Are you thinking about transferring stock to your kids, or does one or more of your kids already own stock in your closely held business? Beware: You, your family and your business could be starting on a dangerous journey—dangerous to your economic and tax health. However, all is not lost. This article shows you how to have a safe and rewarding (economically and taxwise) trip.
Let’s set the scene: A typical business owner (we’ll call him Joe) of a family-owned-business (Success Co.) called me to consult about transferring his business to one or more of his children. For our purposes, Joe’s children are all described by three sets of categories: 1) married or single, 2) Success Co. stockholder or non-stockholder, 3) Success Co. employee or non-employee. Let’s begin with Joe’s oldest child. Ed is single and works full time for Success Co., but he owns no stock in the company. As long as any stock that Ed may eventually own is nonmarital property, the stock is safe from Ed’s spouse-to-be (let’s call her Bride). Bride can have an interest only in marital property that is created after Ed and Bride marry.
Now that you have enough background, you are ready to learn the rules that will keep Joe’s stock out of the reach of the divorce devil.
The question you must always ask is: When is stock (or any other property) nonmarital property? Burn the following rules deep into your mind. It is nonmarital property when: 1) Ed owned the stock prior to marriage; 2) Ed received the stock after marriage by gift or by inheritance; and 3) Ed received the stock after marriage with his own money (which he earned before marriage or received as a gift or inheritance before or after marriage). However, heed this warning: The third rule may be tough to prove in court if Bride sues Ed for divorce.
Actually, you must follow only one simple rule: Do not create marital property. For example, you would create marital property by giving Ed a bonus of Success Co. stock after he married Bride. The best consulting advice is to show the Joes of the world (the business owners) how to make sure that every share of stock their kids own or will own is nonmarital property and stays that way. Start on the first day the kid becomes a stockholder and continue every day thereafter.
What happens when Joe calls and tells me that he has kids who are married and own Success Co. stock? Unfortunately, that stock is already marital property. Divorce usually means an expensive valuation war, followed by a court order to pay a court-fixed price to Joe’s former son-in-law or daughter-in-law. How can you avoid this? A properly-worded buy/sell agreement that fixes the stock price for all current or future stockholders and protects shareholders from ex-spouses is essential.
Let’s summarize. Transferring stock to your kids is smart (to save taxes) and safe (avoids divorce problems) if the stock is nonmarital property in the hands of your kids. Just follow the rules we’ve covered in this article. As far as I know, these rules are the law in every state (except Oregon, where we must use special strategies involving trusts).
Let me close with a final caution: Never transfer stock in your family business to anyone for any reason without first checking with a competent and experienced advisor. It may be bad enough to lose a daughter-in-law or son-in-law, but at least you won’t lose any stock to the divorce devil.