A limited liability company (LLC) is a newer business structure that is neither a corporation nor a partnership, but a hybrid of the two. It is treated as a corporation for liability purposes and often as a partnership for federal income tax purposes. If you want pass-through taxa­tion, limited liability exposure and freedom from certain subchapter S restrictions, an LLC may be right for you.

Why Consider an LLC?

LLCs offer several advantages over other business structures. Let’s take a look at a few:

        C corporations. Both have limited
liability protection, but LLCs offer pass-through taxation.

        S corporations. Both have limited
liability and pass-through taxation, but LLCs offer greater structuring flexibility in ownership criteria. LLCs are not restricted to a specific number of owners (unlike
the 75 maximum for S corps) or types of owners (which can be nonresidents,
cor­porations, pensions, partnerships
and trusts). LLCs can own stock in affiliated corporations.

        General partnerships. Both have pass-through taxation, but LLCs offer limited liability to their owners.

        Limited partnerships. Both have pass-through taxation, but the general partner of a limited partnership does not have limited liability exposure. Also, LLC members do not lose their limited liability protection through management participation. How­ever, a limited partner who participates in the day-to-day management of a partner­ship may be deemed a general partner.
An LLC member is free to meet the material partici­pation tests of the passive loss rules.

        Sole proprietorships. LLCs offer
lim­ited liability, but sole proprietorships do not.

LLCs and Estate Planning Objectives

Estate planning considerations often influence, if not motivate, the decision to use a corpora­tion or a partnership structure. These consid­erations also apply to LLCs. Let’s see how:

Facilitating the use of trusts. You can use trusts as an ownership vehicle for an LLC in the same manner as for a partnership or C corporation. Unlike an S corporation situa­tion, trust-type owners are not limited to grantor trusts, qualified subchapter S trusts (QSSTs), or electing small business trusts (ESBTs), and the two-year or 60-day transfer rule on termination of a trust interest does
not apply. Accordingly, your ability to control an interest, to regulate income distributions and to pass interests to other family members is enhanced.

Facilitating family investments. LLCs can be formed among family members and trusts for family members, as is the case with general and limited partnerships. Also, inter­ests in LLCs can be gifted and bequeathed. The same family partnership rules apply as
to income allocation, especially when the LLC is involved in a service or capital intensive business.

Facilitating planning for income allo­cation. It is possible to structure LLCs with special classes of ownership or membership. There can be subordinated, preferred, deferred or shifting interests, although the tax conse­quences of different types of interest must be considered. Un­like most corporate structures, the flexibility of an LLC allows an estate plan to be struc­tured to provide for a preferred cash flow or a shifting of income or apprecia­tion. In all in­stances, it is necessary to con­sider the tax rules relating to estate freezes so that you don’t face any gift tax surprises.

Valuation discounts. Interests in LLCs can be subject to the same types of discounts as partnership interests and shares in closely held businesses. When family members do not control the LLC, very significant dis­counts may be available for minority interests and lack of marketability. However, when family control exists, restrictions contained in the governing agreement on the ability of an owner or member to cause a liquidation of the LLC generally are ignored if they are more restrictive than the limitations under state law that would otherwise apply. This rule is no different for a limited or general partnership or corporation, but is mentioned here primarily because many state statutes are new and the provisions not uniform.

Drafting considerations. If you are con­templating using an LLC, it may be time to review your wills and living trusts to ensure that trustees have the clear authority to invest in, retain and otherwise deal with LLCs. Also, the principal and income allocation acts of many states have not yet caught up with in­come and principal distributions from partner­ships, let alone LLCs, so your trustee needs clear guidance.

Should an LLC
Be Part of Your Estate Plan?