The story of the prodigal son alerts us to the risks involved in completely turning assets over to our children without some restraints on their control of the property, lest they waste their substance on riotous living.
Taxpayers are often encouraged to do this by consolidating assets under the umbrella of a Family Limited Liability Company (Family LLC). The entity is structured with two classes of ownership interest, one voting (usually 1-2% of the total interest) and the remainder non-voting, initially both classes owned by one or both of the parents.
The folks can then give away portions of the non-voting interest to the kids (protected from gift tax either through use of annual exclusions or the parents’ lifetime exemptions) allowing growth on the value of the transferred interests to occur outside their taxable estate all while maintaining complete say-so in how the company (i.e. its assets) is/are handled by virtue of their retention of all the voting rights. This could also mean that they are reducing their allocation of any year-end earnings (especially if the LLC is taxed as an S-Corp), but this effect can be reduced through a salary paid to the parents for management of the company.
But the two-voting-class LLC can also allow for more effective use of the exclusions and exemptions. A simple calculation suggests that giving 50% of a company with a $1,000,000 fair-market-value to your kids would constitute a $500,000 gift. But, for now at least, a reasonable discount on the valuation of the transfer is allowed due to the transferred interest’s lack of marketability and voting rights. So a successfully argued discount of 25% would result in a reportable gift of only $375,000.
But if those on the House of Ways and Means Committee proposing the Build Back Better Act have their way the discounting bonus available through use of Family LLC could be dramatically reduced. The bill must make its way through the House Rules Committee and then the full House before even considered by the Senate, but in its current form it would disallow any such discount on the transfer of “non-business assets,” defined as passive assets held for the production of income and not used in the active conduct of a trade or business. The most obvious example of non-business assets are marketable securities held in a Family LLC.
The announcement should serve as an urgent planning alert as the proposal, if left unaltered, would apply to transfers after the date of enactment of the BBB Act.
Call our team for assistance with any planning issues.