To understand the tax consequences of using an LLC in Wyoming , it is important to define “fair market value” and its relationship to the LLC. Fair Market Value “FMV” is defined in Treas. Reg. 20.2036-1(b) as:
What a willing buyer would pay a willing seller, when neither is compelled to act and both understand all of the relevant facts.
The LLC agreement itself limits the economic value of an LLC unit by restricting the rights of members. For example, the agreement may state that a Member has no right to demand a distribution, order dissolution of the LLC, participate in the management of the LLC, withdraw from the LLC, or sell his or her LLC units to anyone without a 100% vote of all members. Thus the Member’s interest is not as valuable as the representative share of underlying assets since he or she lacks the rights of a full owner.
Full value is represented by the actual asset, or fraction thereof, that the member would own if there were no LLC. Since this is not what the member has, LLC units are “discounted” to a more reasonable fair market value at death to reflect this marketplace reality, i.e. that they are not “worth” full value on an ongoing basis. An informed buyer would not ordinarily be willing to pay as much for LLC units as for a comparable asset without restrictions on enjoyment of benefits.
When LLC units are given as gifts, they are valued for gift tax purposes at their fair market value. If the fair market value of the LLC units has been determined by a competent appraiser to be less than the fair market value of the underlying assets due to LLC agreement restrictions, the donor of the gift may actually transfer more value using LLC units. For example, if the LLC units are discounted by 1/3, a gift of $10,000 of LLC units is equivalent to the gift of $15,000 in underlying assets. ($15,000 x 2/3 = $10,000)
The LLC is a business entity that can carry on any permitted business activity. This makes it a flexible tool for planning. A Wyoming LLC structure can facilitate wealth planning in several ways.
Many American families keep their financial affairs totally secret, yet expect other family members to manage for them should they become disabled or die. This is especially problematic given the great number of businesses that are family owned, of which 40% are in transition at any time with little or no planning. Also, one of the common issues in American families is the fear that as children mature they will drift away or move away from the family. Senior family members are rightfully concerned about the availability of credit and the temptation to create a lifestyle using it. LLCs are investment tools.
A powerful nontax reason for creating a family business enterprise is that it can be used to train and prepare family members for success in their investment lives. Many of our clients use an LLC as a “kitchen table” mechanism to retain control while providing a forum for family financial and investment planning. This “glue” can help keep the family together. Information critical to the well-being of family members can be shared. Using a business structure in the form of an LLC as a means of creating effective communication and financial goal setting for the family is one of the primary benefits of this form of planning.
Gifting fractional interests in certain investment assets can be difficult and problematic. For example, a farm, real estate, or business is hard to split into fractional interests. To complicate matters, some asset values change on a daily basis. The LLC allows for gifts of fractional interests of the LLC itself, since LLC units are similar to shares of stock. The LLC owns the underlying asset while members own LLC units or a percentage of the entity. A person assigns a share or part of a share in order to transfer units.
The law allows annual gifts, within limits, to be made without paying gift taxes. The limit on such gifts is $13,000 per gift recipient per year as of 2007. (Check with your attorney or tax accountant as this exclusion may change in future years.) If one spouse makes a gift and the other spouse joins in the gift, the annual gift tax exclusion increases to $26,000 per year per gift recipient. Thus, a couple with four children may give away up to $104,000 per year in cash or in kind without using any portion of their lifetime exemption from estate and gift taxes.
Valuation discounts generally apply to fractional interests in any business, including a family business, and whether active or passive. For example, if a valuation discount of 50% applies to LLC units, then a single person making gifts of LLC units could effectively remove $26,000 in comparable asset value from his or her taxable estate each year per gift recipient. With that type of discount, a couple with four children could conceivably gift the equivalent of $208,000 each year in relate underlying assets, by gifting $104,000 of LLC units.
The valuation adjustments discussed above may also apply to the remaining LLC units of any deceased member. % of ownership x FMV x (1 - discount) = Estate Tax Value
Outright gifts of cash or other property can be problematic. The assets or cash gifted may be wasted, lost to creditors, or lost in divorces. It is difficult to give a fractional interest in property other than cash. Accordingly, ownership of LLC units with transfer restrictions can protect the integrity of the LLC structure and its underlying assets from being lost or wasted by the gift recipients. LLC units cannot be spent, wasted, or obtained by creditors. Restrictions in the LLC agreement can prevent the transfer of LLC units to those outside the LLC without the agreement of all members.
General Members are entitled to income in the form of management fees as compensation for managing the LLC. LLCs can be structured with a “preferred equity interest” that pays a set percentage of income to holders of that interest. These potential income sources can provide security to certain members even though they may have given away a substantial percentage of LLC units.
Clients may serve as managing members or simply as managers of the LLC. Sometimes an entity manager is advisable for continuity of management, since entities do not become disabled or die. A management trust, LLC, or corporation could be considered, and even a third-party manager under contract. Should a manager-based LLC be created, the control of a manager could include full control over investment decisions, including decisions about how much LLC income to distribute or to reinvest inside the LLC entity, or far less than that degree of control. Generally, however, a manager answers to the members. Note, however, that a member-manager must act in a fiduciary capacity in exercising management authority.
An LLC with two or more members by default is taxable as a partnership, i.e. a flow- through entity for income tax purposes. This means that members receive their portion of income tax attributes of the LLC. The LLC will file an IRS form 1065 income tax return but does not pay income taxes. However it may also elect taxation as a C or S corporation. Similarly, a sole member LLC may be taxable as a disregarded entity or as a C or S corporation but not as a partnership.
Transfers of property to an LLC are normally not taxable events. Typically the transfer of property into an LLC by an individual is a capital contribution, and the person making the transfer of assets into it receives LLC units (a percentage of ownership) in exchange for the contribution. Finally, upon dissolution of an LLC, the distribution of assets to members would in most cases not trigger an income taxable event since it would usually be a return of capital. There are some exceptions to these general rules on dissolution of the LLC and those exceptions are largely dependent on entity tax status, so the situation should be reviewed at that time. Even if there is no tax on dissolution, there could be capital gains tax consequences when distributed assets are later sold.
The use of the LLC may result in income tax savings through the use of income shifting to members in lower income tax brackets.
In some jurisdictions there are franchise tax savings associated with LLCs that are not available to other business entities. However, in some jurisdictions, LLCs are taxed more heavily than other forms of business ownership. State income tax and franchise tax laws must always be considered. Learn more about Wyoming LLCs here.