Estate Planning: The Family Limited Liability Company as an Advanced Estate Planning Tool
If you are considering your options to transfer your wealth to your children or to keep your family business within the family, you should consider setting up a family limited liability company (LLC). A family LLC is like other LLCs except that it involves your family – the LLC is owned and managed by your family and the LLC assets are familial assets. It is an advanced estate planning tool and, depending on your estate planning needs, it may be the ideal vehicle for you to transfer your wealth to your children and younger generations.
A family LLC may provide numerous benefits to high-net worth individuals, business owners and their families. The benefits range from business and non-tax advantages to clear-cut tax savings.
Business and non-tax advantages
A family LLC allows for various business and non-tax advantages including:
- Maintenance and management of the family business or assets remains in the control of the senior generation
- Involvement of younger generations in the family business or in the management of family assets
- Pooling of business interests and investment risks
- Asset protection and spendthrift protection for younger generations from creditors or divorcing spouses
- Flexibility in dealing with family wealth and ability to gift interests in property that otherwise cannot be easily divided
- Limited liability for members
- Ability to minimize family disputes with built in dispute resolution procedures
A family LLC also provides for various tax savings including:
- Transfer tax savings for federal gift tax purposes in that property transfers to the family LLC, as opposed to transfers directly to children or grandchildren, allow for valuation discounts of the gifted interests based on minority status or lack of marketability
- Income tax savings for the family in that income earned on the family LLC property is taxed to the members and, therefore, may be “shifted” from parents to children or grandchildren who are in lower marginal income tax brackets
- Federal estate tax savings in that the gross estate of parents is reduced because the income and appreciation earned on family LLC assets is removed from the parents’ gross estates
A family LLC is structured similarly to other LLCs. The LLC is “owned” by members and may be managed either by the members or by managers who are appointed by the members. The LLC is registered with the state and there is an operating agreement which states who will control the LLC and make decisions over the assets. The LLC offers its members limited liability, similarly to corporations, but also provides for flow through taxation like partnerships. Thus, income is taxed to the members rather than to the LLC.
In the common family LLC setup, parents transfer business or investment assets, such as rental properties or traded securities, to the family LLC and, in exchange, take back membership interests. The transfers are generally tax free. Usually, there is an operating agreement which will name the parents as managers who make all the decisions regarding investment, management, and decisions over distributions to members. Meanwhile, the parents may gift membership interests in the family LLC to their children or grandchildren. In this way, the parents remain as managers of the family LLC, again, retaining control and making all the important decisions over the assets, while the children or grandchildren become owners.
Parents may make annual gifts to the younger generations of the family LLC interests. Furthermore, they can take advantage of the annual gift tax exclusion so that these gifts incur no gift tax. Because of the valuation discounts, the parents can actually make transfers whose value is more than the annual exclusion amount but, nonetheless, will not cross the tax threshold.
Within the operating agreement of the family LLC, parents can exercise even more nuanced control over the assets. The key is that the operating agreement require be drafted to require manager approval over the family LLC activities. For example:
- The operating agreement may provide that no distributions of cash to members may be made without manager approval or that no member may draw from his capital account without manager approval. Thus, parents control whether or not the children actually receive any funds from the family LLC.
- The operating agreement may limit the ability of members to sell or transfer their interests without manager approval, thus, keeping the family business in the family.
- The operating agreement may require a supermajority vote of the total membership interest, death or voluntary resignation in order for a manager to be removed. In this way, parents stay in control over the family LLC.
It is clear that the family LLC can be a useful tool in estate planning which allows for total family involvement but parental control, and various tax savings. However, the family LLC is not an appropriate estate planning tool for every family. Generally, it is useful for those individuals and families who have substantial wealth or have a family business they wish to pass on to younger generations in a controlled and managed transfer. Essentially, the family LLC is an advanced estate planning tool that should be considered only after you have completed other more basis estate planning techniques
Contact our Philadelphia Estate Planning and Business Law Firm with your questions, comments or concerns.