In recent years, there has been an evolving literature devoted to the disparities in income and wealth between the “upper tier” of Americans and what is often referred to as “the rest of us”. The data seems pretty clear. Whether this disparity deserves attention through taxation or other policy approaches is beyond the scope of a divorce blog. But, in the world of divorce, we are witnessing the emergence of a new class of clients; the rich poor.
Who are these people? Generally, they are between 40 and 60 years old. They have parents aged 65 and over who have very good in a financial sense. More often than not, parents have operated successful family businesses that produce immense incomes. Children (those aged 40 to 60) have often worked in family businesses and are often shareholders or members/partners of the business. But the older generation retains a tight grip on when and how these benefits are distributed; sometimes for reasons more related to “control” than munificence.
The circumstances are as varied as the families involved. Years ago, I worked on prenuptial agreements for a family that had started land development businesses in the 1960s and profited generously from suburban development. The founders’ children all worked in the company and received annual donations of company stock. When I prepared the financial statements, I was struck by how little the children were paid; in some cases well below what would have been a market rate. Each year, they received K-1s reflecting hundreds of thousands of dollars in profit for their holdings. But their profit distributions never exceeded a third of their reported profits because their father only distributed enough money to pay the income taxes owed on the income. The balance was held by the company for “reinvestment”. In most cases, this holdback was reinvested in new projects to develop the business. But, we’ve also seen cases where distributions were withheld because the family patriarch felt the children didn’t “need” the money even though it was technically the children’s money. Most closely held companies have operating agreements that give the managing partner the power to decide what profits will actually be paid out.
Unfortunately, the “control” often does not stop there. Another difficulty is when the younger generation wants a house or a luxury like a swimming pool or a boat. At his discretion, the patriarch over 65 offers or agrees to advance company money to meet this family need, but often with conditions. The house or the boat will be acquired by the company or the company will hold the mortgage. “Children” aged 40-60 are told not to worry, the company will “take care of” the need. But that means there are no assets or it is heavily leveraged. Another concern is the issue of retirement. The parents tell the child and the spouse that retirement savings are not really necessary because when the parents die “there will be a lot of money” from the family business or the parents’ estate.
So, as lawyers, we see a potential client between the ages of 40 and 60. He or she has a spouse who comes from “family money”. There’s a nice house, but it’s owned by a corporation or the corporation owns the mortgage. There are nice cars and/or private schools. But they are paid by the company or from the accounts that the elders have created for the children. There is no significant retirement due to this expected inheritance or the eventual sale of the family business. It can even reach the level where your potential customer has no more money in the Louis Vuitton purse or wallet; only a multitude of corporate credit cards.
They are real “bubble customers”. They live well but inside a wealth bubble over which they have very little control. Often when we ask about marriage issues, they turn to the control exercised by the older generation. Every important decision is subject to the control of wealthy parents. In many cases, the spouse from the wealthy family feels powerless to fend off this interference for fear of being disinherited or fired.
Truth be told, the divorce lawyer can’t do much. The rich family spouse owns very little. And everything the couple owns came as a gift or an indulgence. Often there are no savings or retirement accounts due to the expectations of a trust or inheritance. But it’s rare for a wealthy parent’s estate plan to make a bequest or allowance for a son or daughter-in-law. And the inheritance itself, if given to the child’s descendant, is non-marital property and is not subject to distribution in the event of divorce. You can be married for 20 years or more and leave the marriage with nothing because there is nothing to get until the older generation dies; a prospect that could be decades away.
When we advise young couples about to marry with a prenuptial agreement, we are telling unpaid future spouses that they must protect their own financial future. Unfortunately, many couples marry thinking that everything will be fine when the family business is sold or the eldest dies. They live in bubbles that can include mansions, shore houses, luxury cars, and private schools. But their balance sheet of assets and liabilities is overwhelmed by one spouse’s interest in an illiquid business. A spouse’s minority stake in their parents’ business could be worth millions, but who will pay that money to have a minority stake controlled by your in-laws.
If these facts sound like your marriage, the law is not your friend. There is a federal tax law stating that when parents create gift interest for their children but then act as if no gift had been made (no voting rights of consequence, profit distributions withheld), the gift may make the donation. object of dispute. Alas, even if this argument succeeds, you’ve foiled a well-planned estate plan for your in-laws, but also removed property from your spouse’s asset column. If these facts sound like your son or daughter or friend’s marriage where they are the unpaid spouse living in the “bubble”, it would be wise to suggest that they think about planning for their future in the event of a divorce.