Because limited liability companies (LLCs) provide flexibility in allocating rights to profits and capital, they are frequently used to shift income and property appreciation from higher bracket, older generation taxpayers to lower bracket children and grandchildren. Family LLCs are created by the transfer of property from one or more individuals to the LLC for the common benefit of the family members. The transferred assets are titled in the name of the LLC. Typically, the senior family members (parents) transfer assets to a family LLC in exchange for membership interests, which, under the terms of the operating agreement, carry certain rights, such as management control and income distributions. This initial capitalization of the LLC is generally a tax-free event.
If you are interested in gradually transferring partial ownership of assets to your children, a good method might be to transfer them to a family LLC and subsequently gift membership interests in the LLC to your children. With that in mind, here is some information about using a family LLC to transfer ownership of assets.
Using a family LLC to own a family’s assets, whether it be business or investment assets, can be beneficial. One reason is that consolidation in one entity simply makes it easier to manage the assets compared to individual ownership by you and your children or by you and trusts for your children. Consolidation may also allow you to take advantage of investment or diversification opportunities based on the size of the combined assets held by the LLC.
Another advantage of holding assets in a family LLC is to protect the assets from creditors. The creditor of an LLC member generally cannot access the assets of the LLC or participate in management. Instead, the creditor can only receive distributions to which the member would have been entitled. Additionally, your children, as LLC members, could not reach the assets of the LLC or compel the LLC to make distributions. A buy/sell agreement between LLC members can also be used to prevent the membership interests from being sold or transferred outside the family group, such as a transfer resulting from the divorce of a child.
Since an LLC is governed by an operating agreement that can be amended as needed, it offers a great deal of operating flexibility to help you respond to changing circumstance. In contrast, an irrevocable trust document cannot be amended. Additionally, if you have concerns over giving your children immediate access to the transferred assets, the operating agreement can contain provisions to prevent members from easily converting their interest to cash and to control the extent and timing of distributions. An operating agreement can also be used to require arbitration of family and business disputes, as arbitration of family and business disputes, as well as to establish other ground rules, such as the sharing of expenses involved in a dispute.
A family LLC also offers the advantage of simplifying the process of making gifts to your children. The gift of an interest in the LLC is much easier than gifting undivided interests in each asset to your children and can be accomplished by a simple assignment form.
All of these are excellent business reasons to consider using a family LLC. Additionally, a family LLC offers some estate and gift tax advantages such as permitting a reduction in the value of your estate, having a lack of marketability and, where applicable, allowing for a minority interest. However, these tax advantages should be secondary to the economic, legal, or family reasons we discussed as the basis for creating the family LLC.
Please contact us if you would like to learn more about family LLCs and how this structure can be used to meet your specific needs.