transfer of stock on cessation texas

How Preemptive Rights Work in Texas

In corporations and closely held companies, business ownership is measured by the number of shares a shareholder owns. A shareholder who owns 100 of a company’s 1,000 shares, for example, would be a 10% owner.

For minority shareholders, there are real and warranted concerns when it comes to threats against their ownership interests. If a corporation issues 1,000 additional shares to its preexisting 1,000 shares, for instance, that same 10% shareholder would suddenly become a 5% owner. This is known as shareholder dilution, and it is a common form of minority shareholder oppression and squeeze-out.

However, shareholders with preemptive rights may be able to prevent this type of wrongful dilution.

What Are Preemptive Rights?

Preemptive rights are a shareholder’s right to buy pro rata shares in any future issue of company stock (or other securities) before shares are available to the public. In terms of corporate ownership and shareholder oppression, preemptive rights can function as a mechanism to prevent dilution. Preemptive rights, also known as “anti-dilution provisions,” may be included in shareholder agreements, a company’s governing documents, and other securities, merger, or option agreements.

Establishing preemptive rights is the only legal way to protect against dilution, and can allow existing minority shareholders to avoid suffering damages in the form of diluted voting power and value of their investment, if the selling price is lower than actual value. In some circumstances, preemptive rights may:

• Protect a shareholder’s right centage;
• Preserve a shareholder’s right to maintain voting power if new shares are issued;
• Protect early investors from loss if new shares are priced lower than initial shares;
• Provide incentive to early investors and majority shareholders for the risk they take on;

Though stock issuance or dilution is not necessarily harmful in and of itself, it can certainly be used for squeeze-outs and minority shareholder oppression. As such, a number of states grant preemptive rights as a matter of law. While Texas following an opt-out approach for corporations formed before September 1, 2003, however, shareholders in Texas companies formed after that date do not have preemptive rights, unless they are expressly provided for in the Articles of Incorporation (or the bylaws). This means:

• Corporations formed after 9/1/2003 do NOT have preemptive rights unless stated otherwise in the company’s Articles of Incorporation / Certificate of Formation / governing docs; and
• Corporations formed prior to 9/1/2003 have preemptive rights unless stated otherwise in the AOI / Certificate of Formation / governing docs.

Given this approach, preemptive rights are not the norm for shareholders in Texas, and are not typically granted to all shareholders. Preemptive rights (also called “anti-dilution provisions”) are more likely to be granted to majority owners who want to maintain the size of their stake in a company if and when additional shares are offered, to early investors who take on risk when financing a new venture, and sometimes as an incentive to raise money (especially from early investors) in later funding rounds. However, granting preemptive rights can be time-consuming both for the corporation and the shareholder, and may potentially hinder the ability to quickly rally fresh financial resources.

For those looking to form a corporation in Texas , invest in new ventures, or even rally capital to overcome challenges created by COVID-19 and the coronavirus pandemic, due diligence during business formation, contract drafting and negotiation, and the creation of shareholder agreements should involve thorough assessment of preemptive rights and dispute mitigation strategies.

Because issuing new shares can also be a key ingredient in the recipe for litigation, any corporation looking to raise money should carefully consider the implications of granting preemptive rights in their governing documents or agreements.

Experienced attorneys like those at Hendershot Cowart P.C. can assist start-ups, shareholders, and established businesses in proactively addressing preemptive rights and protections against dilution or other forms of shareholder oppression, while balancing the need for a business to retain financial flexibility and raise capital.

Preemptive Rights Exceptions

Shares sold by corporations may come from newly authorized shares, previously authorized shares never issued, or treasury shares that have been issued and repurchased by the corporation. They may also be issued for consideration in kind, such

When corporations issue new shares or sell treasury shares, a shareholder with preemptive rights has a type of first right of refusal to purchase their proportionate share of the new offering on the same terms – thereby maintaining their ownership percentage and avoiding dilution of ownership through issuance. There’s no obligation that they must purchase any shares; preemptive rights only provide an opportunity to do so.

However, Texas law exempts certain issuances from preemptive rights, unless a share’s certificate provides otherwise. Per Texas Business Organizations Code § 21.204 , exceptions include:

• Shares issued or granted as compensation to directors, officials, agents, or employees of company of subsidiary or affiliate;
• Shares issued / granted to satisfy conversion or option rights created for compensation;
• Shares authorized in a corporation’s Certificate of Formation issued no later than the 180th day after corporation’s formation; or
• Shares sold, issued, granted by a corporations for consideration other than money.

As these exceptions show, even shareholder with preemptive rights may be unable to stop corporations or majority holders from successfully diluting by issuing shares under an exception. Because preemptive rights only provide an opportunity to purchase additional shares to maintain their ownership percentage when new shares are issued, minority shareholders who lack the financial means or willingness to make the purchase may find little benefit in having such rights.

Legal Remedies For Shareholder Dilution

Because preemptive rights are not a fail-safe protection against shareholder dilution, and because Texas’ shareholder oppression doctrine was eliminated in the Texas Supreme Court’s 2014 decision in Ritchie v. Rupe , minority shareholders experiencing a squeeze-out through stock issuance may need to explore other options for legal remedy.

Fortunately, there are a number of legal remedies in the post- Ritchie world for minority shareholders facing dilution, oppression, and violation of their rights. While different statutes of limitations may apply depending on the claim, actions based on preemptive rights in Texas must be brought no later than (whichever is earliest):

• 1 year from the date of written notice of the violation; or
• 4 years from the (latest) date of issuance, sale or distribution.

Though every case is unique and every course of action tailored to the specific facts and circumstances, there are a number of potential actions by which minority shareholders can seek legal remedy. Examples include:

• Breach of fiduciary duty over the issue of a large number of shares for inadequate consideration (shares below FMV), and / or for loss of value to the corporation’s shares;
• Derivative lawsuits to pursue a damages remedy;
• Individual shareholder claims over breach of fiduciary duty, breach of trust and confidence (i.e. a breach of informal fiduciary duty), or stock conversion, which may allow for legal or equitable remedy such as a buyout;
• Breach of contract of a shareholder agreement;
• Fraud , including claims of inducement, fraudulent conveyance / transfer of stock, or state or federal securities fraud;
• Ultra vires actions over unauthorized acts of a corporation or its officers.

Some of these claims relate directly to Directors’ fiduciary duties , which are a flexible and powerful instrument for limiting directors’ discretion in issuing shares, and ensuring their transactions are fair to the corporation. Our team at Hendershot Cowart P.C. can help evaluate your situation to determine the most appropriate path for legal action.

Preventing Disputes & Oppression

Mitigating risks of disputes, oppression, and litigation requires a comprehensive approach. Among these are three key areas of focus that can help strike a balance between shareholders’ rights and the ability of corporations to maintain optimal financial structure:

• Corporate bylaws regarding the allocation of power for determining how and when new shares are issued;
• Preemptive rights in the even new shares are issued and sold; and
• Fiduciary duties of directors who issue and sell new shares.

At Hendershot Cowart P.C., our award-winning attorneys leverage over a century of collective experience to guide clients through a range of matters involving business law , transactions , and shareholder rights. This proactive counsel for individuals and entities in matters of:

• Business formation and incorporation
• Governing documents, bylaws, and contracts
• Disputes over distributions, dividends, and compensation
• Drafting shareholder agreements
• Dispute mitigation planning
• Buy-sell agreements
• Contract review and negotiation
• Corporate restructuring

For shareholders, majority owners, and corporations who need to pursue or defend against legal action, our team can provide representation in mediation, arbitration, or litigation over partnership or shareholder disputes , direct and derivative lawsuits, and other related claims.

Have questions about preemptive rights, shareholder dilution, or how Hendershot Cowart P.C. can assist in your legal matter? Call (713) 909-7323 or contact us online to request a consultation.

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26 CFR § 1.1041-1T - Treatment of transfer of property between spouses or incident to divorce (temporary).

• Table of Popular Names

Q–1: How is the transfer of property between spouses treated under section 1041?

A–1: Generally, no gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse or, if the transfer is incident to a divorce, a former spouse . The following questions and answers describe more fully the scope , tax consequences and other rules which apply to transfers of property under section 1041.

(a) Scope of section 1041 in general.

Q–2: Does section 1041 apply only to transfers of property incident to divorce?

A–2: No. Section 1041 is not limited to transfers of property incident to divorce. Section 1041 applies to any transfer of property between spouses regardless of whether the transfer is a gift or is a sale or exchange between spouses acting at arm's length (including a transfer in exchange for the relinquishment of property or marital rights or an exchange otherwise governed by another nonrecognition provision of the Code). A divorce or legal separation need not be contemplated between the spouses at the time of the transfer nor must a divorce or legal separation ever occur.

Q–3: Do the rules of section 1041 apply to a transfer between spouses if the transferee spouse is a nonresident alien?

A–3: No. Gain or loss (if any) is recognized (assuming no other nonrecognition provision applies) at the time of a transfer of property if the property is transferred to a spouse who is a nonresident alien .

Q–4: What kinds of transfers are governed by section 1041?

A–4: Only transfers of property (whether real or personal, tangible or intangible) are governed by section 1041. Transfers of services are not subject to the rules of section 1041.

Q–5: Must the property transferred to a former spouse have been owned by the transferor spouse during the marriage?

A–5: No. A transfer of property acquired after the marriage ceases may be governed by section 1041.

(b) Transfer incident to the divorce.

Q–6: When is a transfer of property incident to the divorce ?

A–6: A transfer of property is incident to the divorce in either of the following 2 circumstances—

(1) The transfer occurs not more than one year after the date on which the marriage ceases, or

(2) The transfer is related to the cessation of the marriage.

Q–7: When is a transfer of property related to the cessation of the marriage ?

A–7: A transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, as defined in section 71(b)(2), and the transfer occurs not more than 6 years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or amendment to such decree or instrument. Any transfer not pursuant to a divorce or separation instrument and any transfer occurring more than 6 years after the cessation of the marriage is presumed to be not related to the cessation of the marriage. This presumption may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. For example , the presumption may be rebutted by showing that (a) the transfer was not made within the one- and six-year periods described above because of factors which hampered an earlier transfer of the property , such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.

Q–8: Do annulments and the cessations of marriages that are void ab initio due to violations of state law constitute divorces for purposes of section 1041?

(c) Transfers on behalf of a spouse.

Q–9: May transfers of property to third parties on behalf of a spouse (or former spouse) qualify under section 1041?

A–9: Yes. There are three situations in which a transfer of property to a third party on behalf of a spouse (or former spouse) will qualify under section 1041, provided all other requirements of the section are satisfied. The first situation is where the transfer to the third party is required by a divorce or separation instrument. The second situation is where the transfer to the third party is pursuant to the written request of the other spouse (or former spouse). The third situation is where the transferor receives from the other spouse (or former spouse) a written consent or ratification of the transfer to the third party. Such consent or ratification must state that the parties intend the transfer to be treated as a transfer to the nontransferring spouse (or former spouse) subject to the rules of section 1041 and must be received by the transferor prior to the date of filing of the transferor's first return of tax for the taxable year in which the transfer was made. In the three situations described above, the transfer of property will be treated as made directly to the nontransferring spouse (or former spouse) and the nontransferring spouse will be treated as immediately transferring the property to the third party. The deemed transfer from the nontransferring spouse (or former spouse) to the third party is not a transaction that qualifies for nonrecognition of gain under section 1041. This A–9 shall not apply to transfers to which § 1.1041 –2 applies.

(d) Tax consequences of transfers subject to section 1041.

Q–10: How is the transferor of property under section 1041 treated for income tax purposes?

A–10: The transferor of property under section 1041 recognizes no gain or loss on the transfer even if the transfer was in exchange for the release of marital rights or other consideration. This rule applies regardless of whether the transfer is of property separately owned by the transferor or is a division (equal or unequal) of community property . Thus, the result under section 1041 differs from the result in United States v. Davis, 370 U.S. 65 (1962) .

Q–11: How is the transferee of property under section 1041 treated for income tax purposes?

A–11: The transferee of property under section 1041 recognizes no gain or loss upon receipt of the transferred property . In all cases, the basis of the transferred property in the hands of the transferee is the adjusted basis of such property in the hands of the transferor immediately before the transfer . Even if the transfer is a bona fide sale, the transferee does not acquire a basis in the transferred property equal to the transferee 's cost (the fair market value). This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than its fair market value at the time of transfer (or the value of any consideration provided by the transferee) and applies for purposes of determining loss as well as gain upon the subsequent disposition of the property by the transferee . Thus, this rule is different from the rule applied in section 1015(a) for determining the basis of property acquired by gift.

Q–12: Do the rules described in A–10 and A–11 apply even if the transferred property is subject to liabilities which exceed the adjusted basis of the property?

A–12: Yes. For example , assume A owns property having a fair market value of $10,000 and an adjusted basis of $1,000. In contemplation of making a transfer of this property incident to a divorce from B, A borrows $5,000 from a bank , using the property as security for the borrowing. A then transfers the property to B and B assumes, or takes the property subject to, the liability to pay the $5,000 debt. Under section 1041, A recognizes no gain or loss upon the transfer of the property , and the adjusted basis of the property in the hands of B is $1,000.

Q–13: Will a transfer under section 1041 result in a recapture of investment tax credits with respect to the property transferred?

A–13: In general, no. Property transferred under section 1041 will not be treated as being disposed of by, or ceasing to be section 38 property with respect to, the transferor. However, the transferee will be subject to investment tax credit recapture if, upon or after the transfer , the property is disposed of by, or ceases to be section 38 property with respect to, the transferee . For example , as part of a divorce property settlement, B receives a car from A that has been used in A's business for two years and for which an investment tax credit was taken by A. No part of A's business is transferred to B and B's use of the car is solely personal. B is subject to recapture of the investment tax credit previously taken by A.

(e) Notice and recordkeeping requirement with respect to transactions under section 1041.

Q–14: Does the trasnsferor of property in a transaction described in section 1041 have to supply, at the time of the transfer , the transferee with records sufficient to determine the adjusted basis and holding period of the property at the time of the transfer and (if applicable) with notice that the property transferred under section 1041 is potentially subject to recapture of the investment tax credit?

A–14: Yes. A transferor of property under section 1041 must, at the time of the transfer , supply the transferee with records sufficient to determine the adjusted basis and holding period of the property as of the date of the transfer . In addition, in the case of a transfer of property which carries with it a potential liability for investment tax credit recapture , the transferor must, at the time of the transfer , supply the transferee with records sufficient to determine the amount and period of such potential liability . Such records must be preserved and kept accessible by the transferee .

(f) Property settlements—effective dates, transitional periods and elections.

Q–15: When does section 1041 become effective?

A–15: Generally, section 1041 applies to all transfers after July 18, 1984. However, it does not apply to transfers after July 18, 1984 pursuant to instruments in effect on or before July 18, 1984. (See A–16 with respect to exceptions to the general rule .)

Q–16: Are there any exceptions to the general rule stated in A–15 above?

A–16: Yes. Two transitional rules provide exceptions to the general rule stated in A–15. First, section 1041 will apply to transfers after July 18, 1984 under instruments that were in effect on or before July 18, 1984 if both spouses (or former spouses ) elect to have section 1041 apply to such transfers . Second, section 1041 will apply to all transfers after December 31, 1983 (including transfers under instruments in effect on or before July 18, 1984) if both spouses (or former spouses ) elect to have section 1041 apply. (See A–18 relating to the time and manner of making the elections under the first or second transitional rule .)

Q–17: Can an election be made to have section 1041 apply to some, but not all, transfers made after December 31, 1983, or some but not all, transfers made after July 18, 1984 under instruments in effect on or before July 18, 1984?

A–17: No. Partial elections are not allowed . An election under either of the two elective transitional rules applies to all transfers governed by that election whether before or after the election is made, and is irrevocable.

(g) Property settlements—time and manner of making the elections under section 1041.

Q–18: How do spouses (or former spouses ) elect to have section 1041 apply to transfers after December 31, 1983, or to transfers after July 18, 1984 under instruments in effect on or before July 18, 1984?

A–18: In order to make an election under section 1041 for property transfers after December 31, 1983, or property transfers under instruments that were in effect on or before July 18, 1984, both spouses (or former spouses ) must elect the application of the rules of section 1041 by attaching to the transferor's first filed income tax return for the taxable year in which the first transfer occurs, a statement signed by both spouses (or former spouses ) which includes each spouse 's social security number and is in substantially the form set forth at the end of this answer.

In addition, the transferor must attach a copy of such statement to his or her return for each subsequent taxable year in which a transfer is made that is governed by the transitional election . A copy of the signed statment must be kept by both parties.

The election statements shall be in substantially the following form:

In the case of an election regarding transfers after 1983:

The undersigned hereby elect to have the provisions of section 1041 of the Internal Revenue Code apply to all qualifying transfers of property after December 31, 1983. The undersigned understand that section 1041 applies to all property transferred between spouses , or former spouses incident to divorce. The parties further understand that the effects for Federal income tax purposes of having section 1041 apply are that (1) no gain or loss is recognized by the transferor spouse or former spouse as a result of this transfer ; and (2) the basis of the transferred property in the hands of the transferee is the adjusted basis of the property in the hands of the transferor immediately before the transfer , whether or not the adjusted basis of the transferred property is less than, equal to, or greater than its fair market value at the time of the transfer . The undersigned understand that if the transferee spouse or former spouse disposes of the property in a transaction in which gain is recognized, the amount of gain which is taxable may be larger than it would have been if this election had not been made.

In the case of an election regarding preexisting decrees:

The undersigned hereby elect to have the provisions of section 1041 of the Internal Revenue Code apply to all qualifying transfers of property after July 18, 1984 under any instrument in effect on or before July 18, 1984. The undersigned understand that section 1041 applies to all property transferred between spouses , or former spouses incident to the divorce. The parties further understand that the effects for Federal income tax purposes of having section 1041 apply are that (1) no gain or loss is recognized by the transferor spouse or former spouse as a result of this transfer ; and (2) the basis of the transferred property in the hands of the transferee is the adjusted basis of the property in the hands of the transferor immediately before the transfer , whether or not the adjusted basis of the transferred property is less than, equal to, or greater than its fair market value at the time of the transfer . The undersigned understand that if the transferee spouse or former spouse disposes of the property in a transaction in which gain is recognized, the amount of gain which is taxable may be larger than it would have been if this election had not been made.

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• Internal Revenue Code of 1954

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2022 Texas Statutes Water Code Title 4 - General Law Districts Chapter 67 - Nonprofit Water Supply or Sewer Service Corporations Subchapter A. General Provisions Section 67.016. Transfer or Cancellation of Stock, Membership, or Other Right of Participation

Sec. 67.016. TRANSFER OR CANCELLATION OF STOCK, MEMBERSHIP, OR OTHER RIGHT OF PARTICIPATION. (a) A person or entity that owns any stock of, is a member of, or has some other right of participation in a corporation may not sell or transfer that stock, membership, or other right of participation to another person or entity except:

(1) by will to a person who is related to the testator within the second degree by consanguinity;

(2) by transfer without compensation to a person who is related to the owner of the stock or other interest within the second degree by consanguinity; or

(3) by transfer without compensation or by sale to the corporation.

(b) Subsection (a) does not apply to a person or entity that transfers the membership or other right of participation to another person or entity as part of the conveyance of real estate from which the membership or other right of participation arose.

(c) The transfer of stock, a membership, or another right of participation under this section does not entitle the transferee to water or sewer service unless each condition for water or sewer service is met as provided in the corporation's published rates, charges, and conditions of service. A transfer and service application must be completed on the corporation's standardized forms and filed with the corporation's office in a timely manner. The conditions of service may not require a personal appearance in the office of the corporation if the transferee agrees in writing to accept the rates, charges, and conditions of service.

(d) The corporation may make water or sewer service provided as a result of stock, a membership, or another right of participation in the corporation conditional on ownership of the real estate designated to receive service and from which the membership or other right of participation arises.

(e) The corporation may cancel a person's or other entity's stock, membership, or other right of participation if the person or entity fails to:

(1) meet the conditions for water or sewer service prescribed by the corporation's published rates, charges, and conditions of service; or

(2) comply with any other condition placed on the receipt of water or sewer service under the stock, membership, or other right of participation.

(f) Consistent with Subsection (a), the corporation may reassign canceled stock or a canceled membership or other right of participation to a person or entity that has legal title to the real estate from which the canceled membership or other right of participation arose and for which water or sewer service is requested.

(g) Notwithstanding Subsection (a), the corporation shall reassign canceled stock or a canceled membership or other right of participation to a person or entity that acquires the real estate from which the membership or other right of participation arose through judicial or nonjudicial foreclosure. The corporation may require proof of ownership resulting from the foreclosure.

(h) Service provided following a transfer under Subsection (f) or (g) is made subject to compliance with the conditions for water or sewer service prescribed by the corporation's published rates, charges, and conditions of service.

Added by Acts 1997, 75th Leg., ch. 166, Sec. 2, eff. Sept. 1, 1997.

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• FOREIGN INCOME & TAXPAYERS

IRS issues Q&As on Sec. 965 transfer and consent agreements

• International Tax
• IRS Practice & Procedure

Editor: Mark G. Cook, CPA, CGMA

As a result of the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, the United States switched from a global to a territorial tax system, and certain U.S. taxpayers who held ownership in foreign entities were subject to a one-time Sec. 965 transition tax on untaxed foreign earnings. The IRS provided affected taxpayers various elections for paying this tax, including paying it in installments under Sec. 965(h) or deferring payment for S corporation shareholders under Sec. 965(i) until specific acceleration or triggering events occur. Even if such an event should occur, the IRS alleviates the tax burden by allowing transfer and consent agreements if the requirements are met. On June 27, 2019, the IRS released further guidance through its question-and-answer (Q&A) webpage (available at www.irs.gov ) to further recap and clarify the rules for transfer and consent agreements set forth in Secs. 965(h) and (i) and Regs. Secs. 1.965-7(b) through (c).

Background: Sec. 965

Sec. 965 generally applies to U.S. shareholders, as defined under Sec. 951(b), in certain specified foreign corporations. A specified foreign corporation is either a controlled foreign corporation (CFC) or a foreign corporation with a corporate U.S. shareholder (Sec. 965(e)(1)). To the extent the foreign corporation has accumulated post-1986 earnings and profits that have not been previously taxed by the United States, Sec. 965 requires the U.S. shareholder to pay a transition tax on those earnings as of Nov. 2, 2017, or Dec. 31, 2017, in the foreign corporation's last tax year beginning before Jan. 1, 2018, as if the earnings had been repatriated to the United States.

Under Sec. 965(h), the taxpayer can elect to pay its Sec. 965 net tax liability in installments over eight years. The installment amounts are as follows: 8% of the tax for the first five installments, 15% for the sixth installment, 20% for the seventh installment, and 25% for the eighth and final installment (Sec. 965(h)(1)). However, if an acceleration event occurs, the unpaid portion of all the remaining installments becomes due. An acceleration event is:

• An addition to tax for failure to timely pay any required installment;
• A liquidation, sale, exchange, or disposition of substantially all of the taxpayer's assets, including in bankruptcy;
• A cessation of business by a person that is not an individual;
• An event that results in a person no longer being a U.S. person, including a resident alien becoming a nonresident alien;
• A person's becoming a member of a consolidated group;
• A consolidated group's ceasing to exist; or
• A determination by the IRS that an acceleration event has occurred because of a material misrepresentation in a transfer agreement.

An exception to this rule applies if the acceleration event is a covered acceleration as defined in Regs. Sec. 1.965-7(b)(3)(iii)(A)(1), and an eligible Sec. 965(h) transferor and an eligible Sec. 965(h) transferee (as defined in Regs. Sec. 1.965-7(b)(3)(iii)(B)(1)) enter into a transfer agreement with the IRS.

Under Sec. 965(i), a special rule applies to S corporation shareholders and allows the taxpayer to elect to defer the Sec. 965 net tax liability with respect to any S corporation that was a U.S. shareholder subject to Sec. 965. The taxpayer continues to defer the tax until a triggering event occurs. Sec. 965(i)(2)(A) and Regs. Sec. 1.965-7(c)(3)(ii) describe a few triggering events:

• The corporation ceases to be an S corporation;
• There is a liquidation, sale, exchange, or disposition of substantially all of the S corporation's assets;
• There is a cessation of business by the S corporation;
• The S corporation ceases to exist; or
• There is a transfer of any share of S corporation stock by the shareholder.

At the time of the triggering event, the entire amount of the deferred tax liability will be due unless (1) in the case of a stock transfer described in Sec. 965(i)(2)(A)(iii), a transfer agreement is entered into by an eligible transferor and an eligible transferee for stock transfers (Sec. 965(i)(2)(C)); or (2) the S corporation shareholder makes a Sec. 965(h) election to pay the transition tax over eight annual installments instead of immediately (Sec. 965(i)(4)). For specific triggering events described in Sec. 965(i)(2)(A)(ii), such as a liquidation or cessation of business, the Sec. 965(h) election can be made only with the IRS's consent (Sec. 965(i)(4)(D)).

Transfer agreements under Secs. 965(h)(3) and 965(i)(2)(C)

Regs. Secs. 1.965-7(b)(3)(iii)(B) and 1.965-7(c)(3)(iv)(B) highlight the requirements necessary to make a valid transfer agreement for Sec. 965(h)(3) and Sec. 965(i)(2)(C) purposes. The transfer agreement must be timely filed within 30 days of the acceleration or triggering event, and a copy of the agreement must be attached to both the transferor's and transferee's tax returns (Regs. Secs. 1.965-7(b)(3)(iii)(B)(2) and 1.965-7(c)(3)(iv)(B)(2)). In addition, the agreement must be signed under penalties of perjury by the appropr iate parties (Regs. Secs. 1.965-7(b)(3)(iii)(B)(3) and 1.965-7(c)(3)(iv)(B)(3)).

The agreement must be titled "Transfer Agreement Under Section 965(h)(3)" or "Transfer Agreement Under Section 965(i)(2)" (see Regs. Secs. 1.965-7(b)(3)(iii)(B)(4) and 1.965-7(c)(3)(iv)(B)(4)), and the terms must include the following:

• A statement that the transferee assumes the transferor's liability;
• A statement that the transferee (and, if applicable, the transferor) agrees to comply with all the conditions and requirements of the appropriate Code sections and Treasury regulations;
• The name, address, and taxpayer identification numbers (TINs) of the transferor and transferee;
• The amount of unpaid remaining net tax liability or unpaid deferred net tax liability for Sec. 965(h) and Sec. 965(i), respectively;
• A copy of the transferor's most recent Form 965-A, Individual Report of Net 965 Tax Liability , or Form 965-B, Corporate and Real Estate Investment Trust (REIT) Report of Net 965 Tax Liability and Electing REIT Report of 965 Amounts , as applicable;
• A detailed description of the acceleration or triggering event;
• A representation that the transferee is able to pay the net tax liability being assumed;
• If the transferor continues to exist, an acknowledgment that the transferor and any successor will remain jointly and severally liable for the net tax liability;
• A statement as to whether the leverage ratio of the transferee and its affiliated group members after the event exceeds 3-to-1;
• For Sec. 965(h) purposes, a certification by the transferee waiving the right to a notice of liability and consenting to the immediate assessment of the remaining unpaid net tax liability; and
• Any additional information, representation, or certification required by the IRS in publications, forms, instructions, or other guidance.

Consent agreements under Sec. 965(i)(4)(D)

Regs. Sec. 1.965-7(c)(3)(v)(D) highlights the various requirements necessary to make a valid consent agreement for Sec. 965(i)(4)(D) purposes. Besides making a timely Sec. 965(h) election on the tax return and timely payment of the first installment, the consent agreement must be timely filed within 30 days of the triggering event, and a copy of the agreement must be attached to the shareholder's tax return (Regs. Sec. 1.965-7(c)(3)(v)(D)(2)). In addition, the shareholder must sign the agreement under penalties of perjury (Regs. Sec. 1.965-7(c)(3)(v)(D)(3)).

The agreement must be titled "Consent Agreement Under Section 965(i)(4)(D)" (see Regs. Sec. 1.965-7(c)(3)(v)(D)(4)), and the terms must include the following:

• A statement that the shareholder agrees to comply with all the conditions and requirements of the appropriate Code sections and Treasury regulations;
• The name, address, and TIN of the shareholder;
• The amount of unpaid deferred net tax liability for Sec. 965(i);
• A representation that the shareholder is able to pay the net tax liability;
• A statement as to whether the leverage ratio of the shareholder and all subsidiary members of its affiliated group after the event exceeds 3-to-1; and

New guidance from IRS Q&As and observations

The IRS released new Q&As related to transfer and consent agreements that emphasize the more practical issues a taxpayer may encounter and provided citations to the primary source materials as discussed earlier.

Under Q&As No. 2, No. 3, and No. 5, the IRS indicates that a transfer or consent agreement should be filed with the IRS's Memphis Compliance Service Collection Operations at Memphis CSCO, 5333 Getwell Road MS 81, Memphis, TN 38118. All agreements will be considered timely filed only if they are filed within 30 days of the acceleration or triggering event date. However, for the death of a Sec. 965(i) transferor and related triggering event, the transfer agreement may be filed by the unextended due date of the transferor's final tax return (Regs. Sec. 1.965-7(c)(3)(iv)(B)(2)(iii)).

The IRS emphasizes the consent agreement must be filed by the S corporation shareholder, not the S corporation, as the affected taxpayer is the shareholder (Q&A No. 4). If the S corporation has more than one shareholder, each shareholder must file his or her own consent agreement for certain triggering events in order to be permitted to pay the Sec. 965(i) tax in installments under Sec. 965(h). In addition to the consent agreement, the taxpayer is still required to make a timely Sec. 965(h) election (see Q&A No. 6). This signed election statement must be attached to the taxpayer's tax returns; and the appropriate Form 965-A or Form 965-B, which tracks the Sec. 965 tax liability, must be updated for the triggering event, election, and installment payments.

In Q&A No. 7, the IRS reminds taxpayers that if a Sec. 965(h) election is made, excess remittances in the year of a Sec. 965(i) triggering event cannot be refunded or credited to the next year's estimated income tax until the tax year's income tax liability is paid in full, including the Sec. 965(h) installments. The rationale behind this is that the previously deferred Sec. 965(i) net tax liability is immediately assessed as an addition of tax in the year of the triggering event. The Sec. 965(h) election only defers the payment, not the actual tax liability.

As such, with a Sec. 965(h) election in the year of a triggering event, the tax payments must be applied initially to the tax liability without Sec. 965, and the first Sec. 965(h) installment then to any succeeding Sec. 965(h) installments. Once the tax year's liability is fully satisfied, the taxpayer may receive a refund or credit to the next year's income tax if any excess remittances remain. Therefore, if the taxpayer plans to make a Sec. 965(h) election, the taxpayer must be careful of how much estimated tax payments are actually made for the tax year of a triggering event in order to get the most benefit out of the election.

Lastly, the IRS explains that the S corporation and transferor, if applicable, remain jointly and severally liable for a taxpayer's Sec. 965(i) net tax liability, even if a Sec. 965(h) election was made (Q&A No. 8). They will continue to be accountable for payments of the net tax liability, penalties, additions to tax, or other related amounts. The election does not alter the joint and several liabilities of the S corporation or transferor as discussed in Sec. 965(i)(5) and related Treasury regulations.

Editor Notes

Mark G. Cook , CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.

For additional information about these items, contact Mr. Cook at 949-261-8600 or [email protected] .

All contributors are members of SingerLewak LLP.

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Tax-Free Transfers Incident to a Divorce – What Qualifies?

Dividing assets in a divorce is rarely a simple matter. It gets even more complicated when there is a transfer of property between spouses after a divorce.I

When transferring assets as part of a negotiated settlement or divorce proceeding, it might not be possible to complete the transfer immediately due to financial or logistical reasons.

Timing is everything , as the saying goes.

It’s important to understand the rules regarding the transfer of property between spouses after a divorce, and how the timing impacts how – and whether – transactions are taxed.

Does the Transaction Qualify As a Section 1041 Transfer?

A good starting point is to determine whether the transaction qualifies as an IRC Section 1041 transfer.

Internal Revenue Code Section 1041 lays out the rules for property that is transferred between spouses who are divorcing or are divorced. It provides that a property transfer is incident to the divorce if it occurs within one year of the divorce, or if it is related to the cessation of the marriage.

If the transaction qualifies as a Section 1041 transfer, it is not subject to taxation and the basis of the asset carries over to the receiving spouse.

Special Rules Relating to Timing of Transfer

There are special rules relating to the timing of the transfer. To achieve the most advantageous financial outcome for a divorcing client, family law attorneys should consider how these special rules apply to their clients.

The One-Year and Six-Year Tests

Let’s look at some key property transfer benchmarks on the divorce timeline:

Source: Thomson Reuters Checkpoint, 601 Applicability of IRC Sec. 1041

Transfers Taking Place Within One Year of the Divorce

No support or evidence is required when a transaction takes place within one year of the divorce. The presumption is that property transferred between former spouses is merely a shifting around of jointly owned assets and therefore, is not subject to taxation. This rule applies even if the transferred property was acquired after the divorce was final.

Consider this example:

John and Beth were divorced in July 2017. In January 2018, John purchased stock for $50,000. John then transferred the stock to Beth in June 2018, which increased in value to $60,000, to satisfy an obligation to her as part of the divorce settlement. No gain or loss would be recognized by John or Beth for this transaction.

Transfers Taking Place Between the One-Year and Six-Year Anniversary of the Divorce

A transfer of property that occurs between the one-year and six-year anniversary must be made pursuant to a divorce or separation instrument to be presumed related to the cessation of the marriage and qualify for Section 1041 treatment. A divorce or separation instrument includes a decree of divorce or separate maintenance, a written separation agreement, or other court decree.

It is also worth noting that a divorce instrument includes amendments or modifications to the instrument. A divorce instrument that does not provide for a transfer of property can be later modified to include one and will therefore ensure that no gain or loss will be recognized.

Private Letter Ruling 9306015 provides an example of a transfer of property found to be related to the cessation of the marriage:

Mr. and Ms. Young divorced in 1988. In 1989, they entered into a settlement agreement, which provided that Mr. Young deliver to Ms. Young a promissory note for $1.5 million, which was secured by 71 acres of land. In 1990, Mr. Young defaulted on this obligation and entered into a later settlement agreement to transfer 59 acres of land (42.3 acres of the original 71 acres and 16.7 acres of land adjoining that tract). In accordance with the later settlement agreement, Mr. Young retained an option to repurchase the land for $2.2 million on or before December 1992. Mr. Young assigned the option to a third party, who exercised the option and bought the land from Ms. Young for $2.2 million. No gain or loss was recognized on the transfer of the property from Mr. Young to his former spouse. Ms. Young took the marital basis of the land and recognized a gain on the subsequent sale to a third party.

Transfers Taking Place After the Six-Year Anniversary of the Divorce

In general, property transferred more than six years after the divorce is final does not qualify for Section 1041 treatment.

Any transfer that is not pursuant to a divorce or separation instrument and occurs more than six years after the divorce becomes final is presumed to be unrelated to the cessation of the marriage. While the IRS guidance is unclear, there are special circumstances in which property transfers after the six-year mark would qualify as a tax-free transfer.

The presumption that a transfer was not related to the cessation of the marriage “may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one- and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.” (Source: Section 1.1041-1T(b), Q&A-7 of the Temporary Income Tax Regulations)

There is a documented case where the presumption that the transfer was not related to the cessation of the marriage was clearly rebutted.

In Private Letter Ruling 9235026 (May 29, 1992), the IRS ruled that the transfer of the wife’s interest in business property to her ex-husband was incident to the divorce even though the transfer occurred more than six years after the divorce. It was determined that the transfer was delayed because of a dispute over the purchase price and payments terms. After the disputed factors were resolved, the transfer was promptly completed. Temp. Treas. Reg. §1.1041-1T, A-7 specifically provides that the presumption may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage, and there were factors that hampered an earlier transfer of property. 

To qualify for Section 1041 treatment, a transfer of property should take place before the six-year anniversary of a divorce and be supported by a divorce or separation agreement after the one-year anniversary of the divorce. In circumstances where the property transfer cannot be completed within a six-year time frame, the best support is a written divorce or separation agreement documenting the contemplated transfer, and support for why the transfer could not be completed during the six-year time frame. There are documented exceptions to the six-year rule, but the guidance is not clear and would surely be evaluated by the IRS based on the specific facts and circumstances surrounding the property transfer.

Our litigation support professionals help family law attorneys form solid financial strategies for their divorcing clients. Contact us   online  or call 800.899.4623 for help.

Published on February 13, 2019

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Transferring assets into a living trust: Can you do it yourself? by Brette Sember, J.D.

Transferring assets into a living trust: Can you do it yourself?

You may have established a living trust, but it's not functional until you transfer ownership of your assets to it.

Ready to start your estate plan?

by Brette Sember, J.D. updated  May 11, 2023  ·  4 min read

Setting up a living trust is the first step to having your assets owned by your revocable living trust. Funding a living trust means that your assets are transferred to the trust and are officially owned by it so the trust can function as you intended it to.

Changing ownership of a trust

When you transfer assets to a living trust you are changing legal ownership of your assets from your name to that of the trust. Most people create a living trust with themselves as trustee, so you will still be able to use and control your assets, but they will technically be owned by the trust. Note that items in the trust will continue to be assigned to your social security number. To get started, you’ll want to make a complete list of the assets you want to transfer so that you are sure you don’t leave anything out.

Transferring real property to a trust

One of the largest assets most people own is their home, and this is likely an asset you want to transfer into your trust. You can transfer your home (or any real property) to the trust with a deed, a document that transfers ownership to the trust. A quitclaim deed is the most common and simplest method (and one you can do yourself). Alternatively, a warranty deed ensures you have good title when you transfer it and may make it easier for your trust beneficiaries to sell the home down the line.

You will want to check with an attorney about which type of deed is best in your situation. Some states require that all deeds be prepared by attorneys so you may not have a self-help option. Once the deed form is prepared, a real estate deed must be filed with your county and you will need to pay a filing fee.

A deed transfer should not affect your mortgage, even if you have a due on sale provision. You should check on your title insurance (if you have any) though . You may be able to simply transfer it to the trust, or your title insurance company may require that the trust buy a new policy.

Once the deed is transferred, you may need to change your homeowner’s insurance to indicate the trust as owner of the property. If you receive a real estate tax exemption, you will want to make sure that is properly applied by showing documentation of the trust to the taxing authority, such as a certificate of trust (a document your attorney can create that certifies the existence of the trust).

Transferring vehicles to a trust

If you would like to transfer ownership of your car or truck to your trust, you need to first determine if your state will allow a trust to hold ownership of a vehicle (check the DMV web site or consult your attorney). You also should call your insurance company to be certain they will continue coverage once the transfer is made. To transfer ownership, you will need to obtain a title change form from your DMV and complete it, naming the trustee (as trustee of your trust) as new owner. Sales tax should not apply to the transfer and if the clerk tries to apply it, you will need to speak to a supervisor. If you own a boat, you will need to follow a similar procedure to transfer title.

Transferring financial assets to a trust

To transfer assets such as investments, bank accounts, or stock to your real living trust, you will need to contact the institution and complete a form. You will likely need to provide a certificate of trust as well. You may want to keep your personal checking and savings account out of the trust for ease of use.

Transferring personal property to a trust

You likely own many things that you don’t have actual written titles or ownership documents for, such as jewelry, furniture, collectibles, and the miscellaneous things that fill your home. To place them in your living trust fund, you can name them in your trust document on a property schedule (basically a list you attach to the trust document that is referred to in the document) and indicate that their ownership is being transferred to the trust. If any of these items are insured, be sure to transfer the insurance to the name of the trust.

What cannot be placed in a trust?

There are some things that cannot or should not be placed in your trust. Individual Retirement Accounts (IRAs) cannot be owned by a trust , so these must remain in your own name, but you can name the trust as a primary or secondary beneficiary. Revocable living trusts are often named as beneficiaries of a life insurance policy. It's a good idea to talk to a lawyer or accountant to understand any tax implications of doing so.

If you purchase or inherit items after you create the trust, you may want to transfer those items to the trust as soon as possible. If possible, when you purchase items, purchase them as trustee of the trust so they are automatically placed in the trust.

Consider a pour-over will

To further protect yourself, you will want a pour-over will . This last will and testament can be prepared by your attorney and will indicate that any items left in your name are transferred to the trust upon your death, so that your trust will be complete and provide all the benefits you created it for.

Double-check your list of assets to be certain you have moved them to your trust. Ensuring that your living trust is properly funded will provide you with the protection you seek and the peace of mind that your affairs are in order.

About the Author

Brette Sember, J.D.

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Business Income Manual

Bim90055 - post-cessation receipts and expenses: receipts which are not post-cessation receipts: transfer of trading stock.

S252 Income Tax (Trading and Other Income) Act 2005, S195 Corporation Tax Act 2009

Payment for the transfer of trading stock is not usually a post-cessation receipt

When a business ceases to trade, it may still have trading stock which needs to be sold.

If the trading stock is valued in accordance with the tax legislation and included in the profit and loss account in the final period of account, any amount received for the transfer of the stock is not a post-cessation receipt. This is because the value of the trading stock has already been included in calculating the taxable profits of the trade to cessation.

The rules on valuation of stock on cessation are found in Chap 12 Part 2 ITTOIA 2005 and Chap 11 Part 3 CTA 2009. For guidance on the application of these provisions, see BIM33450 onwards.

For these purposes, trading stock takes the definition in S174 ITTOIA 2005 and S163 CTA 2009 (see BIM33000 onwards).

Other receipts which are not post-cessation receipts

Other receipts which are specifically excluded from being post-cessation receipts are:

• payments for transfer of work in progress (see BIM90060 )
• lump sums paid to personal representatives for copyright etc (see BIM90065 )

These exclusions do not apply to companies subject to Corporation Tax.

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