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By Jamie Hargrove, CPA

As soon as your business starts to grow, the pressure to make the right financial decisions will grow along with it. No matter what industry you might be in, what your long-term goals might be, or how your business is structured, you know that you need to be planning for the future.

Jamie Hargrove is an attorney and CPA, and founder of Hargrove Firm LLP. Hargrove Firm is a national tax, estate planning, elder law, probate, and business succession law practice with offices throughout the country. Jamie is also co-founder, president, and chief executive officer of NetLaw, an estate planning technology platform utilized by over 100,000 financial advisors and their clients nationwide. Jamie founded Hargrove Firm in 2011, and for nearly a decade prior, he led a 160-attorney estate and trust practice for a Kentucky-based law firm.

Jamie Hargrove

And as soon as you begin thinking about the future, the topic of estate planning will inevitably emerge. At this point, you’re not only thinking about what will be on your balance sheet next quarter, but you’re also thinking about whether your business will have the legs needed to keep running when you are no longer around.

So, you did it. You transferred part of the stock or LLC membership units (we’ll just call it “stock” here) to one or more of your kids. On paper, this seemed like a great decision. After all, by transferring these ownership units, you can potentially avoid a steep 40% estate tax and enjoy a variety of other financial benefits.

Although many estate lawyers and accountants may support this decision every step of the way, unfortunately, there are still a lot of things that can go wrong.

You’ve worked hard to build your business. You love your kids and they were a hugely motivating factor every step of the way. But even with that in mind, it’s important to be careful in your approach to how you transition ownership of the company.

When it comes to managing your estate, you don’t want to let yourself be blinded by your love for your family or avoid a tough decision. In fact, executing due diligence and creating an effective, tax-minimizing exit plan is, in its own right, an act of love.

An outright transfer of stock or ownership units is, in short, a strategy that will needlessly expose you to risk. At this point, it doesn’t even matter that you completely trust your children and are confident they will do the right thing for your company —why would any rational decision-maker willingly take on additional levels of risk without adequate compensation?

Potential Pitfalls of Stock Transfers to Children

Here are just a few of the potential problems that could emerge: 

  1.  An in-law (even a future in-law whom you haven’t even met yet) could try to lay claim to the assets and move the assets away from your current family.
  2. Creditors could try to seize the assets from your children, which is especially likely if they end up experiencing some sort of future personal legal or financial problems.
  3. The assets could also be placed in your kids’ own estates, which could reintroduce exposure to estate taxes.

You might think your family is immune from these sorts of situations but, as any experienced estate attorney will tell you, they do happen all the time. And, once again, all you are doing is introducing additional layers of risk without any sort of legal or financial benefit.

Establishing a Trust: The Best of Both Worlds

By creating a thoughtfully-crafted trust, on the other hand, you can still avoid exposure to some estate and other taxes, while also allocating effective ownership of your company to your children. In other words, a trust can help you get the best of both worlds: keeping ownership within the family and minimizing tax exposure.

A beneficiary defective inheritance trust (BDIT) is an especially effective type of trust for these situations, and, best of all, even if you have already executed an outright transfer of the stock, it’s not too late to reverse it.

The BDIT, which is a grantor trust, enables the protection of the stock and will also eliminate any “residue” in your kids’ own estates. It combines status quo flexibility with full protection for the future, regardless of what time might have in store.

The bottom line is that business interests should not be held by individuals. In most cases, business interests should be held by trusts for the benefit of individuals. Trusts can be drafted in a myriad of creative ways to provide flexibility while minimizing significant estate taxes and sometimes even income taxes, particularly state income taxes.

So, if you have not yet transferred stock to your child, don’t do it — there are no real benefits that come with choosing to do so, only additional exposure to risk. But if you have already initiated the transfer, then there are ways you still can fix it. With the sound advice of a qualified attorney, you really can balance all your interests at once.

About the Author: Jamie Hargrove, Attorney and CPA 

Jamie Hargrove is an attorney and CPA, and founder of Hargrove Firm LLP. Hargrove Firm is a national tax, estate planning, elder law, probate, and business succession law practice with offices throughout the country. Jamie is also co-founder, president, and chief executive officer of NetLaw, an estate planning technology platform utilized by over 100,000 financial advisors and their clients nationwide. Jamie founded Hargrove Firm in 2011, and for nearly a decade prior, he led a 160-attorney estate and trust practice for a Kentucky-based law firm.