Question

Mimi has completed a preferred stock recapitalization of a business that had been solely owned by her. She retained all preferred shares in the new business entity and gifted all nonvoting common shares to her three children in equal shares. Her preferred shares have a fixed liquidation value and a cumulative right to a fixed amount of income. Which of the following are correct statements regarding the effect of this transaction upon the liquidity of Mimi's estate?

I. She has reduced the cash needs of her estate because she has reduced the size of her gross estate.
II. She has increased the potential cash resources of her estate by establishing a market for the shares in the corporation owned at death.
III. She has decreased the cash needs of her estate by completely eliminating the business as an asset of her probate estate.
IV. If her estate will owe transfer taxes, she has increased the potential cash needs of her estate by using some of her applicable credit amount to pay the gift tax for the gifts to her children.
A) I and II
B) II, III, and IV
C) I, II, and IV
D) III and IV

Answer 1

Mimi's recapitalization and gifting of shares to her children have reduced the cash needs of her estate by reducing its size but may increase future cash needs if her estate owes transfer taxes due to the use of her credit amount for gift tax.

Step-by-step explanation:

The effect of Mimi's preferred stock recapitalization and the gift of nonvoting common shares to her children on the liquidity of her estate can be complex. Considering the statements, we can assess the following:

• Statement I is correct: Mimi has reduced the cash needs of her estate because she has transferred assets out of her estate, thereby reducing its size.
• Statement II is incorrect: There is no information in the scenario that suggests a market for the shares has been established. Nor does transferring nonvoting shares typically enhance marketability, particularly if they remain closely held.
• Statement III is incorrect: The business remains an asset of Mimi's because she retained ownership of the preferred shares, which have significant value due to the fixed income and liquidation rights.
• Statement IV is correct: Mimi has potentially used some of her applicable credit amounts toward the gift tax, which could increase future cash needs if her estate exceeds the threshold for estate taxes.

Therefore, the correct answer would be C) I and IV - She has reduced the cash needs of her estate by decreasing its size, and potentially increased the cash needs if her estate would owe transfer taxes due to the use of her applicable credit amount for the gift tax.