Lifetime tax planning for LLC owners.

• Author: Ellentuck, Albert B.
• Position: Limited liability company

SEVERAL STEPS CAN BE TAKEN BEFORE A limited liability company (LLC) member's death to reduce estate and income taxes and to plan for an orderly succession. One common technique to remove value from an estate is to transfer assets or an interest in assets by gift during a member's lifetime. A member can make a gift outright or in trust.

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Although lifetime gifts remove assets from a member's estate, there are downsides, including:

1. Gifts during 2012 of present interests in assets that have a value in excess of the gift tax annual exclusion amount ($13,000 per donee) reduce the donor's applicable exclusion amount ($5.12 million in 2012). To qualify for the annual exclusion, the gift must be of a present interest.

2. Lifetime gifts do not generate significant estate planning benefits unless the assets transferred appreciate substantially after the date of the gift.

3. The donee's basis in a gifted asset equals the donor's basis (i.e., no basis step-up).

4. To qualify as a gift, the gift must be complete, which requires the donor to give up complete control of the asset transferred.

5. The donor of an LLC interest may recognize income if the donor's debt relief exceeds his basis in the transferred interest.

6. An agreement by the donee to pay additional estate taxes that may be incurred on gifts made within three years of a decedent's death does not reduce the value of the gift (Estate of Armstrong, 119 T.C. 220 (2002); and Estate of McCord, 120 T.C. 358 (2003), rev'd and remanded, 461 F.3d 614 (5th Cir. 2006)).

These disadvantages affect the decision to gift an interest in an LLC during the member's lifetime. In addition, all of the other members of an LLC generally must approve of a gift of an interest in LLC capital under the provisions of applicable state law. (Members may want to consider including a specific provision in the operating agreement to allow assignments by gift of a percentage of a member's interest to family members without the approval of the other members.) Gifts of assignee (profits-only) interests usually can be made without the consent of other members.

A lifetime gift of a noncontrolling interest in an LLC can be an effective means to transfer ownership at a reduced gift tax cost. If the donor is appointed as a manager for life, control can effectively be retained, while the benefits of ownership can be passed to the younger generation. Gift tax savings are generated by applying valuation discounts to...