Structure of Family LLCs
Transferring assets such as patents, museum quality art or large parcels of land owned by an individual family member into a family LLC often shields those assets from federal estate taxes. The Internal Revenue Service recognizes the legitimacy of such transfers made to allow joint management of assets, combine assets to maximize investment potency or facilitate transfers of assets to heirs. Additionally, LLCs shield their members against personal liability for company transactions. The IRS does not recognize LLCs as separate business structures; family LLCs are either partnerships or corporations. LLCs that are not incorporated have members rather than stockholders. Family LLCs that are incorporated may form a conventional C corporation or an S corporation -- the latter is a business structure for a small corporation that allows the LLC to avoid corporate income tax, while providing shareholders exemption from self-employment tax.
Articles of Organization Versus Operating Agreements
Operating agreements differ from articles of organization, which are documents filed by the family LLC with the state where the LLC is established. Articles of organization are public documents and include such information as the name of the LLC, the name of the person registering the LLC, how long the LLC is intended to be in operation and the names of any agents acting on the LLC's behalf. Operating agreements are shared only with members of the family LLC and form the contract for its operation. The operating agreement also addressed such factors as what percentage of LLC assets each family member owns, how voting is handled for resolving LLC issues, changes of membership within the LLC and transferring LLC assets.
Management of Family LLCs
Operating agreements for family LLCs formed to avoid estate taxes often set a term of existence of 100 years or more to make it easier for an estate to remain intact, as opposed to at-will LLCs that exist until family members vote to dissolve them. Many family LLCs are managed by a single member, often an elder member of the family. In such cases, the operating agreement for the LLC often includes provisions for replacing the manager when the need arises. An important aspect of the operating agreement of a family LLC is that it determines how many members are necessary to form a quorum, that is, sufficient representation of the entire LLC membership to allow a valid vote to take place. Without such provisions, family disputes can bring the operation of the LLC to a halt.
Properly drafted and executed operating agreements are essential in protecting the assets of a family LLC from federal estate taxes. In Hackl v. Commissioner, a 2002 case, the U.S. Tax Court found that a family LLC had failed to demonstrate that its assets should be exempt from estate taxes. The operating agreement for the LLC included no provisions for replacing the LLC's manager, a family member appointed for life who had nearly unlimited latitude in deciding how to distribute the LLC's assets. By contrast, in Mirowski v. Commissioner, a 2008 case, the U.S. Tax Court found that the widow of the heart defibrillator implant's inventor had demonstrated "legitimate and significant non-tax reasons" for establishing a single-member LLC. In that case, assets transferred from the LLC into trusts established for her three daughters were allowed to remain exempt from federal estate tax liability.