While trusts of various kinds are important in estate planning, other entities, standing alone or used in conjunction with trusts, are useful in achieving estate planning goals. One such entity is a Limited Liability Company.
A Limited Liability Company (LLC) is a business entity often used instead of a corporation or partnership. It is a hybrid entity that provides the benefit of limiting liability against personal assets for its owners (just like a corporation) as well as the benefits of being taxed for income tax purposes like a partnership.
By establishing an LLC with a "voting interest" component (typically 1%) and a "non-voting interest" component (99%) clients can give away assets, while maintaining substantial control over the administration of those asset during the client’s lifetime. The client (typically a parent) can keep the voting interest and give part or all of the nonvoting interest to children, grandchildren, or other beneficiaries. By retaining the voting interest, the parent maintains control of the operation of the LLC and the assets owned by it, yet is giving away value and future appreciation on the gift portion to others. I liken this to the client sitting in the front seat driving the car and his beneficiaries sitting in the backseat coming along for the ride. By giving away the majority of the non-voting interest during their lifetime (ideally using their Lifetime Gift Tax Exemption), the client reduces the total value of their estate and any potential Estate Tax liability. Another benefit of using the LLC strategy is a potential reduction in the client’s annual income taxes. If the LLC earns annual income, the LLC allocates that income in proportion to the owned interests. Thus instead of the client paying taxes on all of the income, the beneficiaries pay (presumably in a lower bracket) the tax on their share of the income.
The client can transfer any type of asset to the LLC, including cash. Transferring closely held businesses and real estate to an LLC provides additional planning opportunities:
1. If structured properly, the LLC can take advantage of valuation discounts for minority interests and lack of control. In addition, assets such as real estate and closely held businesses tend to have a range of value rather than a specific value, and the client can take advantage of the lower range of the value in order to make more gifts under the Annual Gift Tax Exclusion or the Lifetime Exemption. It is important, if an LLC desires to take advantage of these valuation discounts, that a valuation expert determines the assets themselves and the valuation discount.
2. Using an LLC offers the ability for business succession planning and provides a platform for determining who will operate entities in the future.
3. An LLC provides protection against creditors, both for the client and the succeeding generations.
4. The LLC offers an ability to plan for estate liquidity by purchasing life insurance in the LLC on the life of the client to eventually purchase the un-gifted client interests at the client's death or simply to replace the "client's wisdom and experience" with cash at death.
Clients can transfer an LLC interest as a gift to an individual or as a gift to a trust set up for the benefit of the individual. This is especially beneficial if a beneficiary has creditor issues, marital issues that may result in divorce, or spendthrift issues and an inability to control spending habits. In addition, gifting an LLC interest to a trust for the benefit of a minor allows for protection well beyond the minor's 18th birthday. The trust can specifically provide for income and principal distributions for the benefit of the minor with the eventual distribution at stated ages or certain events.
While the concept and use of an LLC for estate planning purposes is well-established, it is subject to IRS attack if not properly valued or if not appropriately established:
1. The LLC must comply with all state law rules for establishing such an entity and must continue to maintain all the required documents. The LLC must be managed and operated as a separate entity and not just another "pocket of the client".
2. With an LLC, the concept of "if some is good, more is better" is not necessarily a good idea. Clients should not transfer all of their assets to an LLC, because the IRS will argue that the client needs the LLC to maintain their lifestyle and therefore under estate tax rules the assets are deemed to be part of the client’s estate. Based on case law it is an especially bad idea to place the client's residence in the LLC.
3. When making gifts, valuations are necessary to substantiate the amount of the gift. To the extent the gift is in excess of the $13,000 annual exclusion, a Gift Tax Return is required.
4. Certain specific provisions must be included in the LLC to protect its integrity, ensure that gifts will be recognized, and allow gifts to be claimed as a "present gift" using the Annual Exclusion.
Use of an LLC for estate planning purposes is an excellent strategy in the right situation. It may be especially appropriate for any clients still interested in making large gifts before December 31, 2012 to take advantage of the $5,120,000.00 lifetime exemption, which may be going away in 2013. However, before taking any steps to include an LLC in an estate plan, clients should carefully review all tax and legal requirements with qualified professionals.
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