Consultant’s Corner: Transferring Business Ownership to a Spouse
Q. I am currently the sole member of an LLC. I would like to transfer sole ownership of the LLC to my spouse. How would I do this?
The transfer of the LLC ownership to your spouse will have to be properly documented for legal and tax purposes. In addition to the proper legal documents between the parties, there are governance, taxation, regulatory, and other potential important considerations. Also, due to the general complexity of business and tax regulations in these transactions, you will likely need to consult your lawyer and local business tax advisor to consider all of the issues, determine the most effective structure for the transaction, and identify all of the necessary paperwork: LLC governance, state filings, tax filings, etc. For consideration with your local advisors, we have provided the following information, resources, and considerations:
1. Business valuation
We do not know the value of your business. However, if you sell the business, you would have potential personal income tax considerations: ordinary income and capital gains tax. However, when gifting an LLC ownership interest to family members, an accurate valuation of the business is generally important in order to establish a value for gift tax and other financial and income tax purposes. Also, business owners often need to engage or consult professional business brokers or local financial professionals to provide an independent appraisal or otherwise help them value their businesses. Certain industries have rule of thumb valuation factors, such as a multiple of revenues, cash flows (EBITDA), or net income. However, industry guidelines vary based on profit and cash flow potential and cannot always be applied to an individual situation because of asset values, rent and labor costs, financing, and other elements unique to that operation. Establishing the value of a business generally involves determining a) the value of the equipment, supplies inventory and other tangible assets and b) the value of the business customer list/contracts, sales/profit potential, and intangible assets like goodwill, etc. Also, the quality of your customer list and relationships may be a valuation factor. Historical operating results are one part of the valuation; however, businesses are generally valued more for the future potential than the past operations.
As to valuing a particular business, the best information generally involves determining the present value of future cash flows. The key financial statement is the statement of cash flows that will yield the “cash available to service debt.” The future cash flows are then discounted to present value using a discount rate that reflects the amount of risk inherent in the forecast assumptions. The key question is “How much would someone pay for the opportunity to earn $xxx of annual income.” The answer generally depends on how secure the income is and how easy it would be for the buyer to start from scratch without buying the business. If the business has growth potential, it may be worth 10 to 20 times earnings compared to 3 to 7 times earnings for a company with limited, or no, growth potential. Service businesses may sell from 40% to 150% of revenues, for example. Also, a consideration with a personal service business owned by one or only a few individuals is the value of the customer relationships and/or contracts.
Your local CPA can assist you with a business appraisal and provide you with a fee estimate. For discussion with your CPA, you can review discussions of the common valuation methods at the following websites:
http://www.business-valuation.net/methods/
Also, for comparison purposes, you can review other businesses for sale at Internet websites like the following:
http://www.mergerplace.com/business-for-sale/search
2. LLC ownership transfer agreements
Business interests (entire or partial) are customarily transferred to family members, including spouses, through a sale, gift, or inheritance, all three of which can have legal and tax implications. Generally speaking, transferring membership interests, or membership certificates in an LLC from one family member to another involves either a sale or a gift of the membership certificates from one party to the other. In a sale, the selling family member would sell his or her membership certificates to the buying family member in an arms-length transaction based on the fair market value of the membership certificates. In a gift scenario, the gifting family member (donor) would transfer his or her membership interest to the recipient (donee) by formally transferring title to the membership certificates to the recipient. Both membership certificate sales and gifts can have income or gift and estate tax implications depending all the facts and circumstances.
As to documenting the addition of an LLC member, the required documents can vary depending on the structure of the transaction and regulatory requirements. For consideration with your lawyer, you review the sample LLC membership interest sale/purchase agreements and LLC membership interest subscription agreements and other paperwork that may be applicable to your situation:
LLC interest sale:
http://www.northwestregisteredagent.com/sell-llc-membership-bill-of-sale.html
http://www.leaplaw.com/pubsearch/preview/1193_LLCSubscrip.pdf
https://www.docracy.com/0v4et8ci8ka/membership-interest-purchase-agreement
LLC Operating Agreements:
http://www.northwestregisteredagent.com/single-member-llc-operating-agreement.html
http://www.nolo.com/legal-encyclopedia/llc-operating-agreement-30232.html
http://www.ilrg.com/forms/st_businessventures.html
http://www.uslegalforms.com/corporatecenter/llc-operating-agreements.htm
Amendments:
http://www.northwestregisteredagent.com/llc-operating-agreement-amendment.html
https://www.leaplaw.com/pubSearch/preview/1080D_OperatingAmendment.pdf
LLC Membership Certificates:
http://www.northwestregisteredagent.com/LLC-membership-certificate.html
http://www.mycorporation.com/corporation-llc-documents/llc-membership-certificates.jsp
3. Minute book
It is generally advisable for LLCs to have minutes to document the change of ownership, Board of Director elections, officer elections, bank account authorization, and other decisions regarding major contracts and important business issues. The GoSmallBiz membership includes the GoSmallBiz Corporate Minute Writer tool which simplifies the task of keeping your business Minute Book. GSB members can find the Corporate Minute Writer tool through their GSB Account under Applications then Corporate Minute Writer.
4. Taxation
Your personal tax implications will depend on the structure of the transfer: sale or gift. Transfers or conveyances of LLC ownership between spouses will have gift and estate tax implications; however, depending on the fair market value of the conveyed interest, your lifetime gifts, and other factors, the conveyance may not create gift or estate tax liabilities. For example, a gift is not includible in the gross income of the recipient, or donee, of the gift; however, gifts exceeding the annual exclusion for gifts ($15,000 in 2020) may be subject to gift tax, which is the responsibility of the maker, or donor, of the gift. Whether a gift is subject to gift tax will depend on the donor’s total lifetime gifts. Under current tax law, gifts made that exceed the annual exclusion for gifts are only subject to gift tax when they cumulatively exceed the donor’s lifetime gift tax exclusion amount which is $11,580,000 in 2020. Even if a gift is not subject to gift tax, if the gift exceeds the annual exclusion for gifts, the donor would still need to file a gift tax return (Form 709) for the year of the gift. You can review IRS information on estate and gift taxation at the following websites:
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Whats-New-Estate-and-Gift-Tax
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estate-and-Gift-Taxes
Investment gain and loss taxation:
https://www.irs.gov/publications/p550/
https://www.irs.gov/taxtopics/tc409.html
5. State filings
You may have state filings related to changes in the agent of service or other aspects of your LLC. Documents reflecting changes in existing businesses can be filed online at the Secretary of State’s website.
6. Professional assistance
Due to the various governance, legal, financial, and tax implications when transferring LLC ownership, business owners generally use local professionals (CPA, lawyer, and business insurance agent) for help in reviewing their ownership transfer plans and goals and evaluating transaction structure, regulatory requirements, taxation issues, and any risk management issues.
