Structuring Ownership of Privately-Owned Businesses: Tax and Estate Planning Implications

Transcription

1 Structuring Ownership of Privately-Owned Businesses: Tax and Estate Planning Implications Steven B. Gorin Thompson Coburn LLP One US Bank Plaza St. Louis, MO phone fax Materials updated through May 1, 2005 Steven B. Gorin All rights reserved. This is not intended to be comprehensive; many portions only lightly touch the surface. The views expressed herein are not necessarily those of Thompson Coburn LLP. Please do independent tax research or contact a qualified professional.

2 TABLE OF CONTENTS I. Introduction...1 Page II. II.A Income Tax Flexibility...1 Buying into a Business...2 II.A.1 Corporations... 2 II.A.2 Partnerships...2 II.A.3 Comparison... 2 II.B Buy-Sell Agreements...2 II.B.1 General Buy-Sell Concepts... 2 II.B.2 Spousal Issues in Buy-Sell Agreements and Related Tax Implications... 3 II.C Operations...5 II.C.1 Income Taxation of Operations... 5 II.C.1.a Generally...5 II.C.1.b Allocations of Income in Partnerships and S Corporations...6 II.C.1.b.i Allocations of Income in Partnerships... 6 II.C.1.b.ii Allocations of Income in S Corporations... 6 II.C.1.b.iii Advantages of C and S Corporation Reporting of Owners Compensation on Forms W II.C.2 FICA... 7 II.C.2.a II.C.2.b FICA: Partnership or Sole Proprietorship...7 FICA: Corporation...7 II.C.3 C Corporation Advantage Regarding Fringe Benefits... 8 II.C.4 Conversions for Tax Purposes... 8 II.C.4.a From C Corporations to Partnerships and Sole Proprietorships...8 II.C.4.b From C Corporations to S Corporations...8 II.C.4.c From Partnerships and Sole Proprietorships to C Corporations...8 II.C.4.d From S Corporations to C Corporations...9 II.C.4.e From Partnership to Sole Proprietorships and Vice Versa i -

3 II.D Exiting from or Dividing a Business...9 II.D.1 Consequences of a Buy-Sell Agreements Not Dependent on Choice of Entity... 9 II.D.1.a Funding the Buy-Sell...9 II.D.1.b Establishing Estate Tax Values...10 II.D.2 Exiting from or Dividing a Corporation II.D.2.a Corporate Redemption...12 II.D.2.a.i Avoiding Dividend Treatment: Redemptions Under 302 and II.D.2.a.ii Redemptions and Alternative Minimum Tax II.D.2.a.iii Redemptions and Accumulated Earnings Tax II.D.2.b Tax Issues in S Corp. Buy-Sell Agreements 14 II.D.2.b.i Avoiding Ineligible Shareholders II.D.2.b.ii Tax Planning for Purchases of S Stock II.D.2.b.iii Fixing Inadvertent Termination II.D.2.c Corporate Division...18 II.D.3 Exiting from or Dividing a Partnership II.D.3.a Partnership Redemption...18 II.D.3.a.i Partnership Redemption - Generally II.D.3.a.ii Partnership Redemption Complete Withdrawal Using Code II.D.3.b Partnership Division...21 III. Estate Planning Implications...22 III.A Drafting and Administering Trusts...22 III.A.1 General Benefits of Trusts III.A.2 Liability Issues III.A.3 Income and FICA Tax Issues III.A.4 Estate and Gift Tax Issues III.A.5 Trusts Holding Stock in S Corporations III.A.5.a Generally...26 III.A.5.b Trusts as Shareholders: QSST vs. ESBT, Including how to Fix a Late Election and Regulations Dealing with ESBTs...27 III.A.5.c Flowcharts...30 III.A.5.c.i Flowchart of Inter Vivos Trusts (Trusts Created while Grantor is Alive) ii -

4 III.A.5.c.ii Flowchart of Testamentary Trusts (Trusts Created on Grantor s Death) III.A.6 Trust Accounting Income Regarding Business Interests III.B Transfer Tax Issues...33 III.B.1 Transfers During Life III.B.1.a Business Opportunities...34 III.B.1.b Gifts Without Consideration...34 III.B.1.c Valuation Issues...35 III.B.2 GRAT vs. Sale to Irrevocable Grantor Trust III.B.2.a General Description...35 III.B.2.b Tax Allocations Upon Change of Interest...37 III.B.2.b.i S Corporations III.B.2.b.ii Partnerships III.B.2.b.iii Income Tax Reimbursement Clause III.B.3 Estate Tax Issues III.B.3.a General Valuation Problems...42 III.B.3.b Code 6166 Deferral...42 III.B.3.c Marital Deduction Considerations and Related Planning...42 III.B.3.c.i Qualifying for the Marital Deduction III.B.3.c.ii Related Planning III.B.4 Special Valuation Issues III.C Fairness Within Families...42 III.D Hypothetical...48 III.D.1 Facts III.D.2 Trust Accounting and Taxation IV. Glossary...52 IV.A Corporation...52 IV.A.1 C Corporation IV.A.2 S Corporation IV.A.2.a IV.A.2.b Making the S Election...53 Making the S Election iii -

5 IV.A.2.b.i Generally Voting and Nonvoting Stock IV.A.2.b.ii Providing Equity-Type Incentives Without Violating the Second Class of Stock Rules IV.A.2.c Single Class of Stock Rules...56 IV.B Limited Liability Company...56 IV.C Partnership...58 IV.C.1 General Partnership IV.C.2 Limited Partnership IV.C.3 Limited Liability Partnership Registration iv -