Estate planning can be a challenge for many Maine family business owners. Often times, wealth is tied up in their companies, which creates a conflict between the desire to transfer ownership to the next generation and the desire to stay in control. Recapitalizing the business into voting and nonvoting shares is one potential solution, as it allows you to separate ownership succession from management succession.

Reaping the Benefits

The sooner you transfer ownership of your business to the next generation, the better, from an estate planning perspective. This allows for future appreciation and income to be removed from your estate and you avoid gift and estate taxes. Transferring ownership may be particularly tax-efficient this year, because the gift tax exemption is at an all-time high ($5.45 million).

You get to reap the tax benefits of gifting without surrendering control of your business to your children if you choose to recapitalize. For example, you might retain 10% of the company in the form of a voting interest and allocate the remaining 90% among your children in the form of nonvoting shares. You continue to manage the business while removing a large portion of its value from your taxable estate.

In addition, typically nonvoting shares are entitled to valuation discounts for lack of control and marketability. So for gift tax purposes, their value would likely be substantially less than 90% of the company’s value.

How to Avoid Conflict

You can begin the management succession process by transferring your voting shares to your children when the time is right. However, it’s important to note that if you have some children who are involved in the business and some who aren’t, the best option is typically to transfer your voting stock to children who are active in the business. But this can create tension between them and the nonparticipating children. The latter will likely be looking for cash distributions while the former may want to reinvest earnings to grow the company.

In order to avoid this sort of conflict, carefully design a buy-sell agreement that provides for a buyout — at a fair price — of the children who aren’t involved in the business. To avoid placing a financial strain on the business, the agreement should call for the purchase price to be paid in installments over a reasonable period of time.

Not Just for Corporations

Most types of Maine businesses have the option for recapitalization, including corporations, partnerships and limited liability companies. Even S corporations can have voting and nonvoting stock without running afoul of the rule that prohibits S corporations from having more than one class of stock.

Be sure to consult your legal and tax advisors if you’re considering recapitalizing your business into voting and nonvoting shares. Generally, a properly structured recapitalization is not a taxable event for the company or its shareholders, but careful planning is required to ensure the desired tax treatment.