Recapitalization of a Company—Gift Tax
Written By: Guy Schmitz, J.D., LL.M.
Consider advising your clients that all transfers potentially have tax consequences. Clients know that if they sell stock for a purchase price in excess of basis, there will be gain (assuming no offsetting losses). They will recognize quickly (if you tell them) that the transfer of services for money is income; they get W-2s. But there are more subtle transfers that they are not likely to consider as taxable transactions. See the recent Chief Counsel advice memorandum, CCA 201442053.
In the advice memorandum, the Chief Counsel held that there was a gift when a family business was recapitalized.
The family business was held in a limited liability company (LLC). The donor (Mom) held an X percent ownership interest in the LLC. Child A and B each held a Y percent ownership interest. In exchange for the agreement of Child A and B to manage the LLC, the operating agreement of the LLC was amended to provide that, going forward, all profit and loss, including gain and loss attributable to the assets, would be allocated equally between Child A and B. After the capitalization, the sole equity interest of the donor in the LLC was a right to distributions based upon the donor’s capital account balance immediately prior to the recapitalization.
From these facts, it is easy enough to see that there was a shift in value. After the recapitalization, the donor’s sole equity right was frozen at her capital account balance immediately prior to the recapitalization. Donor’s otherwise future profits and losses (and distributions) were shifted to Child A and B. The Chief Counsel, in the advice memorandum, engaged chiefly in an exercise in valuation.
Practitioners will easily see the potential for gift tax, based upon the facts above. The client shouldn’t be expected to see an issue. The lawyer who presumably amended the operating agreement may not have had a tax practice. Thus, as said, consider telling a client that ALL transfers have potential tax consequences (here a gift tax consequence).