Corporate reorganization involving the exchange of shares is a very powerful and versatile tax planning tool.
The simplest and most common corporate reorganization method involves the shareholder of a corporation exchanging all of his/her shares in one class of existing shares, for shares of another authorized class. The primary focus of the share exchange is the “freezing” of the current fair market value of the shares given up by the shareholder, who is referred to as the “transferor”. In exchange, the company issues the transferor shares in another class having the same value. Normally, the transferor would give up all common shares in a particular class. In exchange, the transferor would receive preferred shares with a fixed redemption value equal to the fair market value of the shares given up. Since the redemption value of the preferred shares is fixed, the fair market value of these preferred shares cannot increase as the performance of the company increases. Future success of the company would accrue to the other shareholders of the common class, not to the transferor.
This type of reorganization involving the exchange of shares is commonly used during estate planning where an estate freeze is desired. However, the reorganization tool can also be used in many other instances. Another common example is employee successions involving either an adult offspring or an employee that is not a family member. Just as described in the scenario above, the existing shareholder would freeze the current market value of his/her common shares by exchanging them for preferred shares with a fixed redemption value. The employee or offspring would be issued new common shares so that future benefits of the company would accrue to them.
Another similar scenario would be initiated during a divorce settlement, where each person owns 50% of the company and one spouse is no longer going to be involved with the business after the divorce. Again, the person leaving the company can be issued preferred shares (perhaps without voting rights) in exchange for the common shares as discussed above.
As demonstrated through the examples above, corporate reorganizations are an effective tool that can be employed in many situations for the benefit of all parties involved – both in business and personal life.
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