Somewhere between a corporation and a partnership lies the limited liability company (LLC). This hybrid legal entity is beneficial not just for small-business owners, but is also a powerful tool for estate planning. If you want to transfer assets to your children, grandchildren or other family members – but are concerned about gift taxes or the burden of estate taxes your beneficiaries will owe upon your passing – an LLC can help you control and protect assets during your lifetime, keep assets in the family and reduce taxes owed by you or your family members.
What is an LLC?
An LLC is a legal entity recognized in all 50 states, although each state has its own regulations governing the formation, running and taxation of the company. Like a corporation, LLC owners (called members) are protected from personal liability in case of debt, lawsuit or other claims, thus protecting personal property such as a home, automobile, personal bank account or investment. Unlike a corporation, LLC members can manage the LLC in whatever fashion they like and are subject to fewer state regulations and formalities than a corporation. Like a partnership, members of an LLC report the business's profits and losses on their personal tax return, instead of the LLC itself being taxed as a business entity.
Why Would I Want an LLC for Estate Planning?
You’ve worked hard to earn your wealth, and you probably want as much as possible to stay in your family once you’re gone. Establishing a family LLC with your children allows you to effectively reduce not only the estate taxes your children would be required to pay on their inheritance, it also allows you to distribute that inheritance to your children, during your lifetime, without being hit as hard by gift taxes. All of this while providing the ability to maintain control over your assets. It’s a win-win for you and your children.
If you are attempting to avoid estate taxes, it's important to note that as of 2018, the feared 40% estate tax only takes effect if an individual's estate is valued over roughly $11 million. Estates worth less than this are considered exempt from the tax. Gift taxes, however, go into effect after $15,000 is transferred in a single year if unmarried (if you're married and each spouse makes a gift, you can jointly give $30,000). This total resets each year, and the taxes are owed by the person giving rather than receiving the amount. This limit applies per recipient, so giving $15,000 to each of your three children and five grandchildren would not incur gift taxes. Also, keep in mind: If you exceed the $15,000 per year annual gift tax exclusion limit, there is a lifetime cap of $10 million. After that, the gift tax becomes 40%. Before you reach the cap, each amount given over the $15,000 limit is deducted from your lifetime cap, bringing you closer to the 40% tax rate. Considering this, the benefits of transferring wealth between family members with the use of an LLC starts to become more appealing.
How Does a Family LLC Work?
In a family LLC, the parents maintain management of the LLC, with children or grandchildren holding shares in the LLC’s assets, yet not having management or voting rights. This allows the parents to buy, sell, trade or distribute the LLC’s assets, while the other members are restricted in their ability to sell their LLC shares, withdraw from the company or transfer their membership in the company. In this way, the parents maintain control over the assets and can protect them from financial decisions made by younger members. Gifts of shares to younger members do come under the gift tax, but with significant tax benefits that allow you to give more, plus lower the value of your estate. Here's how it works.
After you have established your family LLC according to your state’s legal process, you can begin transferring assets. You then decide on how to translate the market value of those assets into LLC units of value, similar to stock in a corporation. Now you can transfer ownership of your LLC units to your children or grandchildren, as you wish. Here’s where the tax benefits really come into play: If you are the manager of the LLC, and your children are non-managing members, the value of units transferred to them can be discounted quite steeply, often up to 40% of their market value. This discount is based on the fact that without management rights, LLC units become less marketable. Now your offspring can receive an advance on their inheritance, but at a lower tax burden than they otherwise would have had to pay on their personal income taxes, and the overall value of your estate is reduced, resulting in an eventual lower estate tax when you pass away.
The ability to discount the value of units transferred to your children also allows you to give them gifts of discounted LLC units, thus going beyond the current $15,000 gift limit without having to pay a gift tax. For example, if you wish to gift one of your children non-management shares of LLC units that are valued at $1,000 each, you can apply a 40% discount to the value (bringing the value of each unit down to $600). Now, instead of transferring 15 shares before having to pay a gift tax, you can transfer 25 shares. In this fashion, you can give significant gifts without gift taxes, all while reducing the value of your estate and lowering the eventual estate tax your heirs will face.
What Can I Transfer Into an LLC?
You can transfer just about any asset into an LLC, then pass those assets along to your children and grandchildren. Typical assets include:
- Cash – you can transfer money from your personal bank accounts into the LLC, then distribute it amongst the LLC members.
- Property – you can transfer the title to land and structures built on that land into your LLC. Check with any mortgage holder prior to such a transfer, however, as you might need their approval.
- Personal possessions – you can transfer ownership of automobiles, stocks, precious metals, artwork or other significant belongings into your LLC.
The Bottom Line
A family-owned LLC is a powerful tool for managing your assets and passing them along to your children. You can maintain control over your estate by assigning yourself as the manager of the LLC, while providing significant tax benefits to both yourself and your children. Because estate planning is very complex, and the regulations governing LLCs vary from state to state and evolve over time, always check with a financial advisor before formalizing your LLC plan.