A QUICK LOOK AT OPPORTUNITY SHIFTING
Copyright 1999 - Thomas J. Keating, IV
All Rights Reserved
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One estate planning technique which, in my experience, does not
receive nearly enough attention, is the resolutely low-tech but
nevertheless highly effective stratagem known as "opportunity
shifting". The chance to utilize it is highly episodic; many,
probably most, families never get the chance to do something of
the sort, at least on any dramatic level, but when the chance
presents itself, it is something which should be quickly recognized
and closely examined. Briefly stated, the idea is to allow the
younger (and/or less financially able) members of a family or extended
family a chance to share in an advantageous business opportunity which
has become available to the older (and also generally wealthier)
family members.
The sort of factual pattern which most compellingly suggests
this type of transaction is as follows:
1. The existence of a close relationship among a group of
persons who are generally, but not necessarily, of the same immediate
family.
2. Some disparity, the more substantial the better, between
the net worths of the older members of the group and the younger members.
3. The existence of an opportunity to enter into an economically
advantageous investment or business transaction.
4. A willingness on the part of the holder of the opportunity to
share in, or perhaps to forego entirely, the prospective economic
advantages of the transaction.
Consider the following hypothetical fact situation, which shows
how this technique might work in a specific case. A married couple in
their 70's, who between them own a controlling interest in a profitable
manufacturing business, and whose net worth is very substantially in
excess of their combined estate tax exemptions, has become aware of an
opportunity to purchase a parcel of commercial real property, which could
be utilized by their business, for the sum of $1,000,000. They have
received independent appraisal advice to the effect that it is worth twice
that amount.
If their appraiser is correct, and if they purchase the property
themselves, they will have, accordingly, increased their personal net
worth by $1,000,000 (the new $2,000,000 asset less the $1,000,000 paid
for it). If they were in their 40's, and worth a good deal less than
they are, this would be a most welcome event. Given their age and net
worth, however, it would be counter-productive for them to place this
"profit" in their own names, simply to have it subjected to death taxes,
possibly sometime within the next decade, perhaps at a rate of over 50%.
What might they do to avoid this result? Let's have a look.
The couple have two grown children, both of whom are in their late
40's, happily married, and who have two children of their own. Their
banker, who also believes that the property is dramatically under-priced,
has indicated that he would lend $900,000 toward the $1,000,000 purchase
price, thus making it necessary for the family to come up with only
$100,000 of its own money to carry out the acquisition. Moreover, the
manufacturing business controlled by the senior members of the family has
a need for additional space of the sort which would be provided by the
acquisition property, and the fair market rent payable by the manufacturing
company, as tenant, would be sufficient to service the mortgage debt, to
pay the taxes, maintenance and insurance, and to perhaps have a little
left over besides.
A possible solution might be for the couple (a) to arrange to have
the junior members of the family substituted for the senior members as the
acquiring parties, and (b) to give to their children and grandchildren
(and perhaps also their children's respective spouses) enough cash so that
the junior members could, in the aggregate, come up with some or all of
the $100,000 of capital which is needed to complete the acquisition. Also,
thought should be given to possible methods of utilizing the senior members
greater capital and/or credit to enable the junior members to avail
themselves of the opportunity, through direct loans, loan guarantees,
pledging of assets, or other financing techniques. In this instance
there is no danger that the senior members will be criticized for
appropriating an opportunity which might properly belong to their
corporation, but this issue should always be considered in the context of
the specific facts of the case.
The exact details of the acquisition, the choice of business
entity which the children/grandchildren choose to create in order to own
and operate the property, and other details, are beyond the scope of this
brief examination; suffice it to say that the result of this hypothetical
transaction, if correctly carried out, would be that the
children/grandchildren would, collectively, own a $2,000,000 property on
which they owed $900,000, thus giving them an aggregate equity in the
property of $1,100,000, at no cost to the parents in estate or gift taxes,
and with all future increases in the value of the property inuring to the
children's/grandchildren's net worth and not to the parents'.
Needless to say, it is highly desirable, some might say crucial,
that the senior members accomplish the necessary "party-switching" before
acquiring a legally enforceable interest in the opportunity. Failing to
do so might, in a particular case, result in a claim that a taxable gift
had been made, which is precisely the result that is sought to be avoided
by this whole technique. Accordingly, in the illustrative situation
described above, it would not be prudent for the parents themselves to
contract for the purchase and subsequently assign the contract to their
children/grandchildren, nor would it be wise for the parents to acquire
the property and subsequently convey it to the children/grandchildren.
Doing this sort of thing often requires quite a mind-shift on the
part of the senior family members. A shift away from the customary,
probably even reflexive, acquisitive mode through which they have
successfully built their estates to the present position, and toward a
new, relaxed, self-less mode whose thoughts are focused more on disposition
than on acquisition. In my experience, sadly, not everyone has the
strength of will and the clearness of vision to accomplish this shift;
many are so driven, so habituated, or so in love with the chase that
they simply cannot adapt to new strategies. That is a shame.
Adaptability to different or changing circumstances is the key to
long-term success, for individuals and for families as well as for entire
species. Think about the lessons of Charles Darwin, and think also about
how long it has been since you last saw a dinosaur.
Statistically, in the life of any individual family these sorts
of opportunities will seldom arise, but an active estate planner would
likely spot several such chances each year. It would behoove the estate
planning lawyer to alert those of his partners who are in the
transactional areas of the practice to keep their eyes open for chances
to explore these sorts of possibilities with the firm's acquisition-minded clients.
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