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Golden Handcuffs, Part 1: Should an Active Heir Receive a Bigger Piece of the Pie?

  • 27 May 2014
  • Author: Cari Holbrook
  • Number of views: 3193
  • 0 Comments
Golden Handcuffs, Part 1:  Should an Active Heir Receive a Bigger Piece of the Pie?

Welcome to Part 1 of our blog series on “Golden Handcuffs: Passing Down the Business to Heirs.” Over the next few months, we’ll discuss ways to pass down your family business to your heirs. Some heirs may be active in the business, others may be passive; this scenario holds many challenges. In this post, we look at ways you can answer the question:

Should an active heir receive a bigger piece of the pie?

An active heir in the family business plays a special role in keeping the business thriving. With this in mind, doesn’t it make sense to give that heir a larger share in the business? Not necessarily. In many cases, compensating the active heir through wages is a better idea. Here’s why:

1.  Personal income in a common family business structure like an LLC is passive income that can be taxed at a much higher rate than what would be taxed as wages.

2.  In the corporate setting, an active heir receives wages and therefore qualifies for employee benefits like retirement plans and, possibly, health insurance. However, in an LLC, an “owner” cannot be an employee. Passive heirs do not qualify for employment benefits.

3.  Splitting shares in the business among the heirs could result in an overall lower tax bill, as the income is sprinkled among several taxpayers.

4.  Giving equal ownership supports the idea of golden handcuffs, which is a term we often use to refer to strategies that protect both active and passive heirs from making decisions that may not be fair to the other owners—or healthy for the business as a whole.

That being said, the scenario of passing down a business equally to active and passive heirs can have inherent challenges. At times, these two types of owners can have intensely different opinions on what decisions are in the best interest of the company. This often leaves the active heir feeling trapped by passive heirs who they believe don’t understand the business as well.  On the flipside, passive heirs can often feel that active heirs are too “close” to the business to see clearly, allowing emotional attachment to get in the way. Deciding whether your active heirs receive more control than passive heirs ultimately comes down to your unique situation and how the benefits listed above can outweigh the restraints it will present for them.

Image credit: antartis / 123RF Stock Photo

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