Family Limited Liability Companies:  A valuable tool for generational wealth transfer and asset protection

Posted on

Our role as client advisors is to simplify our clients lives by providing thoughtful and quantifiable solutions to issues/obstacles faced by successful individuals and families. When it comes to transferring wealth to the next generation, one valuable tool can be the Family Limited Liability Company (Family LLC), which addresses both estate planning and asset protection. Family LLCs add additional complexity to an estate plan and are recommended for families with over $10 million in assets who are business owners or who hold substantial illiquid assets such as real estate.

What is a Family LLC?

A Family LLC must serve a legitimate business purpose, such as managing a family business or real estate holdings outside of your primary personal residence. One or two family members serve as the managing member(s) who control the entity and make day-to-day decisions. Other family members can hold a limited interest—which excludes management and voting rights–either by investing their own assets in the LLC or by being gifted shares from a managing member. In a typical Family LLC, one or both parents would be managing members while children and/or grandchildren are appointed as limited members.

What is the benefit of a Family LLC?

A Family LLC is similar to a regular Limited Liability Company with the primary difference being that the LLC is formed by family members who are related by blood, adoption or marriage. When properly structured, a Family LLC can seek to provide protection from creditors and lawsuits by restricting members’ voting rights, ability to change management, and ability to withdraw and reacquire their interests.

In addition to creditor protection, a Family LLC can be a powerful estate planning tool, allowing the managing member to gift shares to the limited members at a significant discount while maintaining control over the LLC and its assets. Gifts of LLC shares may be discounted by up to 40% of market value, because limited members do not have voting rights and their shares are therefore considered to be less marketable*.

In practice, the managing members of a Family LLC can transfer wealth to their descendants during their lifetime without giving up asset control and can gift more than they could outside of the Family LLC (above the $16,000 annual exclusion amount without using any of their lifetime exemption). It also allows the managing members to use less of their lifetime exemption, if they desire.

How to Establish a Family LLC

You will need to engage a skilled attorney to establish and maintain your Family LLC. Your Freestone client advisor can help connect you with an attorney to assist in this process, if needed. In formalizing an operating agreement, the managing member defines and restricts ownership rights, transferability of assets, and other decision-making items. The restrictions put in place in the operating agreement will help to support the valuation discounts available to the LLC members.  Lastly, you will also need to engage a qualified valuation discount expert who will determine the most appropriate discount for the Family LLC.

Case Study

Mr. & Mrs. Smith own a family business along with several rental properties, totaling $10 million in value. They’d like to begin gifting assets to their two children, but are reluctant to release control of their business and properties, and they have limited liquid assets to gift. Mr. & Mrs. Smith have set up a Family LLC, naming themselves as managing members and their two children as limited members. Under the current annual exclusion gift limit of $16,000 per person, they can gift a total of $32,000 to each child in 2022 without using any of their lifetime exemptions. By gifting shares of their Family LLC rather than cash, they may be able to gift shares valued up to $53,333 to each child if using the maximum discount of 40%. By creating a Family LLC to hold both the business and real estate, Mr. & Mrs. Smith can gift their children without giving up control of their business or properties, while also protecting the assets for themselves and their children.

The decision to use a Family LLC depends on the types of assets you own, the market value of those assets, and your family’s planning goals; it is just one tool we explore to give clients the freedom to focus on what truly matters. As part of our integrated services, your Freestone Client Advisor can discuss Family LLCs and can provide resources to experienced attorneys. Contact us to learn more.

Article Takeaways

  • Family LLCs are recommended for families with over $10 million in assets, who are business owners, or who hold other substantial illiquid assets such as real estate.
  • A Family LLC must serve a legitimate business purpose, such as managing a family business or real estate holdings outside of your primary personal residence.
  • When properly structured, a Family LLC can provide protection from creditors and lawsuits and an estate tax benefit for the managing members.

* These valuation discounts are very expensive and time-consuming.  It may not be worth the cost of paying for a discount valuation each year, just to give the annual exclusion amounts.  Typically, this discount valuation involving LLCs are done in the process of a large gift/sale transaction to family trusts. 

Important Disclosures: Nothing in this document is intended to provide, and you should not rely upon it for, accounting, legal, tax, or investment advice or recommendations. Each individual is in a different situation and has different items to address, and the options in this document are not appropriate for everyone. We are not making any specific recommendations regarding any estate planning, and you should not make any estate planning decisions based on the information in this document. The intention of this document is educational, and it is intended only to discuss a few limited aspects of Family LLCs. This document is not a comprehensive or complete summary of considerations regarding its subject matter. Each individual is in a different situation and has different items to address, and the options in this document are not appropriate for everyone. Please consult your Freestone client advisor and a lawyer regarding options specific to your needs.

Posted By: Stephanie d'Ippolito, CFP®

Stephanie d’Ippolito, CFP®, is our Managing Director of Financial Planning. She is passionate about helping people and believes that financial planning can be a valuable tool for clients to understand and solve their unique financial problems. She lives in Seattle with her husband and two dogs, Toby and Thurman.