This blog was written by Isabelle Cadotte – Estate and Trust Consultant with Scotia Wealth Management
If you have a child, you probably hear these words uttered ad nauseam. Whether it’s because little sis got to eat her grilled cheese sandwich with the crusts cut off or big bro gets to sleep over at his friend’s house overnight, the grass always seems greener on the other side of siblinghood. And, to be sure, only-child households aren’t immune from “it’s-not-fair-itis” either.
These dynamics can and do carry over into estate planning and estate administration, as many will and estate practitioners can attest. For good reason, too. Parents want to ensure they leave a legacy to their children in a way that is meaningful and fair. They want to lessen the risk of a dispute cropping up once they are no longer there to mediate between their children. They also want to each child to be treated as an individual in their own right, and in light of their respective characteristics and life circumstances. Children become estate beneficiaries, carrying with them the same family baggage that lead them to claim “it’s not fair” in the first place.
For many parents, dividing the estate equally amongst all children can achieve a fair outcome. But, for those involved in a family-run business – whether it’s a manufacturing operation, a centennial farm or a real estate consortium – , dividing the estate equally amongst their children might not achieve true fairness. That’s why when we’re advising families in business (as when we’re parenting) we often refer to the well-worn maxim: “What’s fair isn’t always equal. What’s equal isn’t always fair.”
Imagine a family-run centennial farm, passed down through the generations, where all land is owned jointly by Mom and Dad in their personal names, and a privately-held corporation also owned by Mom and Dad runs the day-to-day operations (“OpCo”). Daughter and her spouse take an active role in farming and Son and his spouse live and earn income exclusively off-farm. Daughter and her family all live in a modular home on the homesteaded quarter-section owned by Mom and Dad.
Mom and Dad’s mirror Wills were made when the children were not yet school aged and divide the estate equally amongst the children. Mom and Dad intend to leave the Will as currently drafted because they feel Son and Daughter will be able to come to an agreement, notwithstanding that their children’s relationship can be characterised as running hot and cold at the best of times. What happens if Mom and Dad met an untimely demise? Let’s look at potential consequences:
- All of the estate, include all voting shares in OpCo would be divided equally between Daughter and Son. The farmland would be transferred to both children. All investments and cash are likewise divvied up evenly.
- The executor (Mom’s brother) would ultimately decide whether the farmland is sold or kept. Sister is likely to want to keep the land whereas Brother may be more interested in receiving a cash windfall from its sale.
- If Brother is amenable to releasing his interest in the farm property (the land, equipment and OpCo shares) in exchange for value, Sister would need to use her inheritance and possibly have to obtain additional financing to “buy out” Brother’s interest. If she cannot obtain financing or a fair value cannot be agreed upon, Sister and Brother will have to continue running the family farm business together.
- In which case, decisions as to when and on what terms OpCo can purchase new machinery, at what price cattle should be sold or how to assure cash flow stability during the off-season must now be made by Sister and Brother.
- Likewise, Sister must now get Brother’s approval to set the annual rent amount for OpCo’s use of the farmland. Brother might feel an appropriate rent amount is fair market value whereas Sister may wish to continue the longstanding practice of offering a discounted rate to OpCo to ensure continued viability of the business.
- Sister and her family now live on the homesteaded quarter-section at the pleasure of Brother. He may decide it wasn’t fair in the first place that Daughter got to live rent-free on Mom and Dad’s land for all these years despite the modest wage she received for her years of hard work on the farm. Brother might insist that Sister pay rent. If Sister wants to refinance to renovate the home, she must obtain Brother’s approval and he may not be pleased to become a co-mortgagor on title.
- If the intergenerational farm rollover isn’t available (or an elected cost cannot be agreed upon) or Mom and Dad’s lifetime capital gains exemption isn’t sufficient to cover the estate’s tax liability, a portion of the estate must be realized to pay the tax debt. In turn, this would reduce the funds available to Sister to buy out Brother and potentially put the viability of the farm business at risk.
- The executor here was not beneficially interested in the estate, which greatly improved the likelihood of an impartial estate administration and the resolution of disagreements between beneficiaries. But, had Brother and Sister been appointed as co-executors, who then would have been there to resolve impasses and make appropriate, impartial decisions?
The practical result doesn’t seem all that fair to either of the parties, and is likely to cause ongoing business management and ownership issues down the road. As advisors then, it behooves us to consider how to help our clients involved in family businesses to attain a fair outcome – both in the estate distribution and its administration – without risking the family legacy.