Should husbands and wives jointly own the family business?

• Author: Kempson, Barry B.
• Position: Yes - Column

Many successful family businesses have been started and developed by one spouse or by spouses working together. In many cases, these businesses are owned in the name of only one spouse. The sole ownership may have little effect during the early and middle years of development. When couples begin planning for the transition of the business, retirement or death, however, they will likely find -- often too late -- that there are many benefits to be gained from splitting ownership so that each spouse has a share. This article describes some of the retirement, tax and estate-planning benefits to consider under the Internal Revenue Code when both spouses are named as owners of a family business.

Retirement planning for C corporations

During their working years, shareholders of closely held C corporations usually take money out of their companies in the form of salary and other compensation. Upon retirement, they may no longer be working in a capacity that reasonably justifies significant compensation. Pulling money out in the form of a dividend distribution yields harsh tax results because dividends are ordinary income to the recipient and not deductible by the corporation. Also, a partial redemption of shares probably will be treated for tax purposes as a dividend.

The tax code has long permitted such shareholders to redeem their entire business interest by a sale of it to the corporation. This redemption is treated as an exchange eligible for the lower capital-gain tax rates. If any stock in the corporation is owned by any other family member, the redeeming owner must redeem his entire interest to achieve this treatment. If both spouses own stock, then either spouse's entire interest can be redeemed while the other spouse retains ownership.

This split-redemption technique enables a couple to obtain some cash while retaining a significant voice in the corporation. Use of this technique requires advance planning: If the redeeming shareholder either transferred to or received gifts of stock from a family member within the preceding 10 years, then the redemption may be treated as a dividend (ordinary income) rather than an exchange (capital gain).

If a child also owns stock and the redemption causes the child's ownership percentage to increase, it is worth noting that this technique also gives the parents a chance to evaluate the child's control of the corporation before the other spouse redeems or transfers his or her remaining interest.

Estate...