sale of stock closely held corp to children

I have clients, husband & wife, who are the sole shareholders in a closely held C corp. They would like to retire and have their two sons who work for them take over the operations. They are at the very beginning of this process and have asked for advise on how to structure this transition. Their main objective is to generate income for themselves rather than sheltering any assets for estate or Medicaid purposes.

If the stock is sold to the sons they would sell on an installment basis. They have not done a business valuation of the corporation (which I have encouraged them to do) and have an amount they would be willing to sell their stock for.

One son would not have the resources to purchase their stock. If the stock is sold to the sons he would want to pay his share from the corporation-which would result in a dividend to him.

I've explored having the corporation redeem a portion of the shareholder's stock. I believe this would result in dividend treatment to the parents since they have not reduced their ownership interest.

The other option is to just have the parents draw a dividend from the corporation each year without going through a redemption of the stock since both options result in dividend treatment. There is enough E&P to support a dividend similar to the cash they would like to receive in an installment sale. The shares would remain theirs and eventually would pass to their sons at the stepped up basis through their estate.

A sale would be beneficial to enable them to recover their cost basis. However since they would be selling to their sons the family attribution rules would apply under sec.318(a)(1). They possibly would be able to waive the family attribution rules if they meet the criteria of a complete termination under Sec 302(c)(2). They own the building which the corporation rents which I believe would not be a violation under section 302(C)(2). However they have not yet decided if they will continue to work for the corp in a small capacity which may violate Sec.302(c)(2).

Assuming they decide on a course of action that results in dividend treatment is their any benefit to them going the redemption route verses just receiving an annual dividend if both result in dividend income? Does a business valuation need to be done?

Appreciate any thoughts

How about a recapitalization into preferred and common, with the preferred carrying enough dividend to provide the income they need/want? Then a sale and/or gift of some or all the common to the children. Be sure, however, they are aware of Sec 306. As to a business valuation, I can think of no valid reason not to do one.

If they sell a relatively modest amount of the initial stock holding to their sons, say 5% each, they should be able to redeem the other 90% over a number of years and receive sale/exchange treatment. As they redeem their remaining stock, their sons proportionate ownership of the company will increase.

How about a recapitalization into preferred and common, with the preferred carrying enough dividend to provide the income they need/want? Then a sale and/or gift of some or all the common to the children. Be sure, however, they are aware of Sec 306. As to a business valuation, I can think of no valid reason not to do one.

Would the sale of the common stock be tainted 306 stock or only if they sold the preferred stock? The basic problem with 306 stock is the inability to recover their cost basis from amounts realized-am I correct in this? It would be considered dividend income?

If they sell a relatively modest amount of the initial stock holding to their sons, say 5% each, they should be able to redeem the other 90% over a number of years and receive sale/exchange treatment. As they redeem their remaining stock, their sons proportionate ownership of the company will increase.

In order to avoid the family attribution rules they would have to have a complete termination which meets the waiver requirements at sec 302(c)(2) . Assuming they meet the family attribution waiver requierments -by selling a small % to their sons they 've established the sons as shareholders at which point the remaining shares can be redeemed by the corporation for a note payable. At that point they would be entitled to sales treatment vs. dividend treatment and able to recover their cost basis. The note payable would enable them to utilize the installment method.

Makes sense?

I had a similar situation a while back. Since the corporation was small, with very few assets, we decided to just let the parents corporation wind down. The children formed a new corporation & took the old corporation's name (with permission). They basically began running everything through the new corporation as of a certain date. This worked great in our particular situation. Just a suggestion to see if it may be an option for you.