Small business owners have many goals when choosing the legal entity for their business, ranging from protecting their assets to retaining flexibility in management. The type of entity you use will not only affect your present business operations but can have lasting effects on the future of your business and how your estate will be handled after you die. This is especially true if you run a family business Protect the legacy of your business by considering the future and your estate plan when forming it.
If your goals include protecting your personal assets, structuring your business with flexibility, minimizing your estate and gift tax liability, and ensuring the legacy of your family business, a family limited liability company (family LLC) can prove advantageous. Read on to learn about the benefits of family LLCs, how to form them, and how they can become an essential part of your estate plan. applicable
Before diving in, some context and definitions would be helpful to keep in mind. Family LLCs are limited liability companies (LLCs) owned and operated by members of the same family.
A family LLC is an LLC owned by members of the same family. An LLC is similar to a corporation in that it provides limited liability to its members. Limited liability means the personal assets of members are shielded from lawsuits and debts of the business. (By contrast, unlimited liability means creditors of the business can reach the owners' personal assets if the business cannot pay its debts or judgments.) If someone sues the LLC, the limited liability protection means you risk only the assets you invested in the business.
Like a partnership, an LLC provides flexibility in structure and management. Members of an LLC can decide whether to manage the business themselves or appoint a non-member manager. Members can also decide how the business will be taxed. LLC members often elect pass-through taxation, meaning the business will not pay income taxes as a separate entity. Instead, the business profits will pass-through to the members who then pay income taxes individually.
To create a family LLC, follow the same process to form an LLC in your state, and include the members of your family who you intend to involve in the business. Once created, transfer your business assets to the LLC, by changing the designated owner of the asset from the business owner to the LLC. An LLC can hold most assets, including real property, bank accounts, vehicles, and other valuable personal property.
Family LLCs offer you significant estate and gift tax advantages. Here are the rules you have to deal with: When you die, your estate (including your business) will be subject to estate taxes of 40% for any amount that exceeds $12.92 million (for deaths in 2023—but this number is subject to change). Gifts that exceed $17,000 per recipient per year will likewise be taxed at 40% (married couples can combine their exclusions and give up to $34,000 per recipient, gift tax-free). Gifts that exceed the annual exclusion count as taxable gifts and apply towards the lifetime exemption.
When it comes to minimizing estate and gift taxes for family LLCs, the IRS is your friend. It allows you to discount the value of transfers of interest in a family LLC, up to 40%. The devaluation is legitimate because interest in a family LLC cannot be easily sold to the public (few investors want minority stakes in a family business). By discounting the value of the assets you transfer, you'll more slowly approach the tax threshold, and can divest yourself of more assets than you could if you had to play by their original value.
To take advantage of the valuation discounts, you can create a family LLC and transfer non-controlling units of it to your children or grandchildren over time. The discounts allow you to maximize the assets transferred free of gift taxes and will reduce the size of your overall estate. As the manager the LLC, you will retain control of the business even while you transfer ownership to your heirs.
To illustrate, a married couple could use a family LLC to transfer assets with a fair market value of $50,000 to their child in a single year without incurring gift taxes. After applying a 40% discount, the value of the family LLC units transferred would amount to $30,000 and remain within the annual gift tax exclusion ($17,000 for each spouse, or $34,000). Without the discount, the gift would exceed the annual exclusion, and $16,000 would be applied to the couple's lifetime exemptions.
Use a family LLC to keep your family business family-owned. The operating agreement for your family LLC should identify the family members who will take over as managers of the business when you pass away. The operating agreement should also restrict the ability of members to transfer their interests in the business outside of the family. These controls will protect your legacy and ensure your family business remains in the family.
Living trusts avoid probate, a court process to distribute property to a person's heirs through a will or by law if the person did not have a will. Probate has earned a bad rap, and for good reason in most cases. Probate usually involves legal fees and costs, and it can take from several months to a couple of years to complete. As a court procedure, probate also tends to be public. A living trust, by contrast, distributes assets to beneficiaries privately after a person's death, and can be accomplished relatively quickly and without great expense.
If you have a living trust, the trust can hold your business to ensure probate is avoided after your death. You will want to confirm that the trust and the LLC's operating agreement align regarding distribution and appointment of successor managers to avoid confusion and potential litigation.
Consult with an estate and business succession planning attorney in your state to see whether your estate plan could benefit from the use of a family LLC.