Global Tax Insights
Give Away Your Business and Run It, Too — By RecapitalizingMay 05, 2015
Save gift and estate taxes and avoid giving up management control of your company by recapitalizing.
If you own a family business, it likely makes up the majority of your net worth. Lack of planning or improper planning can have disastrous gift and estate tax results, perhaps even requiring the sale of the business in order to pay these taxes. This is especially true if the estate taxes attributable to the business exceed the available liquid funds to pay them. This is why, from an estate planning perspective, it’s generally beneficial to start transferring ownership to the next generation sooner rather than later.
Recapitalizing the business is one way to achieve this without giving up management control of the company. By recapitalizing the business into voting and nonvoting interests, you can split ownership succession from management succession, allowing you to transfer ownership yet continue to run the company.
C corporations aren’t the only type of entity eligible for recapitalization. Having both voting and nonvoting interests doesn’t violate the rule that S corporations can have only one class of stock. Recapitalization is even an option for partnerships and limited liability companies.
Potential Tax Savings
Transferring ownership in your business removes future appreciation and income from your estate. With recapitalization, you can enjoy gift and estate tax savings while still controlling the company. For example, you can retain 10% of the business in the form of voting interests and gift the remaining 90% to your children in the form of nonvoting interests.
You may be able to save even more taxes because valuation discounts for lack of control and marketability generally apply to nonvoting interests. This means the value of the 90% nonvoting interests might, for gift tax purposes, be as little as 60% of the company’s value. Applying the $14,000, per donee, annual gift tax exclusion amount in conjunction with the valuation discounts can allow you to transfer more out of your estate and minimize gift and estate taxes.
Transferring Control — When You’re Ready
Once you’re ready to give up management control of the business, you can transfer your voting interests. Having both voting and nonvoting shares provides flexibility in transferring the business interests among heirs. If only some of your children are active in the business, you’ll probably want to transfer your voting interests only to them. To avoid conflicts among your children, you can put buy-sell agreements into place structured in a manner to minimize financial strain on the company.
Avoiding a Taxable Event
Careful planning is necessary to properly structure a recapitalization to ensure it isn’t a taxable event for the company or its owners. Please contact us to evaluate if this option is right for you.