Forming a Family Limited Liability Company

Forming an LLC for the family business has the advantage of not only shielding the owners' personal assets from obligation of the business, but it's a way to transition ownership to other members of your family--all the while lowering the size of your eventual estate.

Small business owners have several options when choosing a legal entity for their family business, from the most uncomplicated (partnerships) to the most complex (corporations). Selecting the right legal entity for your business can affect how you manage your business and how much personal liability you risk. Forming a family limited liability company (family LLC) can provide many benefits for your family business, including asset protection and flexibility, as well as certain estate planning advantages. In a nutshell, an LLC combines the desirable characteristics of a corporation and a partnership: It gives you the personal asset protection of a corporation and the flexibility of a partnership. Read on to learn why a family LLC might suit your business better than a corporation or partnership, and learn how to form a family LLC.

Family LLCs vs. Corporations

Like a corporation, a family LLC provides liability protection for its members (which means that members' personal assets like bank accounts and homes are protected from legal judgments against the business). Similarities between the two entities end, however, when it comes to how the business will be managed and taxed. Corporations must follow strict governance and corporate taxation requirements. By contrast, a family LLC allows you to choose how the business will be taxed and managed. For example, a family LLC can elect pass-through taxation, meaning the business will not be taxed as a separate entity like a corporation (instead, the business distributes profits to its members, who pay personal income taxes on those distributions). A corporation must also elect of a board of directors to run the business, while members of an LLC can decide to manage it themselves.

Family LLCs vs. Partnerships

A family LLC provides flexibility in management and structure like a partnership. However, if you find asset protection is just as important as flexibility for your business, a family LLC might be better suited for your business than a general partnership or family limited partnership.

Partnerships, including family limited partnerships, do not offer the same level of asset protection as a family LLC. Here's what you should know about liability and asset protection in partnerships. The level of liability a partner risks depends on the type of partner. A general partner assumes the most risk for business debts, by carrying unlimited liability, which means that creditors of the business can target a general partner's personal assets to pay off obligations if the business cannot do so. A limited partner risks less than a general partner, by benefiting from limited liability. Limited liability means that the limited partner's personal assets cannot be used to satisfy business debts. A general partnership provides the least level of asset protection because it is comprised of only general partners. A family limited partnership offers limited liability protection for its limited partners, but still must have at least one general partner who risks unlimited liability.

By contrast, the family LLC shields the personal assets of each of its members. Only the family LLC itself (assets owned by the business) will be responsible for judgments and creditor claims against the business.

Estate Planning Advantages

A family LLC also offers significant advantages for your estate plan. If you have an estate valued above the federal estate tax exemption (for 2021, that figure is $11.7 million), you're in line to pay estate tax upon your death. To avoid that hit, you might want to use a family LLC to transfer your business to your heirs.

Here's how a family LLC can help get your estate below the threshold for owing federal estate taxes. While normally you would want your assets appraised at their highest values, in this situation, less is more. The IRS helps you out by allowing significant discounts in valuation for a family LLC. These discounts recognize that investors are generally uninterested in buying into a family-owned business, especially if they're buying non-controlling shares of that business. With the discounts, you'll reach the estate tax threshold slower than if you transferred the underlying assets at their actual values. Essentially, a family LLC can help you transfer more to your heirs before you will owe estate taxes than if you transferred the assets without the discounts.

In addition, if you want to ensure your family business will continue to be family-owned, a family LLC can protect your legacy. With a family LLC, you can restrict the ability of members to transfer their interests outside of the family.

A family limited partnership also provides these estate plan advantages, but without the liability protection that a family LLC offers.

How to Form a Family LLC

Once you have considered your options and determined a family LLC meets your business needs, you will need to form it. To form a family LLC, follow the steps below to form an LLC and include the family members who you intend to involve in the business. Make sure to check your state's local regulations because each state enacts its own statutes governing LLCs.

The general steps to form an LLC are as follows:

  1. Choose a name for your LLC that complies with your state's rules.
  2. File Articles of Organization with your state and pay the filing fee. Some states call this document a "Certification of Formation" or "Certificate of Organization."
    The filing fee for Articles of Organization typically will not exceed $100, but fees vary state-by-state.
  3. Identify a registered agent to accept service of legal documents.
  4. Decide whether the LLC will be managed directly by its members or by a non-member.
  5. Prepare an Operating Agreement that describes how the LLC will operate and be managed.
    While not all states require LLCs to have operating agreements, you should create one. For a family LLC, the operating agreement should list your family members and prevent transfers of membership interest to non-relatives. This ensures the family LLC remains family owned.
  6. Comply with all state and federal rules and regulations for LLCs. This includes obtaining an IRS employer identification number (EIN), acquiring requisite business licenses, paying annual state taxes, and filing regular reports with the state.
    Fees for filing the required annual or biennial report can range widely according to location. Annual taxes for LLCs also vary significantly according to the state, so check your local statutes.

After you have formed a family LLC, you can transfer your business assets to it, including real property, bank accounts, and valuable personal property. Be aware that the terms of any loans or leases might require you to get the lender's or landlord's consent before you can successfully assign the loan or lease to the LLC.

You have worked hard to grow a successful family business. Make sure you take into account your business needs and future plans when choosing its legal entity. If you want to protect your assets, retain flexibility, and take advantage of estate and gift tax savings, consider forming a family LLC.

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