| For estate planning purposes, a family partnership is | | | | member's interest, nor do they step into the member's |
| typically a limited liability company or a limited | | | | shoes as a substitute member. The creditor can only |
| partnership. A limited liability company ("LLC") is an | | | | apply to the court for a "charging under" to require the |
| entity that combines the limited liability of a corporation | | | | FLLC to pay to the creditor distributions that would |
| with the "pass-through" taxation of a partnership. A | | | | otherwise go to the debtor/member. However, if the |
| family limited liability company ("FLLC") is a standard | | | | manager of the FLLC decides not to make |
| LLC which is owned exclusively by family members. | | | | distributions, then the creditor (as opposed to the |
| The typical FLLC is formed with two classes of | | | | debtor/member) may be taxed on the FLLC's |
| ownership interests (voting and non-voting), and is | | | | undistributed income. This potential for negative cash |
| managed by a "manager" who is selected by the | | | | flow may facilitate an out of court settlement for |
| owners (or "members"). A family limited partnership | | | | pennies on the dollar. Thus, the debtor/member |
| ("FLP") is very similar to an FLLC. Although, an FLLC | | | | receives "inside" protection from his/her personal |
| offers more protection than an FLP since no general | | | | creditors. |
| partner (with unlimited liability) is required. | | | | Proper Administration |
| Example | | | | The IRS has been scrutinizing FLLCs closely and has |
| Parents transfer $2 million of commercial real estate to | | | | challenged the size of the valuation discounts applied |
| an FLLC in exchange for a 1% voting interest and a | | | | to the non-voting membership interests. The burden of |
| 99% non-voting interest. With the voting interest they | | | | proving the appropriateness of the discounts falls on |
| appoint themselves as the managers of the FLLC. | | | | the taxpayer. Thus, following are the leading principles |
| Soon afterward, they gift the non-voting interests to | | | | established by recent cases to achieve the desired |
| their children, grandchildren and/or to trusts for the | | | | results:o The FLLC must be operated as an actual |
| benefit of their children and grandchildren (the | | | | business, including maintenance of accurate records, |
| "donees"). These gifts will be gift tax-free to the extent | | | | proper titling of assets, and compliance with applicable |
| of the parents' $13,000 ($26,000 for a married couple) | | | | laws as well as the FLLC's governing documents.o |
| annual gift tax exclusion and $1,000,000 ($2,000,000 for | | | | Assets transferred to the FLLC should not be used |
| a married couple) lifetime gift tax exemption. | | | | for the donor's personal use (unless fair market value |
| There is no gain or loss to the parents upon the | | | | rent is paid), nor leave the donor without sufficient |
| contribution of the real estate to the FLLC. The | | | | assets to maintain his/her standard of living without |
| parents, as managers, will continue to manage the real | | | | having to rely on distributions from the FLLC. Moreover, |
| estate and can even receive a reasonable | | | | there should be no commingling of the donor's assets |
| management fee for their services. Each member will | | | | with the FLLC's assts.o When distributions are made |
| owe income taxes on his/her/its proportionate share | | | | by the FLLC, they must be made to all members in |
| of the FLLC's income. | | | | proportion to their respective membership interests. |
| Tax Advantageso The future income and appreciation | | | | IRS Challenges |
| on the nonvoting membership interests gifted are | | | | Recently, the IRS has been successful in including in a |
| removed from the parents' gross estates, even though | | | | decedent's estate all of the assets that the decedent |
| the parents continue to manage the FLLC. While there | | | | transferred to an FLP or FLLC. Under Internal |
| is a present lapse in the estate and generation-skipping | | | | Revenue Code Section 2036, transferred assets can |
| transfer taxes, it's likely that Congress will reinstate | | | | be included in the transferor's estate if the transferor |
| both taxes (perhaps even retroactively) some time | | | | retained until his/her death (1) the possession or |
| during 2010. If not, on January 1, 2011, the estate tax | | | | enjoyment of the assets, or (2) the right to determine |
| exemption (which was $3.5 million in 2009) becomes $1 | | | | who would possess or enjoy the assets. |
| million, and the top estate tax rate (which was 45% in | | | | Despite the IRS's recent success in some cases, the |
| 2009) becomes 55%.o To the extent the donees are | | | | FLLC remains a powerful vehicle for transferring |
| in lower income tax brackets than the parents, income | | | | wealth when properly designed and operated. |
| tax savings are achieved.o If the gifts of the | | | | Following, is a checklist of ways to minimize an IRS |
| non-voting membership interests are made to a | | | | attack under IRC Section 2036: |
| so-called "grantor trust" established by one of the | | | | 1. Include some operating business or real estate |
| parents, the grantor-parent will be taxed on the trust's | | | | investment in the FLLC. Do not transfer personal use |
| income. The grantor's payment of the trust's income | | | | assets to the entity. |
| taxes is the equivalent of a tax-free gift to the | | | | 2. Create the FLLC well before death, and adhere to |
| beneficiaries of the trust.o Because the non-voting | | | | the terms of the operating agreement. |
| membership interests lack control and lack | | | | 3. Do not transfer all of the donor's assets to the |
| marketability, those membership interests are usually | | | | FLLC; and make sure the donor has sufficient liquidity |
| eligible for significant valuation discounts, ranging from | | | | apart from the FLLC. |
| 15% to 45%! Such discounts "leverage" the parents' | | | | 4. Distribute profits unless needed for business |
| $13,000/$26,000 annual gift tax exclusion and | | | | purposes; and always make distributions pro rata. |
| $1,000,000/$2,000,000 lifetime gift tax exemption. | | | | 5. Avoid making distributions, before and after death, to |
| Non-Tax Advantageso An FLLC allows the donor to | | | | meet the personal obligations of the donor or the |
| serve as the manager of the FLLC even if he/she | | | | liabilities of the donor's estate. |
| gives away 100% of his/her membership interests in | | | | 6. Document the business purpose in the operating |
| the FLLC.o An FLLC makes it much easier to make | | | | agreement. |
| fractional interest gifts of assets like real estate which | | | | 7. Keep valuation discounts within amounts that are |
| would otherwise require the preparation and recording | | | | less likely to draw audit suspicion. |
| of separate deeds each time a gift is made.o An | | | | 8. Have junior generational members contribute capital |
| FLLC consolidates investment assets to promote | | | | to the FLLC, instead of relying exclusively on gifts of |
| efficient and centralized management of those assets. | | | | membership interests. |
| It also allows donors to involve their heirs in the | | | | 9. Have annual partnership meetings to update events; |
| operation of the FLLC without losing control. Finally, | | | | and actively manage the FLLC's assets. |
| FLLCs provide the members with privacy since the | | | | 10. Finally, by operating the FLLC as though the |
| state filings and annual reports neither require the | | | | members were non-family members, the likelihood of |
| names of the members to be disclosed nor any | | | | challenging an IRS attack should be much greater. |
| information regarding the FLLC's underlying assets. | | | | Conclusion |
| Asset Protection | | | | In order to achieve the desired tax results, the FLLC |
| Outside Protection. The FLLC accomplishes the goal | | | | must have a valid business purpose. Whether a valid |
| of protecting the members' personal assets from | | | | business purpose exists (other than to secure tax |
| business risks. Members of an FLLC are generally not | | | | benefits) is a facts and circumstances test requiring |
| liable for the debts, contracts or acts of the FLLC. In | | | | the input of estate planning specialists. In any event, the |
| other words, a member's personal wealth is not | | | | FLLC is an important technique that should be |
| exposed to the "outside" debts and liabilities of the | | | | considered as part of any estate plan, asset protection |
| FLLC. Members can only lose what they invest in the | | | | plan, or business succession plan. |
| FLLC. However, this protection will not shield the | | | | TO THE EXTENT THIS ARTICLE CONTAINS TAX |
| FLLC's members from personal liability arising from | | | | MATTERS, IT IS NOT INTENDED OR WRITTEN TO |
| unlawful acts committed personally or contracts signed | | | | BE USED AND CANNOT BE USED BY A |
| personally. | | | | TAXPAYER FOR THE PURPOSE OF AVOIDING |
| Inside Protection. Conversely, the FLLC's assets are | | | | PENALTIES THAT MAY BE IMPOSED ON THE |
| protected from the creditors of one of the members. | | | | TAXPAYER, ACCORDING TO CIRCULAR 230. |
| The creditors of a member cannot force a sale of a | | | | |