A family-owned limited liability company saved a family $14 million in taxes, in the latest ruling from the U.S Tax Court on this technique.
With a family LLC, parents create a company and fund it with valuable assets. Then they give their children ownership interests in the LLC. Giving these interests triggers less gift tax than giving the underlying assets, because they are “worth” less on the open market. That’s because outside investors would be reluctant to buy a share of a family business that they couldn’t control.
The basic concept is the same for both a family LLC and a family limited partnership, or FLP. The technique works, but only if there’s a genuine business purpose behind the LLC or FLP and it doesn’t exist simply to reduce taxes. Also, the LLC or the FLP has to operate as a “real” business. If the parents continue to control all the assets and treat them like they still own them personally, the IRS will be able to claim that the arrangement is a sham.
The recent case involved the widow of the inventor of the heart defibrillator implant. At age 80, she created an LLC and transferred significant assets into it. Some assets were also contributed by three trusts that had previously been established to benefit her three daughters.
Four days before she died unexpectedly, the widow gave a 16 percent interest in the LLC to each of the three daughters’ trusts.
The IRS claimed this was a sham transaction that was simply intended to avoid taxes. But the Tax Court said they were legitimate purposes behind the LLC, including the ability to jointly manage the family’s assets and the desire to pool assets to maximize investment opportunities.
In this case, it helped that the daughters’ trusts had contributed assets initially, because it showed a genuine “pooling” of assets. It also helped that the widow had a long and documented history of urging the daughters to work together to manage investments.
Family LLCs and FLPs can be a great idea, and in the right case they can save a fortune in taxes. But they’re tricky and they require a commitment to keeping up all the formalities of a business.