What is a Limited Liability Company?
Basically, a limited liability company (LLC) is a legal entity that became available under Oregon law during 1993. An LLC is an unincorporated association that provides its members with the beneficial tax aspects of a partnership and the limited liability which shareholders of a corporation enjoy.
For tax purposes, an LLC is a “pass-through” entity, meaning that all items of gain and loss pass directly through to the owners, rather than being taxed at both the entity and owner levels. The benefit of “limited liability” means that a business owner is liable only for the obligations of the business to the extent of his or her investment in the company. Absent the business owner’s own wrongdoing or negligence, creditors and those bringing lawsuits against a company may only look to business assets for relief.
Who are the Owners of an LLC?
Owners of an LLC are called “members.” Each member’s interest is expressed in terms of the number of “units” owned by that member. A member’s ownership interest is further expressed in terms of his or her “economic rights” and “management rights.” Management rights include the right to control and manage the property of the LLC. A member’s economic rights represent that individual’s allocable share of the LLC’s profits, losses, and property.
How Can an LLC Further a Member’s Estate Planning Objectives?
As you may be aware, the Internal Revenue Code imposes a tax on all transfers made during the life and on the value of all property owned at death. There are exceptions to this imposition of tax for gifts valued at not more than $13,000 per donee per year for property given away during life and for the first $5,000,000 of property given away at death. There are also unlimited deductions for transfers to a spouse or to a charity. Given these rules, many often attempt to reduce or avoid the imposition of these taxes by reducing the value of their property and by giving it away.
Family-owned LLCs allow individuals to accomplish these goals by allowing them to transfer economic wealth to their children (or others) while retaining significant control over the business’ assets and by further providing valuation discounts, which serve to accelerate the rate at which wealth is transferred out of an estate and estate tax is reduced (discussed in paragraph 5). To begin this process, you simply form an LLC and transfer selected property to it. By making annual gifts of interests in the LLC, you can maintain control over the property, while taking advantage of the annual gift tax exclusion, thus diminishing the ultimate estate tax burden.
Procedure for Forming an LLC.
Forming an LLC is a relatively easy process. To do so, you must first file a one-page document with the Oregon State Corporation Division called “Articles of Organization.” The document that governs the relationship between the members of an LLC is called an “Operating Agreement.” That document specifies who has the right to manage the property and who is entitled to the economic benefits received from the property. Finally, the selected property must be conveyed to the LLC. Beyond this, any gifts of ownership interests in the LLC should be documented and included with the records for the LLC.
Valuing LLC Interests.
The value to be placed on a business interest is based on many factors. For example, some businesses are properly valued by looking to the value of the underlying assets. Whatever method of valuation is used, it is recognized that the value of the assets of a business may exceed the aggregate value of all of the separate ownership interests in that business. Simply stated, the whole may be greater than the sum of its parts. This is because the IRS recognizes that the fair market value of a partial interest in a business may be less than the same proportionate share of the business’ assets.
In valuing business interests held by a deceased person, the valuation inquiry is focused on what the deceased person owned immediately before his or her death. However, in valuing gifts, it is not what the donor gave up that is valued, but rather what the donee receives. This determination is generally made using discounts in valuing business interests, primarily discounts for a lack of marketability and for gifts of minority interests.
Ownership interests in a family business generally incorporate a fairly strong prohibition on transferring the interest. This is known of as a lack of marketability, which serves to discount the value of the underlying interest. If an interest is less than a controlling interest (a “minority interest”), an additional discount is generally applied to that ownership interest, as the owner has little or no control over the business. Therefore, a $13,000 gift of a properly valued minority interest in an LLC may equal as much as $25,000 or $35,000 of the value of the underlying assets. Through annual gifts of LLC interests, you can be capable of reducing your ultimate estate tax significantly.
By transferring property to an LLC and making annual gifts to children, grandchildren, or others of ownership interests in the LLC, one can obtain many estate planning objectives: keeping valued property in the family, reducing estate taxes and retaining significant control over assets. In addition, many find that such a process actually serves to better prepare children for the succession of ownership in property by involving them in the management process from an earlier point in time.