Good News for Family LLCs

Gift Tax

As a proponent of Family Limited Liability Companies (LLCs) for asset management, creditor protection, and ease of gifting, I was pleased to read about the U.S. Tax Court’s decision in Mirowski v. Commissioner, T.C. Memo 2008-74.  March 26, 2008.

Mrs. Mirowski, widow of the inventor of the heart defibrillator implant, created a trust for each of her three daughters in 1992, which were funded with portions of her interests in the patent licenses.  Then, in 2001, she formed a single member LLC, transferring substantial assets to it.  Shortly thereafter, Mrs. Mirowski gifted a 16% interest in the LLC to each of the trusts.  A mere four days later, she died unexpectedly.
The IRS argued under Section 2036(a) of the Internal Revenue Code that Mrs. Mirowski retained the right to income or enjoyment of the gifted property, so that it was included in her taxable estate.  The estate maintained that the Section 2038 “bona fide sale” exception applied, so that the transferred assets were not subject to estate tax.
The Tax Court agreed, holding that the LLC’s activities do not have to be equivalent to those of a “business” for the bona fide sale exception to be applicable.  The Court stated that Mrs. Mirowski had “legitimate and significant  non-tax reasons” for establishing and funding the LLC, including 1) joint management of family assets, 2) combining family assets to maximize investment opportunities, and 3) enabling equal transfers to her daughters.
Some key points for Family LLCs to hold up for gift and estate tax purposes:
  • Strictly follow the terms of the Operating Agreement
  • State the reasons for the LLC in the Operating Agreement
  • Have the Agreement reviewed by separate counsel for all initial members
  • Leave enough assets outside the LLC to live on and pay taxes
  • Don’t mingle LLC assets with personal assets
  • File the proper tax returns each year
  • File the necessary documents with the Secretary of State each year
  • Don’t put your personal residence in a Family LLC
  • Make sure the senior generation does not have the power to allocate profits and losses
  • Require annual distributions
  • Have the junior family members (or their trusts) make initial contributions to the LLC to provide for the pooling of assets
  • Don’t wait until the senior family member is near death
 The bottom line is that Family LLCs remain a viable and attractive option for transfers of family wealth, while also providing asset protection and management advantages.  Just make sure you use an attorney experienced in forming Family LLCs to assist you, and carefully follow all of his or her instructions.
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