our next part, we will cover a different type of complexity. Those surrounding family dynamics.