Often when we meet with a married couple with children, one of the parents will tell us that she wants the estate administration and division to be “fair”. When we talk about what “fair” means, each person has a different idea. Some define “fair” as equal. In other words, each asset should be divided equally, across the board, on a pro rata basis, for the benefit of each child.
Unfortunately, that does not always work out the best for the beneficiaries. A classic example is a family business or farm. It may be the case that one child has worked in the family business her entire life. Would it be “fair” to give that employee/child an equal share, and to also give an equal share to her sibling who moved out of state and has never worked a single day in the business? The child who has worked on the farm or family business might have made significant contributions to the business over the years, greatly increasing the value for the family (and the parents). The child who lives out of state might want to immediately sell the business when the parents both die, and the child who is the employee might want to continue running the business, taking care of long-term employees and clients, etc.
If the children are equal owners in the business (or the family farm), and they disagree, the dispute might lead to attorneys (and attorneys’ fees), and potentially even litigation.
What can the parents do to provide a “fair” division of assets that might not necessarily be pro rata and technically equal?
1. Provide in the trust or will that the estate will be divided equally (based on approximate total values each beneficiary receives, not on an equal division of each asset), at the discretion of the fiduciary (the Trustee or the Personal Representative (known as the “Executor” in some states)). The fiduciary has a legal duty to not benefit one beneficiary over the other and should work with them to equitably divide the assets. The employee child might inherit the stock or membership interests in the business, and the non-employee child might instead inherit the family cabin and an investment account with an approximately equal value to the family business.
The fiduciary will need to fully and fairly disclose the assets and comply with the terms of any governing document and state law. Of course, in such a situation the parents would generally not want to name either of the children as the fiduciary. It would be preferable to have an independent fiduciary (or a “Unicorn” as you might recognize from prior blog posts).
2. The parents could leave the business or farm in equal trust shares for each child, with an independent Trustee. Each of the children would benefit from the annual profits or the ultimate sale of the business, but the Trustee would make the operating business decisions. The trust agreement could provide as much or as little detail as the parents wanted regarding the rights of the employee child. Should she be hired as the manager of the business, so long as the Trustee deems it reasonable? Should she have the final say before the Trustee enters into an agreement to sell the business? Or should the independent Trustee simply continue running the business as the parents had, and employing the child in her same position? The parents can clarify their wishes in the trust agreement.
3. The parents could have their business documents reviewed by their corporate attorney to see if the controlling interest in the business could be strategically held by someone after the death of the survivor of the parents. For example, if the business currently only has one class of stock, the parents might “recapitalize” to create voting and non-voting stock. The voting stock could then be given to the employee child, if the parents felt that such a structure would be in the family’s best interests. The parents might also simply leave one child 51% of the stock and the other child 49% of the stock.
4. Depending on each parent’s health and age, they might consider investing in a life insurance policy to provide liquidity at the death of the survivor. The proceeds from the life insurance policy could be used to equalize the distributions, to purchase the stock from the non-employee child, etc.
Most importantly, the parents should talk with the children ahead of time. The parents might think that each of the children wants to use the family cabin or the timeshare, or wants to own the business, but in reality, one or more children may have little to no interest in an illiquid asset. Each option to address the “fair vs. equal” analysis has benefits and disadvantages and could potentially affect the relationship between the children for years to come. Each option might have unintended consequences with respect to fiduciary duties and potential litigation, in addition to the impact on family relationships.
Is “equal” always “fair”? Sometimes, but not always. Unusual and illiquid assets warrant frank and significant discussions with family members ahead of time to address these difficult issues. Also, don’t forget the Unicorn!