Limited Liability Company – Questions and Answers Tax Planning

Question 1: If I transfer an asset into a single-member LLC, will I have to pay any tax?

Answer: No. The transfer is to yourself for income tax purposes, thus there is no capital gains on the transfer.

Question 2: If I give membership interests to my children, will I have to pay gift tax?

Answer: Whether or not you pay gift tax and how much you might pay depends on the value of the membership interests you transfer. The IRS taxes the transfer of property by gift, whether direct or indirect. Any transaction in which a property interest is gratuitously passed or conferred upon another, regardless of the means or device employed, constitutes a gift subject to tax. You are permitted to transfer up to $12,000.00 per year per person. On top of this, you have a $1,000,000.00 lifetime exemption that you may use by filing a Form 709 gift-tax return. The fair market value of the membership interest transferred may be less than the fair market value of the same percentage of property ownership outside the LLC. With the LLC you may leverage your gift-tax exemptions. This may also work in situations where you expect the underlying asset to appreciate considerably over time.

Question 3: If I transfer an asset to an LLC and then transfer membership interests to my children, what percentage of the value of the property will be included in my taxable estate?

Answer: The answer depends on whether or not you relinquished sufficient control over the asset to remove the value of the asset from your estate. The IRS imposes a federal tax on the taxable estate of every decedent who is a citizen or resident of the United States. A “taxable estate” is defined as the value of the gross estate less applicable deductions. The value of the “gross estate” includes the value of all property to the extent of the interest therein of the decedent at the time of his death. In addition, any property that the decedent transferred during his life is returned to the gross estate if the decedent retained the enjoyment, possession or right to income during his lifetime. For example, if you transfer a membership interest in an LLC to your child for free, but retain the right to 100% of the LLC income, i.e. ignore your child’s right to his pro rata share of income, the full value of the property will be included in your estate. You should respect the terms of the operating agreement and not try to avoid the economic substance of the transaction through some express or implied agreement to the contrary.

Question 4: Upon what will the IRS base its decision whether or not to bring the asset back into my estate?

The IRS will first look at the documents to see if they meet the requirements of the Tax Code. If so, then they will try to discover evidence to prove that you did not act according to the legal terms of the operating agreement. There are several tax doctrines that the IRS may rely on: (1) step transaction; (2) substance over form; (3) business purpose (more than just tax avoidance); (4) sham transaction; and (5) economic substance. It is always a good idea to have a purpose for the LLC other than just tax reduction or avoidance. These purposes may include asset-protection, ease of management, access to markets, etc.

Question 5: How is an LLC taxed?

Answer: A multi-member LLC is taxed as a partnership and a single-member LLC is taxed as an individual, i.e. all items of income and loss are reported by the members. The LLC is a flow-entity. Each member is responsible for his pro rata share of income taxes. Each member must report his share of company profits, whether distributed or not, on his individual return. Generally, the character of items for tax purposes is determined at the company level and they retain that character in when they flow through to the member.

If capital is not an income-producing factor, the transfer of a membership interest to a family member may be disregarded as an ineffective assignment of income. Where an interest is acquired by gift (an interest purchased by one family member from another is considered to have been acquired by gift), allocation of income among the partners according to the partnership agreement will not control to the extent that: (1) it does not allow a reasonable salary for the donor of the interest; or (2) the income attributable to the capital share of the person receiving the interest is proportionately greater than the income attributable to the donor's capital share. The transfer must be complete and the family member receiving the interest must have control over the membership interest consistent with the status of member. If he is not old enough to serve in the capacity of member, his interest must be controlled by a fiduciary for his benefit.

Question 6: I don’t want to give up the use, enjoyment, control of and income from my property. Can I still use an LLC?

Answer: You can still use the LLC, and it still may offer significant asset-protection and other economic benefits, but it will not be an effective tool to reduce estate taxes. It all depends on what you want to and need to accomplish. Rejecting an LLC on the grounds that it does not reduce taxes even if it can benefit you and your family in some other way, is short sighted.

Question 7: Does the jurisdiction of where I form my LLC affect my tax liability?

Answer: The state of formation may impose certain taxes and fees, so you should consult an accountant in that jurisdiction. The federal rules govern throughout the United States, so they will not change regardless of where you form the company.

Question 8: Does forming an LLC in a foreign country offer any tax benefit?

Answer: Generally speaking, no. There is no additional tax benefit to forming an LLC in a foreign country. A multi-member LLC will be taxed as either a foreign corporation or a partnership, and a single-member LLC will be disregarded. The foreign LLC may, however, provide additional asset-protection benefits. The filing requirements are comparable to those required of grantors of international trusts. Citizens of the United States are taxed on income derived from all sources, both domestic and international. There may be tax benefits for entities conducting business internationally.

Question 9: I’ve heard of cases where a United States citizen can enjoy tax-free income by opening a foreign corporation or LLC and “hiding” the income. What do you think?

Answer: It’s illegal to “hide” income. Consider legal ways to avoid taxes and keep you out of jail.

Circular 230 disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax information contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. The information contained in this communication is not legal advice and shall not be considered as such. It is for information purposes only. The use of Limited Liability Companies is case specific. Whether or not this technique is appropriate for any individual depends on a complete analysis of the individual’s assets and liabilities and personal circumstances. Consult knowledgeable professionals before using a limited liability company.

Prepared By Michael B Mangini, J.D.

35 Court Street
Freehold, New Jersey 07728

Tel: (732) 409-3209

www.newjerseyestatelaw.com

www.njapts.net

michael@njapts.net                                           ã 2007 Michael B. Mangini – All Rights Reserved

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© 2007 Michael B. Mangini – All Rights Reserved