By Anthony F. Vitiello and Daniel B. Kessler
In last month’s estate planning article, we discussed the benefits of a “dynasty” trust, which is a trust designed to remain in existence for a child’s lifetime as well as the lifetimes of that child’s descendants. A properly-drafted dynasty trust allows descendants to enjoy their inheritance, while at the same time protecting that inheritance from creditors, divorcing spouses and potential estate taxes in the future. We now discuss one technique used to fund a dynasty trust, being the transfer of interests in a business holding entity such as a limited liability company (an “LLC”).
Families may choose to consolidate active businesses, real estate, cash, stocks, bonds and other investment assets into a business holding entity such as an LLC. By placing businesses and family wealth into an LLC, a family can accomplish many important non-tax, business-driven goals such as the (i) the centralized management of businesses and investment assets, which allows for smooth management transitions between generations; (ii) the pooling of investment assets, which allows for unique investment opportunities; (iii) the avoidance of transfers of underlying business interests or investment assets to non-family members, since the LLC can have significant restrictions on transfer; and (iv) the increased creditor protections provided by law for members of the LLC.
Provided that a family has established a business holding LLC for a non-tax, business-driven reason, an ancillary benefit is that fractional interests in the LLC can be discounted for their “minority interest” status and “lack of marketability” in the open market. Because of these discounts, a member of the business can gift fractional interests to a dynasty trust at discounted rates. This is known as leveraging the gift tax exemption (i.e., transferring assets at reduced gift tax values).
A key feature of using an LLC in gift planning is to obtain an appraisal of the entity by a qualified appraiser. The qualified appraiser will take into account the assets and business purposes of the LLC and will provide the “minority interest” and “lack of marketability” discounts noted above. Depending upon the assets and purposes of the LLC, the appraiser may discount fractional interests as much as 25% – 40%.
By way of illustration, assume an individual places $10,000,000 of real estate and various investment assets into an LLC for the business purposes noted above, and then transfers 25% of the LLC to separate dynasty trusts, one for each of his 4 children and that child’s descendants. The undiscounted value of 25% of the LLC would be equal to $2,500,000, but after a qualified appraiser determines that a 35% discount is appropriate, the individual need only report $1,625,000 as the value of the transfer to each dynasty trust. In effect, the individual transfers $10,000,000 out of his or her estate at a gift tax value of $6,500,000.
Congress has long considered restricting valuation discounts on transfers to family members or trusts established for their benefit. As of the writing of this article, however, no such restrictions have become the law, and the use of LLCs to transfer family wealth at discounted values remains a viable estate planning option.
*Anthony F. Vitiello is Chairman of the Taxation and Estate Planning Group of Connell Foley LLP in Roseland, N.J. and Daniel B. Kessler is an attorney in the group.
