Own a Family Business? Finally, An Easy to Win the Transfer/Succession Game

June 1, 2008

How many hats do you wear? We are going to play a hat game—a fun but money-saving, tax-saving and sometimes family-saving game. To play this hat game, you must own all or part of a family business and be a parent—the business/parent hat. Grandma and grandpa can play, too. More hats if you are also a wife (or husband) and a boss to your kids in the business. And of course, like it or not, you wear a hat as a taxpayer.

Typically, your most valuable hat and asset is your business. It represents pure wealth (in current-dollar value) and produces a stream of income to support you and probably other members of your family. But a portion of this pure wealth, which usually grows a bit in value each year, must someday go to the IRS.

This article relates an old but wonderful tax case (TCM 1989-231) and how we have used it over the years and still use it in our office to make business owners happy hatters.

Here’s the tax-case story: Clara Winkler died, leaving stock in the family business to her children. Some of the stock was voting, some nonvoting. Clara’s estate valued all the shares at $20 per share. The IRS pushed for a $46 value for the voting stock and $42 for the nonvoting stock.

The tax court compromised in a very interesting , valuing the voting stock at $38 per share (close to the IRS figure) and the nonvoting stock at $25 per share (close to the estate’s figure). The one thing both the IRS and the court agreed on: Nonvoting stock has a lower value than voting stock.

Now, here’s the three-step strategy we use, based on the Winkler case, to keep you wearing the hats you want and significantly shrink the cost of the tax hat.

Step 1—Recapitalize your corporation by turning in all of your voting common stock and exchanging it for new voting common stock (say, 1000 shares) and new nonvoting common stock (say 99,000 shares). This tax-free transaction works for S corporations as well as C corporations.

Step 2—Transfer the 99,000 shares of nonvoting stock to your children. Since the nonvoting stock is worth less per share than the voting stock, you can give more shares without owing any gift tax.

An important side note: Never sell the stock to your kids. It als is an expensive tax mistake.

Step 3—Select the method to transfer the nonvoting shares to the kids. Here are the three methods we use: 1) Outright gifts to the kids (and/or grandkids), typically limited to $12,000 per child per year by dad/husband and mom/wife—a total of $24,000. 2) Use a grantor-retained annuity trust (GRAT) or 3) a sale (actually a form of gift) to an intentionally defective trust (IDT)—currently, the most popular method. When the value of the business being transferred is $1 million or more, we use an IDT. The tax savings, when using an IDT, average $807,000 per $1million of the value of the business being transferred. For example, if you are transferring a business worth $2 million, an IDT will save you and your kids more than $1.6 million.

One warning: A transfer to your kids using this wonderful three-step process is easy and inexpensive to do, but make sure you work with an experienced and knowledgeable professional. If the professional even talks about a traditional sale to your kids—you know, the kid buys your stock and pays you in real dollars—find another professional or you will be triple-taxed.

Let’s examine how this strategy accomplishes many family business goals. First dad/mom: They stay in absolute control of the business (owning only voting stock). The GRAT or IDT give dad/mom a flow of tax-advantaged income, yet the nonvoting stock is removed from their estates.

Now the kids: They, whether in the business or not, own the nonvoting stock. We use a buy-sell agreement to get all the stock into the hands of the business kids after dad and mom have passed on. In the end only the business kids own the business and the nonbusiness kids get their fair share of the family wealth in other assets.

The flexibility and possibilities are endless. Each transfer plan is designed to perfectly fit the business owner, the family and the business. Everyone, except the IRS, becomes a happy hatter.

Want to learn more? Browse http://www.estatetaxsecrets.com/. Or if the transfer/succession itch is too much to bear, call me (Irv) at 847/674-5295. MF

Industry-Related Terms: Case, Form, Transfer
View Glossary of Metalforming Terms

Technologies: Management


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