Financial Intel Monthly

Equalizing Distributions to Children - with a Spin-Off

Jul 30, 2020 11:06:00 AM / by The Retirement Group (800) 900-5867

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What Is It?

Part of the Business Becomes Separate Business Entity

A spin-off is the conversion of a division, department, or branch of your family business into a new and independent business entity. Your children who are active in your business own and operate the new entity. A spin-off makes the most sense when a portion of the family business is easily severed. A satellite location or independent division can logically be converted into a new corporate entity. If your participating children are already in charge of the portion you wish to sever, then the transfer can be completed with little disruption of business. This equalizes distributions to children only if each part generates equal revenue.

Remainder of Business Sold to Generate Cash

The remaining portion of the business can be sold to generate cash for distribution to your nonparticipating children. The buyer might be a third party or, if they can fund the purchase, your participating children. A spin-off is a way to provide your participating children with a portion of the family business while providing your nonparticipating children with cash, hopefully of equal value. The sale proceeds will be available for distribution to your nonparticipating children during your lifetime or upon your death.

Example(s): Ted owns a home heating oil business. His son, Jethro, runs the installation and service department of the business, which generates about one-half of the business's revenue. His daughter, Nellie-Mae, has never worked in the family business. Ted can spin-off the installation and service department of his business and leave it for Jethro to own and operate as an independent company. He can sell the remaining part of his business and make either a gift or bequest of the sale proceeds to Nellie-Mae.

When Can It Be Used?

Portion of Family Business Can Be Operated As Separate Entity

It must be possible to operate a portion of your business as a separate company. Your business needs to have a branch location, division, department, or some other severable portion that can survive on its own. A business that produces one type of goods, uses one set of tools, and exists at only one location is probably not a good candidate for a spin-off arrangement.

Strengths

Gives Participating Children Exclusive Ownership and Control of a Business

Once the spin-off business has been transferred to your participating children, they will enjoy exclusive ownership and control. They will be free from interference by your nonparticipating children and will not have to pay dividends or make payments for the benefit of the nonparticipating children.

Allows You to Convert a Portion of Business to Cash

Once you have spun off a portion of your company, you can sell the remaining portion to a third party. The sale proceeds are available for distribution to your nonparticipating children.

Provides Prompt Cash Distribution for Nonparticipating Children

Unlike a minority position with buy-sell over time agreement or a nonvoting stock arrangement for equalizing distributions to your children, and assuming that each part generates equal revenue, a spin-off is a way to get a lump sum of cash to your nonparticipating children. Once the remaining portion of the business is sold, you can distribute the sale proceeds to them. They will not have to wait for the business to make payments or issue dividends.

Distribution to Nonparticipating Children Not Contingent on Success of Spin-Off Company

Your nonparticipating children will not have to rely on your participating children for their distribution. They will receive cash directly from you. If the participating children fail in their business endeavors, your nonparticipating children will still receive their share. This differs from arrangements where the nonparticipating children must rely on the participating children to generate profits, make payments, or issue stock dividends.

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Tradeoffs

Involves Complex Tax Planning

If the family business is an S or C corporation, then the spin-off can be structured to avoid excessive tax liability. However, the tax rules regarding corporate spin-offs are complicated and require expert tax planning.

Original Business May Become Competition for Spin-Off

If the spun-off company and the original company conduct business in overlapping markets, then competition might develop between the two.

Example(s): Hal owns a home heating oil business. The business operates out of two locations in the same town. Hal delivers oil from location one. His son, Bob, delivers oil from location two. Hal decides to spin-off location two and leave it to Bob. He sells location one to a third party and gives the proceeds to his other son, Ken. Bob no longer works with location one to service the same customer base. Instead, he competes against location one and its new owner.

How to Do It

Create the Spin-Off Corporation

You should hire professionals to prepare corporate documents, do a tax analysis, and advise you with respect to the technical aspects of the transaction. The spin-off involves the creation of a new company, so you will have to go through the registration process required of any other new business. The specific requirements vary by state and choice of business entity.

Transfer Appropriate Assets to New Corporation

The parts of your business that will make up the spin-off company must be transferred to the new business. Depending upon the situation, the transfer may merely take place on paper, but it is necessary in order to distinguish the new business from the old.

Sell Remaining Portion of Original Business

The remaining original business can be sold piecemeal (as individual assets) or as a going concern. Your participating children are potential buyers. You gave a portion of the business to them, and they may be willing to buy the rest of it. You might also consider employees. They may want to own and operate what is left of the business. Your competitors are also potential buyers.

Distribute Sale Proceeds to Nonparticipating Children

Once a portion of your business has been converted to cash, you can decide when, and how much of the proceeds should be distributed to your nonparticipating children to provide them with an equal share of your wealth.

Tax Considerations

Income Tax

The tax rules regarding corporate spin-offs are complicated and technical. However, given proper planning, a C or S corporation may be able to avoid excessive tax liability. It is generally easier to structure a spin-off of a portion of the business assets of a partnership or limited liability company without adverse income tax consequences. Consult your tax advisor.

Gift and Estate Tax

The portion of the company that is transferred to your participating children may be subject to gift taxes. Sale proceeds transferred to your nonparticipating children may be subject to gift taxes if the transfer is made during your lifetime and to estate taxes if it is made after your death.

Questions & Answers

Can You Spin Off More Than One Part of Your Company?

Yes. Further, if you have several participating children, you can spin off a different part of the business for each one. This is a useful strategy if your participating children do not often agree when it comes to business decisions.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

 

The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.

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