Think Your Kid's Stock Will Survive A Divorce?

By Irving L. Blackman Tax Authority Are you thinking of transferring stock to your kids, or does one or more of your kids already own stock in your closely held business? Beware: You, your family and your business could be starting on a dangerous journey dangerous to your economic and tax health. But take heart. This column shows you how to have a safe and rewarding (economically and tax-wise) trip.

By Irving L. Blackman
Tax Authority

Are you thinking of transferring stock to your kids, or does one or more of your kids already own stock in your closely held business? Beware: You, your family and your business could be starting on a dangerous journey — dangerous to your economic and tax health. But take heart. This column shows you how to have a safe and rewarding (economically and tax-wise) trip. Every time!

Let's set the scene: A typical owner, Joe, of a family-owned business, Success Co., called me to consult (really get a second opinion) about transferring his business to one or more of his children. For our purposes, Joe can have three kinds of children: married or single; own stock of Success Co. or don't; and work for Success Co. or don't.

Let's start with Joe's oldest child, Ed, who is single, works full time for Success Co., but owns no stock of Success Co. As long as any stock that Ed will eventually own (or owns now) is nonmarital property to start with, the stock is safe from Ed's spouse-to-be (let's call her Bride). Bride can only have an interest in marital property, which can only be created after Ed and Bride marry.

OK, you now have enough background and are ready to learn the rules that will keep Joe's stock out of the reach of the divorce devil. (after Ed marries Bride, he acquires stock in Success Co., and then divorce rears its ugly head.)

The question you must always ask is when is stock (or any other property) non-marital property? here's the answer. Burn these four rules deep into your mind:

  1. When Ed (substitute your own child's name) owned the stock prior to marriage; and it makes no difference — for example, by gift or purchase — how Ed came to be the owner;
  2. When Ed received the stock after marriage by gift or
  3. By inheritance; and
  4. When Ed bought the stock after marriage with his own money (earned by Ed before marriage or received as a gift or inheritance before or after marriage). a little warning: the fourth way may be tough to prove in court if Bride sues Ed for divorce.

Actually, you must learn only one simple trick: Do not create marital property. You would, for example, create marital property by giving Ed a stock bonus of Success Co. stock after he married Bride. The best consulting/second opinion advice in this area is to show the Joes of the world how to make sure that every share of stock their kids own or will own is nonmarital property and stays that way. Start on the first day the kid becomes a stockholder, and continue every day thereafter (whether married, single or divorced, and no matter how many combinations of the possibilities).

But what happens when Joe calls and tells me that he has kids who are married and own stock of Success Co. (whether the kids work for Success Co. is immaterial) that is already unfortunately marital property? Then divorce usually means an expensive valuation war, followed by a court order to pay the court-fixed price to your former son-in-law or daughter-in-law.

What to do? A properly-worded buy/ sell agreement that fixes the stock price for all stockholders (current or future) and protects shareholders from ex-spouses is essential.

Let's summarize. transferring stock to your kids is smart (to save taxes) and safe (avoids divorce problems) if the stock is non-marital property in the hands of your kids. Just follow the four rules given in this column. And the same rules apply to you and your spouse too. as far as I know, the four rules above are the law in 49 states (except Oregon, where we must use special strategies involving trusts).

One caution: Never transfer any stock in your family business to anyone for any reason without first checking with a competent and experienced adviser. Then, although you may lose a daughter-in-law or son-in-law, you won't lose even one share of stock in your business to your kid's ex.

Want to learn more about how to protect your family without losing a bundle of taxes to the IRS? Spend a little time browsing my website, www.estatetaxsecrets.com. or if your tax concerns or unanswered questions are causing you to lose sleep, call me at 847/674-5295.

Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Plaza, Suite 900, Chicago, IL 60606; telephone 312/207-1040, or via e-mail at [email protected].