Limited Liability Companies Protect Assets and Reduce Taxes

Copyright (c) 2011 Jeffrey Matsen

One of the most effective methods of estate planning and asset protection is to hold personal or business assets in a limited liability company (LLC) or limited partnership (LP), rather than owning such assets directly in your own name or in the name of a living trust. When you transfer assets to an entity such as an LLC or LP, you exchange the assets in exchange for membership units in the new entity. LLCs and LPs can hold full, operating businesses, real estate, cash and securities, and other types of assets. This method provides not only much stronger asset protection for the individual, but it also can aid in business succession planning and can provide tax savings in a large estate. LLCs provide additional advantages over LPs. A LP requires a general partner to be in place, who is subject to unlimited personal liability. Alternatively, LLC members are not subject to any liability in excess of their member interest in the LLC (although there are additional methods to protect a member interest in an LLC). For that reason, it is advised that you, almost exclusively, use LLCs to hold assets.

Gift Tax: Many individuals who transfer assets into an LLC eventually wish to transfer their assets on to the next generation by making gifts of member interests during their lifetime. However, you must be sure that the gift of the member interest does not exceed a certain value, otherwise the IRS requires the person making the gift to pay taxes on the value. This is known as the gift tax exclusion, and it is currently set at $13,000 per individual per year for gifts to one individual. For example, Tom Client owns 100% of an LLC which is valued at $100,000.00, and wishes to transfer 20% of the control to his adult son, Junior Client. The value of a 20% interest would be $20,000.00, therefore subjecting Tom to taxes. Tom can only transfer 13% per year. However, if Tom owned the LLC interest together with his wife, Cindy Client, they could each gift a member interest valued at $13,000.00 to Junior, therefore giving Junior 26%. Additionally, they could each transfer an additional 13% each to Junior's wife, for a total transfer of 52% ($52,000.00) per year.

Minority Discount: Accounting and valuation rules allow individuals who make gifts to reduce the value of the gift by taking into account applicable discounts. For example, were Tom, in the above example, wish to sell 20% of his interest in the LLC on the open market to an unrelated third party, rather than gift it to his son, he would be unlikely to receive full value for that 20% interest. Why? Tom must take into account the difficulty and costs involved in attempting to find a buyer of a minority interest in a small, non-publically traded company. Additionally, because a 20% interest in a business would give the buyer zero control over the actions and direction of the company (they would always be outvoted by the 80% member), they would be unwilling to pay full value. Combined, the discount that he would need to factor for the 'Lack of Marketability' and the new buyer's 'Lack of Control' can be significant. For purposes of gifting to family members, then, the member interest can be valued at a lower amount (20%-40% is a typical range), allowing for example Tom, above, to gift 20% of his interest and value it at 40% below $20,000.00.

Restriction on Liquidation: Many practitioners previously attempted to build in additional limitations in the Operating Agreement to be able to claim additional discount amounts. Specifically, they attempted to allow full control over the interest during the lifetime of the member, but to fully restrict the ability of a member to liquidate their interest in the LLC after their death. By doing so, the estate would attempt to greatly reduce the value of the interest included in the taxable estate of the member, by claiming that, on the open- market, an interest in an LLC which does not allow you to liquidate the assets is not worth very much. These methods are particularly important for high net-worth individuals with assets in the tens of millions of dollars, and can significantly reduce the tax burden on their estates.

Congress has attempted to restrict these attempts by passing the Special Valuation Rules, four new code sections in the tax code which would restrict the use of 'Restrictions on Liquidation' as it is called in the code. Specifically, where a Restriction on Liquidation is written into an operating agreement of the LLC, it is disregarded for tax purposes if the jurisdiction state of the LLC has less restrictive rules in their applicable business code where a transfer is made to a family member. Nevada has moved to the cutting edge of LLC rules by enacting new legislation to re-write their code to allow 'Restricted Entities' which will allow the above type of valuation. In a nutshell, the new law allows a default 10 year period restricting liquidation of the entity's underlying assets. This will allow LLC's to exist with restrictive Operating Agreement provisions, allowing greater valuation discounts for gifted interests to family members.Your attorney can help you determine what the most appropriate restriction period would be for you, ranging anywhere from no restriction to 10 years.

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