A Family Limited Liability Company (Family LLC) can be a valuable tool for transferring wealth to the next generation.
It can also be useful for both estate planning and asset protection considerations. In this article we will discuss what Family LLCs are and how to best utilize them.
Family LLCs must be created for a legitimate business purpose, typically to manage either a family business or real estate holdings beyond a primary personal residence. One or two family members serve as the managing member(s) who control the entity and make decisions on a day-to-day basis. Other family members can hold a limited interest either by investing their own assets in the LLC or by receiving shares as a gift from the managing member. Limited members do not have management or voting rights. Typically, one or both parents would be managing members of a Family LLC, with children and/or grandchildren as limited members.
A skilled attorney should be engaged to assist in the formation and maintenance of a Family LLC. An operating agreement will need to be drafted, in which the managing member can define and restrict ownership rights, transference of assets, and other decision-making items.
If properly structured, a Family LLC can provide protection from creditors and lawsuits by restricting the 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, based on the fact that limited members do not have voting rights and their shares are therefore considered to be less marketable. What this means in practice is that the managing members of a Family LLC can transfer wealth to their descendants during life without giving up control of the asset, and can gift more than they would be able to outside of the Family LLC, thereby allowing the managing member to gift above the $15,000 annual exclusion amount without using any of their lifetime exemption. It also allows the managing members to utilize less of their lifetime exemption than they would without the Family LLC structure, if they choose to do so.
Mr. & Mrs. Smith own a family business along with several rental properties, with a total value of about $10 million. They would like to begin gifting assets to their two children but are concerned about giving up control over their business and properties and have limited liquid assets from which to gift.
To accomplish this goal, Mr. & Mrs. Smith choose to set up a Family LLC. They name themselves as managing members and name their two children as limited members. Under the current annual exclusion gift limit of $15,000 per person, they are able to gift a total of $30,000 to each child in 2021 without using any of their lifetime exemptions. By gifting shares of their Family LLC rather than gifting cash, they may be able to gift shares valued up to $50,000 to each child if the maximum discount of 40% may be used1.
By creating a Family LLC to hold both the business and real estate, Mr. & Mrs. Smith can accomplish their goal of gifting to their children without giving up control of their business or properties, with the added feature of asset protection for both them and their children.
The decision to use a Family LLC depends on several factors, including but not limited to the types of assets owned, the market value of those assets, and the family’s planning goals. Your Freestone Client Advisor can assist in an initial discussion surrounding Family LLCs and can provide referrals to experienced attorneys as needed.
1A gift valued at $25,000 that is discounted by 40% results in an actual gift amount of $15,000. With both parents as managing members, this amount can be doubled without impacting lifetime exemptions. Note that this example is for illustrative purposes only; gifted shares may or may not be eligible for the full 40% discount shown here.
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.