Corporate Stock Transfer Strategies

The plan design for successfully transitioning business wealth from one generation to another usually includes a program for transferring stock to other family members while one or both of the parents are still living. The strategic options include gifts of stock to other family members or the trust established for their benefit, sales of stock to the corporation, sales of stock to other family members or to trusts, and compensation transition strategies. No option is clearly superior to the others. Each has disadvantages and limitations that need to be carefully evaluated. Often a combination approach is the best alternative. Plus in some cases, as we’ll illustrate, the need to actually transfer stock may be mitigated or eliminated completely by business restructuring techniques that have the effect of transitioning future value without actually transferring stock.

Let’s start first with gifting strategies. A gift strategy is clearly the simplest and the easiest to comprehend. The challenge is to structure the gifts to avoid or minimize all gift taxes on the transfers. In our case study, Steve and Betty could commence a program of gifting corporate stock to Dave, the child involved in the business, and gifting other assets to other family members. For gift tax purposes, the value of any gifted stock may qualify for lack of marketability and minority interest discounts which together may equal as much as 40%. Steve and Betty each have a gift tax annual exclusion that shelters from gift taxes any gifts of present property interests up to $13,000 that they make to a single donee in a single year. All gifts of stock and other assets that fall within the scope of this $13,000 annual exclusion will be taken out or removed from Steve and Betty’s estates for estate tax purposes.

Steve and Betty have 10 potential family donees: 3 children, 3 spouses of children and 4 grandchildren. At $26,000 per each done – that’s $13,000 for each of them – Steve and Betty’s annual gift tax exclusions would enable them to collectively transfer tax-free $260,000 of assets each year to immediate family members. If discounts are factored in at 40% on the stock, this simple strategy could shift up to $400,000 of value out of Steve and Betty’s estates each year. In addition to their annual gift tax exclusions, Steve and Betty each have a gift tax unified credit that enables each of them to make tax-free gifts during their lifetime that are not otherwise sheltered by the annual exclusion.

For 2011 and 2012, the unified credit has been expanded to gift tax protect up to $5 million for each spouse – that’s $10 million for a couple. So, there’s a huge gifting capacity in these years. Starting in 2013, the free amount drops back to $1 million unless congress changes the law again. Truth is, no one knows what the lifetime gift tax-free amount will be after 2012.

Now what happens if they actually exceed these gift tax free limits and actually start paying gift taxes, is that a good thing to do?

Many parents will consider a gifting strategy so long as no gift taxes need to be paid. The strategy becomes much less appealing when the possibility of paying gift taxes is factored into the mix. In our case study, the issue would be whether Steve and Betty should consider making taxable gift transfers, transfers that exceed the limits of their annual exclusions in their gift tax unified credit in hopes of saving larger estate taxes down the road.

There are two potential benefits to these taxable transfers. First, all future appreciation on the gifted property will be excluded from the parent’s taxable estates. Second, if a taxable gift is made at least 3 years before death, the gift taxes paid by the transferring parent are not subject to transfer taxes resulting in a larger net transfer to the donee, usually the children.

Do these potential benefits justify writing a big gift tax check now in hopes of saving bigger estate taxes down the road? Most business owners have little or no appetite for this potential opportunity. As a result, many families confine their gifts of stock to transfers that are fully tax protected by the annual exclusion or the lifetime unified credit. Although the gifting strategy may result in a reduction of future estate taxes and a shifting of taxable income, it has its disadvantages and limitations.

For many parents, the biggest disadvantage is the one-way nature of the gift. They receive nothing in return to help fund their retirement needs and provide a hedge against the non-certain future. You will recall that financial security was Steve and Betty’s primary goal. Their insecurities may be heightened as they see their stock being gifted away over time.

Another disadvantage of the gifting strategy relates to Dave’s plans for the future because a gifting strategy is usually implemented over time in incremental steps that take place over many years. The plan may frustrate or at least badly dilute Dave’s goal of garnering the fruits of his future efforts for himself right now. If Dave is successful in expanding and growing the business, his success will be reflected pro rata in the value of all of the common stock including the stock retained by Steve and Betty and any common stock that may be gifted to Kathy and Paul or other family members or trusts for their benefit.

Finally, there’s an income tax disadvantage to any gifting strategy. The tax basis of any stock owned by a parent at death will be stepped up to the fair market value of the stock at death. If Steve and Betty made gifts of stock, their low basis in the stock will be carried over to the donees, the ones getting the stock and the opportunity for the basis step0up at death is lost forever. This can be significant if a donee sells the stock down the road. These potential disadvantages need to be carefully evaluated in the design of any transition plan. The result in many situations is a gifting program that starts slowly, perhaps geared to the limits of the annual gift tax exclusion, then accelerates as the parents become increasingly more secure in their new uninvolved status and then shifts into high gear following the death of the first parent. In other situations, the fear of future estate taxes prompts the parents to aggressively tackle the strategy upfront.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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