Using stock bonuses to transfer control.

• Author: Ellentuck, Albert B.

Editor's note: This case study has been adapted from PPC Tax Planning Guide--Closely Held Corporations, 17th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Keller, Gary W. Brown, James J. Mogelnicki and William R. Bischoff, published by Practitioners Publishing Company, For Worth, TX, 2004 ((800) 323-8724; ppc.thomson.com).

When a corporation's owner's successors are also its employees, ownership can be transferred by paying a bonus in stock, instead of cash. Assuming there are no unreasonable compensation issues, Rev. Rul. 69-75 allows the corporation to take a deduction for the fair market value (FMV) of the stock distributed. The recipients include the stock's FMV in gross income. (If the stock is subject to a substantial risk of forfeiture, it is included in an employee's income at its FMV when the risk lapses. A Sec. 83(b) election permits the employee to include the stock in income at its date-of-distribution value.)

A stock bonus increases the successor's ownership interest in the corporation relative to the senior owner's interest, because of the additional shares outstanding. Thus, the bonus effectively transfers ownership to the successors.

Example

Judy Ramos owns 100% of the outstanding stock (1,000 shares) of Fast Distribution, Inc. (FDI). Judy would eventually like to retire and transfer FDI's management and ownership control to her son, Mike, who is FDI's vice president of operations.

As part of a plan to transfer ownership to Mike, Judy authorizes the corporation to pay him a bonus of 10 shares of FDI stock as part of his compensation. After the bonus, Jane owns 99% (1,000 shares/1,010 shares), and Mike owns 1% (10 shares/1,010 shares) of FDI's outstanding stock.

Benefits

Using a stock bonus to transfer ownership may be more advantageous than gifting stock, for both the owner and the employee. Although an employee receiving a stock bonus pays income tax on the stock's value, the highest individual income tax rate is usually less than the owner's marginal gift tax rate. The corporation's compensation deduction reduces the net income tax on the bonus even further. Finally, with a stock bonus, the employee's basis is FMV; the employee takes a carryover basis if he or she receives a gift of stock.

Deducting a Bonus

According to Regs. Sec. 1.162-7(a), to be deductible, a stock bonus must be reasonable relative to the services rendered. Because all compensation is taken into account when determining...