LLC: The Estate Planning Tool

January 1, 2019

Estate planning is an important tool to ensure your family’s financial safety and security, once you have passed. Although a hard and emotional pill to swallow, properly planning for your future will ultimately make your loved ones’ lives easier once you have passed away.

Estate planning is the process through which your assets can be distributed to your family, friends, charitable organizations or other individuals as you wish.

Among other things, through proper estate planning, you can determine who will manage and how your assets will be managed during your lifetime should you be unable to manage them yourself or after your lifetime, and when you would want your assets to be distributed either during or after your lifetime.

A common misconception is that estate planning is done only through writing a will and can only determine how your assets will be distributed. However proper estate planning will cover financial, tax, medical and business planning as well.

The most common entity form used for the purpose of estate planning is a Limited Liability Company (LLC). LLCs can facilitate gifting assets by individuals to their heirs and therefore minimizes the value of assets subject to estate taxes at death. LLCs also allow individuals to manage their assets during their lifetime even after the assets are gifted.

What is an LLC?

An LLC is a business entity that provides limited liability protection, tax advantages and capital flexibility to its owners. LLC owners are referred to as “members” and may be individuals, corporations, partnerships, other LLCs, or for estate planning purposes, a trust as well.  Rather than a member managed LLC that allows its members to serve as managers, for estate planning purposes a manager managed LLC, where management and ownership are kept separate, is generally more ideal.

In an LLC, owner liability is limited. This means that, under most circumstances, owners of an LLC are not be responsible for the debts and liabilities of the company.

Tax Benefits

A great estate planning tool is to gift away your assets while you are alive. For 2015, $14,000 (subject to inflation) may annually be gifted to another without having to pay taxes. By making these gifts during your lifetime, the gifted assets will not be subject to estate taxes of up to 40% once you have passed.

Although you will not receive an income deduction for the gifted amount, individuals receiving the gift must not report the gift as income. LLCs allow individuals to reduce their estate taxes by transferring assets to an LLC while still maintaining control.

While maintaining your fiduciary duties to the LLC and other owners, you will give your ownership interests away to your beneficiaries of choice; such as your children. As a result, the value will be deducted from your taxable estate. Because these interests cannot be sold or transferred with the individual’s approval, there is no market for them. As a result, the assets will be discounted for tax purposes.

The beauty of LLCs as an estate planning tool is the ability of individuals to maintain control over their gifted assets and ensure their money and or assets are responsibly spent and used.

Control and Management

As owners of an LLC, individuals will maintain management and voting rights over the LLC’s assets. Furthermore, owners will maintain their role as primary decision maker and set restrictions and limitations on how the assets will be used or spent.

In the case where parents own a business, gifting membership interest in an LLC will allow the parents to pass their interest to their children without relinquishing any management or control over the business.

A parent who owns the LLC may control all distributions of the company’s assets and may transfer restrictions on the asset. These restrictions may include how and when money may be withdrawn from the company, when the company may be sold, or even dissolved when the parent has passed away.

In addition, individuals may impose restrictions on assets to protect the assets from potential creditors and or ex-spouses from attempting to get control.

Although there are many benefits to creating an LLC as part of an estate planning tool, there are two major benefits. Fractionalizing and discounting ownership interests are the two major benefits.

Fractional Ownership Interests

When an asset is transferred to an LLC for estate planning, shares of interest such as stock are created and assigned a value. The shares of interest represent a “fractional interest” in the LLC’s assets as a whole.

Fractionalizing assets makes gifting assets not easily capable of being divided, such as real property, convenient to gift away. The assets can easily be transferred between and to different beneficiaries.

However fractional ownership interests do have a negative side. Because the assets are divided, there is no marketability in the asset as a whole. For that reason, the asset will be discounted.

Discounting Ownership Interests

As mentioned, because fractionalized interests are divided, owners of the interest are not capable of realizing the entire value of the asset. As a result, the ownership interests in the assets of the LLC are valued below fair market value.

Many factors must be considered when determining the appropriate discount to be given to an interest owner. The terms of the LLC’s operating agreement may address the applicable discount. Generally, fractionalized ownership interests receive a discount anywhere between 30-40%.

There are many reasons why a fractionalized ownership interest will be discounted. For starters, those purchasing an interest in an LLC owned and controlled by a family are not likely to pay full market value for that interest.

In addition, because LLCs may restrict and control the interest, the interest is not freely transferable and owners may not sell their interests.

How Does All This Work?

An individual may transfer his or her assets such as real property, stocks, jewelry, or even cash to the LLC in exchange for ownership shares. The individual may then gift his or her interest shares in the LLC to whom they wish.

For example, in cases where the asset being passed through an estate planning tool is a real estate property, an LLC will allow individuals to divide interest in the property into equal shares among several individuals. An LLC will allow individuals to divide their interest without creating separate deeds of transfer for each beneficiary. Stock investments may be distributed between several beneficiaries without splitting the investment assets into separate portfolios.

Depending on your situation, an LLC may or may not be the appropriate estate planning tool for you. Contact your local estate planning and or tax attorney of further questions regarding an LLC.  


Topics: , , , , ,