Compensation Equity Transfers
Suppose Steve and Betty have concluded that it makes sense to start transferring to Dave a larger share of the company’s equity as part of a transition plan. He has, after all, devoted his career to the business. As previously described, making gift stock to Dave, that this gifting can cause problems. It may trigger a gift tax or at a minimum, consume valuable gift tax credits that would otherwise help in planning for the entire family down the road, and it may cause some problems with the other kids.
Why is Dave being given large gifts now and not us? To avoid these problems, often the best course is to plan ahead and structure stock transfers to Dave as compensation income from the corporation over an extended period of time. Although these types of transfers trigger taxable income for Dave, the corporation receives an offsetting tax deduction, and in nStevey all cases the corporation’s income tax savings will nStevey equal or exceed Dave’s income tax cost. The result is a near-zero net income tax burden and a simple gross-up cash bonus can be used to transfer to Dave the corporation’s tax savings to cover Dave’s income tax hit. So, from a current income tax perspective, this compensation structure usually is no worse than a push with the gift option. But this compensation structure offers 3 big advantages that could never be realized with a gift.
First, unlike a gift where Dave takes the parent’s low basis in the stock, a compensation transfer results in Dave receiving a basis in the stock equal to its fair market value at the time of transfer – a real tax saver for Dave at time of sale.
Second, with the compensation structure, the parents have no gift tax concerns and there are no gift tax opportunity costs. The transaction does not consume any of the parent’s gift tax annual exclusion or unified credit benefits.
Finally, since the transfers or compensation payments are made overtime, the potential of complaints from the outside children, Kathy and Paul, goes way down. Often this type of compensation planning is used in combination with other strategies.
Nate Nead
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