As it can create a variety of challenges for both the effective administration of the business as well as the ongoing relationship between children active and inactive in the business, business owners often see the value of transferring business interests to the children active in the business, while transferring other assets to children not active in the business.  But what happens when the business is a very substantial asset in the business owner’s estate, and the business owner cannot treat all the children equally without transferring business interests to the children not active in the business?

Under these circumstances, it can sometimes be a part of the solution to transfer certain assets, such as real estate, to the inactive children and provide for a long-term lease of such assets by the business.  Not infrequently, business owners may lease certain key assets, such as real estate and equipment, to the business.  Providing for the transfer of such assets to the inactive children, and potentially providing for a long-term lease of such assets by the business, may:

1. permit assets associated with the business and an important part of the business owner’s estate to be transferred to the inactive children;
2. permit actual ownership interests in the business to be transferred exclusively (or to a greater extent) to children active in the business; and
3. minimize sources of tension between active and inactive children as to the ongoing administration of the business by the participating children.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Check out our Contact Us page, and feel free to set-up a no-charge initial consultation.]

There are substantial issues to consider when contemplating granting ownership interests in a business to children who are not active in the business, as well as to children who are active in the business.  There are many ways in which issues can arise.

Children not active in the business may second guess the business decisions of the participating children in various ways.  Is too much income of the business being distributed as salaries, leaving the nonparticipating children with too little dividend income?  The nonparticipating children may also take the view that too much of the company profits are being reinvested in the company instead of being distributed as dividends.  Are the participating children taking too many business risks and risking the future of the company?  Are the participating children borrowing too much money on behalf of the business which is impinging on the ability of the company to make profit allocations and risking the long-term viability of the company?

If the nonparticipating children are unhappy with how the company is being run and have minority interests in the business, for a variety of reasons they may be in a difficult position to sell their interests.  As a result, they could feel trapped and resentment could grow between the participating and nonparticipating children.

Even if the participating and nonparticipating children fundamentally get along, conflict may nonetheless arise as the children’s spouses weigh in and express their opinions.

Depending on a business owner’s circumstances, it is not always feasible to simply provide that the participating children will receive the interest in the business, while the nonparticipating children will receive other assets, particularly if the business interest is the most valuable asset in the business owner’s estate.  However, depending on the circumstances, there can be creative solutions to address these issues even if the business interest is the most valuable asset in the estate.

To what degree have you developed an estate plan for your business and family that address these issues?  In developing a plan that is right for your business and family, you will want to consider administrative, relationship and financial issues and goals.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Check out our Contact Us page, and feel free to set-up a no-charge initial consultation.]

Business owners can often be overwhelmed with working out the details of how they are going to get through the day, much less contemplating how their current choices on business organization may affect estate planning for their business and their families down the road.  An advantage to an S Corporation election can be the avoidance of double taxation of income (once when the corporation is taxed for this income and once when shareholders are taxed for the distribution of this income) while still retaining other benefits of incorporation.  However, along with this advantage, there are restrictions associated with an S Corporation election that may complicate certain estate planning objectives when it comes time to plan for the transfer of the business owner’s interest after his or her death.

One common estate planning tool used by business owners is to create a revocable trust.  Transferring assets to a revocable trust during life, and providing for the transfer of assets to the revocable trust through beneficiary designations, can permit:

1. assets to pass to heirs outside of the court probate process, simplifying administration and avoiding probate fees;
2. planning as to when and under what circumstances family members will inherit, including the creation of additional trusts that will be administered for the benefit of family members until certain conditions are met; and
3. coordination of various assets to effectuate intent as to who should benefit financially from the estate, in what amount, and how.

However, with an S Corporation election the federal government imposes restrictions on the types of trusts that may own an interest in an S Corporation.  This can complicate, or in some cases thwart, a business owner’s planned use of a revocable trust to provide for his or her family.

For example, the federal government does permit a “qualified subchapter S trust” to be a shareholder of S corporation stock.  However, the challenge for business owners is that the federal government imposes severe restrictions on the design of a “qualified subchapter S trust.”  In order to qualify to hold S corporation stock, a “qualified subchapter S trust” must:

1. have only one income beneficiary of the trust during the life of the current income beneficiary;
2. distribute any trust principal only to the sole income beneficiary during the life of the current income beneficiary;
3. provide for the termination of the income interest of the sole income beneficiary either on the sole income beneficiary’s death or when the trust terminates;
4. distribute all of the trust assets to the sole income beneficiary if the trust terminates during the life of the sole income beneficiary; and
5. name a sole income beneficiary who is an individual who must be a citizen or resident of the United States.

Possibly the biggest issue associated with the “qualified subchapter S trust” for many business owners is that they often desire to design their trusts to have more flexibility to provide for multiple family members in varying amounts and under various circumstances over the life of the trust.  This becomes an increasing issue to the extent that the corporate interest represents the dominate asset in the estate of the business owner.

Under federal law, a business owner may also consider making an “electing small business trust” the shareholder of S corporation stock.  In important ways the “electing small business trust” is a more attractive option for business owners developing their estate plans, including permitting the trust to have multiple beneficiaries and permitting the trustee discretion to either accumulate trust income or distribute trust income among the trust’s various beneficiaries.  However, substantial disadvantages of the “electing small business trust” include:

1. the requirement that all income of the trust must be taxed at the highest marginal federal income tax rates; and
2. for business owners wanting to provide for charities as a part of their estate plan, an “electing small business trust” may not be a charitable remainder annuity trust or a charitable remainder unitrust.

How may S Corporation restrictions complicate the estate planning you may want to complete now, or down the road?  A great time to consider these questions is when first forming the business.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Check out our Contact Us page, and feel free to set-up a no-charge initial consultation.]

 

Electing S Corporation status can appear to be, and may be, an attractive option for certain business owners.  For example, with an S Corporation election, the S Corporation may enjoy many of the advantages that otherwise exist with a C corporation, but avoid the double taxation associated with C corporations: first the corporate income tax on its profits and then shareholders being taxed again on profits distributed to them as dividends.

However, while an S Corporation election may permit business owners to avoid the double taxation of income associated with C Corporations, S Corporation business owners must also abide by the restrictions that come along with an S Corporation election.  Two such related restrictions are that an S Corporation:

1. can generally only have one class of stock; and
2. will not be treated as having more than one class of stock solely because of differences in voting rights among the shares of common stock.

But what if preferred stock would be desired as a part of a business owner’s estate plan?  [Remember that preferred stock generally entitles the holder to a fixed dividend, the payment of which takes priority over any dividends paid to holders of common stock.]  For example, a business owner might wish to grant preferred stock to children not active in the business, but permit children active in the business to be paid salaries and to reap the additional benefit of successful company performance through the payment of common stock dividends.  Alternatively, a business owner might wish to grant preferred stock to children active in the business with the logic that those most invested in the business should be the first ones to receive any profits from the business.  Such arrangements would not be permissible for S Corporation business owners.

How may S Corporation restrictions complicate the estate planning you may want to complete now, or down the road?  A great time to consider these questions is when first forming the business.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Check out our Contact Us page, and feel free to set-up a no-charge initial consultation.]