When getting your estate plan in order, one tool to consider that can help safeguard your wealth and secure it for your family’s future is a limited liability company (LLC). This strategy can help reduce the size of your estate and minimize estate taxes.
An LLC grants you the freedom to share property ownership with family members without posing the threat of personal liability. LLCs protect all members against third-party creditors, including liability lawsuits, divorces, and bankruptcies, so your loved ones can inherit what you intended. LLCs can also be an effective way to pass a family vacation or second home to your family. The terms and conditions of future ownership are set forth in the LLC operating agreement and make a transfer to the next generation(s) manageable.
What is a limited liability company? Simply put, an LLC is a business structure that protects from personal liability for business debts. It’s owned by members who invest money or property into it. You can have a single-member LLC or a multi-member LLC; if there’s more than one member, they can manage it together or hire a manager.
What can an LLC own? When people think of an LLC, they assume that it is a structure to operate a business. However, many types of accounts and property can benefit from being owned by an LLC:
- Real estate. An LLC can hold a second home, a rental property, or a property in the family for generations.
- Family Businesses An LLC can be an excellent vehicle for an unincorporated business in certain situations.
- Investments. An LLC can sometimes be formed to allow multiple people to pool their money and invest it with a larger volume.
- Expensive and risky property. An LLC can own items such as airplanes and boats.
Why should I consider using an LLC in my estate plan?
Asset Protection Setting up LLCs can be an invaluable way to protect your assets – whether you’re running a business or just looking to do some estate planning. While trusts can be useful in certain situations, they come with some major drawbacks. An irrevocable trust notably removes your ability to change or cancel it, leaving you with limited control over your property. Instead, consider using an LLC to achieve your goals and keep full authority over your assets while alive.
Because the LLC is a separate entity, an LLC can offer protection for personal assets from business liabilities. Typically, the LLC’s creditors can only go after the LLC’s money and property, not the member’s personal accounts or property. Also, if the proper formalities are in place, the member’s individual creditors may not be able to reach the LLC’s accounts and property to satisfy the member’s personal debts. Note: In some states, a single-member LLC does not enjoy the same protection from the member’s individual creditors. The rationale of these laws is that your creditors should be able to seek relief through your LLC interests to satisfy their claims because no other members will be negatively impacted by the LLC’s seizure of money and property.
Probate Avoidance Anything owned by the LLC, either retitled into the name of the LLC during your lifetime, bought by the LLC, or transferred by operation of law at your death, will not go through the public, costly, and time-consuming probate process. The probate process only moves accounts and property that you owned at your death. By using an LLC, the LLC—not you—owns the accounts and property. However, if you own a membership interest in your own name, transferring the membership interest at your death may need to go through the probate process.
When you hold property in more than one state, you have to probate your will in each state where you own property. These out-of-state probate processes are often called “ancillary probate” because they occur in a state where you are not domiciled. This can be a time-consuming and expensive process. To avoid this, many people will use trusts to hold property. However, you can also use an LLC to accomplish the same goal.
You transfer the property that you own out of state into the LLC. Then, even after the decedent’s death, the LLC continues to hold that property, and it will pass to other members of the LLC without the need for court intervention or the probate process. The decedent’s membership interest in the LLC will pass to others, but individual assets will not change hands.
Tax Advantages. LLCs have a unique option to choose whether they will be taxed as a corporation or as a pass-through entity. As a result, LLC creators can opt to be taxed as a sole proprietor or partnership or as a C-corporation or S-corporation. This creates flexibility when it comes to selecting the most advantageous tax structure for a company. There are additional benefits afforded to LLCs in certain situations that should be explored.
How can an LLC be used in an estate plan?
How It Works
During your lifetime, you create an LLC and then transfer accounts and property to the LLC or name the LLC to be the beneficiary of your accounts and property at your death.
Once it has been created, you may also purchase property or create accounts in the name of the LLC. As the creator of the LLC, you will be a member. A member owns an interest in the LLC and may also manage the LLC depending on the number of members and the type of management. If you are married, your spouse may also be a member. You can add others as LLC members when the LLC is created or later.
At your death, the only item that may need to be transferred is your ownership interest in the LLC; the accounts and property owned by the LLC will remain owned by the LLC. An LLC’s ownership structure can help transfer wealth efficiently.
For example, a couple could establish an LLC to buy property, with the parents owning 70% and their three children owning the remaining 30%. The parents would then gift the children their shares, reducing their lifetime estate tax exemption and removing future appreciation from their estate. The parents would still manage the property, while 70% of the LLC would remain taxable. Later, when the parents pass away, the children could buy their share and use a permanent life insurance policy for cash support. The parents could also transfer more of their interests by making gifts.
Operating Agreement Most LLCs have an operating agreement that outlines the rules for managing and transferring a member’s interest in the LLC. These agreements cover:
- who the members of the LLC are,
- the percentage of ownership that each member has,
- how conflicts among members are settled,
- any restrictions on a member’s ability to transfer their membership interest (including transfers to a trust), and
- what happens to each member’s interest if the member dies (in most cases, whatever is stated in the operating agreement controls).
Trust Agreement As an additional protection layer, you may transfer your membership interest in an LLC to a revocable trust. As the creator, trustee, and beneficiary of the trust, you would still be able to participate in the management of the LLC and benefit from the LLC; you would do so as the trustee of the trust and not as an individual. Because the trust owns the membership interest, transferring the membership interest will not require probate because the trust does not die. In fact, the trust can continue to own the membership interest after your death, which you can include in the trust’s instructions, along with a provision allowing a successor trustee to step in for you and handle LLC matters on behalf of the trust’s beneficiaries. Alternatively, you could state in the trust instructions that the membership interest be distributed to a named beneficiary at your death or at a specific time. At that point, the beneficiary would have control of the membership interest.
Best Practices for Using an LLC To ensure you can take full advantage of the benefits associated with an LLC, you must follow all the rules. An LLC is supposed to be a separate entity, and you need to treat it as such. This means that there are some formalities you need to abide by, some of which include filing your annual report with the appropriate state government office and keeping separate records to showcase all transactions and meetings that the LLC is involved with. Additionally, you must keep your personal money and property separate from the LLC’s money and property. You should not treat the LLC bank account as your own personal wallet.
Conclusion. LLCs offer several advantages:
1. Asset protection: An LLC can protect personal assets from business liabilities.
2. Tax benefits: An LLC has pass-through taxation, meaning that the income and expenses of the business are reported on the owner’s personal tax return. This can lead to lower tax rates than other types of corporations.
3. Succession planning: Planning for the transfer of ownership of an LLC after your passing can ensure that it continues to operate smoothly.
4. Management considerations: It’s important to consider who will manage the LLC after your passing and ensure that they have the necessary skills and experience.
5. Funding: It may be necessary to provide funding for the LLC to continue operating after your passing. This can be done through life insurance, investments, or other means.
6. Overall, incorporating an LLC into your estate plan can provide a number of benefits, but it’s important to carefully consider all the factors involved before making any decision
If you would like to explore how you can incorporate a limited liability company into your estate plan, please reach out to us.
