Both corporate legal work and estate planning may play key roles, but different ones, in the long-term success of construction and real estate companies. Corporate attorneys typically help businesses choose the appropriate legal structure, navigate the complexities of growth, manage risk and claims, ensure appropriate governance, document key agreements, and negotiate and draft complex transactions — including those related to liquidity events such as mergers and sales.

Estate planners can help ensure that a business owner’s property is distributed correctly at death, achieving tax, business and charitable goals by minimizing estate or gift taxes, transitioning a company to the next generation of owners, evaluating and implementing charitable giving strategies, and protecting intended beneficiaries. Additionally, they help plan for the owner’s incapacity, nominate guardians for minor children, and avoid probate delays. Estate planners typically possess a unique skill set to help business owners navigate estate and gift tax considerations, charitable planning, gifting, and related areas.

Failure to align the business structure and succession plan with the owners’ estate plans can have adverse effects for construction industry owners and their businesses.

Here are some common examples of misalignment among the business structure, corporate documents, and the owners’ estate planning:

The buy-sell agreement is not aligned with the estate plan

Many companies’ buy-sell agreements provide for some transfer rights in the event of death, disability or incompetency, and all can drastically impact a company’s operations. Often, those agreements do not contain detailed definitions of disability or incompetency, or the definitions are inconsistent with how those situations are addressed in the estate plan. Another area of frequent misalignment relates to transfers for estate planning purposes. Many buy-sell agreements allow owners to make transfers for estate planning, including to trusts. However, trusts come in many different types, with vastly different results in how they are controlled. The buy-sell agreement may restrict subsequent changes to trusts or transfers out of trusts when those events are contemplated as part of the estate plan, opening the door for unintended consequences.

The valuation methodology is not consistent with the estate plan</strong

It is common for owners to obtain valuations of their business interests for gifting purposes. Often, the buy-sell agreement includes a valuation mechanism for buyouts triggered by specified events different than the valuation used for gifting. For example, the buy-sell agreement may provide that valuation is tied to the book value of equipment and other assets and affords no discounts for lack of marketability or minority interests, while the value of assets for estate and gift tax purposes may be based on a different valuation methodology that applies discounts. The result is that the decedent’s estate may pay more in estate taxes if discounts are not allowed to be taken into consideration for the buy-sell agreement.

Life insurance and purchase structures are not aligned

Recent judicial decisions underscore the importance of carefully examining the buy-sell structure to prevent life insurance proceeds from increasing the company’s taxable value upon an owner’s death. In some cases, it may be prudent to draft cross-purchase agreements where company owners purchase life insurance on each other and use those proceeds to purchase the decedent’s interest directly, rather than a mandatory company redemption structure with company-owned life insurance.

An estate plan may contemplate dispositions that are not permitted under the corporate structure</strong

A purported transfer of a business interest under an owner’s estate planning documents may violate the transfer restrictions in the buy-sell agreement or imposed by the company structure. Many construction companies are structured as Subchapter S corporations. S corporation ownership is generally restricted to natural persons (who are U.S. citizens or residents) and specific qualified trusts and entities. It is common for a business owner to establish a trust that is not qualified to hold Subchapter S stock and for that trust to acquire the company’s shares, which can result in the termination of Subchapter S status.

Additionally, many companies in the real estate and construction industry provide services that require specific licensure. It may not be possible to transfer ownership of certain companies to beneficiaries of an estate plan without relicensing or other steps that require planning. In other cases, such as for licensed contractors, notice of ownership changes must be provided to the licensing board.

The estate plan does not provide a workable structure for the next generation of owners

Many parents want to leave their estates in equal shares to their children, with a possible result being two children each ending up with 50 percent of the family business’ interest. However, if the company governing documents require a majority vote and contain no mechanism for breaking a deadlock, or no mechanism for a child to exit the business if desired, that can lead to negative consequences for the company. Similarly, if multiple beneficiaries assume ownership, and the structure allows a single owner to block company action, it may be difficult for the company to make sound decisions.

Corporate documents do not make appropriate use of transfer on death (TOD) designations

When the owner of a company dies, who is paid when the deceased’s stock is repurchased? Upon an owner’s death, ownership interests often become part of their estate, requiring navigation of a probate process administered by an estate representative. That process can be avoided by using transfer on death (TOD) designations that register an owner’s interests with a designated death beneficiary. The designation of a TOD beneficiary does not affect ownership of the stock until the owner’s death. TOD designations are often overlooked.

Effective corporate governance and succession planning can require careful coordination between the company’s legal advisors and the owner’s estate planners. The stakes can be high if there is misalignment in the corporate structure and estate planning goals of the owners.

Matt Bisturis is a Schwabe, Williamson & Wyatt shareholder. Contact him at 360-905-1113 or [email protected].

June Wiyrick Flores is a Schwabe, Williamson & Wyatt shareholder. Contact her at 503-796-2477 or [email protected].