Page 264 - TaxAdviser_2022

CASE STUDY
CASE STUDY

Freezing stock value with a

corporate recapitalization

Editor: One business succession strategy to con- shareholder does not or cannot
Trenda B. Hackett, CPA sider is a corporate recapitalization. A terminate his or her interest
recapitalization is a form of reorganiza- completely;
tion that involves changes in the class of ■ The value of existing stock is too
stock a shareholder possesses. It occurs high to allow purchases by other
when a shareholder exchanges some or family members, shareholders, or
all of his or her stock for another class employees; or
of stock in the corporation (i.e., a re- ■ A shareholder wishes to protect the
capitalization results in the shareholder’s interests of children actively involved
acquiring a new class of stock in return in a corporation while providing
for giving up all or some of his or her some benefit for those with no active
A corporate original stock). Generally, recapitaliza- involvement.
recapitalization can tions are not taxable events for the Recapitalizing with common
shareholders (however, they may create
freeze the value of gift tax considerations between the and preferred stock
the owner’s stock, shareholders) or corporation as long as In a typical recapitalization, one class
of voting common stock is exchanged
the exchange has a business purpose and
potentially reducing the value of the stock given up equals for two classes of stock (usually voting
the owner’s estate tax the value of the stock received. preferred with a cumulative dividend
A corporate recapitalization can
liability by removing freeze the value of the owner’s stock, po- feature and nonvoting common). The
owner retains the voting preferred stock
future appreciation tentially reducing the owner’s estate tax and, therefore, control of the business
in the value of stock liability by removing future appreciation operations. Because the preferred stock
in the value of stock from the owner’s
does not participate in the growth of
from the owner’s estate. However, with the increased the corporation’s value, the owner’s
estate. exclusion amount, planners must weigh stock value is frozen.
the benefits of freezing the stock’s value The common stock created in the
versus holding the stock until death and recapitalization is transferred to the
receiving a step-up in basis for income owner’s children. Because the total
tax purposes. value of the corporation’s stock does not
Shifting control using a recapitaliza- change as a result of the recapitaliza-
tion is especially useful when: tion (i.e., new preferred + new common
■ A stock sale would result in substan- = old common), the value of the new PHOTO BY COMSTOCK/STOCKBYTE/THINKSTOCK
This case study has been adapted from tial tax; common stock transferred to the chil-
Checkpoint Tax Planning and Advisory ■ A redemption does not qualify for dren is reduced by the value attributed
Guide’s Closely Held C Corporations
topic. Published by Thomson Reuters, capital gain (exchange) treatment to the preferred stock retained by the
Carrollton, Texas, 2022 (800-431-9025; because it is not substantially owner. The recapitalization allows the
tax.thomsonreuters.com). disproportionate or the redeemed owner to transfer ownership and future

46 May 2022 The Tax Adviser