By: Tamara Pow
Although I do not practice estate planning law, as a limited liability company lawyer (“LLC lawyer”) in San Jose, I have worked with estate planning attorneys to form many LLCs for families that want to include them in their estate plan. Traditionally, the entity of choice for estate planning was the Family Limited Partnership (“FLP”). Once LLCs were introduced in California, attorneys began using an LLC to be the general partner in the Family Limited Partnership. The parents would contribute assets (often income producing real estate) to a Family Limited Partnership in exchange for limited partnership interests which would be gifted to the next generation, and a general partner interest which would be retained by the parents in their wholly owned LLC. This maintained control with the parents, but unlike holding the general partnership interest in their individual names, it provided them with a layer of liability protection as well.
Gifting of limited partnership interests is more attractive than outright gifting of the underlying asset for two reasons: First, the donor can retain control in the form of the general partnership interest. Second, the gifted limited partnership interest can get a valuation discount for terms in the partnership agreement such as lack of control and lack of marketability of the interest. In other words, a parent can gift her child 50% of a property worth $1,000,000, making the gift worth $500,000; or a parent can gift her child a 50% limited partnership interest in a partnership that owns the $1,000,000 property, making the gift worth approximately $350,000 because the partnership interest is not a controlling interest and cannot be easily transferred. LLCs are entitled to this same valuation discount so long as the transferee has limited rights.
Over time, estate planning attorneys have become more comfortable with using Family Limited Liability Companies in place of Family Limited Partnerships, rather than just as their general partners. Using one entity instead of two can sometimes reduce the amount of California franchise taxes paid by the family to maintain the entities and can simplify the annual reporting requirements for the family. Also, the transfer of assets to a Family LLC can avoid the potential of a gift occurring when parents transfer assets to an FLP and take limited partnership interests but give the next generation the general partnership interest (the IRS sees this as a transfer of control resulting in a gift without valuation discounts). This same argument against valuation discounts does not apply to LLCs because the transfer of assets to an LLC with one class of members does not involve the same disproportionate transfer of control.
There are many more business and real estate considerations to an operating LLC than just the estate planning considerations. A good LLC attorney is critical to drafting an operating agreement for the LLC that will both satisfy the family’s estate planning intentions and satisfy its business protection needs, management needs and other tax requirements. A trust and estates attorney can set up trusts for the members to hold the LLC interests and work with the LLC attorney to make sure the ownership and control succession plan dictated by the operating agreement is in line with the succession plan for the family.
As an LLC attorney with an MBA, a California real estate broker’s license and experience in public accounting, I cannot overemphasize the importance good planning plays in choosing an LLC, LP or corporation as the proper form of entity for business and real estate investments, including those involved in family estate planning.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.