Seeing as how it’s tax season, I thought it would be apropos to include a bit on the subject of taxes.  Taxes are no fun to deal with.  When tax issues become intertwined with family business decisions, it’s even less fun.

The four Stockton brothers – Charlie, John, Kevin and Dean – are members of the “Lucky Sperm and Egg Club.”  Their grandfather founded a successful, heavy construction company that has been passed to generation three (G-3), their generation.  Soon the brothers will make a similar transfer to G-4, their children.  For this article, I'll refer to the company as “Stockton Construction, Inc.”  All names are fictional to protect the identity of the individuals.  The brothers range in age from 34 to 46.  All are graduate civil engineers, two have MBAs and all work in the business.

Stockton Construction builds bridges across vast bodies of water and drills tunnels for subways in major cities.  Last year, company profits exceeded $100 million dollars.  They handle their money very effectively.

Stockton Construction has been successfully transferred from the founder to the second generation, and then from the second to the third.  When the founder died, he was a wealthy man, as are all members of the second and third generations.  However interpersonal issues in the family have complicated matters, in addition to a financial decision that lingers from the past.

The third generation, which now controls the company, is made up of four brothers.

About Dean:  Being the youngest, Dean accumulated substantial funds in his account while he was in high school and college.  He worked in the business for a couple of years following college graduation, then got his MBA, worked for a financial institution for three years and then returned to work at Stockton.  He had the option to choose where he would live.  Being a savvy businessman, he selected Texas, a state with no personal income tax.  He has 2½ children.

About Charlie:  As the oldest, Charlie was the first brother to work in the business.  He moved as necessary with the company’s various construction projects and was working in California when he fell in love and married a “California girl.”  The only place a “California girl” is really happy is in California, and that is where they live.  California ranks number three in terms of the highest tax rate on personal income in the U.S.  Charlie, father of three daughters, is a very affable man, but has not had the best record of success in the business.  A few years ago, he elected to get into the real estate market, just at the wrong time.  After taking a substantial loss, he is back in the mainstream of the company, serving in an important business development role.

About John:  John is second oldest, a classic, driven, Type “A,” person.  He is a fine man and has the potential to be a “take no prisoners” type leader.  A great deal of the current success of the company can be attributed to him.  He harbors some resentment about Dean’s accumulation of money and has said, “I was working in this business for 15 years before Dean came to work.”  John’s path was similar to Charlie, for he too found a “California girl” and California is where he lives… same high tax rate.  Like Charlie, he has three children, two daughters and a son.  He is co-president with Kevin.

About Kevin:  Kevin received an MBA in Paris.  When he came back to the U.S., his father conscripted him to return to the sleepy mid-western town where the company is based, where he would grow into his current role of co-president.  He has a keen eye about the present and benefits from being pushed to focus on optimum opportunities in the future.  He found his bride in that sleepy town and now they have four children.

As co-presidents, Kevin and John receive very substantial bonuses in addition to their industry-appropriate salaries.

Now comes the rub.  When Dad was running the company, he would direct funds from Dean’s accumulation account to Charlie and John, so they would not feel the heavy “bite” from the California tax.  He called it “equalization” but I have never been able to establish what was equal.  Technically, the accumulation account was Dean’s personal property and dad was giving money from that account to the brothers who lived in California.  After age 21, Dean had a legal right to direct those funds for his personal use.  Dad took the “all in the family” point of view, which he could do when he had absolute control.

Now we have four men, brothers, with different views and different wives.  Of course the California residents want the practice to continue while the Texas residents, who pay no personal income tax, want the “equalization” practice to stop.

As if this were not complex enough, in 18 months the brothers will make the transfer of Stockton shares to their children.  That means that 8 of the shareholders, Charlie, Mike and their children, will live in California, which begs the question: “Will the equalization continue when G-4 are owners?”

Dean advocates that when G-4 become owners, the practice must stop.  After much debate, even heated disagreement, the decision was made to end the practice when the stock transfer from G-3 to G-4 takes place.  Dean was very eloquent when he wrote the following to his brothers:

“We all should have some heartburn with family business. It shows that we are learning to give and not always thinking about negotiating the best deal for ourselves.  I have had a lot of heartburn for a long time, but one of the greatest things I learned from Bork is that life depends on how you frame it in your mind.  If you truly believe that you get more from giving than receiving, it changes the way you view the world.  Regardless of how much money I receive in compensation and distributions, the most important thing to me is that when you, my brothers, are working with me or playing golf with me or even just when we are having a glass of wine together, that you are glad I am your brother and partner in business.”

Throughout my career, I have worked with many Turkish families in business.  In Turkish families, it is not uncommon to have the practice of “One Pocket” when it comes to money.  Family members spend out of  a family account.  In some ways, that was the way the father of the Stockton brothers was operating when he was “equalizing.”  He just called the practice by a different name.

The “One Pocket” practice in Turkey may soon be a thing of the past.  There are families where some adult children live “the good life” as if there is no limit to the resources.  It seems to be approved by the elders, but when the elders are gone, those brothers and sisters who are “living large” will likely have to deal with siblings who have different, and perhaps more conservative, views on how money is to be used.

What transpired with the Stocktons is that the brothers became accustomed to receiving special treatment and being rewarded accordingly.  They lost the mindset that “we are in this together.”  John has such high expectations that one has to wonder if he will ever be satisfied, even though he has more wealth than most of his age contemporaries.  There was discussion of both Charlie and John moving their families to Texas – home of zero personal income tax, but the Pacific Ocean is a long way away and their wives and children don’t want to leave the California sunshine.

If families in business are to avoid the Stockton heartburn, they must carefully examine the family monetary policy and what it is that holds their families together.

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