Succession Planning Basics

Question:  I am the sole owner of stock in a corporation in which my child is actively employed. I wish to pass my shares to my child but provide a continuing income stream to my spouse once I cease working for the company.  I do not want my spouse involved with the business.  Any thoughts on how I might get started?

Answer:  With the new year upon us, the time is ripe for all closely-held business owners to consider whether their business succession plan is up to date. Regretfully, many business owners have failed to make appropriate arrangements for a business transition to the next generation. With a multitude of factors to consider, your question calls for some basic actions to be taken.

Providing cash flow for your spouse and replacing lost income after the cessation of your employment with the company is often addressed through insurance or the use of liquid assets outside of the company. In the absence of insurance or other available liquid assets, the business must provide the necessary liquidity.  If the corporation pays dividends, company stock can be held in trust for the benefit of your spouse who can receive dividend income paid to the trust while your child can serve as trustee and control the company.   As an alternative, the company can be recapitalized to provide for two different classes of stock, voting stock and non-voting stock. The non-voting stock can be given to your spouse who can receive an income stream from company dividends while the voting stock can be given to your child who can maintain control of the business.

If dividends are not regularly paid by the corporation, then some form of salary continuation can be paid to your spouse for the balance of your spouse’s lifetime.  As with any salary continuation plan, the plan must be in writing and adopted prior to the time of an owner’s death or disability. Various other legal technicalities must be observed in connection with salary continuation plans.

The stock transfer can be done now or at some point in the future.  Lifetime share transfers are often recommended as valuation discounts can be utilized which will decrease the value of the gift and the concomitant use of your transfer tax exemption. Because the shares of your corporation are not publicly-traded, a discount for the lack of marketability of the shares can be taken. If the transferred block of shares constitutes a minority interest in the corporation, a minority interest discount can also decrease the value of the gift.  If you opt for the recapitalization of the corporate structure with voting and non-voting stock, the gift of non-voting shares can be made now while permitting you to maintain control of the company as long as you choose.

Income tax considerations, on the other hand, often favor a post-mortem transfer as the income tax basis of shares is adjusted to the fair market value of the stock on the date of death.  The typical upward adjustment to the stock’s fair market value can reduce the gain on an eventual sale of the company.

The impact on your employees must also be considered.  The burden of ownership is eased with a stable workforce and continuity of management employees.  In appropriate circumstances, employment agreements containing non-competition restrictions, covenants preventing solicitation of company customers and restrictions on soliciting company employees for hire can preserve the company’s infrastructure.  All of these covenants must be carefully crafted to ensure they are enforceable as courts are reluctant to uphold covenants which prevent individuals from earning a livelihood.  Equally effective and not inconsistent with employee restrictions are incentive compensation arrangements for key company employees.

Consideration should also be given to children who are not involved in the business.  Where there is a desire to equalize gifts and bequests to all children, the optimal approach is to leave an equivalent value of non-business assets to the children who are not involved in the business.  This will not only permit your children to share equally in your estate but also free the child involved in the business from interference from the children who are not involved with the company. In cases where the business represents substantially all of the estate’s value, some alternatives will need to be utilized in equalizing the assets you pass to your children.

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

CIRCULAR 230 Notice:  In order to comply with requirements imposed by the Internal Revenue Service, we wish to advise you that (a) any U.S. federal tax advice contained in this communication is not intended and cannot be used for the purpose of avoiding tax-related penalties, and (b) no one, without prior written consent, may use any advice contained in this transmission in promoting, marketing, or recommending any entity, investment plan, or arrangement to another taxpayer.

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