Category Archives:Shareholder Agreement

Policies Every Family Business Needs

Join Kennedy Sutherland attorney, Dub Sutherland, on Wednesday, May 20th, as he presents at Broadway Bank’s Family Resource Business Center luncheon on “Policies Every Family Business Needs.”  Mr. Sutherland will discuss the basic family business policies you should have in place like a shareholder’s policy. family employment policies, as well as policies that are trending such as risk management policies dealing with social media issues. Most importantly he will cover the process of getting these policies discussed, written down and approved while keeping the entire family involved and supportive!

Time: Wednesday, May 20, 2015 11:30 AM – 1:00 PM
Location:Charles Cheever Administration Building

Register Now, seating is limited.

Shareholder Divorce for S Corps

One of the most important aspects of managing an S corporation shareholder group is knowing when and how the family attribution rules apply to treat multiple shareholders within the same family as a single shareholder for purposes of the 100 shareholder limit. Due to apparently conflicting provisions in the Internal Revenue Code (the “Code”) and Treasury Regulations (the “Regulations”) there is often confusion regarding how to treat a married couple that later divorces. Originally, the Code and Regulations treated spouses as a single shareholder and upon divorce, as separate shareholders. The enactment of the family attribution rules in 2004, however, changed this rule so that both spouses and former spouses would always be treated as a single shareholder. While seemingly a minor distinction, noting this rule may be important for S corporations that are approaching the 100 shareholder limit.

The general rule applying to married couples and family is found in Code Section 1361(c)(1)(A):

For purposes of subsection (b)(1)(A) [referring to the shareholder limit], there shall be treated as one shareholder –
(i) a husband and wife (and their estates), and
(ii) all members of a family (and their estates).

The Regulations go on to state that this treatment “will cease upon dissolution of the marriage for any reason other than death.”  Reading these two provisions alone, it appears clear that spouses are treated as a single shareholder, but on divorce they are treated as separate shareholders. The later enacted provisions describing the family attribution rules, however, contradict this clear cut rule.

Code Section 1361(c)(1)(B)(i) provides that for purposes of the family attribution rules “the term ‘members of a family’ means a common ancestor, any lineal descendant of such common ancestor, and any spouse or former spouse of such common ancestor or any such lineal descendant.” (emphasis added). The Regulations go on to reiterate this family attribution rule that both a spouse and a former spouse will continue to be treated as a member of the family. The result is a contradiction between Regulation Section 1.1361-1(e)(2) and Regulation Section 1.1361-1(e)(3), stating first that upon divorce spouses are treated as separate shareholders and later that spouses and former spouses are treated as members of a family, and thus, as a single shareholder.

This contradiction resulted from a drafting error when the family attribution rules were enacted in 2004. Congress should have repealed earlier-enacted provision dealing solely with a husband and wife, which were later subsumed within the broader family attribution rules. This was likely not done because the Code sections merely reveal a redundancy between Code subsections (c)(1)(A)(i) and (c)(1)(A)(ii) and the contradictory provision appears in the Regulations enacted thereunder.

In summary, spouses and former spouses (whether by divorce, death, or otherwise) should always be treated as a single shareholder due to the “family attribution rules.” In discussing this issue with a colleague, I discovered a useful analogy: “The family attribution rules are like the mob. Once you’re in the family, you’re always in the family.”

For questions or more information regarding Shareholder Divorce and the Family Attribution Rules for S Corps contact Patrick J. Kennedy, Jr.

A Shareholder Agreement as a Sword and Shield

A shareholder agreement is a contract between and among the shareholders of a corporation and potentially the company as well. Shareholder agreements can do all of the following:

  • create limitations on the number and type of shareholders that may own a company’s stock;
  • create the mechanisms to allow existing shareholders or the company the option to acquire any shares prior to their being sold or transferred to a new shareholder;
  • ensure that certain administrative functions and securities laws are complied with throughout future transfers of the stock;
  • create unilateral or mutual obligations and duties on the part of shareholders or the company;
  • outline the methods and process for determining fair market value of the company’s stock and any related disputes; and
  • establish programs for shareholder liquidity.

All of these considerations and related provisions may impact the value of a company’s stock and the ability to ever realize that value. Taking the time to understand the shareholder agreement is of critical importance for all shareholders. Taking the time to periodically review the shareholder agreement and ensure its ability to achieve its intended purpose and provide the greatest benefit to the company and shareholders is even more important.

For more information on a shareholder agreement related to your company or institution contact William D. Sutherland VI.