Why Gifting Shares of a C-Corp is Not a Good Idea

Problem:

My wife and I are in a good position. We don’t need much income. We have three kids and eight grandkids. One son farms with us. Our other two work outside the farm. We’re all different, but we get along great. 

We operate through a C corporation that holds machinery, grain, livestock, and a little land. Most of our land is owned outside the corporation. Our estate keeps growing beyond our needs, so we’re both thinking of gifting $18,000 of corporate stock to each child annually around Christmas. Is this a good way to start transferring the farm?

– Submitted by email from D.O.

Solution: 

It sounds like you’ve reached a rewarding stage of life, D.O.! It’s great that you want to start gifting. Before you begin, let’s sort out what’s “merry” with your Christmas plan and what’s not.

The Merry Christmas: Annual stock gifts reduce your taxable estate, your kids feel involved, and you can help steward the gift while living. You don’t sacrifice your control or income. The C corp can continue to pay your salary and rent your personal ground. The gift simply shifts a percentage of your equity to your kids. This may also qualify your corp for valuation discounts due to minority interest and lack of marketability, which benefits your gift and estate strategies. That’s all on the nice list!

The Bah Humbugs: C corp stock is easy to gift but hard to unwrap! Unlike partnerships, S corporations, and limited liability companies (LLCs), which are pass-through entities, all C corp profits remain in the company. To get money to the shareholders, the corporation must pay them a salary, issue dividends, or loan them money. Salaries require material participation and FICA tax. Dividends generate corporate and personal taxes. Loans to shareholders could jeopardize the business and must be repaid with interest. These are like lumps of coal hidden in the off-farm heirs’ stockings.

So, how do off-farm heirs ever realize the value of gifted shares? They sell. 

Unfortunately, gifted shares don’t get a stepped-up cost basis upon your death. Your kids will pay tax on the gains. If your farming son buys them out, he cannot deduct the purchase or re-depreciate the assets. He also accepts the tax liability of unwinding the corp someday. (Yet, would anyone else buy their share of stock? Probably not.) This often strains relationships, as siblings realize they’re “stuck” and what they really have isn’t that valuable after all. 

Some might suggest converting from a C to an S corporation. Net profits could then be distributed to all owners based on ownership percentages. While this may be part of the solution, meeting IRS conversion rules takes time and planning, and doesn’t eliminate the tough decisions. Should net profits go to the shareholders or back into the operation? The challenge is, you’re gifting the business operation to the kids. That’s more intensive than holding land or cash. 

Gifting Strategies

In my experience, giving C corp shares to non-participants doesn’t end well. I wouldn’t do it. If you do, then don’t forget the “instruction manual” for your gift. Your operating agreement should provide management rules, voting requirements, and funded buy-sell agreements at discounted values. Otherwise, explore options such as gifting stock to your farm heir, and cash to others. Or consider gifting land in an LLC.

Nobody wants their gift to become a constraint. Plan your estate distribution strategy first. Then, keep your gifting strategy aligned to it. That way, your annual gifts simply advance your long-term plan. That should keep everyone happier at Christmas!