Introduction
If you have given shares of your closely held business to your participating children during your lifetime, you can include an equalization clause in your will or trust to ensure that your nonparticipating children are treated fairly upon your death. An equalization clause directs your executor to ensure that your nonparticipating children receive equal treatment with respect to distribution of your wealth before any remainder of the estate is distributed. This can be accomplished only if you have sufficient assets to effectuate equalization.
Example(s): Ted owns a business. His son, Bob, works for him. His daughter, Nellie-Mae, does not. Ted wants to ensure that both Nellie-Mae and Bob receive equal shares of his estate. In each of the last six years, Ted has given Bob shares of the business valued at $10,000, for a total of $60,000. He has made no such gifts to Nellie-Mae. If Nellie-Mae and Bob each receive half of Ted’s remaining estate upon his death, then Bob will have received significantly more of Ted’s wealth than Nellie-Mae.
Example(s): Ted puts an equalization clause in his will directing his executor to equalize distributions to Nellie-Mae and Bob before distributing the remainder of the estate. Upon Ted’s death, the estate holds net assets valued at $200,000. The executor makes the following calculation to determine what each child will receive:
| Net Estate | $200,000 |
| Value of Lifetime Gifts to Bob | + 60,000 |
| ———- | |
| Subtotal | 260,000 |
| Divided by Number of Children (2) | |
| Total to Each Child | 130,000 |
| Distribution to Nellie-Mae | 130,000 |
| Distribution to Bob | 130,000 |
| Less Amount Received during Lifetime | – 60,000 |
| ———- | |
| Total Remaining Distribution to Bob | $ 70,000 |
Strengths
Generally inexpensive and easy to do
Arranging to have an equalization clause inserted in a will or trust is fairly easy and inexpensive. It is imperative that your intentions are clear in writing and that your records properly reflect the value of gifts transferred during your lifetime. Your executor will need this information to make accurate calculations and avoid disagreements among your children.
Shifts burden of equalizing distributions to your executor
Use of an equalization clause allows you to avoid making an immediate decision about how to equalize distributions. It makes your intentions clear and leaves your executor to work out the details based on the circumstances that exist at the time of your demise.
May allow you to minimize estate taxes
Transferring shares of your business to your participating children during your lifetime will reduce the value of your business in your estate, and you may be able to minimize potential estate taxes. The equalization clause can be applied to the balance of your estate to make sure that nonparticipating children receive fair treatment.
Tradeoffs
Does not guarantee that sufficient funds will be available
An equalization clause, by itself, does not guarantee that your estate will have sufficient funds to carry out your intentions. If you survive well beyond your life expectancy and hospital or medical expenses erode the value of your estate, there may be few remaining assets for your executor to administer. If that is the case, your nonparticipating children may receive less than your participating children, regardless of your best intentions. You can be more certain that cash will be available for nonparticipating children by equalizing estate distributions using life insurance or a buy-sell arrangement .
Does not solve corporate control problems
Many equalization plans seek to make assets available to nonparticipating children while allowing the participating children to maintain control over the closely held business. Equalization clauses do not provide such a mechanism. If your estate contains only business assets, your nonparticipating children may end up owning a voting share of the company.
Tip: Use of an equalization clause in conjunction with a nonvoting stock arrangement or buy-sell agreement may eliminate this concern. Or, the equalization clause can tell the executor which assets to allocate to which children, assuming sufficient assets exist.
Leaves executor to work out details
By using an equalization clause, you leave your executor to work out details of the distribution scheme that are not otherwise made explicit in your will or trust. Circumstances as they exist upon the date of your death may differ from their original condition. You may not have been able to anticipate all possible variables. You will be leaving important decisions about your family and your family business to someone else.
How to do it
Transfer shares of family business to participating children during your lifetime
Transferring shares of the family business to your children during your lifetime may help to minimize estate taxes by reducing the value of the business held by your estate. Transfers can be made systematically over a period of years to take advantage of the annual gift tax exclusion.
Speak to an attorney about equalization issues
You will want to discuss your situation and equalization issues with an attorney who is familiar with business planning and tax issues. The attorney should draft the equalization clause as part of your will or trust.
Keep accurate records
Your executor will need to know exactly what was transferred to whom during your lifetime. Good records can help your executor make accurate determinations and settle conflicting claims made by heirs.
Periodically review the plan
You should periodically review your plan. Hospital and medical expenses could diminish your estate, the value of your business assets could change dramatically after you retire, or you may decide to make additional gifts to children. You want to be certain that your estate will have enough assets to carry out your plan in a way that makes sense for your family and the family business. Otherwise, you may need to explore other planning solutions.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal professional.
LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.
This article was prepared by Broadridge.
LPL Tracking #1-595960
