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?

a. She has reduced the cash needs of her estate because she has reduced the size of her gross estate.
b. She has increased the potential cash resources of her estate by establishing a market for the shares in the corporation owned at death.
c. She has decreased the cash needs of her estate by completely eliminating the business as an asset of her probate estate.
d. 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.

Answer 1

Mimi's recapitalization through gifting of nonvoting shares has partly reduced the size of her gross estate, potentially lowering estate taxes. However, this does not establish a market for the shares or eliminate the business from her estate for probate purposes.

Step-by-step explanation:

When Mimi completed a preferred stock recapitalization and gifted all nonvoting common shares to her children, she effectively altered the ownership structure of the business while retaining control through preferred shares. This move has significant implications for the liquidity of her estate.

Option a, which suggests that she has reduced the cash needs of her estate by reducing the size of her gross estate is partly correct. By gifting the nonvoting common shares to her children, she has indeed moved these assets out of her estate, which can potentially reduce the size of her estate and thus the estate taxes due upon her death. However, this reduction is only in the size, not necessarily in the liquidity needs, as the preferred shares still have value.

Option b is incorrect because establishing a market for the shares does not necessarily increase cash resources unless the shares are actually sold. Furthermore, gifting nonvoting shares does not in itself establish a market for the shares.

Option c is incorrect as the business is not completely eliminated from her probate estate; Mimi still owns the preferred shares, which are part of her estate.

Option d is correct. The gifting of shares to her children likely used some of her lifetime gift tax exemption (applicable credit amount), which would reduce the remaining credit available to offset estate taxes at the time of her death. Thus, her estate may have a higher cash need to cover any additional estate taxes.