Family LLCs Still Work… If You’re Careful

While the caveat in my title applies to [probably] all estate plans, it is especially true for family LLCs which have been steadily declining in popularity because of the IRS’ “enforcement” (read: limitation) over the last 8-10 years. But this post by Mirowski v. Commissioner, T.C. Memo 2008-74. March 26, 2008 (PDF).

Mrs. Mirowski was the widow of the inventor of the heart defibrillator implant and created a trust for each of her three daughters in 1992. She funded these trusts, during her lifetime, with portions of her interests in her late husband’s patent licenses. In 2001, she formed a single member LLC and transfered substantial assets to it. “Shortly thereafter, Mrs. Mirowski gifted a 16% interest in the LLC to each of the trusts. A mere four days later, she died unexpectedly.”

The IRS sought to include the assets she trasnferred to her daughter’s trust in her estate, thus invalidating the transfer based on Section 2036(a) of the Internal Revenue Code. They argued that Mrs. Mirowski retained the right to income or enjoyment of the gifted property, so that it was included in her taxable estate.

The estate argues that Section 2038’s “bona fide sale” exception applied, so that the transferred assets were not subject to estate tax.

The tax court agreed holding that “the LLC’s activities do not have to be equivalent to those of a ‘business’ for the bona fide sale exception to be applicable.

Some key points for Family LLCs to hold up for gift and estate tax purposes:

  • Strictly follow the terms of the Operating Agreement
  • State the reasons for the LLC in the Operating Agreement
  • Have the Agreement reviewed by separate counsel for all initial members
  • Leave enough assets outside the LLC to live on and pay taxes
  • Don’t mingle LLC assets with personal assets
  • File the proper tax returns each year
  • File the necessary documents with the Secretary of State each year
  • Don’t put your personal residence in a Family LLC
  • Make sure the senior generation does not have the power to allocate profits and losses
  • Require annual distributions
  • Have the junior family members (or their trusts) make initial contributions to the LLC to provide for the pooling of assets
  • Don’t wait until the senior family member is near death

The bottom line is that Family LLCs remain a viable and attractive option for transfers of family wealth, while also providing asset protection and management advantages. Just make sure you use an attorney experienced in forming Family LLCs to assist you, and carefully follow all of his or her instructions.

UPDATE:

Also see this post by David Goldman about In re Estate of Hjersted, 175 P.3d 810 (Kan. 2008) specifically regarding Family Limited Partnerships and discounts in relation to an elective share, and this one by Mitchell A. Port about The Estate of Virginia A. Bigelow (PDF).  Both cases rest on the court’s analysis on IRC 2036.

0 Responses to “Family LLCs Still Work… If You’re Careful”


  • No Comments

Leave a Reply