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Divorce
Financial Planning/Investment Article
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Conserve Cash in a
Business Property Settlement
By Gregory K. Brown, Partner, Gardner, Carton & Douglas &
Robert J. Krawitz, CPA, CVA, BW Valuation Services, Chicago, Illinois.
One of the most compelling problems in a divorce concerns the
division of marital property, which includes a closely held business.
In such instances, the business is frequently the major portion of
the marital estate. Often this problem is somewhat resolved with a
transfer of a portion of the company's stock followed by a stock
redemption. When property is transferred from one spouse to the other
incidental in a divorce, it is a tax-free transaction under IRC Section
1041. Due to the complexities involved, the IRS has often challenged
this type of program. Most divorces, therefore, result in the provider
requiring either a bonus or distribution of profits to meet the
obligation. The ensuing tax burden then reduces the amount of funds
available to meet the payment for the portion of the business.
A unique alternative may be of value in certain circumstances. The
use of an Employee Stock Ownership Plan (ESOP) affords the seller of at
least 30% of the outstanding stock to the ESOP tax free treatment
(under IRC Section 1042) when the sales proceeds are invested within
the prescribed period in equalified replacement property (essentially
US corporate stocks and bonds). The replacement stock can then be
distributed tax-free to the spouse under IRC section 1041. The spouse
will not need to be concerned about the provider's ability to make
payments and will receive a diversified portfolio. However, the
receiving spouse will be liable for the capital gain taxes if, and
when, the replacement stock is sold.
The ESOP will need to borrow funds from a lender (with a corporate
guarantee) and the corporation will be able to make tax-deductible
contributions to the ESOP to repay the lending institution. An example
of the possible tax savings is presented on the attached page. Although
simplified for presentation purposes, the illustration presents a large
tax savings as well as enhanced cash flows.
An ESOP is therefore acting as a facilitator for the owner of a
closely held business to meet the property obligations in a divorce
situation, effectively minimizing taxes in the transaction. If desired,
further programs relating to charitable and non-charitable gifting and
estate tax planning become available with the formation of an ESOP.
The benefits to the parties in the illustration indicate that beyond
the use of ESOPs for tax purposes, there is great merit in the
attributes of an ESOP as a financial tool.
ESOPs And Divorce
Analysis of Property Settlement
Problem: Property settlement is for $360,000 per year (Five years)
Tax rates: Corporate 35% Individual 40%
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Company
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Shareholder Provider
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Total
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Income
(currently)
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$700,000
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$300,000
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$1,000,000
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Needed to pay
on settlement:
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Bonus
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(600,000)
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600,000
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0
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Taxes
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(240,000)
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(240,000)
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Payment to
spouse
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(360,000)
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(360,000)
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Normal tax
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(35,000)
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(120,000)
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(155,000)
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Remaining
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$65,000
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$180,000
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$245,000
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Total tax paid
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$395,000
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UTILIZING ESOP:
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|
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Company
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Shareholder Provider
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Total
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Income
(currently)
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$700,000
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$300,000
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$1,000,000
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ESOP
Contribution
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(360,000)
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(360,000)
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ESOP loan
interest
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(120,000)
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(120,000)
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Normal tax
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(77,000)
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(120,000)
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(197,000)
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Remaining
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$143,000
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$180,000
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$323,000
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Total tax paid
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$197,000
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Total
Tax Savings (per year)
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$198,000
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Total
cash flow savings (per year)
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$78,000
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Robert J. Krawitz, CPA, CVA, has
over 35 years experience as a public accountant. He is a partner with
BrookWeiner, L.L.C., a Chicago based CPA firm specializing in
consulting and valuations of closely-held businesses.
Gregory K. Brown is a partner
with Gardner, Carton & Douglas with 25 years' experience in
Employee Benefits and Executive Compensation, including extensive work
with ESOPs and ERISA. He has represented clients as an expert witness
on behalf of clients' ESOP/Employee Benefits Plans both regionally and
nationally.
For more articles on assistance regarding your financial matters
before and after divorce, visit http://www.divorcemag.com/articles/Financial_Planning/.
MARYLAND DIVORCE ARTICLES - APRIL
2008
1. "He said...She said"
2. How to have "the perfect divorce"
for your family
3. Reaching renewal
4. Should you stay or go?
5. Conserve cash in a business property
settlement
6. Beating stress -- before it beats you
7. The art of negotiation
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