June 18, 2014

Entity Choice as a Wealth Transfer Method


By Douglas Cushing

October 2010

There are many forms of asset transfers used for intergenerational shifts of ownership and wealth, from trusts to shared ownership options. These can be used too for pure ownership transfers to nonfamily members in succession planning. Use of a simple entity is also a good choice. Using a limited liability company (LLC) or limited partnership entities, together with judicious gifting techniques (see our "Succession Planning: Now Is the Time for Gifts — Done Right" June 2010 article) can make this choice very effective.

The partnership form to employ is a limited partnership so that only a general partner (often itself an entity, such as a corporation or an LLC) has broad liability for the entity debts. The limited partners have no exposure beyond their investment, unlike the general partner, which may be liable for all the obligations of the business or the investment. In a classic general partnership, all partners are responsible for all entity debts.

The rights of a limited partner to control operational decisions or income distributions are typically limited by the terms of the partnership agreement. The key assets, whether an operating business or passive investment property, must be managed by a general partner who is responsible for maintaining a profitable operation or ensuring that an asset base retains or increases in value. Identifying who may replace that general partner in the future is very important, but that must always be done on its own considerations.

Transferring limited partnership interests, which are typically discounted, and including children and grandchildren as liberally as possible may facilitate a significant shift of value. Gift-splitting between a husband and wife if only one spouse owns the asset maximizes the transfer options. If an owner is comfortable with the children's spouses, since the ability to multiply annual exclusions, the transferability of value can be increased. Many family settings simply do not support such sharing for a host of reasons.

Using the LLC model provides many of the same benefits as a limited partnership in terms of discounts for minority ownership and lack of marketability. The LLC also affords the same limitation of individual liability risk for the owners. In addition, it has another built-in advantage — which can be forged in a partnership with very careful drafting — that of setting up the "manager managed" form of operation. This facilitates continuation of a business or retention of an asset in which no family member really fits the position of the operator. By having a nonowner manager who controls the day-to-day operations but holds only a negligible ownership position, family ownership can be retained. The typical LLC operating agreement will control the provisions regarding buyout of a member's interest, whether one wishes to sell or suffers a disability or death, and can control in the event of marital dissolution or an involuntary individual bankruptcy. LLCs are new enough that in most states, including Oregon and Washington, very few disputes have risen to the level of appellate court decisions interpreting operating agreements. But the flexibility LLCs provide on many levels makes them very efficient as a means of shifting ownership and wealth, and what is most important in many cases, as a means of shifting future appreciation to successive generations. Transfers made during 2010 have particular value inasmuch as no generation-skipping transfer tax is imposed during this year under the current state of the federal estate and gift tax statutes.

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