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Using LLCs for Estate Planning

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An LLC, or Limited Liability Company, is a business entity that is separate and apart from its owner(s). It offers asset protection and a less complicated tax and formal structure than a corporation. Small businesses and individuals often use them for personal and investment purposes. What many people do not realize, however, is that LLCs can also be used as estate planning tools.

If you are concerned about passing your assets to your family and friends without incurring gift taxes or estate taxes, then having an LLC can be extremely helpful. It can allow you to control and protect your assets while you are alive and then pass those assets to your loved ones after you are gone.

What Is an LLC?

The best way to describe an LLC is to recognize its similarities and differences to a sole proprietorship and a corporation. Like a corporation, an LLC’s owners are protected from liability. However, unlike a corporation (and more like a sole proprietorship or partnership), members can organize their LLC however they would like and manage it in any way that they see fit. There are far fewer formalities that apply to LLCs compared to corporations. There are also fewer filing requirements, which makes an LLC cheaper to maintain generally as well.

Like a partnership, members of the LLC report their income and losses from the business directly on their personal tax returns. Reporting occurs like this because both LLCs and partnerships are pass-through entities. This type of reporting makes tax time far less complicated. It also means that LLCs do not have their own tax rate as corporations do, and there is no “double taxation” as there would be with a corporation.

Management of an LLC

Management for LLCs occurs in two ways: member-managed and manager-managed. In a member-managed LLC, the members act as partners and they each have a role in the administration of the company.

Another form of management is the “manager-managed” LLC. In this type of management style, one person takes on the role of manager on behalf of all of the other members of the LLC. The manager-managed form is common for LLCs used for estate planning.

Management is essentially segregated from ownership. This management style is helpful for families who may have a “head” owner and the remaining family members are listed as owners but do not really have any ownership control of the LLC. These silent partners often have no right to participate as owners and have specific restrictions on transferring their ownership in the LLC, such as being unable to sell their ownership interest or unilaterally withdraw. This family-based LLC, sometimes called an FLLC, is the most common way that LLCs are used as estate planning tools.

You can add virtually anyone you want to a membership role in an LLC, but each member must be at least 18 years old. However, you can still involve your minor relatives in an LLC by creating a trust that includes them as a beneficiary. LLC members can be trusts, other LLCs, corporations, and even pension plans.

How Can an LLC Be Used for Estate Planning?

As management of an LLC is not based on ownership (although it can be), transferring assets from one generation to the next is a relatively simple process. Owners can even make these transfers without giving up control of the LLC. Transfer restrictions for some owners can help protect assets from creditors or from heirs that may not make the best financial choices.

Transferring interests through membership units of an LLC also allows you to simplify the process of dividing assets. For example, imagine that parents hold a rental property in their LLC. Instead of deeding the property to both of their children, they can just transfer the same number of membership units to each child, making fractional deeds unnecessary.

What Types of Assets Can an LLC Hold?

As an LLC is a separate legal entity, it can carry a variety of property on your behalf. Once distributed into the LLC, the individual members of the LLC will each hold a portion of the asset. You may want to put the following assets into an LLC that you plan to use for estate planning purposes:

  • Cash
  • Real property
  • Personal property

You may need to check with your mortgage holder before you transfer real estate to an LLC. Most mortgage holders will automatically approve such a transfer, but it is a good idea to check because moving the property without prior approval may be considered a default on your mortgage note in some situations.

Registering Property

You can transfer virtually any type of personal property into the LLC, including things like stocks and securities, vehicles, and artwork. You can register these items in the LLC’s name or you can simply indicate that the LLC owns them by including them on the books and records of the company. If a piece of property requires registration, however, it should be in the LLC’s name.

Transferring Interest in an LLC: Valuation Discounts

Once you create the LLC and transfer property into it, you must take steps to value the LLC. Determining the market value can be a tricky process, but there are services available that will do this type of valuation on your behalf. Then, you transfer ownership of specific LLC units to your children or grandchildren.

When you move the units from a managing member to a non-managing member, the valuation significantly decreases. This is because non-voting, non-controlling membership interests have a far lower market value than the controlling interest. The value often “drops” by up to 40% just by making the transfer. This type of assignment also permits you to move more and still be within the $14,000 gifting limitation as well.

This kind of transfer allows family members to hold valuable membership assets without being taxed on their actual value. That means that family members pay less on their income taxes. It also has the advantage of moving out of your estate, which results in lower estate tax when you pass.

Using an LLC for Asset Protection

One of the most valuable reasons people choose to set up LLCs is because of their asset protection abilities. While businesses certainly benefit from asset protection, individuals can benefit as well, even in the estate planning context.

Many people attempt to use trusts as asset protection tools in estate planning. However, a trust only offers asset protection if it is irrevocable, and irrevocable trusts take away much of the flexibility that you have when you own your property outright. An irrevocable trust cannot be changed, altered, or canceled (with a few rare exceptions). As such, you lose much of the ability to transfer, use, or enjoy your property when you place it in this type of trust. Instead, you can use an LLC to accomplish many of the same goals while also having full control over your property while you are alive.

Using LLCs to Hold Out-of-State Property

When you hold property in more than one state, you have to probate your will in each state in which you own property. These out-of-state probate processes are often referred to as “ancillary probate” because they occur in a state in which you are not domiciled. This can be a time-consuming and expensive process. To avoid this, many people will use trusts to hold property. However, you can also use an LLC to accomplish the same goal.

You simply transfer the property that you own out of state into the LLC. Then, even after the decedent’s death, the LLC continues to hold that property, and it will pass to other members of the LLC without the need for court intervention or the probate process. The decedent’s membership interest in the LLC will pass to others, but individual assets will not change hands.

LLCs and Estate Taxes

When an LLC holds a property instead of the individual holding the property outright, it is not considered part of the person’s estate. This is a significant benefit because it allows that property to avoid federal estate taxes entirely. However, this may not necessarily be true if the individual state in which you hold property has an estate tax and you own property both in and out of the state. Nonetheless, you should keep in mind that only those estates that are over $5,450,000 will be subject to the federal estate tax. As such, the majority of taxpayers do not have to worry about incurring federal estate tax.

Setting Up an LLC

LLCs are used most often in the business context. That is, they are a separate legal entity created around a business venture. However, they are technically permitted whenever you have a venture wherein you intend to make a profit. You do not have to actually make a profit; you just have to intend to do so.

This definition is extremely broad and can be used for a variety of potential business opportunities, from real estate to investments. Some ventures that you may not consider “businesses” would actually qualify as an LLC. For this reason, LLCs can be used for estate planning in addition to being a good choice for a business entity. Creating an LLC also has significant income tax advantages as well.

The process of setting up an LLC is very straightforward. It requires just a few formal steps. While the process varies slightly based on your particular state, they follow the same general pattern.

  • Choose a name – Start by selecting a name for your LLC. Many LLC owners who are using LLCs for estate planning purposes choose to associate their LLC's name with their family name or some other name that has meaning to their family. Keep in mind that you cannot choose the same name as another LLC that is set up in your state, and it should comply with specific state regulations.
  • Create and file articles of organization – Every LLC is required to have articles of organization. This document will set out the owners of the LLC, the name of the entity, how to get in touch with the owners, and other basic information about the LLC. You should also note who your registered agent is in this document. A registered agent is the individual who has been designated to receive legal papers on behalf of the LLC.
  • Pay any required fees – To file your articles of organization and register your LLC, your state will likely require that you pay a fee. The cost will vary depending on the state in which you file your paperwork. It can be as little as $100, or it can be several hundred dollars.
  • Publish a notice of intent to create an LLC – Some states will require that you post a notice in the local newspaper that you intend to create an LLC. You may be required to publish this notice over a particular period of time or a specific number of occasions. Some states will also require that you file an affidavit of publication to verify that you met the publication requirements.
  • Create an LLC operating agreement – The operating agreement is the most complex part of creating an LLC. Thankfully, however, there is really no wrong way to do it. You may not even be required to file such an agreement in many states. Nonetheless, it is still a useful document to have so that you can avoid potential conflicts between owners down the road. The LLC operating agreement will set out the rights and obligations of the owners of the LLC. In the estate planning context, it will indicate which owners have the right to alter or transfer property in the LLC. It will also describe voting powers, any required owners meetings, and division of profits and losses.