The estate planning process aims to simplify the transfer of assets and properties between generations while minimizing costs and streamlining wherever possible. By default, dying intestate (without a will or any other estate planning documents) means that anything you own will automatically be distributed as per state law.
This may not be in your best interest, as you have no say or control over who receives what. In the case of blended families, preliminary separation, or estrangement, many of your belongings might go to relatives and exes you haven’t seen or heard from in years. For larger estates or estates with more complicated assets and ownership documents, a simple will dictate who gets the car and who gets the home might not cut it either.
More comprehensive estate planning options exist to help those who might otherwise face hefty taxes on their assets and property during the probate and bequeathment process, from minimizing estate tax liability to avoiding unnecessary probate costs and dealing with assets and property in different states and countries. One of the more inventive and exciting ways of minimizing taxes related to estate planning is through a specialized family LLC.
What Is an LLC?
An LLC is a limited liability company. LLC’s rules and regulations are state-specific, but their creation and existence are allowed in each of the 50 states. An LLC combines the inherent characteristics of a corporation and a sole proprietorship.
Like a corporation, LLC owners (or members) enjoy limited liability. This means they are not held personally accountable for an LLC’s debts, thus protecting their personal property and assets. Unlike a corporation, LLCs suffer formalities and regulations.
Owners of an LLC can also exercise greater control over it than they might in a corporation. LLCs also are not taxed like corporations are – instead, individual LLC owners are taxed on the LLC’s profits and losses based on the units (or shares) they hold. The simple pros of an LLC include:
- Pass-through taxation, as with a partnership or sole proprietorship.
- Limited liability, as with a corporation.
- Excellent flexibility, from member count to setup.
On the other hand, the cons of an LLC can be summarized as:
- Potentially costly, which is why the benefits will have to be professionally weighed against the state-specific costs and fees.
- Your income is based on your LLC share, so you cannot set your wages.
- Those interested in forming an LLC for business purposes might like to know that investors are more likely to invest in corporations.
However, these cons may be irrelevant when pursuing an LLC as an estate-planning solution.
How an LLC Can Be Used in Estate Planning
You can establish an LLC for your family, funding it with family assets, and utilizing it to distribute a more significant amount of wealth between your family members before you pass away in the interest of lowering your total estate value and thereby avoiding estate taxes upon death. The reason LLCs are a preferred vehicle for distributing assets among loved ones is because of the tax considerations surrounding LLC shares or units and gift taxes.
Estate Taxes, Gift Taxes, and Probate
While the estate tax is a one-time inheritance tax of 40 percent on any assets and property exceeding the federal exemption limit ($11.58 million in 2020), those wishing to reduce the value of their estate below that limit by making early distributions to their children and relatives will have to beware the annual gift tax exemption limit of $15,000 (lifetime gift tax exemption is tied to one’s estate tax exemption limit, meaning any amount gifted past $15,000 begins eating into one’s estate tax exemption limit).
A family-owned and run LLC can minimize gift tax liability by shaving up to an additional 40 percent off the market value of any gift made through the LLC (in the form of an LLC unit) if the transfer is from a managing member of the LLC to a non-managing member (your children).
This means that the transfer of assets valued at $2000 may ultimately be taxed as a transfer of $1200 instead if made to a non-managing member in the form of LLC units. This effectively allows you to transfer more assets and property without infringing on your annual or lifetime gift tax exemption limit.
This is because anything used to fund an LLC (such as cash and account transfers, but assets) can be translated into LLC units or shares. These shares are held individually by managing and non-managing the LLC members, representing their stake in the company. This is referred to as a fractionalized interest.
The transfer of these shares has tax advantages (a discount of up to 40 percent, for example), making it a perfect setup for complicated estate plans. This is because interest in an LLC does not have the same market value as the actual asset itself, so its value is discounted while transferred in the form of an LLC unit.
The exact numbers and discounts will vary based on your state’s rules and regulations and other individual circumstances related to the LLC design. It is best to discuss these details with a tax and estate planning professional who can help you explore your options and figure out the best way to leverage a family LLC’s benefits in your favor.
Funding a Family LLC
Setting up a family LLC is best done through an estate planning professional, as there are operational fees and steps to consider. Funding an LLC is flexible, and assets that can be financed into an LLC include cash and accounts and precious metals, jewelry, vehicles, real property, and even works of art.
Because setting up and managing an LLC will include both initial and annual fees. It is typically ideal for larger estates looking for an efficient way to transfer assets before death, minimize or avoid state and federal estate taxes, and without paying gift taxes.