Using LLCs to Expand Lifetime Gifting

So far, our discussion regarding the use of gifting an estate plan has revolved primarily around cash gifts, it is important to understand that gifts can consist of any type of property, including interests in real estate and business entities. A family owned Limited Liability Company is an excellent tool for transferring a variety of assets from one generation to the next, often at a reduced value, while allowing parents to retain control of the assets during their lifetime.

     While the use of cash gifts provides clients with a tool for reducing their potential estate tax liability, clients may be able to gain greater benefits through by using a Limited Liability Company (LLC) in their estate planning. The client can establish an LLC with two classes of Membership Interest, voting and nonvoting, and can retain control over assets by keeping the voting interests and gifting the nonvoting interests to beneficiaries..

     To make use of this gifting strategy, clients first establish a LLC (or modify an existing LLC) with a 1% Voting Member Interest and a 99% Nonvoting Member Interest. This allows the owner of the 1% Voting Member Interest to control the company regardless of who owns the 99% Nonvoting Member Interest. Clients then transfer ownership of other assets, such as real estate or business interests, to the LLC. Now the client is able to make gifts of the Nonvoting Member Interest, without giving up control of the assets. This allows clients to begin transferring highly appreciating assets during their lifetime, reducing any potential estate tax liability because the appreciation of the assets is now out of the Estate, and providing a potential source of income to their loved ones. Clients can transfer these  Nonvoting Member Interests in the LLC using either their lifetime estate exemption and/or their annual gift tax exemption, further reducing potential tax liability. These nonvoting member interests can be given to adult children as well as minor children and grandchildren, with trust holding the interest for these minors. These trusts can then be used to provide funds for education for the minors as income is distributed from the LLCs

     Another benefit of including an LLC in an estate plan is the potential to receive a valuation discount when making gifts of Nonvoting Member Interests. The IRS recognizes that a member interest in an LLC which does not allow the owner control over the company and which restricts the owner's ability to sell or transfer the member interest has less value than an unrestricted interest. Thus, a properly structured LLC may allow clients to transfer larger portions of the Nonvoting Member Interest as part of an annual gifting plan. While using an LLC in this manner is a well-established practice, it is important to acknowledge that without proper appraisals and planning, and such transfers may be subject to IRS scrutiny.

     In order to comply with the law and IRS regulations is important to manage and operate the family-owned LLC as a separate entity, and not just an extension of the client’s own affairs. The LLC should not contain all of the client assets, especially not the client’s residence, because the IRS argues that the LLC is necessary to maintain the client’s lifestyle and therefore, under estate tax rules, the IRS may deem the LLC's assets part of the client’s estate.

     For many clients the use of an LLC as part of their estate planning is an excellent strategy to increase the value of annual gifting. It is also an excellent tool for transferring ownership of family-run businesses to the next generation while ensuring that the clients retain control of the business operation. It is important to remember that this is a complex planning technique that clients should not attempt without consulting qualified professionals for assistance in reviewing the tax and legal implications.

The Changing Role of the Irrevocable Life Insurance Trust

Today we look at an advance trust, the Irrevocable Life Insurance Trust, whose role in the the estate planning process continues to evolve in response to changes in the tax code.

     With the Estate Tax Exemption now over $5,000,000 for an individual and $10,000,000 for a married couple, the Irrevocable Life Insurance Trust (ILIT), a once common tool for offsetting estate tax liability, is used less often. While the benefits of an ILIT as a tool to offset the estate tax liability have decreased for the majority of individuals, there are other situations where an ILIT can still be a very useful tool in estate planning.

     An ILIT is designed to own a life insurance policy, normally on the life of the Grantor, without the proceeds from that policy being included in the Grantor’s estate for the purposes of estate taxes. The premiums for the insurance policy are paid by the Trustee, most often with contributions made to the trust by the Grantor using the Annual Gift Tax Exclusion. In order for these contributions to qualify for that exclusion, they must be what the IRS regulations refer to as "present gifts". This means that the recipient of the gift must have the ability to take the gift outright and free of trust if they so choose. The terms of the ILIT require the Trustee to give the trust beneficiaries written notice of a limited window of time during which they may withdraw their gift from the trust. After that time period passes, the gift becomes a trust asset and the Trustee can use it to pay the premiums on the insurance policy owned by the trust. This notice is often referred to as a "Crummey Notice", and is named after a tax case named Crummey vs Commissioner.

     A keen observer might ask what is to keep the ILIT beneficiaries from simply withdrawing their gifts immediately and leaving the Trustee without any assets to pay the policy premiums. The answer to this question lies in the beneficiaries' understanding that not withdrawing this gift from the trust in the short term will result in a larger benefit in the long term. If that logic fails, the Grantor can simply refuse to make gifts subject to the Crummey withdrawal rules, not providing the beneficiaries with the ability to withdraw gifts. The negative of this strategy is that the gifts do not qualify for the annual exclusion.

     An ILIT's benefit is that the proceeds from a life insurance policy owned by the trust is not considered to be in the estate of the grantor and therefore not counted for calculation of estate tax liability. For those couples with estates in excess of the $10,000,000 estate tax exemption this means a pool of assets that can offset the portion of an estate used to pay the tax bill. For those clients who do not have a taxable estate, there are also benefits.

• For clients who own small, or not so small, businesses that they intend to leave or sell only to children active in the business, an ILIT allows them to create a pool of assets that can pass to the children who will not inherit the family business, creating equity among children and minimizing interfamily squabbles after death, without increasing the size of the client’s estate and risking potential estate taxes. 
• An ILIT also can be used to provide assets for the benefit of a second spouse, protecting client's other assets for the benefit of children of a prior marriage 
• If a client has substantial charitable inclinations, an ILIT can be used to provide children or other loved ones with a certain amount of inheritance while leaving the remainder of an estate to the client’s favorite charities, creating a charitable estate tax deduction. 
• As with other trusts,  for those clients who want to make gifts, but retain some control over the gifted assets, an ILIT allows them to provide and additional benefit to their loved ones while retaining control over the circumstances under which those loved ones may receive distributions from the trust.
• The ILIT also can leverage the grantor’s generation skipping transfer (GST) tax exemption because the grantor’s GST tax exemption can be allocated to an ILIT holding a life insurance policy that may substantially increase in value. As a result, numerous generations may benefit from the trust assets free of federal estate and GST tax.

     While the value of using an ILIT has been reduced by the current ever-growing Lifetime Estate Tax Exclusion, there are still circumstances where an ILIT may be useful to clients. Like any other tax and estate planning strategy, it is important to consult with experienced professionals before deciding to make use of the technique in order to ensure that clients do not expose themselves to unintended consequences.