Anderson Banta Clarkson, PLLC: What You Should Know About Family Limited Liability Companies

Law Offices of Stephen F. Banta, P.L.L.C.
What You Should Know About Family Limited Liability Companies
by Tom Bouman

1.        What is a Family Limited Liability Company?
The family limited liability company (“family LLC”) is a form of business or investment entity ownership, which seeks to provide its owners with enhanced protection from creditors and, in some cases, substantial estate and gift tax savings. Its characteristics usually include multiple owners who are related to each other (“family LLC”) and a restrictive operating agreement.

This planning technique is traditionally referred to as a family limited partnership, although the limited liability company (“LLC”) has become the favored entity in Arizona.

The general intent behind the LLC is to encourage business development and investment by offering enhanced creditor protection to its members. However, an active business is not required; rather any person may transfer personal assets to a LLC and may qualify to receive the same benefits as a business owner.

A family LLC may own almost anything. The most common assets held by a family LLC are investments such as business property, brokerage accounts and rental properties.

2.         How does a Family Limited Liability Company work?

The owners of the family LLC are referred to as members. Members are entitled to their respective share of distributions, but they have no control over company operations. The original owner can maintain day-to-day management control over the assets, if desired; sometimes through a separate management entity. Thus, a parent can maintain control over the entity, even if children own most or all of the membership interests.

In general, the initial member will be the original owner’s living trust. Then in future years, the original owner will gift or sell membership interests to children or to trusts for their benefit.

A family LLC is governed by a restrictive operating agreement that defines the terms upon which the company will do business. For example, the agreement should carefully restrict the rights of a member to withdraw or dissolve the company. It should similarly restrict the rights of a creditor seeking to enforce a judgment against a member. As a general rule, a more restrictive operating agreement provides more protection from creditors and higher discounts for tax purposes.

3.         How does a Family LLC protect assets from seizure by a creditor?

A family LLC offers the same benefits as any LLC. For example, the members can isolate company liability from personal liability. But when structured properly, a family LLC will provide enhanced protection from seizure of assets by a creditor. First, the family LLC should be registered in a state with protective laws. The most protective state laws (including Arizona) provide that a charging order is the only remedy a court can use to seize assets from a LLC. This means that any distributions otherwise payable to the debtor/member must instead be paid to the creditor, but a judge cannot order a distribution of assets. Second, the family LLC should have more than one member, if possible, because a multi-member LLC provides stronger asset protection than a single member LLC. Therefore, gifts from the original owner to other family members may be appropriate. Third, the family LLC should be governed by a comprehensive operating agreement that carefully limits the rights of members and creditors regarding withdrawal, distributions, dissolution, and management of the company.

4.         What are the tax consequences of establishing a Family LLC?

A family LLC may qualify for substantial discounts for estate and gift tax purposes. The term “discount” means that a membership interest will be valued less for tax purposes than the actual value of the underlying assets. A qualified appraisal is needed to substantiate the discount, which is usually for lack of control and lack of marketability. The size of the discount depends on many factors, but may range as high as about 50%.

A family LLC is usually treated as a partnership with flow-through taxation, so income and losses inside the entity are passed through pro rata to the members.

The contribution of business or investment assets to the family LLC is not a taxable event.

5.         How much does a Family LLC cost?

Establishing a family LLC or family limited partnership (either is commonly referred to as an FLP) requires a substantial amount of legal and tax counsel. The process is much more complicated than establishing a single member LLC to isolate business and personal liability (aka “naked LLC”) and nothing more. The lawyer who prepares the operating agreement must be familiar with the latest case laws affecting family business entities. The legal fee may be $5,000 to $10,000 or more. Ongoing expenses include annual meetings and accounting costs. Generally, a family LLC is not appropriate unless funded with at least $300,000.

About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.