Somewhere between a corporation and a partnership lies the limited liability company (LLC). This hybrid legal entity is beneficial for small-business owners and a powerful tool for estate planning.
For those who want to transfer assets to children, grandchildren, or other family members and are concerned about gift taxes or the burden of estate taxes your beneficiaries will owe, an LLC can help. Individuals can control and protect assets during their lifetime, keep assets in the family, and reduce taxes.
Key Takeaways
- A limited liability company (LLC) is used to pass assets to loved ones while avoiding or minimizing estate and gift taxes.
- A family LLC allows heirs to become shareholders who benefit from the assets held by the LLC.
- The tax benefit of the LLC lies in the fact that the value of the shares transferred to heirs can be discounted steeply, often up to 40% of their market value.
What Is an LLC?
An LLC is a legal entity recognized in all 50 states, although each state has regulations governing the formation, administration, and taxation of LLCs. Like a corporation, LLC owners are protected from personal liability in case of debt, lawsuit, or other claims, protecting personal property such as a home, automobile, personal bank account, or investment.
Unlike a corporation, LLC members can manage the LLC however they like and are subject to fewer state regulations and formalities. As a partnership, members of an LLC report the business's profits and losses on their tax returns, instead of the LLC being taxed as a business entity.
The LLC formation process is simple and individuals can use an LLC filing service.
Estate Planning With an LLC
Parents who establish a family LLC with their children maintain control over assets, reduce theestate taxeschildren pay on their inheritance, and distribute that inheritance to children during a parent's lifetime, without being hit as hard by gift taxes. The federal lifetime gift and estate tax exemption is $13.61 million per person and $27.22 million per married couple in 2024.
A gift tax applies after $18,000 in 2024 if the giver is unmarried. Married couples can jointly give $36,000. This total resets annually, and the giver pays the taxes rather than the receiver. This limit applies per recipient, so giving $18,000 to each child and various grandchildren would not incur gift taxes.
Family LLCs
In a family LLC, 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. Other members are restricted in their ability to sell their LLC shares, withdraw from the company, or transfer their membership in the company.
Parents maintain control over the assets and can protect everyone from financial decisions made by younger members. Gifts of shares to younger members will incur gift tax, but with significant tax benefits that allow parents to give more and lower the value of their estate.
Once a family LLC is established according to the state’s legal process, parents can begin transferring assets. They decide how to translate the market value of those assets into LLC units of value, similar to stock in a corporation. Parents can then transfer ownership of LLC units to children or grandchildren.
Tax Benefits
The discount on the value of units transferred to non-managing members of an LLC is based on the fact that LLC units without management rights are less marketable. For those who manage the LLC, with children as non-managing members, the units transferred to them can be discounted steeply, often up to 40% of their market value.
Offspring can receive an advance on their inheritance, but at a lower tax burden than they otherwise would have had to pay on their income taxes, and the overall value of a parent's estate is reduced, resulting in an eventual lower estate tax when they pass away. The ability to discount the value of units transferred to children also allows parents to give them gifts of discounted LLC units, thus going beyond the gift limit without gift tax.
For example, to gift one child non-management shares of LLC units valued at $1,000 each, parents can apply a 40% discount to the value (down to $600). Instead of transferring 16 shares before paying a gift tax, parents can transfer 26 shares. Parents can give significant gifts without gift taxes while reducing the value of their estate and lowering the eventual estate tax their heirs face.
Assets Allowed in an LLC
- Cash: Parents can transfer money from their personal bank accounts into the LLC and distribute it among the members.
- Property: Parents can transfer the title to land and structures built on that land into their LLC after first checking with any applicable mortgage holders.
- Personal Possessions: Parents can transfer ownership of automobiles, stocks, precious metals, artwork, or other significant belongings into their LLC.
How Does an LLC Pass at Death?
When the owner of an LLC passes away, some states declare that the LLC must dissolve unless a specific plan of succession has been made. However, dissolution can be avoided by providing for a transfer to another individual upon death detailed in the operating agreement, creating a joint tenancy membership, creating a revocable trust to hold the LLC membership, or probating the LLC through court to determine the succession plan.
What Are Some of the Downsides of an LLC?
Compared to a sole proprietorship, LLCs are more costly to create and maintain. Depending on the state, an LLC typically requires a formation fee and various ongoing fees. Sole proprietorships do not typically require registration or associated costs.
Is the Owner of an LLC Liable for the LLC's Debts?
No, the owner of an LLC is not liable for the debts of the company, which is one of the key benefits of an LLC. An LLC provides protection to the owner from creditors in the event that the company defaults, enters bankruptcy, or otherwise cannot make its obligations. Creditors are not allowed to go for the owner's own personal assets.
The Bottom Line
A family-owned LLC is a powerful tool for managing assets and passing them to children. Parents can maintain control over their estate by assigning themselves asthe manager of the LLC while providing significant tax benefits to both themselves and their children. Because estate planning is very complex, and the regulations governing LLCs vary from state to state, individuals should check with a financial advisor before formalizing their LLC plan.
