Tax Secrets of the Wealthy: Thinking of making your child a stockholder?

What happens if divorce enters the financial picture?

Are you thinking of transferring stock to your kids, or does one or more of your kids already owns 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. But take heart. This article shows you how to have a safe and rewarding (economically and taxwise) trip … every time!

Let’s set the scene: A typical owner (we’ll call him Joe) of a family-owned business (Success Co.) called me to consult (really get a second opinion) about transferring his business to one or more of this children.

For our purposes, Joe can have three kinds of children: 1. Married or single; 2. Own stock of Success Co. or don’t , and; 3. Work for Success Co. or don’t.

Let’s start with Joe’s oldest child, Ed, who is single, works full time for Success Co., but owns no Success Co. stock. As long as any stock that Ed will eventually own is nonmarital property to start with, the stock is safe from Ed’s spouse-to-be (let’s call her Bride). Bride can only have an interest in marital property, which can only be created after Ed and Bride marry.

Okay, you now have enough background and are ready to learn the rules that will keep Joe’s stock out of the reach of the divorce devil. (After Ed marries Bride, he acquires stock in Success Co., and then divorce rears its ugly head).

The questions you must always ask is when is stock (or any other property) nonmarital property? Here’s the answer. Burn these four rules deep into your mind: 1. When Ed (substitute your own child’s name) owned the stock prior to marriage; and it makes no difference — for example by gift or purchase — how Ed came to be the owner; 2. When Ed received the stock after marriage by gift; 3. Or by inheritance, and; 4. When Ed bought the stock after marriage with his own money (earned by Ed before marriage or received as a gift or inheritance before or after marriage). A little warning: The fourth way may be tough to prove in court if Bride and Ed are playing the divorce game.

Actually, you must learn only one simple trick — do not create marital property. For example, you would create marital property by giving Ed a stock bonus of Success Co. stock after he married Bride. The best consulting/second opinion advice (in this area) is to show the Joes of the world how to make sure that every share of stock their kids now own or will eventually own is nonmarital property and stays that way. Start on the first day the kid becomes a stockholder, and continue every day thereafter (whether married, single or divorced and no matter how many combinations of the three possibilities).

But what happens when Joe calls and tells me that he has kids who are married and own stock of Success Co. (whether the kids work for Success Co. or not is immaterial) that is already unfortunately marital property? Then divorce usually means an expensive valuation war, followed by a court order to pay the court-fixed price to your ex-son-in-law or daughter-in-law. What to do?

A properly-worded buy/sell agreement fixes the stock price for all stockholders (current or future) and protects shareholders from ex-spouses. How? By making the spouse of every one of your children/stockholders a “nonpermitted transferee.” Then you are guaranteed to keep all the stock of your family business in the family.

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 given in this article. And the same rules apply to you and your spouse too. As far as I know, the rules above are the law in all 50 states (except Oregon, where we must use special strategies involving trusts). One caution: Never transfer any stock in your family business to anyone (especially married kids) for any reason without first checking with a competent and experienced advisor. Then, although you may lose a daughter-in-law or son-in-law, you won’t lose even one share of stock in your business to your kid’s ex.

Want to learn more about how to protect your family (not only from the hazards of your kids getting divorced but) without losing a bundle of taxes to the IRS? Then spend a little time browsing my Web site, taxsecretsofthewealthy.com. Or if your tax concerns or unanswered questions are causing you to lose sleep, call Irv (847-674-5295).

Irv Blackman is a certified public accountant who lives part-time on Marco Island and specializes in estate planning, business succession and asset protection. E-mail him at wealthy@blackmankallick.com or call 417-9732. His Web site is taxsecretsofthewealthy.com.

© 2009 marconews.com. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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