Attorneys in Texas frequently utilize corporate entities as part of their client’s estate plan. Corporate entities have a number of advantages, including:
- IRS Discounts – The IRS “discounts” the value of assets when placed into certain corporate entities. They do so because the assets within these entities have restrictions on how they are used, which in turn reduces the value of these assets. As a result, these assets will be taxed less than if they were not owned within the corporate entity.
- Asset Protection – creditors of an individual who places assets into certain corporate entities cannot access those assets to satisfy a debt or judgment against that individual. Similarly, creditors of corporate entities cannot usually access the personal assets of the owners of that entity.
- Control – corporate entities allow individuals to gift assets to children or other family members while maintaining control over those assets to ensure that they are managed properly.
Two of the most commonly used corporate entities are the family limited partnership (FLP) and the limited liability company (LLC). FLP’s and LLC’s have a number of similarities. First, they both enjoy “pass-through” taxation, thus avoiding the “double taxation” problem associated with corporations. Both qualify for the annual gift tax exclusion and lifetime gift tax exemption. And both allow individuals to transfer ownership shares while retaining control of the way the entity is run. However, there are also a few important differences between an FLP and an LLC:
- Discounting – FLPs are generally better for discounting purposes. The IRS discounts the shares of limited partners because they don’t have any operational control of the business. To illustrate, consider an FLP worth $1 million. Would you pay market value ($100,000) for a 10% share of this FLP? Keep in mind that you’ll have no control as to how the business is run or when distributions are made. Therefore, you’d probably demand some sort of discount to compensate for this lack of control – say 25% off of the asking price of $100,000. This is exactly what the IRS does when computing the value of gifts of FLP shares. Rather than giving $1 million to a child outright, it may be better to give it to them in the form of FLP shares because the value of the gift will be discounted. The FLP therefore enables you to make larger tax-exempt gifts than you would otherwise. Depending on your state, it can be considerably more difficult to claim a discount with an LLC. The LLC’s must be carefully structured and managed for any discount valuation to apply. For this reason, an FLC is usually the better choice for discounting purposes.
- Protection against liability – while LLCs protect all members against liability, FLPs only protect limited partners. General partners can be held fully liable for the actions of the FLP.
- Management participation – limited partners in an FLP cannot actively participate in the management of the business. To do so risks losing their liability protection as limited partners. All members of an LLC, on the other hand, can fully participate in management without losing their protection against liability.
- Tax deductions – FLP limited partners, as passive investors, typically can’t deduct partnership losses for tax purposes. In contrast, LLCs usually allow all members to deduct their share of losses.
Attorneys will sometimes combine these entities to further insulate estate assets from creditors.
The laws governing corporate entities as they relate to estate planning are complicated and change frequently.Contact an attorney today for a free consultation regarding your estate plan.