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Multi-Member LLCs: Structure and Issues

By: Ted Sutton

LLC structure with regard to members

Graham has been a prominent real estate investor for over a decade. After coming from humble beginnings, he has built a large portfolio that holds over 100 properties. He decided to teach people how he did it, so he started making YouTube videos. Graham figured this would be a good opportunity for him to both educate a younger audience and generate a second stream of passive income. Over time, Graham began to build a large following. He also met many like-minded YouTubers along the way. He became especially close with Jaspreet, Marko, and Natalie.

Given their popularity, Graham and other three YouTubers decided to make a financial education super-conglomerate. A one-stop shop for financial education organized under one business entity. This fearsome foursome formed an LLC, contributed capital, and received membership interests in return.

This article illustrates how multi-member LLCs are formed, managed, and continued after a member departs. Each will be discussed in detail below, continuing with the example above.

What is a member? 

A member is an individual or an entity that owns an ownership interest in an LLC.

Here, Graham, Jaspreet, Marko, and Natalie are all members. A chart reflects their membership interests:

Multi Member LLC Graphic 1

When Entities Are Members 

LLCs are also allowed to be owned by another legal entity. In many cases, they are owned by another LLC. They can also be owned by a corporation.

The entity’s ownership must be reflected in both the Operating Agreement and the meeting minutes. When one LLC owns another LLC, the Manager from the entity with the authority to sign should sign both the Operating Agreement and minutes.

Marko has a very large stock portfolio. Because he is concerned about personal liability, he set up an LLC to hold his paper assets and another to hold his syndication interests. These two are owned by a passive Wyoming holding LLC. He then decides to have his Wyoming holding LLC own the new Financial Education LLC. This provides an extra layer of protection between Marko personally, and his interest in the financial education LLC. He signs both the Operating Agreement and the meeting minutes as the manager of his LLC. A chart illustrates Marko’s ownership interest below:

Multi Member LLC Graphic 2

If Marko is sued personally (after a car wreck, for example) a victim will have to fight through Wyoming’s very strong protections to try and get at Marko’s paper assets, syndication and financial education interests.

Ownership percentages 

Members can own different ownership percentages in an LLC. Generally, ownership percentages are based off the member’s capital contributions. However, members are also free to allocate the ownership percentages that have an economic basis in any manner that makes economic sense.

Graham has been a successful real estate investor who has a large portfolio. Since his net worth is significantly higher than the remaining members, he agrees to contribute $1 million to the Financial Education, LLC. Because Graham also manages each of his rental properties, he decides to take a more passive role in the LLC. He agrees to own a 10% membership interest. Jaspreet, Marko, and Natalie agree to run the operations and own 30% each. But Graham wants a priority return on his money, since he is putting up the most. It is agreed that he will receive the first $1,500,000 in profits, his money back plus 50%. These interests are reflected below:

Multi Member LLC Graphic 3

The LLC taxed as a partnership allows for priority returns like this. Be sure to work with your CPA on these issues.

Who is the manager? How to decide who will act as the Manager. 

The manager is, quite simply, a person who manages the LLC. LLCs can have more than one manager, and they also provide for two different management structures. 

Member-Managed LLC

The first is member-managed. In a member-managed LLC, the manager can only be one of the members. A member managed board can be all of the members. Management is determined by a vote of the members during a meeting. Members who want to have more control in the LLC may prefer this structure.

If their Operating Agreement specifies that the LLC is member-managed, then only Graham, Jaspreet, Marko, and Natalie are allowed to manage the LLC. 

Manager-Managed LLC

The second option is manager-managed. In a manager-managed LLC, the manager can either be one of the members, or the members can elect to hire an outside manager. This structure is ideal where members prefer a more passive role in the LLC’s affairs. We prefer manager management to better clarify and separate the roles between ownership and management, which can help solidify the corporate veil of protection.

Let’s say the LLC’s Operating Agreement states that the LLC is manager-managed. Kevin is a friend of the group and is also very passionate about financial education. He is known for his hard work and wants to be involved with the LLC. However, none of the other members want Kevin to own a membership interest. This doesn’t bother Kevin one bit. At their next meeting, the four members agree to elect Kevin to manage the LLC’s affairs. Everyone is happy. Kevin gets to do the management work nobody else wanted to do, and the four members get to watch their business grow. A chart illustrates this below:

Multi Member LLC Graphic 4

Member Leaves 

As is true with life, membership interests in LLC constantly change. LLC members can leave for a number of reasons, and there are several different ways they can leave, and how the remaining members can handle the ownership of the departed member’s interests. The most common method is including a right of first refusal provision in the Operating Agreement, described below.

Right of First Refusal

A multi-member LLC may select a right of first refusal provision. This procedure gives the remaining members first priority to buy a departing member’s interest. This helps the remaining members because have a say in who can take the departing member’s place. For this reason, we include such a provision in our Operating Agreement.

Here’s how it works. In the event that a departing member receives an offer to buy their interest from a third party, the departing member must first take that same offer to the remaining LLC members. The remaining LLC members then have the right to buy that interest on the same terms proposed by the third party. If the remaining LLC members refuse that offer, then the third party can buy the departing member’s interest on the same terms.

Let’s assume that the honeymoon period ends and relationships begin to sour. Graham is disappointed with the direction of the LLC and the other members’ philosophies. He certainly regrets contributing additional capital for a smaller ownership percentage since his priority return has not materialized. Graham’s friend, Andrei, learns of his discontent and offers to buy his membership interest. Andrei has always wanted to be involved in a financial education business. He also gets along with the remaining members. Andrei puts in an offer to buy Graham’s 10% membership interest for $750,000.

The Operating Agreement has a right of first refusal provision. Graham then goes to Jaspreet, Marko, and Natalie with Andrei’s offer. If the three members agree to buy the interest, they can pay $250,000 each to own the remaining 10% membership interest. If Jaspreet, Marko, and Natalie decline the offer (the more likely outcome here), then Andrei buys Graham’s 10% interest for $750,000. Andrei then must be voted in by the others to become a full member of the LLC with a 10% ownership interest and the rights to the priority return. A chart illustrates this process below:

Multi Member LLC Graphic 5

A Member Dies 

Another fact of life is that people die. When an LLC member passes away, there are several ways their interests can transfer. Each are described below. These transfers may also apply when a member leaves the LLC.

Jaspreet left the United States to visit family in India. However, his plane had mechanical issues en route and crashed into the ocean. Nobody survived. The remaining members were not only devastated but also unsure what to do with Jaspreet’s membership interest. Fortunately, the Operating Agreement may tell them how to proceed. 

Right of First Refusal 

As discussed, before, the company and the other Members may have the first right in the Operating Agreement to buy the deceased member’s interests. This can be useful if the other members don’t want to have Jaspreet’s heirs inside the business. The Operating Agreement provides a method for valuing Jaspreet’s interest. With Jaspreet’s estate paid off (in some cases overtime pursuant to a promissory note) the business continues with the working members.

Estate Transfers 

If allowed by the Operating Agreement, Jaspreet’s Estate (and/or other beneficiaries) may be allowed to own an interest in Financial Education LLC. The estate can always sell the interest to the other members if needed. Assume that Jaspreet’s wife Alex holds onto the LLC interest, then the chart below illustrates the ownership:

Multi Member LLC Graphic 6

Agreement is Silent 

If the Operating Agreement is silent on a certain event, then state law governs. Some states require that the LLC must be dissolved entirely when a member dies.

Let’s assume that the LLC is formed in a state with such a law, and the Operating Agreement is silent on the event of death. After Jaspreet’s death, the LLC is required to be dissolved. It doesn’t matter that Andrei, Marko, and Natalie are still alive. Their financial education business must end.

To avoid this unfair result, it is important to include Operating Agreement provisions that govern how membership interests transfer upon death or departure.

Conclusion

The above examples demonstrate that the LLC provides flexibility with regards to formation, governance, and membership departure. When forming a multi-member LLC, it is important to have a well-drafted Operating Agreement that spells out what to do when each event happens. Corporate Direct can help with all these issues. Schedule your free 15-minute consultation with an Incorporating Specialist to find out more!

 

 

Design Your Asset Protection Plan

You design a lot of things in your life. The layout of your house, the flow of your business, the requirements on your children, and many more scenarios are all elements of conscious design.

Asset protection is no different. There is an architecture, a cohesive structure, to your properly planned legal safeguards. Sometimes you try and do it yourself, which could be fine. Many people are into DIY. And yet, with all the asset protection misinformation on the internet, you’ve got to be careful. Does that overpriced ‘guru’ really know what they’re doing? You won’t know until the plan they’ve designed holds. Or fails.

Designing your asset protection plan does not improve with setting up more entities than you need. When your plan is solid with three LLCs, who benefits by adding 5 more LLCs to the mix? I know you will answer that question correctly.

Your effective design should never be a matter of confusion to you. If you don’t understand what your asset protection planner is suggesting, demand a clear explanation. If they respond that most attorneys and no clients will ever understand their ‘brilliant’ structure, get up and walk out. That’s not how it works. As well, if you ask to get a second opinion from another lawyer about the plan and they claim that no lawyer will even begin to comprehend what they’ve put together for you, as a special client and part of the elite inner circle, it is also time to leave. You need to clearly understand the plan. And so does your spouse.

Sometimes, like an old bridge, a plan design has fault lines. The structure appears fine, until it collapses under pressure. This can be the case with land trusts. Promoters tout them for their asset protection benefits while they offer no such feature. To cover this inconvenient issue, they suggest that one or more land trusts be beneficially owned by one LLC. The structure appears as follows:

Land Trust Structure

How will this structure hold up?

When a tenant in the duplex is injured on the property, they have the ability to sue the land trust for their damages. Some promoters claim that the tenant will never know the owner of the land trust because such information is confidential. Without exaggeration, this is one of the greatest legal fallacies in history. If the tenant’s attorney can’t locate the land trust owner all they have to do is publish notice of the lawsuit in the paper. It is very easy to do. And if the owner doesn’t respond to the lawsuit the tenant can win by default. You’ve lost the case and they are foreclosing on the property. “Well,” says the land trust promoter as they close shop and move 1,000 miles away, “I guess that didn’t work.”

Contrary to what these promoters may suggest, you don’t want to hide. You actually want to be found if needed, so that you can receive the notice of a lawsuit. You want to promptly turn the claim over to your insurance company so they can defend you and hopefully settle the case. If you hand them the claim after a default is entered in virtually all cases they don’t have to cover you. You didn’t give them proper notice of the lawsuit. Your design flaw is not their problem.

There is another design flaw in the structure above. Let’s say the promoter acknowledges that an LLC needs to be in the mix for its benefits of limiting liability. So, the beneficial owner (a required feature of land trusts and akin to a shareholder in a corporation or a member in an LLC) is listed as XYZ, LLC. When Land Trust #1 is sued by the tenant the liability flows to the beneficial owner, or XYZ, LLC.

Now if XYZ, LLC were on title to the property instead of the land trust, the liability would be contained within that one LLC. But in our design flawed structure, the liability flows from the land trust into the LLC. What does the LLC own? Not only Land Trust #1 but also Land Trust #2 and Land Trust #3. So the tenant can also get what the LLC owns, which is equity in all three land trusts. “Well,” says the land trust  promoter as they prepare to move to Alaska, “that didn’t work either.”

As is clear, the design of your asset protection plan really does matter. When building it listen to your little voice, the one that is always there and always protective. If the proposed plan doesn’t make sense, if it doesn’t add up, think again. Get another opinion. Your asset protection is too important to be left to unquestioned amateurs.

Corporate Direct, on the other hand, does not advise using land trusts or any overly complicated structures. We have been in the business of asset protection for over 30 years and we can help you structure your entities correctly and in a straight forward and affordable manner. Get your free 15-minute consultation to get started today!

Employer Identification Number (EIN)

EIN stands for Employer Identification Number. The IRS requires that you have such a number when you incorporate or form an LLC. Think of an EIN as a Social Security number for your business. You will file all your tax returns using this number and you will need this number to open a bank account for the business.

Once you’ve filed your incorporation papers and they’ve been approved by the Secretary of State, your corporation needs to file for an Employer Identification Number, or EIN. An EIN is a permanent number assigned to your business, which is used for official corporate business such as opening bank accounts and paying taxes.

How Do I Get an EIN?

You can apply for the EIN yourself on the IRS.gov website for free; however, some people find this confusing and/or do not wish to spend the time doing it themselves. If this is the case for you, Corporate Direct can obtain one for you for a small service fee. Whichever way you choose, know that it required for your business.

The IRS allows businesses to apply for an EIN either online, by phone, fax or mail. If applying online, the EIN is assigned immediately upon completion of the interview-style application that walks you through type of business, identity of business, authentication, addresses, details and confirmation of the new EIN number.

Even though receiving the number is immediate, it can take up to two weeks to be added into the IRS database and until it is added, the number can’t be used for filing returns. In order to avoid any issues, be sure to obtain your EIN as soon as possible. 

C Corporation

What is a C Corporation?

illustration of a storefrontCorporations have been used for over 500 years to limit owners’ liability and thus encourage business investment and risk taking. Their use for this purpose continues to this day. 

You will hear about both C Corporations and S Corporations. Both are corporations with charters granted by the state of organization. You can organize in Nevada for the best asset protection laws, for example, and qualify to do business in California. In that case, you will have one corporation paying annual fees in two states (which many people do). While we like and often use S Corporations, we keenly appreciate the advantages of C Corporations. They certainly have their merit and a place in your entity structure strategy.

The C and the S refer to IRS Code Sections. C corps feature a double taxation – one tax at the company level and another tax on profits distributed to shareholders. This double tax is why many people consider S corps, which has only one level of tax. But there are restrictions on ownership of S corps, where as there are no such limits on C corps.

Here is a quick list of C Corporation advantages:

  • They can have an unlimited amount of shareholders, from anywhere in the world.
  • For Nevada and Wyoming corporations, officers and directors can reside anywhere in the world. This can be a boon for foreign investors. 
  • They can have several different classes of shares.
  • They have the widest range of deductions and expenses allowed by the IRS (more on this below).
  • They are the most widely recognized business entity in the world, and are the premier entity for going public.
  • In Nevada and Wyoming, nominee (or stand-in) officers and directors can be utilized, adding extra levels of privacy.
Image Link to download full c-corporation guide pdf

Tax Advantage: Wide Range of Deductions and Expenses

A C Corporation has the widest range of deductions and expenses allowed by the IRS, especially in the area of employee fringe benefits. A C Corporation can set up medical reimbursement and other employee benefits, and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, will also not pay taxes on the value of those benefits.

This is not the case in a flow-through entity, such as an S Corporation, LLC or LP. In each of those cases the entity may write off the costs of the benefits, but any employee/shareholder who owns more than 2% of the entity will pay taxes on the value of their benefits received. So, if having the maximum deductions and all of the employee fringe benefits on a tax-free basis is important to you, a C-Corp may be your entity choice.

Which type of business works well as a C Corp?

C Corporations are great for a business that sells products, has a storefront and employees, and may or may not have a warehouse where it keeps its inventory. C-Corps don’t work well with businesses that want to hold appreciating assets, such as real estate, because of the tax treatment on the sale of these assets.

Tax Disadvantage: Double Taxation Issues

The most often-cited disadvantage of using a C-Corp is the “double-taxation” issue. Double-taxation happens when a C-Corp has a profit left over at the end of the year and wants to distribute it to the shareholders as a dividend. The C-Corp has already paid taxes on that profit, but once it distributes the profit to its shareholders, those shareholders will have to declare the dividends they receive as income on their personal tax returns, and pay taxes again, at their own personal rates.

How to Avoid the Double-Taxation Scenario

There are many things you can do to avoid the double-taxation scenario:

  • Structure the C-Corp so that there are no profits left over – use all of the write-offs and deductions allowed by the IRS to reduce the C-Corp’s net income.
  • Offer great benefit plans!
  • Pay higher salaries to yourself and the other owner/employees than you would if you were using a flow-through entity such as an S-Corp. Yes, you will have to pay payroll taxes and personal income taxes on those monies, but you would pay personal taxes on dividends paid to you anyway. And it may be that in the big picture, the savings on one side outweigh the additional taxes paid on the other side.

The decision as to what entity is best for you really does, in so many cases, hinge on taxes, and that is why, with any corporate-related decision, you are wise to seek the advice and assistance of a good CPA.

Corporate Direct along with your CPA can help you decide which corporation is best for you.

S Corporation

Is an S Corporation the right entity type for you?

This is a great question to explore when starting a business, or changing your existing business from a Sole Proprietor or General Partnership. It can make a difference in asset protection as well as in taxes. An S Corporation is one of the three popular choices for those incorporating their business. Other choices include Limited Liability Companies (LLCs) and C Corporations.

Business owners can select how they wish to be taxed, and an S Corporation is one of those tax designations that can make a big difference in how much you pay in taxes, and how to handle profits and distribute shares. There are pros and cons to every entity type and it’s important to understand which business model is best for you.

An S Corporation is a corporation that has elected to be taxed as a flow-through entity (similar to an LLC or Limited Partnership). The “S” also refers to an IRS code section. This type of taxation, the S election, allows the shareholders to be taxed only at the individual level only instead of at both the corporate and individual level, thus avoiding the double taxation like the C Corporation.

Of all of the entities, the S Corporation has the tightest restrictions on ownership. There can only be 100 or fewer shareholders (owners), which all must be individuals or their living trusts. Corporations, multi-member LLCs, and non-US residents cannot be S Corporation owners. If the restrictions aren’t followed, the IRS will decide the corporation is C Corp and will double tax it accordingly.

S Corporations can help some service-oriented businesses to avoid being characterized as a Personal Service Corporation, or “PSC” by the IRS. PSCs are C Corporations that are classified by the IRS as providing a service, such as consulting, to the general public.

Now, as you may know, the IRS assesses C Corporations with a pretty low initial rate — 15% on earnings up to $50,000. That’s quite a bit lower than you would pay personally if you were receiving that same $50,000 as salary. And, that 15% rate is also lower than you would pay if your business was an S Corporation. So, to head off the anticipated revenue drain, the IRS closed the loophole by designating C Corporations that provide services as PSCs.

The tax rate for PSC earnings? 35%! That’s probably higher than you would pay through your S Corporation if you took a reasonable salary and the rest as passive income. And, it’s enough, in many cases, to make the difference between going “S” or going “C.” Again, you will work with your CPA, tax and/or legal advisors to determine the best entity for your specific situation.

Advantages Of S Corporations:

  • Limited liability for management and shareholders.
  • An unlimited number of management, no state residency requirements.
  • Distinct, court-recognized existence, which helps protect you from personal liability that can cause you to lose your personal wealth in assets like your home, car, or nest egg.
  • Flow-through taxation: Profits are distributed to the shareholders, who are taxed on profits at their personal level.
  • Good privacy protection, especially in Nevada and Wyoming.
  • Great income-splitting potential for owner/employees. Can take a smaller salary and pay income taxes and regular payroll deductions, then take the remainder of profit as a distribution subject to income tax only.
  • S Corporations are great for businesses that:
              • will provide a service (i.e. consultants);
              • will not have significant start-up costs;
              • will not need to make major equipment purchases before beginning operations; and
              • will make a sizable amount of money without a great deal of expense.

Disadvantages Of S Corporations:

  • At shareholder level, shares are subject to seizure and sale in court proceedings.
    Maximum of 100 shareholders, all of whom must be U.S. residents or resident aliens. Shares must be held directly, except in special circumstances.
  • Owner/employees holding 2% or more of the company’s shares cannot receive tax-free benefits.
  • Because flow-through taxes will be paid at the personal rate, high-income shareholders will pay more taxes on their distributions.
  • Not suitable for estate planning vehicle, as control is ultimately in the hands of the stockholders. In a planned gifting scenario, once majority control passes to children from parents, children can take full control of the company.
  • If tax status is compromised by either non-resident stockholder or stock being placed in corporate entity name, the IRS will revoke status, charge back-taxes for 3 years and impose a further 5-year waiting period to regain tax status.
  • Not suitable to hold appreciating investments. Capital gain on sale of assets will incur higher taxes than with other pass-through entities such as LLCs and Limited Partnerships.
  • Limited to one class of stock only.

What is needed to form a corporation? How does it protect me?

Essentially, you file a document that creates an independent legal entity with a life of its own. It has its own name, business purpose, and tax identity with the IRS. As such, it — the corporation — is responsible for the activities of the business. In this way, the owners, or shareholders, are protected. The owners’ liability is limited to the monies they used to start the corporation, not all of their other personal assets. In the event of a lawsuit it is the company, not the individuals, being sued.

A corporation is organized by one or more shareholders. Depending upon each state’s law, it may allow one person to serve as all officers and directors. In certain states, to protect the owners’ privacy, nominee officers and directors may be utilized. A corporation’s first filing, the articles of incorporation, is signed by the incorporator. The incorporator may be any individual involved in the company, including frequently, the company’s attorney.

The articles of incorporation set out the company’s name, the initial board of directors, the authorized number of shares, and other major items. Because it is a matter of public record, specific, detailed, or confidential information about the corporation should not be included in the articles of incorporation. The corporation is governed by rules found in its bylaws. Its decisions are recorded in meeting minutes, which are kept in the corporate minute book.

Can I change entity types?

Yes, if you think you may want to go public at some point in the future, but want initial losses to flow through, consider starting with an S Corporation or a Limited Liability Company. You can always convert to a C Corporation at a later date, after you have taken advantage of flowing through losses. Corporations can make the election at the beginning of its existence or at the beginning of a new tax year.

More benefits to business owners: No self-employment tax!

The big benefit of S Corporation taxation is that S Corporation shareholders do not have to pay self-employment tax on their share of the business’s profits. But they will be taxed on the salary they pay themselves. This is the catch. Before there can be any profits, each owner who also works as an employee must be paid a “reasonable” amount of compensation (e.g., salary) that is subject to Social Security and Medicare taxes to be paid half by the employee and half by the corporation. As such, the savings from paying no self-employment tax on the profits only kick in once the S Corporation is earning enough that there are still profits to be paid out after paying the mandatory “reasonable compensation.”

More Questions? An Incorporating Specialist can help!

Limited Partnerships – Advantages and Case Study

Advantages of Limited Partnerships

  • LPs allow for pass-through taxation for both the limited partner and the general partner.
  • Limited partners are not held personally responsible for the debts and liabilities of the business, although the GP, if an individual, may be personally responsible.
  • The general partner(s) have full control over all business decisions, which can be useful in family situations where ownership – but not control – has been gifted to children.
  • Estate planning strategies can be achieved with LPs.
  • Limited partners are not responsible for the partnership’s debts beyond the amount of their capital contribution or contribution obligation. So, unless they become actively involved, the limited partners are protected.
  • As a general rule, general partners are personally liable for all partnership debts. But as was mentioned above, there is a way to protect the general partner of a limited partnership. To reduce liability exposure, corporations or LLCs are formed to serve as general partners of the limited partnership. In this way, the liability of the general partner is encapsulated in a limited liability entity.
  • Because by definition limited partners may not participate in management, the general partner maintains complete control. In many cases, the general partner will hold only 2% of the partnership interest but will be able to assert 100% control over the partnership. This feature is valuable in estate planning situations where a parent is gifting or has gifted limited partnership interests to his children. Until such family members are old enough or trusted enough to act responsibly, the senior family members may continue to manage the LP even though only a very small general partnership interest is retained.
  • The ability to restrict the transfer of limited or general partnership interests to outside persons is a valuable feature of the limited partnership. Through a written limited partnership agreement, rights of first refusal, prohibited transfers, and conditions to permitted transfers are instituted to restrict the free transferability of partnership interests. It should be noted that LLCs can also afford beneficial restrictions on transfer. These restrictions are crucial for achieving the creditor protection and estate and gift tax advantages afforded by limited partnerships.
  • Creditors of a partnership can only reach the partnership assets and the assets of the general partner, which is limited by using a corporate general partner which does not hold a lot of assets.
  • The limited partnership provides a great deal of flexibility. A written partnership agreement can be drafted to tailor the business and family planning requirements of any situation. And there are very few statutory requirements that cannot be changed or eliminated through a well-drafted partnership agreement.
  • Limited partnerships, like general partnerships, are flow-through tax entities.

For more information on this topic, get the book!

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Case Study:

When a Limited Partnership is Best

Jim is the proud father of three boys. Aaron, Bob, and Chris are active, athletic, and creative boys almost ready to embark upon their own careers. The problem was that they were sometimes too active, too athletic, and too creative.

At the time Jim came to see me, Aaron was seventeen years old and every one of the seemingly unlimited hormones he had was shouting for attention. He loved the girls, the girls loved him, and his social life was frenetic and chaotic.

Bob was sixteen years old and sports were all that mattered. He played sports, watched sports, and lived and breathed sports.

Chris was fifteen years old and the lead guitarist in a heavy metal band. When they practiced in Jim’s garage the neighbors did not confuse them with the Beatles.

Jim has five valuable real estate holdings that he wants to go to the boys. His wife had passed on several years before and he needed to make some estate planning decisions. But given the boys’ energy level and lack of direction he did not want them controlling or managing the real estate.

Jim knew that if he left the assets in his own name, when he died the IRS would take 55% of his estate, which was valued at over $10 million. And while estate taxes were supposed to be gradually eliminated, Jim knew that Congress played politics in this arena and no certainty was guaranteed. Jim had worked too hard, and had paid income taxes once already before buying the properties, to let the IRS’s estate taxes take away half his assets. But again, he could not let his boys have any sort of control over the assets. While the government could squander 55% of his assets, he knew that his boys could easily top that with a 100% effort.

I suggested that Jim place the five real estate holdings into five separate limited partnerships.

I further explained to Jim that the beauty of a limited partnership was that all management control was in the hands of the general partner. The limited partners were not allowed to get involved in the business. Their activity was “limited” to being passive owners.

It was explained that the general partner can own as little as 2% of the limited partnership, with the limited partners owning the other 98% of it, and yet the general partner can have 100% control in how the entity was managed. The limited partners, even though they own 98%, cannot be involved. This was a major and unique difference between the limited partnership and the limited liability company or a corporation. If the boys owned 98% of an LLC or a corporation they could vote out their dad, sell the assets, and have a party for the ages. Not so with a limited partnership.

The limited partnership was perfect for Jim. He could not imagine his boys performing any sort of responsible management. At least not then. And at the same time he wanted to get the assets out of his name so he would not pay a huge estate tax. The limited partnership was the best entity for this. The IRS allows discounts when you use a limited partnership for gifting. So instead of annually gifting $14,000 tax free to each boy he could gift $16,000 or more to each boy. Over a period of years, his limited partnership interest in each of the limited partnerships would be reduced and the boys’ interest would be increased. When Jim passes on, his estate tax will be based only on the amount of interest he had left in each limited partnership. If he lives long enough he can gift away his entire interest in all five limited partnerships.

Except for his general partnership interest. By retaining his 2% general partnership interest, Jim can control the entities until the day he dies. While he is hopeful his boys will straighten out, the limited partnership format allows him total control in the event that does not happen.

Jim also liked my advice that each of the five properties be put into five separate limited partnerships. I explained to him that the strategy today is to segregate assets. If someone gets injured at one property and sues, it is better to only have one property exposed. If all five properties were in the same limited partnership, the person suing could go after all five properties to satisfy his claim. By segregating assets into separate entities the person suing can only go after the one property where they were injured.

Jim liked the control and protections afforded by the limited partnership entity and proceeded to form five of them.

Is a Limited Partnership right for you? Get your free 15-minute consultation today!