The Crucial Role of Irrevocable Trusts when Gifting Family Business Interests

In Episode 4, through a compelling case study, hosts Danielle Friedman, Herb Fineburg, and Charles "Max" McCauley III explore the vital role of irrevocable trusts when gifting closely held family business interests for the benefit of children.

A client gifted a mere 1.5% stake in his company to each of his three children without using irrevocable trusts, aiming to save on costs. When one child faced divorce unexpectedly, the divorce proceedings centered around this small 1.5% stake in the family business owned by the child. Further complications arose when that same child, who remarried, unexpectedly died, leaving his business interests to his surviving spouse. This led to family conflicts for the children, which destroyed the relationships among the client's grandchildren.

The hosts discuss the missed opportunities for protecting the family business from the divorce and death of a child who owns an interest in the business. This Episode emphasizes how irrevocable trusts can shield assets from divorce and permanent family conflicts. Learn crucial lessons on proactive trust planning to protect both assets and family bonds. Join us for this insightful discussion on safeguarding your legacy.

If you are interested in learning more or have any questions, please feel free to contact Danielle at [e-mail], Herb at [e-mail], and Max at [e-mail]. 

Episode Transcript

Danielle Friedman (00:05):
Welcome to Trust Us Estate Planning Wisdom,
the podcast where we unravel thecomplexities of estates and
trusts to empower you with theknowledge needed for effective
estate planning.

Max McCauley (00:16):
This podcast is hosted by seasoned estates and
trust attorneys, DanielleFriedman, Herb Feinberg, and

Herb Fineburg (00:21):
Charles Max McCauley. This podcast is your
guide to the intricatelandscapes of estate planning,
including wills, trusts, andprobate.

Danielle Friedman (00:31):
Thank you for joining us, and we hope you find
the discussion informative. Butremember, when it comes to legal
matters, always consult with aqualified attorney regarding
your specific case.

Herb Fineburg (00:44):
I'd like to go over a case where we learned
that even gifting small businessinterests should be in trust and
shouldn't be outright to yourchildren. This client owned a
large rental company, and manyyears ago he gave a 1.5%
interest to each one of histhree adult children. He did not

(01:07):
want to establish irrevocabletrust for those interests,
because he thought it would betoo expensive. Later on, I
convinced him when he gave awaythe rest of the company to give
it into an irrevocable trust.But let's review what happened
to the 1.5% interest that hegave to each of his children.
One of the children who washappily married when they made

(01:27):
the gift, three years later cameto him and said he was getting
divorced from his spouse, andthat 1.5% interest became a
target of the divorceproceedings.

Danielle Friedman (01:38):
Isn't it true though that if you receive a
gift and you're married, it'syour separate property? So when
a child is divorcing, the parentcould assume that, you know,
this one and a half percent isnot going to end up with their
soon to be ex daughter-in-lawbecause it stayed in son's name

(02:03):
and he didn't commingle it withmarital property. That's the
case, correct?

Herb Fineburg (02:09):
Yeah. I think the Jordan Law was going to get the
1.5%. That was always going tostay in the family, going to
stay with the son. However,probably Max, it probably has
some impact on the divorceproceedings because it's not
only a division of property,some other things are going on
in the divorce.

Max McCauley (02:27):
Well, although
that should be the clear casewith the 1.5% in a divorce or in
any kind of litigation, there'salways uncertainty. So when in
the divorce they're valuing thatinterest, they very well might
seek discovery into that valuevis a vis obtaining tax returns

(02:48):
or financial statements or bankaccount records.

Herb Fineburg (02:51):
Their interest in the income also that is produced
by that interest, because thatimpacts his ability to pay
alimony, his ability to paychild support in addition to the
value. So it's going to be, ifhe owns it outright, the court,
which wears a divorce court,which wears a hat of equity, can

(03:12):
ask those questions.

Danielle Friedman (03:13):
And they're not just inquiring into Sun's
one point five percent, they canlook deeper into the finances of
the company, look at loandocuments, look at the tax
returns, and information aboutthe other partners in the
company, including dad'sfinancial information. So

(03:35):
daughter-in-law is getting allof this data that could have
otherwise been protected if the1.5% was in trust, because it
absolutely would not be part ofthe divorce proceeding.

Max McCauley (03:50):
Yes, Danielle, it could be very intrusive and
expensive.

Herb Fineburg (03:53):
It's embarrassing to have your daughter-in-law
know all your finances. When shedidn't know it, the only reason
she's getting to look at it isnow she got divorced. The only
reason it's becoming relevant isbecause he didn't give it in
trust.

Danielle Friedman (04:07):
So at the end of the day, Son got to keep his
one and a half percent when thedivorce was finalized, but it
was counted against him in termsof calculating spousal support.

Herb Fineburg (04:20):
Yeah.

Danielle Friedman (04:21):
And then

Herb Fineburg (04:22):
After divorce, that's when he gave him the
other remaining interest in thebusiness, which he did give it
in trust. But as life would haveit, son unfortunately passed
away just a few years later, andhis one point five percent he
left to his surviving spouse. Hehad a, I love you, Will. He

(04:44):
said, Everything I have goes tomy surviving spouse. And she
ended up getting the other 1.5%because it wasn't in this
irrevocable trust.

Danielle Friedman (04:52):
So he got remarried and he left the 1.5%
to his second wife. And the wifebecame a partner in this
business with her deceasedhusband's family.

Herb Fineburg (05:06):
Yes. It was pretty much a shock to realize
that they had a new partner, butthat's what happened when they
had given now right to the sonand he wanted it to pass under
his will to his wife.

Max McCauley (05:20):
So it sounds like there are several concerns that
could have been solved by usingan irrevocable trust who would
have addressed issues concerningdivorce, lawsuits, creditor
protection, and dad's desire tokeep the business and the family
bloodline.

Herb Fineburg (05:35):
It's always a surprise of what passed. Where
your children leave theirassets, you can't control that.

Danielle Friedman (05:41):
One question that comes up, this is really
addressed to Max as the businessattorney here. Could any of
these problems have beenaddressed through the
partnership agreement, whetherit contained restrictions on
transfer or some other terms?Not so much for the divorce

(06:02):
proceeding, because I thinkthey're kind of stuck, but for
the second kind of issue thatarose, which was the husband
leaving the 1.5% to his secondwife in his will. What, if
anything, could the partnershipagreement have done?

Max McCauley (06:20):
You can eat away at the concerns. There's no
substitute for using theirrevocable trust. But two
things that come to the top ofmy mind would be, as you said, a
transfer restriction or maybeput differently, a buy sell
provision in the operatingagreement or partnership
agreement that says in an eventof divorce, the company has the

(06:41):
right to buy it back at acertain stated value or even a
discounted value. You canaddress it that way. But
secondly, as a matter ofcontract law, partnerships and
operating agreements, excuse me,limited liability companies and
partnerships are creatures ofcontract.
A fundamental tenet of thecontract law is you can't force

(07:02):
somebody to be a partner to acontract if the other parties
don't agree. Now, that againdoesn't solve the problem
completely because although thatspouse may not have the right to
vote or participate indecisions, the court would
certainly assign an economicvalue to the rights that were

(07:23):
given to her. So you're stillgoing to have to deal with that.
So if you didn't buy that spouseoutright, like what's the case
here, again, the buy sellprovision might help you. But
the silver bullet, the concernthat solves all of these would
really be the use of theirrevocable trust.
So yes, from a business planningstandpoint, from a business

(07:46):
attorney standpoint, we canaddress it in part, but the
better solution is to use theirrevocable trust.

Herb Fineburg (07:53):
And in this situation, it would have been
very important because each ofthe three children were actively
involved in the business. Theywould have been getting one who
passed away, The spouse wouldn'tbe working for the business,
wouldn't be getting a salary.The other two would be getting a
salary. Then the common problemis the surviving spouse asking,

(08:13):
What is your salary?
Is that reasonable? Shouldn't webe paying more dividends? They
become business partners. Thatis where the relationship starts
to evolve or the familyrelationship starts to
disintegrate.

Max McCauley (08:28):
Good question, Danielle. The short answer to
your question is yes, in part wecan. As a business attorney, we
can address these concerns withtransfer restrictions and buy
sell provisions, but the bettersolution is to use their
irrevocable trust, and a morecomplete solution is to use
their irrevocable trust.

Danielle Friedman (08:46):
And how did things end with the wife? Did
she end up being a partner, ordid they buy her out? Or, you
know, What happened to the 1.5%at the end of the day?

Herb Fineburg (08:58):
Yeah, they didn't want her to be a partner, so
they bought her out, theynegotiated a price, she got what
she wanted. It was of courseunfortunate, it got nasty, she
stopped talking to our client'sson and daughter, and this also
impacted our client'sgrandchildren. They stopped
talking to each other becausetheir mother was fighting with

(09:21):
the family. So it resulted in adestruction of the family
itself. Very powerful,unfortunate result when you
don't do proper planning.

Danielle Friedman (09:35):
It's really too bad that at the end of the
day, this minor interest in thiscompany that dad wanted to save
a little bit of legal fees onand not put an irrevocable trust
ended up being so disruptivethrough multiple major life
events, and ultimately resultedin disintegration of these

(10:01):
really important relationships.I mean, we think about trust as
protecting assets from creditorsand, you know, from other claims
and just passing down wealth,but they also avoid these types
of conflicts.\

Herb Fineburg (10:18):
They preserve, in essence, they preserve family
relationships. And those are themost valuable things that we
think about when we think aboutour children and our
grandchildren.