Can a Family Limited Liability Company or Limited Partnership Reduce Estate Taxes?

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Posted on: May 19, 2022 | by: Graber & Johnson Law Group, LLC
These vehicles let a family manage multiple interests, preserve parental control and protect assets from claims of creditors and divorcing spouses, among other benefits.

Family LLCs or LPs (limited partnerships) are used to protect assets, reduce estate taxes and more efficiently shift income to family members, reports the article “Handling Estates Like An LLC Can Reduce Taxes” from Financial Advisor. The qualified business income and pass-through entity tax deductions may add significant benefits to the family.

What is a Family LLC? Limited liability companies are flexible business structures that offer liability protection. They have members (owners) and can have managers, who control the business. Limited partnerships are partnership owned by two or more individuals, with two classes of owners: general partners (typically the parents) and limited partners (heirs). With the proper setup, contributed assets of the general partners are no longer considered part of their estate, and future appreciation on the assets are not counted as part of their taxable estate. The general partner is in charge of managing the partnership, which limits the liability of the limited partners.

Consider the LLC or LP as three separate pieces: control, equity and cash flow. Because of the separation, you can maintain control of the personal/business assets, while at the same time transferring non-controlling equity of the assets to someone else via a gift, a sale, or a combination of the two.

An added benefit—transfers of non-controlling equity can qualify for a discount on the value for tax reporting, minimizing any gift or estate tax consequences of the transfer. Discounting business entities with very liquid assets is generally not advisable. However, illiquid assets could warrant a discount as high as 40%.

These types of structures are complicated. Therefore, you’ll need an estate planning attorney with experience in how Family LLCs or LPs interact with estate planning. The LLC or LP must be properly structured and have a legitimate business purpose. While relatively similar results are possible with both, there are situations where one entity is favored over the other. An experienced estate planning or business planning attorney will be able to help you decide.

It’s important to note that if a real estate or operating business is put into an LLC and taxed as a pass-through entity instead of a sole proprietorship, they may be eligible for the 20% discount under Section 199A, or for the passthrough entity tax workaround for the limitation of the deductibility of state taxes for individuals and trusts.

Every state has its own rules about income qualifying for a state income tax deduction on the federal level. If you have an entity in place, you’ll want to speak with your attorney to determine if a pass-through entity on the state level will be advantageous. If so, this election may allow for a state income tax deduction on the federal level.

Your estate planning attorney will help you get a qualified appraisal of the assets, since the IRS will require an accurate value of the transfer for reporting purposes, especially if a discount is being contemplated. This is a complex matter, but the estate planning and tax advantages to be gained make it worthwhile for families with a certain level of assets to protect.

Reference: Financial Advisor (April 4, 2022) “Handling Estates Like An LLC Can Reduce Taxes”

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