Question:  I plan to give stock of my corporation to my child.  Since my child is an adult, is there any reason I should not make an outright gift?

Answer:  One general principle of gifting is to not give away anything you might want back at some point in the future.  With a natural order of deaths and the non-occurrence of a child’s divorce, an outright stock gift may serve your purposes.  Nevertheless, you might consider an alternative arrangement which can protect against unanticipated consequences.

If your child predeceases you, uncertainty may arise as to who will receive the deceased child’s shares.  The shares may pass to your child’s surviving spouse or another beneficiary who is not a blood relative of yours. Alternatively, if your child is married and later divorces, the divorcing spouse may make a claim to the ownership of the child’s shares, the property considerations of local law notwithstanding.  In either scenario, shares may pass into the hands of an unrelated party who, through various legal rights afforded to shareholders, could challenge actions you take as a controlling owner and impede the operation of your business.

A better arrangement is to create a trust for your child to serve as the receptacle of company stock.  The trust can authorize periodic distributions to your child as appropriate for the child’s support, maintenance, and other purposes.  The trust can also designate how the stock will pass upon your child’s death, whether to the child’s descendants or other beneficiaries of your choosing.  That is, the trust you create, not your child’s Will or other estate plan documents, will direct how the stock passes upon the child’s death. If you wish, the trust can vest your child with a so-called power of appointment which permits your child to override the trust’s provisions and direct how the stock in the child’s trust will pass upon the child’s death or in other circumstances. For this purpose, your child’s power of appointment can be as broad or as restrictive as you wish. The appointment right will enable your child to take changing circumstances into account in providing for the eventual passing of the stock.

Under the laws of the State of Illinois and many other states, property received by gift, whether before or after marriage, constitutes separate property which remains the donee’s property in the event of a divorce. This principle applies whether the gift is made outright or in trust.   Property held in trust will retain its separate property classification while property which is re-transferred into a spouse’s name could lose that beneficial classification. Also, consider what might happen in the event of a company sale. Sale proceeds held in trust retain their separate property classification whereas sale proceeds distributed to a child and commingled with other assets of a married couple may no longer be treated as separate property.

There are, no doubt, other techniques to consider in protecting gifted assets.  A stock restriction or buy-sell agreement can be created entitling the company or the other shareholders of the company to purchase the shares upon a shareholder’s death or perhaps upon a shareholder’s divorce.  This presumes you are willing to spend money to purchase shares you have gratuitously transferred.  Alternatively, the initial gift can be made of non-voting stock so that if any of the unintended circumstances arises, the third party shareholder may have less of an opportunity to impact the operation of the business.

It is quite common for parents to make gratuitous transfers of their company stock to their children.  Regretfully, many parents do not consider the life events that could thwart their donative intention.  Trusts provide an effective means of accomplishing a parent’s objectives while preventing the gifted stock from inadvertently passing to unrelated beneficiaries.

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter or if you have questions you want to be answered, you may contact Bruce at (312) 648-2300 or send an e-mail to [email protected]