Can You Use an LLC for Estate Planning Advantages?
Many U.S. businesses are set up as limited liability companies (LLC) because the structure offers tax advantages and helps protect the owners' assets. However, family LLCs can also be used as an estate planning tool that can help pass your assets on to family members in a manner that both controls how they are distributed and reduces the estate tax bill.
Creating a family LLC to hold your business or other assets will allow you to distribute a significant amount of your wealth to family members during your lifetime. This enables you to reduce the size of your estate and minimize the estate taxes that must be paid. A family LLC also lets you distribute your assets in the manner of your choosing without incurring any gift taxes. Finally, like all LLCs, family LLCs provide their owners with some measure of asset protection.
What Is an LLC?
An LLC is a way of organizing a business that both protects owners from liability for the business's debts and offers flexibility with regard to how it is taxed. A correctly-established LLC operates as an entity separate from its owners—often referred to as "members." This separation means that you can't be found liable for the debts and financial obligations of an LLC that you own either by yourself or with others.
LLC members have several options when it comes to how the business is taxed. The following list sets out the three most common LLC ownership structures and how they are taxed:
- Single-member LLCs: LLCs with a single owner are treated as disregarded pass-through entities by the Internal Revenue Service (IRS) and most states. That means the company is not treated separately from its owner, and any income earned by the LLC is taxed as income earned by the owner.
- Multi-member LLCs: LLCs with at least two owners are treated as pass-through entities for tax purposes. Thus, they are taxed in much the same manner as a partnership or single-member LLC. That means the company itself pays no tax on its income. Instead, any income received by the LLC is treated as the members' personal income, who pay a percentage based on their ownership interest in the company.
- LLCs that are taxed as corporations: One of the primary benefits of organizing your business as an LLC over a corporation is that the LLC avoids "double-taxation." That is where a traditional C corporation's (C-corp's) income is taxed both when the company earns it and again when it is distributed to shareholders. However, it is more beneficial financially for owners for the LLC to be taxed as a C-corp in some circumstances. An example of this would be when the business is reinvesting most of its profits in the company rather than distributing them to shareholders.
LLCs are also responsible for collecting and paying the 15.3% self-employment tax due on the income earned by members working for the company to cover their Social Security and Medicare contributions. In addition, it must pay any state and federal employment taxes due on amounts paid to employees.
What is a Family LLC?
The primary difference between a family LLC and a standard LLC is that only people related by blood or marriage can form a family LLC. Otherwise, family LLCs operate in the same manner as a standard LLC. That means the IRS and most states will treat a family LLC like a standard LLC when it comes to paying income taxes and the rules and regulations that apply to the company.
The advantages that a family LLC provides are due to the estate planning benefits they provide. When used as an estate planning tool, the family LLC lets the organizers—usually parents who own the LLC's assets--give shares in the company to other family members. This offers several benefits:
- Control of asset distributions: The family LLC organizers can distribute shares in the company in the manner of their choosing during their lifetime.
- Reducing the size of an estate: By giving away some of the shares in the LLC, it reduces the organizers' stake in the company. Since the organizers' stake in a business is subject to the estate tax when they die, this reduces the size of the estate that is subject to the tax.
- Avoiding gift taxes: These are the taxes paid on gifts of more than $15,000 each year. The tax does not apply to the transfer of ownership interests in a family LLC.
- Keeping assets in the family: When the family LLC is formed, the organizers can place restrictions on transferring shares outside the family. This keeps individuals who have been gifted shares from selling or transferring stake to anyone outside the family.
Most family LLCs own businesses, rental properties, and brokerage companies, but a family LLC can own almost any asset that is not a personal residence. IRS rules bar all types of LLCs from owning private residences.
How Do Estate Taxes Work?
According to the IRS, the federal estate tax is "a tax on your right to transfer property at your death." It is a 40% tax levied on estates of more than $11.7 million based on the fair market value of the deceased's combined assets. Taxable assets include real estate, business interests, securities, trusts, annuities, cash, and bank accounts. A taxable estate does not include property passed to surviving spouses, mortgages, expenses for estate administration, or charitable donations.
While the estate tax does not apply to estates with a taxable value below $11.7 million for 2021, the threshold drops dramatically in 2026. That's because the Tax Cuts and Jobs Act of 2017 sunsets in January 2026, and the estate tax threshold will drop down to the previous $5.5 million amount at that time (expected to be roughly $6 million when adjusted for inflation). Congress may take action before the act sunsets, but given the uncertainty regarding the amount that will be exempt from the estate tax, it is a good idea to have a plan for minimizing the size of your estate.
A few states levy either an estate or inheritance tax of their own. Estate taxes are paid from the estate, while the beneficiary pays inheritance taxes.
How Do Gift Taxes Work?
The federal gift tax is levied on the transfer of assets or property from one person to another in return for either nothing or less than total value. The tax was created to keep taxpayers from giving money and other valuable assets to others—usually family members—to avoid paying the federal income tax.
While called the gift tax, the tax applies every time someone is given something in exchange for less than its total value. The donor is required to report the gift on their individual income tax return and pay the gift tax. Depending on the size of the gift, the tax is assessed at between 18% to 40% of the gift's value.
Fortunately, a gift tax exclusion generally spares those giving smaller gifts from the tax. For 2021, the exclusion was set at $15,000 annually for each gift, with a total lifetime exemption of $11.7 million per donor. That means that an individual can only make a total of $11.7 million in exempt gifts to anyone tax-free while they are alive. In January 2026, the lifetime exemption drops to $5.5 million with the sunset of the Tax Cuts and Jobs Act.
Additionally, some categories of gifts are not subject to the tax. For example, you can give your spouse an unlimited amount of money if they are a U.S. citizen. Other gifts not subject to the tax include:
- Gifts to charitable organizations
- Gifts to political organizations
- Gifts made to cover medical or educational expenses, such as payments to a college or hospital on another's behalf
- Gifts to a spouse who is not a U.S. citizen of up to $159,000 annually (for 2021)
A Family LLC Provides Asset Protection
One of the primary reasons business owners organize their companies as LLCs is to protect their personal assets from creditors owed money by the business. Family LLCs also provide this benefit if they are correctly set up and registered with the state. This liability protection stems from the LLC's operating agreement that has been agreed to by each of the company's members.
Once all of an LLC's members have signed it, an operating agreement is legally binding and protects members from personal liability for the company's debts and other obligations. However, if there is no agreement, most states have default rules that are applied. These default rules are generally vague and provide some asset protection but are not written with estate planning in mind. So be sure that your LLC's operating agreement is valid and that it serves your needs as an estate planning tool.
Have More Questions? Ask an Attorney
LLCs are complicated on their own. Ensuring that a family LLC set up for estate planning purposes meets your needs adds an additional layer of complexity. If you are forming a family LLC, it is recommended that you meet with a local attorney who has experience with both establishing LLCs and estate planning. A skilled attorney will ensure that you follow all of the legal formalities necessary to set up a family LLC and that it serves the estate planning purposes for which it is intended.
Can I Solve This on My Own or Do I Need an Attorney?
- DIY is possible in some simple cases
- Complex estate planning situations usually require a lawyer
- A lawyer can reduce the chances of a family dispute
- You can always have an attorney review your forms
Get tailored advice and ask your legal questions. Many attorneys offer free consultations.