One of the many benefits of owning a profitable company is the ability to share the success of that business with future generations and give them a financial advantage. But most business owners don’t want to relinquish control of the business, at least not before they’re ready to retire.
Additionally, most families have some members who don’t have the business acumen or cooperative spirit necessary to keep the business running at its full potential, so owners also need to control which family members are able to participate in business decisions and who that control will pass to. When the business in question is a limited liability company or closely held corporation, the answer to these goals often lies in recapitalizing the business.
Recapitalization, in this case, is the process of restructuring and reissuing the shares of interest in the business into voting and non-voting shares or, in the case of an LLC, voting and non-voting membership units. (For the remainder of this article, the term “shares” shall refer to both shares of a corporation and membership units of an LLC.) Usually, a minority of the shares (1 to 10%) include voting privileges while non-voting shares comprise the vast majority. This division of business interests provides great flexibility for estate and tax planning and for succession planning. Owners whose business is an S corporate can create shares with voting power as the only difference in shares or they will lose their S corporation status with the IRS and will be subject to double taxation as a C corporation. Limited liability companies are not limited in this way and can also create preferred stock.
Once shares or membership units of a business have been restructured into voting and non-voting shares, sharing business interests with family is easy to do without giving up control over the business. The owner or partners of the business keep the voting shares to themselves and distribute the non-voting shares to the people they want to share the value and profits of the company with. The owner can also control who receives control of the business after their retirement or death by passing the voting shares to their chosen successor. See more about this in our article on “Recapitalizing Your Business for Business Succession Planning.”
There are a variety of strategies a business owner can use to share the profit interests of his business with his family and heirs. However, when leaving shares of a company as an inheritance for children and grandchildren, it is commonplace to set up a trust for those individuals and transfer the shares to the trust. The shares could be transferred directly as a gift, but depending on the value of the shares doing so may exhaust a donor’s $5 million lifetime exemption for estate and gift taxes.
A more tax-savvy strategy would be to gift an amount of cash to the trust, then sell the shares to the trust on a low-interest note to be paid over a period of time, like 20 years, so that it continues for the remainder of the business owner’s life or at least until retirement. Done right and if future profit estimations are correct, the dividends paid to the trust because of the shares will exceed the annual payment on the note, so the trust will always have enough money to make its annual payment and hopefully has enough left over to increase the value of the trust.
This strategy has the additional effect of replacing most of the income lost to the business owner by paying dividends to the trust rather than to himself. The income simply comes by way of the trust’s payments rather than as a direct dividend. Once the note is paid in full, which should be close to the business owner’s retirement or death, the income then belongs solely to the trust and its beneficiaries. In essence, then, this strategy ensures that the future value and profits of the company will go to the business owner’s heirs while the business owner continues to realize the value and profitability of the company during his lifetime.
A well-planned strategy employing trusts and recapitalization techniques can also minimize estate and gift taxes for the portion of shares passed to family. It can also reduce income taxes for the business owner. The variety of techniques and strategies that can be employed is nearly endless and your plan should be custom tailored to fit the specific circumstances of your family and business.
In Ohio, the business planning attorney’s office of Gudorf Law Group, LLC, can assist in the recapitalization of your business and identifying the best planning strategies for sharing the success of your business with family and heirs. Call our office at 1-877-483-6730 to schedule a free consultation.