The passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Relief Act) has opened an unexpected window of opportunity for the tax-exempt transfer of significantly more wealth to the next generation than was possible under prior regulations. The unification of the gift and estate tax exemptions at $5 million, allowing individuals to give up to $5 million tax-free during their life or at death, combined with lowering the tax rate on taxable gifts and estates to 35 percent, is very significant. It's possible that Congress will extend these raised exemption limits and reduced tax rates beyond their current scheduled expiration date of Dec. 31, 2012. But it's more likely that the urgent need to materially reduce America's structural public sector budget deficits will be met through a combination of higher taxes and spending cuts and that these tax increases won't spare estates.

This probability hasn't been lost on trusts and estates specialists who have flooded clients with the latest and greatest structures to accomplish these transfers. But, just because you can do something doesn't mean you should. Accelerating the transfer of wealth over the next two years may negatively affect family dynamics. For example, it may redistribute power in privately held companies among unprepared shareholders or place additional responsibilities on children who aren't ready to accept them. Clients may not have fully discussed or thought about these negative effects.

So, before jumping to implement these structures, it's important that your clients consider: What are the implications to the family's dynamics of accelerating substantial wealth transfers to the next generation, and how can negative outcomes be avoided altogether, or at least mitigated?

Accelerating Wealth Transfers

It's tempting to make large gifts now to take advantage of the 2010 Tax Relief Act. But other factors come into play. For example, a married couple that gifts $10 million by the end of 2012 to the next generation must consider the major implications that the gift has for both the donor and the beneficiaries. Ten million dollars remains a substantial sum, especially if it's transferred in the form of gifted corporate stock in private companies that are undervalued or in other long-lived assets such as commercial real estate or income-producing natural resource properties. If the beneficiaries are in their early 20s, the donor may be concerned about the demotivating aspects that such a gift could have on them. For example, career plans may change if a young college graduate extrapolates the appreciated future value from a stock gift received today in a private company without factoring into that calculation the execution risk associated with realizing that future value over the next decade. Unexpected gifts of assets that can easily be converted into cash may lead younger recipients to reinvest the cash into very risky ventures or ill-conceived business plans with their equally inexperienced friends, squandering decades of hard work by their parents. And unexpected wealth can significantly impact a marriage, especially if the spouses decide that they no longer need to work as hard as they did when they entered the marriage, or not work at all. This can change the relationship dynamics upon which the marriage was founded and lead to unexpected discord and divorce.

The donor might have been planning to make the maximum exempt gift in 10 years, when the beneficiaries would be in their 30s. Making a $5 million gift now, while extremely attractive from a financial point of view, could create issues that the donor wanted to avoid (that is, gifting large sums of money before he felt the beneficiaries were mature enough to handle it).

Changed Dynamics

Taking this one step further, say the asset under consideration is a privately held operating company. Once you've run through the illiquidity and non-control discounts for a gift of stock, $10 million may represent a large minority stake and have the unintended consequence of giving younger family members more power to govern the company. The beneficiaries may not have a voice at the board table today, but making such a transfer could create an important new voting block of stock that could change the dynamics of how decisions are made at the company — now or in the future. This could be a positive, desired change, or it could be fraught with potential problems. For example, donors should avoid hasty transfers driven principally by tax considerations, without giving enough thought to the governance implications of those transfers until it's too late.

If the asset to be gifted is real estate, such as the family's primary residence or a vacation house, the donor must address related questions, including what percentage of the property should remain in the donor's estate for the balance of his lifetime, relative to what's passed on to his children now. If a gift of real estate contemplates transferring more than 50 percent to the next generation, the donor should address certain questions before the transfer, including: (1) who will be responsible for capital improvements in the future; (2) under what circumstances can the property be sold or converted into an income-producing property; and (3) should a formulaic buy-sell agreement be in place in the event that the children no longer wish to share the property? A further complication arises when considering the children's current marital status and what would happen if they became divorced in a community property state and some portion of these assets were to end up in the hands of ex-children-in-law. This issue also clearly applies to gifts of corporate stock in family controlled operating companies that want control to remain in family-friendly hands. Disenfranchised ex-spouses as minority shareholders can lead to great strife absent well thought out buy-sell agreements that consider all of the “what-ifs” in advance.

The goods news is that many flexible trust vehicles and legal venues are available if you're willing to live with some level of complexity in your estate planning.

To address the changed family dynamics that may result from accelerating the transfer of wealth however, you must first be aware of them. Then, you must think through the possible unintended consequences that you would like to avoid and finally, you must be prepared to document the implementation of the solution. Working with skilled trusts and estates attorneys is critical to completing this planning cycle. At the same time, the client should formulate the vision that he wants to see and have his attorney work as an instrument of that vision, not substituting the attorney's own vision for the client's.

Consider Key Questions

Many advisors to families don't recognize that families need to spend the time discussing the difficult family issues before they meet with the financial advisor to implement the mechanics of a robust plan.

Specifically, advisors to families contemplating accelerating wealth transfer during this window of opportunity should advise their clients to consider the following key questions:

  • What defines your vision, values and goals?
  • What defines the vision, values and goals of your children and how do these converge with or differ from your own?
  • What concerns do you have about providing for the future welfare of your grandchildren?
  • What outcome do you want to avoid from accelerating wealth transfer during this window of opportunity?

Who Asks?

While family decisionmakers may think that they intuitively know the answers to these questions without formally discussing them with their spouses or children, they really don't know what their spouses or children are thinking unless they ask them directly. Further, asking their children directly doesn't mean parents will get the most truthful answers, because children are likely to be influenced by their beliefs about their parents' expectations before they answer.

Having a neutral third party (for example, an attorney or a consultant to the attorney who's a specialist in the area of working with wealth transfer issues) raise these questions removes pressure from both sides. It may also be helpful if that third party isn't a long-term advisor to the family. Why? Often the relationships that are in place between clients and their long-term advisors will color the answers from the next generation and also influence the advisor to support the viewpoint of the family member who employs him.

Overseeing New Responsibility

If donors will be gifting larger sums to the next generation than previously anticipated, they must prepare their children for the increased responsibility of stewardship of these assets. Alternatively, donors need to recognize that their children (1) don't want to have these responsibilities, or (2) aren't capable of fulfilling them because they lack the skills to do so. It's inescapable that the next generation will be impacted in ways that they and their parents may not be currently considering if they receive substantial assets now and in the future. It's wishful thinking by parents to expect even balanced, successful and driven offspring to seamlessly incorporate the oversight of unanticipated wealth into their lives — the burden of responsibility that this entails must be digested, both by the donor and the recipient, and a process must be developed to communicate and to responsibly oversee these responsibilities.

Once you've come up with the answers, structuring the solution doesn't need to be complex. Working with a trusted advisor who's experienced in this area will make things easier for the family, as well as preserve confidentiality, if the donor decides to make the larger or accelerated gift during this window but not inform the beneficiaries until a later date.

Governance Structure

Governance, as noted above in the example of the operating company stock transfer, is another major area that requires thoughtful consideration. The “right” choice of governance structure will be the one that works best for both the decisionmakers in the nuclear family and for the future generations of the extended family. (See “Checklist of Key Issues,” this page.) For example, some families, particularly those led by first generation wealth creators, typically default to the “enlightened dictator” model of governance, in which the wealth creator typically calls all the shots and informs the rest of the family of the decisions after they've been made. For other families, particularly as the second and third generations mature and begin to express their own opinions, power becomes more distributed. In many families, a small inner circle analogous to oligarchs wields power, with the most common oligarchy consisting of two people — husband and wife or siblings. Transferring wealth implicitly transfers power and impacts governance, and wealth creators need to really think through the implications of what could be smart estate planning when considered in a vacuum. For many families, it may make sense to delay the beneficiaries' knowledge of the wealth transfer for more than a few years and to maintain the current governance structure — but this should be part of a well-conceived business strategy and not an afterthought.

Get Started Early

It's critical for estate-planning attorneys and accounting professionals to reach out to their clients and revisit current estate plans, not only to recognize the current estate planning opportunities, but also to fully discuss their implications. Advisors should make sure that their clients are thinking through the iterations of accelerating the implementation of something they might not otherwise do because of the dynamics of their family today.

From our experience, it can take upwards of six months, and in some cases more than one year, to properly conceive and effectively execute an asset transfer that would take advantage of the opportunities currently available. Many practitioners, especially those who are most expert, will be in great demand over the next year. For these reasons, it's more important than ever for advisors and their clients to immediately begin reviewing their portfolios of assets and take the steps necessary to transfer those assets in a tax-advantaged manner, while first considering how such transfers may affect family dynamics.

Pascal Levensohn is the managing director of the Family Enterprise Strategies division of The Presidio Group, a San Francisco-based wealth management advisory firm


Express Yourself This photograph, “Girls in the Windows, New York City, 1960,” by Ormond Gigli (65.7 cm. by 65.7 cm.) sold at Christie's Photographs auction on April 8, 2011 in New York for $30,000. Gigli was inspired by a building being demolished across from his apartment on East 58th Street. He worked quickly to secure the permissions, models (including his wife, second floor, far right) and the Rolls Royce to be parked outside to capture this famous scene.

Checklist of Key Issues

When deciding on the right strategy and its effect on family dynamics, senior family leaders should think about their answers to the following questions:

  • What is your vision of an ideal future for yourself and your family?
  • What is your stage in life and the time horizon related to your vision?
  • Are you thinking about how to protect the value of your assets for the next generation or how your wealth can be managed for future generations?
  • What are your expectations of the capabilities of your children (and their children) now and in the future?
  • Where are you as an individual in terms of being willing to make decisions about material charitable gifts?
  • What are you willing to share with the other members of your family, and what do you wish to remain confidential between the two senior family members?
  • How will you delegate authority outside of your traditional comfort zones to your children and to the next generation?
  • What will be your tolerance for judgment mistakes by the next generation?
  • How will you manage conflict regarding those mistakes?
  • What kind of process will you put in place to further develop the next generation's capabilities?

Pascal Levensohn