A stock is a type of property and, so, can be transferred freely unless transfer is prohibited by law or contract. If there are contractual limitations on the transfer of shares, they must be stated in the company’s articles of incorporation or bylaws, an agreement among the shareholders or in an agreement between the shareholders and the corporation.[1]
Generally, a company has broad discretion in restricting the transfer or sale of its stock if the restriction has a legitimate purpose. Transfers restrictions, where they exist, are governed by state law. While laws vary from state to state, many states have adopted a version of the Model Business Corporation Act. Under the Act, restrictions on the transfer or sale of stocks are valid if the purpose of the restriction is:
- to maintain the corporation’s status, when it is dependent on the number or identity of its shareholders;
- to preserve exemptions under federal or state securities law;
- In connection with shares issued by the corporation to its officers, directors, employees or independent contractors, including as equity-based compensation under the Internal Revenue Code; or
- For any other reasonable purpose.[2]
The Model Act also states that certain types of restrictions can be imposed without limitations. Under Section 6.27 of the Act, categories of restrictions may be imposed by the issuer without limitation. These include restrictions that:
(a) Obligate the shareholder first to offer the corporation or other designated people, an opportunity to acquire the restricted shares before transfer. This is known as a “right of first refusal.”
(b) Obligate the corporation or other designated people, to acquire or transfer the restricted shares.
(c) Obligate a shareholder to transfer the restricted shares to the corporation or other designated people for an agreed price or a price based on a specified formula. This is sometimes part of a “buy-sell agreement.”[3]
Also, as long as it is not manifestly unreasonable, a restriction can also require approval of the transfer of the shares by the corporation or designated people or prohibit the transfer of the restricted shares to certain people.[4]
Because transfer restrictions can potentially permanently limit the market for shares by disqualifying all or some potential purchasers, if a restriction is determined to be manifestly unreasonable, it will not be enforced. The Model Act does not expressly define the meaning of “manifestly unreasonable.” But, a federal court decision in Dell v. AB&T National Bank does provide some guidance on the intent of this term.
In Dell, the court considered whether two restrictions were valid under Georgia’s version 6.27 of the Model Business Corporation Act. The restrictions included a 10-year restriction on the transfer of shares and a total restriction on non-family transfers. In analyzing each restriction, the court first considered whether the restriction fit within one of the categories of restrictions allowable under Section 6.27. The court reasoned that the intent of the “manifestly unreasonable” language in the statute is to strike a balance between:
(1) the public policy against absolute restraints on a property owner’s right to sell, transfer, or otherwise dispose of property, and
(2) the ability of corporations to make and enter into contracts.[5]
Ultimately, the court decided that the 10-year restriction was unreasonable and against public policy, which should discourage absolute restrictions on the right to sell, transfer or otherwise dispose of property. On the other hand, the court found that the non family transfer restriction, which prohibited transfers to people who were not family members, was valid and not manifestly unreasonable. In reaching this conclusion, the court reasoned that under the law, shareholders are allowed to restrict the potential market for their shares to a single entity.[6]
The takeaway from the Dell case is that a restriction is valid as long as it fits within one of the categories of restrictions allowed under the law or is reasonable
Even if a restriction is valid under the law, it will not be enforced if the stock owner did not receive notice of the restriction. The owner is considered to have knowledge of the restriction even without actual knowledge if the restriction is stated conspicuously on the front or back of the stock certificate or contained in the information statement required for non-certificated shares.[7]
Finally, a restriction is not enforceable against owners of shares that were issued before the restriction was adopted unless the holders agree to the restriction or vote in favor of the restriction.[8]
Stock Transfer Methods
Next, we’ll turn to the process for the voluntary transfer of stock ownership and ways in which stock ownership can be automatically transferred upon the occurrence of an event such as death.
As long as the shareholder is not restricted in his right to transfer his shares, the transfer process is relatively straightforward. To transfer shares, the shareholder must contact the holder of the shares, and request transfer documents, such as from a transfer agent or the brokerage firm. Once the appropriate forms are completed, executed and submitted, the transfer occurs. Once transferred, the shares are registered in the new owner’s name.[9]
Shares can also be automatically transferred to a designated beneficiary through a transfer on death registration, or “TOD.” It is important to note that the TOD beneficiary has no rights to the account as long as the owner is living. That means that the owner of the account can sell, transfer or close the account without any consent or input from the TOD beneficiary and the TOD beneficiary is not owed any type of reimbursement or protection.
An account with a TOD registration is typically referred to as such in the registration name. An example of a TOD account might be “John Smith, TOD Lisa Smith.”
The “TOD” designation in the account’s registered name signals to the bank, firm or company that following the owner’s death, the account is to be re-registered at the request of the beneficiary. TOD registration is not necessarily a right of share ownership. Therefore, the availability of TOD registration is at the discretion of the brokerage firm.
The advantage of the TOD registration is that the designated beneficiary will automatically acquire ownership of the shares without the need for probate, which is a time-consuming and expensive process under which a state court reviews the process by which a deceased person’s property is collected, administered and distributed.[10] As such, TOD registration is commonly used by owners who wish to transfer their shares to family members, such as a children or grandchildren, with as few hurdles as possible.
After the account owner dies, the beneficiary of a TOD account must take certain steps to re-register the shares in her name. This usually involves sending an application for liquidation or re-registration and a copy of the original owner’s death certificate.[11] Examples of other documents that may be required include:
(1) A copy of an order of appointment as executor from a probate court, when the estate is subject to probate
(2) A stock power of attorney
(3) A tax waiver, and,
(4) An affidavit of domicile
The tax waiver typically comes from a taxing authority, such as the IRS or state tax administrators, that states that the transferred shares are not subject to transfer for tax or that all such taxes have been paid. These may be required because, otherwise, shares may be subject to tax liens making transfers ineffective or partially effective.
Uniform TOD Security Registration Act
TOD registration is governed by state law. As such, TOD registration laws vary from state to state. Almost all states have adopted some version of a uniform law called the Uniform TOD Security Registration Act.[12] An account owner can obtain a TOD registration if any of the following is located in a state that has adopted the Uniform TOD Act:
- Legal residence
- The brokerage firm’s principal office
- The incorporation of the issuer of the stock or the stockbroker
- The office of the transfer agent
- The office creating the registration.[13]
For example: John maintains his legal residence in Texas. Texas has not adopted a version of the Uniform TOD Act, and therefore TOD registration is not allowed. However, the principal place of business of his brokerage firm is located in Delaware. Delaware has adopted a version of the Uniform TOD Act. Even though he lives in Texas, John’s shares are eligible for TOD registration because the principal place of business of his broker firm in located in a state that has adopted a TOD law.
The purpose of the Uniform TOD law is to provide the legal authority for transfer of shares outside of probate. However, depending on how the account is registered, it may not be eligible for TOD registration.[14] Shares can be registered as:
(1) Sole or “individual” ownership,
(2) Joint Tenants with Right of Survivorship, which is a type of co-ownership between two or more people. As a matter of law, joint tenancy with a right of survivorship allows for the automatic transfer of a deceased owner’s interest in the property to the remaining surviving owners.
(3) Joint Tenants without a right of survivorship,
(4) Tenants in Common, which is a type of concurrent ownership where each tenant owns a divisible interest in the property,
(5) Community Property, which is a type of property ownership that is only created in certain states and is limited to owners that are married. Community property is property that is obtained during a marriage and that is owned equally by the married co-owners.[15]
(6) Tenants by the entirety, which is a type of property ownership that is also restricted to owners that are married. Under this type of property ownership, when one spouse dies, the remaining interest automatically transfers to the surviving spouse.[16]
Under the Uniform TOD law, only accounts that are registered to either an individual or joint tenants with right of survivorship can have a TOD registration.[17] Also, if the registration fails to state the registration type, securities with multiple owners and a TOD registration are held as either joint tenants with right of survivorship, tenants by the entireties or as community property with right of survivorship (but not as tenants in common). This section of the TOD law means that co-owners cannot list a beneficiary who could take any of the security interest before the deaths of all of the co-owners (since the share must be held in forms that include rights of survivorship). Finally, this section includes rights of survivorship to the beneficiaries of the transfer on death instructions if multiple beneficiaries are listed as post-death beneficiaries.[18]
Gift Transfers
The right to sell, transfer, and dispose of one’s property includes the right to transfer one’s stock ownership to another as a gift. Gifting shares to family members and charitable organizations is a common practice for stock owners. Unless the value of the gifted shares exceeds the IRS gift tax exclusion amount, the owners of the shares are not responsible to pay any transfer taxes. This is one of the benefits of transferring stocks rather than selling them, as selling shares could create capital gains tax ramifications.
The IRS has defined a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”[19]
For tax year 2019, the annual exclusion amount for gifts is $15,000 per recipient. It is important to note that the annual exclusion amount is subject to change from time to time as federal tax laws and IRS regulations are amended and updated.[20] Gifts of more than this amount to a single beneficiary may implicate transfer tax, though whether tax is due depends on other factors, such as whether the grantor has used his lifetime transfer tax exemption amount.
In addition to gifts that are valued below the annual exclusion amount, some other gifts are not subject to gift taxes. These include gifts to a US citizen spouse, charitable gifts and gifts to pay some qualified tuition or medical expenses of another person.[21]
A charitable contribution is a donation or a gift to an organization without the expectation or agreement to receive anything in return.[22] One of the benefits of gifting shares is the ability to deduct the value of the gift for income tax purposes. This is called a charitable contribution deduction.[23]
Under the federal tax rules, the person gifting the property is only eligible to receive a charitable deduction on his taxes if he donates the property to a qualified organization. The IRS describes qualified organizations as “nonprofit groups that are religious, charitable, educational, scientific, or literary in purpose, or that work to prevent cruelty to children or animals.”[24] Other groups and entities that can qualify for tax-exempt status include war veterans’ organizations, fraternal societies, non-profit cemetery companies and state and local government units.[25] Before gifting to an organization, the stock owner can search the organization’s status as a tax-exempt organization through the IRS’ database.[26]
The value of a gift of stock is determine by the fair market value of the shares, which is the amount that could be obtained if the property were sold on the open market or in an arm’s-length transaction. So, for example, if a person gifts shares to charity, she can take a charitable income tax deduction for the value that the shares would have if sold, regardless of what the donor paid for them originally.[27] A failure to accurately state the value of gifted stocks can result in significant tax penalties of up to 40% of the amount of underpaid taxes.[28]
In our last module, we’ll expound on our discussion of the tax ramifications of transferring shares of stock.
[1] MBCA, § 6.27(c).
[2] Id.
[3] MCBA § 6.27, Official Comment.
[4] Id.
[5] Dell v. AB&T National Bank, Case No. 1:13-cv-00014-WLS (M.D.Ga. 2013)
[6] Id.
[7] MCMBA § 6.27(b).
[8] MCMBA § 6.27(a).
[9] See Computershare Sample Transfer Packet
[10] FINRA, Plan for Transition: What You Should Know About the Transfer of Brokerage Account Assets on Death, http://www.finra.org/investors/alerts/plan-transition-transfer-brokerage-account-assets-death
[11] U.S. Securities and Exchange Commission, Transfer on Death (TOD) Registration, https://www.sec.gov/fast-answers/answerstodreghtm.html
[12] https://my.uniformlaws.org/committees/community-home?CommunityKey=4138971b-da18-4a73-8bfa-86a3790c4408
[13] Mary Randolph, Bypass probate by naming a beneficiary for your securities, NOLO, https://www.nolo.com/legal-encyclopedia/free-books/avoid-probate-book/chapter3-2.html
[14] See What Types of Registrations Are Available for Me to Transfer Shares?, Computershare FAQs, https://www-us.computershare.com/TransferWizard/FAQs.aspx
[15] Marriage & Property Ownership: Who Owns What?, NOLO, https://www.nolo.com/legal-encyclopedia/marriage-property-ownership-who-owns-what-29841.html
[16] Avoiding Probate With Tenancy by the Entirety Ownership, NOLO, https://www.nolo.com/legal-encyclopedia/free-books/avoid-probate-book/chapter6-4.html
[17] See KRS 292.6502.
[18] Section 6402, Registration in Beneficiary Form, Uniform Law Comment, https://govt.westlaw.com/pac/Document/NA3E49EE0342E11DA8A989F4EECDB8638?viewType=FullText&originationContext=documenttoc&transitionType=CategoryPageItem&contextData=(sc.Default)
[19] Frequently Asked Questions on Gift Taxes, Internal Revenue Service, https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes#1
[20] Inflation Adjustments Under Recently Enacted Tax Law, Internal Revenue Service, https://www.irs.gov/newsroom/inflation-adjustments-under-recently-enacted-tax-law
[21] Id.
[22] Publication 526 (2017), Charitable Contributions, Internal Revenue Service, https://www.irs.gov/publications/p526#en_US_2017_publink1000229634
[23] Internal Revenue Service, Charitable Contribution Deduction, https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions
[24] Id.
[25] Id.
[26] Tax Exempt Organization Search, Internal Revenue Service, https://www.irs.gov/charities-non-profits/tax-exempt-organization-search
[27] Charitable Contributions, Publication 526, Internal Revenue Service, pg. 11 https://www.irs.gov/pub/irs-pdf/p526.pdf
[28] Id. at pg. 13.