Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 Combines limited liability like a corporation with the pass through income tax rules of a partnership for its members –Avoids double tax on income –Losses incurred by the entity will be passed through and deductible by the members What Is A Limited Liability Company (LLC)?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 No limits on classes of memberships in an LLC Upon death of a member, the LLC may elect to adjust the basis of the assets to FMV to the extent of the decedent’s interest What Is A Limited Liability Company (LLC)?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 An LLC, like an FLP, can be used to manage a family business, real estate, or other investment assets without naming a GP to assume personal liability for the debts of the entity In most jurisdictions the LLC and its counterpart the LLP (limited liability partnership) are used as a form of organization for a professional practice What Is A Limited Liability Company (LLC)? (cont’d)

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Check state statute for specifics General requirements for an LLC to be treated as a partnership for income tax purposes: –Articles of organization setting forth the purpose for which the entity is formed –Participants are called members Other entities such as corporations, partnerships, trusts and estates can be members –Provisions for capital contributions What Are The Requirements?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 General requirements (cont’d): –An operating agreement governs management of the entity Specifies if the LLC will have officers/managers Specifies whether management will lie with the officers or with all members Specifies allocation of profits and losses Provisions can alter many of the legal requirements under the governing state statute What Are The Requirements?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 General requirements (cont’d): –Voting is generally in proportion to capital contributions –Assignment of interests in LLC generally follow pattern of an LP –Dissolution of the entity will occur upon expiration of a fixed term or unanimous consent of the members, and has considerable tax consequences What Are The Requirements?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 Example: –10 unrelated investors are interested in joining together to acquire and develop mining property in a western state Very risky venture Will produce large profits if successful Large losses if unsuccessful Liability for debts, potential damage to adjacent properties, and injuries to workers Limited insurance to cover liability risks How Is It Done?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 An LLC would allow: –Direct passthrough of profits or losses –Different classes of ownership and participation –Limited liability –Either active participation by all members or delegation of management How Is It Done?

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Key is to make sure the entity qualifies for partnership income tax treatment One way is to make sure the entity only contains two of the four corporate characteristics: –Limited liability –Centralized management –Free transferability of interests –Continuity of life Tax Implications

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Second way is to follow the “Check–the-Box” regulations and ask three questions: –Is there an entity separate and apart from its owners? If so, –Is that entity a trust – or is it a business entity? If it is a business entity, then –Is the entity – “per se” – a corporation? If “no” then it can elect its classification for federal tax purposes, merely by checking a box Federal tax law, not state law, determines whether or not an organization will be recognized as an entity separate from its owners Tax Implications

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 “Per se” corporations include –Business entities incorporated under federal or state statutes where the statute describes or refers to the entity as incorporated or as a corporation, –Associations, –Joint stock companies –Insurance companies –State chartered banks insured by the FDIC –Business entities owned by a state or one of its political subdivisions –Business entities taxed as corporations under certain IRC provisions, or –Certain foreign entities Tax Implications

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 Merely checking a box may not eliminate all problems, caution is advised An entity will be considered a business entity if it is not a trust or is subject to a special tax regime Tax Implications

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 An entity will be considered a business entity if it is not a trust or is subject to a special tax regime Once considered a business entity, it will be treated as a –Corporation  Always taxed as a corporation (Under state law or publicly traded entity) –Partnership  Taxed as partnership, unless (2 or moreaffirmative election to be taxed members)as corporation –LP, LLC, LLP –Single member,  Taxes as sole proprietorship, unincorporated unless affirmatively elects to be association taxed as corporation Tax Implications

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company14 Even though only one spouse is listed as a member of an LLC, –If the assets contributed to the LLC were characterized as marital or community property, –The membership itself will be characterized as community property Check state law, but a classification of a membership as marital may also give a member’s spouse rights to participate in voting or management Issues In Community Property States

Limited Liability Companies Chapter 44 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company15 In the event of a death of either a member or non- member spouse, or a divorce –Rights in the membership may be divided to reflect the rights of the spouses under community property laws –Depending on the state, a nonmember spouse may be treated as an assignee and not have the full rights of a member Issues In Community Property States