Dear Michael: We have a very complex life since the oil industry started. We had a fairly good sized ranch before the oil. This ranch alone, with the growth in per acre value over the past ten years, is probably close to ten million. Then we started getting minerals off of the land we owned and we don't know for certain what they are worth although the income has been good. Last, but not least, we helped our son start a welding business. He didn't have much money, so we started an LLP – under the guidance of our attorney – and gave him twenty percent of the business. We started the LLC as a shelter for liability to our other assets, but now another advisor is telling us to use this LLC and another LLC to own our minerals and perhaps part of our ranch. Are we doing the right thing by jumping into all of these different entities to protect estate taxes? Is the LLC the 'magic fairy dust' we've been looking for? – Do You Believe in Miracles?
Dear Miracles – Unfortunately, miracles only happen on ice and we have to go back to Al Michaels call back in 1980 on the Olympics to even hear that again!
One, of course, is the limitation of liability to the assets held within the company itself. In other words, in your welding business, if you cause an accident in the course of your business and get sued, the other party can only receive assets owned by this LLC. This is a good argument for using LLC's for high risk businesses – such as one with trucks out on the road.
Now, using LLC's or LLP's to reduce estate taxes is a wholly different issue from limiting liability exposures.
In the old days (ten years ago) if I fractured ownership in my assets by gifting shares to my children, I could discount those gifts by as much as forty percent. I could also claim the remainder value of my assets – in my estate – should be discounted by this amount, due to loss of market value.
IRS, after seeing LLP's and LLC's for so many years, has now devised formulas you need to use to claim these. There are still a few firms out there claiming to get 30% or 40% discounts – in order to drum up clients – but if you call a reputable CPA firm – like Eide-Bailey – they would shy away from these promises.
In the meantime, if I was, say, working with someone who promised me huge deductions in my estate and I spent a lot of time and money gifting to my children (not knowing IRS as much as ten years to disallow these gifts and/or their discount) I might be blissfully ignorant of the storm heading my way.
In addition, you've also just given away chunks of your business, your ranch, and/or your minerals and haven't really put into terms what that means. Right now, all your focused on is how much you kept from going to IRS.
You see, along with 'gifting' of LLC shares or LLP percentages, you also gave away your right to receive all of the income from these entities. In either an LLC or LLP, the 'profit' of the business will be split between all of the owner entities – voting and non-voting alike. You may have just given away all of your income and/or control to avoid estate taxes. You may have handed it to your kids – who may not be ready to handle this type of 'free' money.
I've always wondered why a person would give up control and/or fifty to seventy percent of their income – especially income that could drop dramatically in a few years when rags to riches turns into rags again – when they could have set up a simple trust to pay estate taxes – using life insurance – and paying five to ten cents on the dollar in most cases. Some companies even have 'return of premium' – if you don't need the coverage anymore – and you get your money back.
But some people are so anti-life insurance, they'd rather give up three hundred thousand dollars in income to avoid five hundred thousand dollars in estate taxes – and all they had to do was gift fifteen thousand dollars a year to an irrevocable life insurance trust. They can maintain control and spend the other two hundred and eighty-five thousand. Talk about cutting of your nose to spite your face.
There will always be those people out there looking for the next 'fairy dust' to not pay estate or income taxes, and there are plenty of people out there selling 'fairy dust' – but long-term the costs of setting these plans up is going to cost them so much, much more than if they'd done just a simple annual gift and let the insurance company pay the tax liability. It's the same when you pay your car insurance, your home insurance, your farm liability insurance – you pass liability on to an insurance company.