Suppose we put our assets into trusts, and placed the beneficial interests into a Business Trust, as mentioned previously, and formed a corporation and used it to operate any business interests we had. This would provide both privacy and tax planning options. Next, let’s have these two entities form a Limited Liability Company. It would be the part of our iceberg seen by the public. The corporate Managing Member of the LLC would meet and greet customers, sign contracts and leases. What might this accomplish?
From the standpoint of asset protection, the LLC as a business form was developed specifically to protect its owners and managers from any personal liability brought on by the conduct of a business. Although LLCs have been used in this country for almost 20 years, there have been only a smattering of lawsuits in which they were even attacked. I know of none in which a claimant prevailed in piercing the LLC to get at its owners’ assets. What about tax strategies?
LLCs are a rare breed. Depending upon the LLC Act in the State where they are formed and the Revenue Rulings which apply to that State’s Act, an LLC can be taxed as a sole proprietorship, a partnership or a corporation, obtaining the benefit of the tax rulings which might apply to that particular form of business organization. When LLCs are taxed as partnerships, they offer a unique blend of tax benefits.
LLCs can allocate income, gain, and basis among their members according to their LLC’s Operating Agreement. That means that a high tax-bracket member can elect to give up a proportion of income and gain, while arranging to have the lions share of the depreciable basis. A Member in a high-taxed State could trade off income for future gain at the time the LLC shares were sold. In the meantime, his share of taxable income might flow to a lower-taxed member in a lower taxed State. If the LLC were formed by a Trust, organized by a resident of highly taxed New York and by a low-taxed Nevada corporation, you can see the obvious advantages of a majority of the income flowing through to Nevada to be stored as retained earnings.
LLCs have begun to become popular as replacements for family limited partnerships in estate planning. Here’s why: When the shares of a corporation are inherited, they get a step up in tax basis; but the assets of the corporation themselves retain their adjusted cost basis. By way of contrast, under partnership tax rules, both the shares and assets of an LLC get a step up in basis to fair market value upon the death of the LLC Member. This can make a big difference in capital gains taxes if assets must be liquidated to raise money for estate taxes.
Net LLC earnings and profits flow through to the members automatically for tax purposes. Where the LLC is managed by its Members, all income that flows through to them is deemed to be active income, subject to payroll taxes. But, when the LLC’s operating agreement stipulates that a non-Member Manager, or contracting entity, or a designated Member is to have 100% of the management responsibilities; income then flows through to the remaining passive members according to the manner it was received. In such a case, rental income would be treated as passive income for tax purposes, and investment income would be taxed as portfolio income. You can see that the Members would enjoy considerable flexibility in their tax planning.
When you begin to combine the privacy, asset protection and tax advantages of these three organizational forms, you’ll find them to be as flexible and useful as our Swiss Army knife, if not as simple and convenient. But, if you don’t actually put them to use, like any unused tool, they’ll lose their edge and ultimately be of no value to you at all.