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  Management Feature

Passing the Baton:
Ownership Transfer Strategies,
Estate Planning Go Hand-in-Hand

Posted 11/13/2006
By Mike Henning

You can beat Uncle Sam's tax machine if you come up with a workable plan. The sooner you do, the greater the tax savings will be.

With few exceptions, transferring the control or ownership of your property will be the single most important lifetime transaction for your family. The dollars involved are great, and eventually they must be divided among family members. Some of the family members actively participate in the business and some do not. As the owner, you confront a seemingly unsolvable set of problems. When and where do you begin? Have you already done enough? Do your plans meet your objectives and are they emotionally sound for your family?

The good news is that you can beat Uncle Sam's tax machine if you translate your family objectives and the applicable tax law into a workable plan. The sooner you do, the greater the tax savings will be.

Asset Transfer Methods
and Tax Planning

In this article we will discuss five basic strategies for transferring ownership of a family business:

  1. Sale of Stock. Selling corporation stock by the owner to another family member is a no-no! Why do some families do it anyway? It is quick, easy and cheap (initially). So why not? The tax consequences make this method prohibitive. Why? The selling family member must pay 15 percent capital gains tax on the profit and the buyer must use after-tax dollars to make the payments. These are not deductible.

    The Advantages

    • Future growth in the stock is transferred to the heir.
    • The heir gets a stepped-up basis for the stock.

    The Disadvantages

    • The portion of the gain realized each year will be subject to an immediate tax.
    • If the parent dies before receiving full payment of the installment obligations, they will be included in his/her estate for tax purposes.

  2. Stock Redemption. A stock redemption occurs when a corporation uses its property (money, securities, property) to repurchase from a selling shareholder all of the outstanding shares owned by that individual. Tax treatment is the vital question here. Will the gain be treated as a dividend or capital gain? The difference is 100 percent of a dividend to the extent of retained earnings is subject to tax.

    On the other hand, a capital gain is tax free for the full amount of the tax basis of the stock. If the redemption qualifies as a sale or exchange, the excess of the proceeds over the taxpayer's basis is a capital gain (15 percent taxation). If the redemption does not qualify, the entire amount of the proceeds is a dividend (taxed as ordinary income). To ensure capital gain treatment, you must make a complete redemption of the stock to the corporation and make it substantially disproportionate.

  3. Sale of Assets. If you want to turn fixed assets to cash, control your income, eliminate estate taxes, guard against inflation, retain future income from real estate and maintain some control, then the asset sale - or sidewise sale - is the ticket for you.

    • Financing. The bank/lending institution provides the new corporation with a loan to acquire the assets from the older corporation.
    • Parent's Role After the Sale. You become a property manager and a collection agency.
    • Liquidation of the Old Corporation. Gain from the sale of assets and recapture of depreciation could be taxed at a maximum corporate rate of 39 percent. As an option, income can be drawn out as compensation.

  4. Gifting Stock in the Business. Sometimes an annual gift program can totally transfer ownership and control of a family corporation. The primary advantage is its true simplicity. In some cases, a gifting program can accomplish all the family's objectives. For example, if you currently gift stock to active family members, you can provide the same opportunity for younger children who may enter the business later. Your gifting program could have a different timing sequence - you could put the stock in a voting trust, or you could provide an option for those children to enter the business at a later date.

    Basic Rules for Gifting Stock: Current estate and gift tax laws provide parents an opportunity to give $11,000 per child annually without filing a gift tax return or paying any gift taxes. Additionally, during your life you and your spouse can give another $1 million each ($2 million total) without taxation.

  5. Offsetting Sales Strategy (counter payment). If the parents are asking a higher price for the company than the book value or adjusted book value, or if real estate is included, then an offset sale strategy should be considered. Essentially, the actual sale of the business assets or stock is based on a third party valuation and appraisal. The excess dollars are made up in retirement benefits, compensation plans, defined benefit plan, non-qualified plan, consulting agreement or a noncompetition agreement.

    Overall, the deductions for the heir/buyer can make the transaction more affordable. Due to prefunding of certain benefit programs and tax deduction of portions, the overall tax savings will range from 15 percent to 30 percent. There is basically no difference for the parents/sellers whether the transaction is deductible or nondeductible to the business.

Mike Henning Editor's note: This article is one of several management articles that will be contributed to AutoInc. this year by Automotive Management Institute (AMI) instructors. To learn more about AMI, its courses and instructors, visit

Michael G. "Mike" Henning is an Automotive Management Institute instructor. He is the founder and president of the Henning Family Business Center, a management and consulting firm specializing in business growth, change and future leadership headquartered in Effingham, Ill. His e-mail address is, and he may also be contacted by phone at (217) 342-3728.

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