An important part of estate planning is making sure you direct your wealth and assets to heirs and beneficiaries of your choosing. Another important part might also involve reducing the federal estate tax burden on these heirs and beneficiaries. Depending on the size of your estate when you pass, your spouse, children, or grandchildren might owe taxes on your assets when you pass away.
One way to potentially reduce those taxes – and to keep better control of your assets – is through a limited liability company (LLC). LLCs are primarily connected with business ownership. But a family LLC can also be an important part of your estate planning process.
Definition of a Family LLC
Limited liability companies are state-regulated organizations that (as the designation suggests) limit the liabilities of their members. Business LLCs mean company members aren’t held personally liable for the entity’s debts or liabilities. A family LLC operates on the same principle in that it offers protection for family members and their assets.
Forming an LLC generally requires the following actions:
- Following the requirements of your state to form the LLC
- Adding your family members to the LLC as non-managing members
- Transferring your assets (cash, property, and personal possessions) into the LLC
- Translating the market value of those assets into LLC units of value, then transferring ownership of those units to your family
Family LLCs and Estate Planning
At this point, you might be wondering how a family LLC helps with estate and tax planning. This formation can be beneficial in the following ways:
Lower Asset Valuations
The value of your LLC units can be discounted up to 40% when transferred to the non-managing family members of your organization. Without management rights, these units are less marketable to anyone outside of your family.
This can help reduce the gift tax, which is $16,000 in 2022. As an example, you decide to gift LLC units worth $1,000 each to family members, the 40% discount brings that value down to $400. This means you can transfer up to 26 unit shares before having to pay a gift tax.
As mentioned above, the reason why business owners like the LLC structure is because of liability protection. If someone wants to sue them, personal assets aren’t in danger. The same can hold true for a family LLC. The structure can protect your assets against creditors and liens.
Reduction of the Estate
Transferring assets from your estate to a family LLC means your estate shrinks – and so does its value. The lower the value, the lower the eventual estate tax, and the less burden on your heirs. In 2022, the estate tax threshold is $12.06 million, which jumps to $12.92 million in 2023. If you can reduce your estate’s value to below these thresholds, no tax will be owed.
When you formulate your family LLC, the operating agreement should restrict all LLC members from transferring their business interests outside of the family. This can help protect your legacy, while keeping assets within the family.
While a family LLC can be helpful with potentially reducing a tax burden, there are some caveats involved.
For one thing, the setup can be costly and require paperwork. Many states require an initial formation fee and ongoing annual payments to keep the entity going. Additionally, a specific plan of succession should be in place or, at the very least, a specific transfer to another member upon death should be stated in the operating agreement. Failure to do so could mean dissolution of the LLC.
While a family-owned LLC does allow you control over your estate and assets, it’s always a good idea to work through an estate attorney or financial advisor before creating and finalizing your LLC.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Hypothetical examples shown are for illustrative purposes only.