New England Forestry Consultants, Inc.
|Volume 7, No. 1
ESTATE PLANNING - PART III FAMILY PARTNERSHIPS & LIMITED LIABILITY COMPANIES
If you have been a regular reader of the NEFCo newsletter, you are probably
starting to conclude that I have a morbid fascination with death. In the
winter 2001-02 NEFCo newsletter, I made the guarantee that at some point in the
future, you would die. In the winter 2003-04 NEFCo newsletter that
guarantee was repeated. Well, once again it is time to face up to your own
mortality. While I do not find the subject of death to be particularly
appealing, it is a subject that is continually on my mind when it comes to
estate planning. Nobody wants to address it, but if you don't, the
repercussions could be catastrophic to your family and to the very things that
you worked so hard to achieve in your lifetime.
Estate planning means looking to the future and planning appropriately to
insure that there are no surprises. You can either ignore the need to plan
for your estate and possibly provide your heirs with some very unpleasant tax
surprises, or you can face the situation "head on" and insure a smooth
transition of your estate. I have yet to meet a client who owns and
manages his/her land for the expressed purpose of giving it to the government in
estate taxes; therefore, it is logical to conclude that the majority of
landowners would like to insure that their heirs benefit from their diligent
Previous newsletters discussed various land management tools. The
winter 2001-02 issue discussed conservation easements, and the winter 2003-04
issue discussed the living trust, otherwise known as the A/B trust. Both
of these tools can be used in your estate planning process. Two other
available tools are Family Partnerships and Limited Liability Companies.
A partnership is created when two or more people engage in doing business
together without incorporating. This process may occur informally with a
handshake, or formally, through the formation of a partnership agreement.
For the purposes of estate planning, a partnership based on a handshake is
doomed to failure. A written partnership agreement is a must for the
survival and effectiveness of a family partnership.
A partnership can own property and conduct business. However, a
partnership does not need to be an equal partnership. Some partners can
have greater rights, interests, and liabilities than others.
Essentially there are two types of partners in a family partnership.
The first is the general partner(s) who are the decision makers. The
second are the limited partner(s) who have only a beneficial interest in the
partnership. Limited partners share in the profit and losses of the
partnership, but have no say in the day-to-day operation.
The formation of a family partnership that owns land allows parents to give
their children (or others) a beneficial interest in the property without making
an outright gift of a specific tract of land.
IRS regulations allow a taxpayer to make annual tax-exempt gifts of up to
$10,000 per individual to an unlimited number of people. Therefore, a
married couple could give up to $20,000 annually to an individual. This
$10,000 annual amount is not limited to cash, but instead a parent could give
$10,000 of partnership value to a child.
In order to understand how a family partnership could benefit your estate
planning, it is important to recognize the ultimate goals: to reduce your
personal estate to an amount not subject to the "death tax", and to continue
your land management legacy. I will address the land management legacy
later in this article, but for right now let me address the estate value issue.
One of the primary reasons that landowners do not plan the disposition of
their estates is because they believe it will require them to give up control of
their assets. They have worked hard to accumulate these assets, and the
concept of losing control of them is not acceptable. The family
partnership allows the person to maintain control while also reducing his/her
estate value. Remember, a family partnership is not a democracy.
Decisions are made by the general partner(s), and it is not subject to a vote.
Therefore, a landowner can reduce his/her estate value by giving interest in the
partnership to his/her children (up to $10,000 per person per year) and maintain
control by being a general partner. Additionally, if limitations are
attached to the interest in the partnership, i.e. limiting who can purchase the
interest in the partnership, etc., the gift value can be discounted. For
example, a limitation may be placed on the interest in the partnership that
reduces the value to $8,000 rather than the $10,000 limit. This reduction
in value would mean that the parent could give $12,000 interest in the
partnership, which would be considered only a $10,000 gift by the IRS.
Thus, reducing the estate value is the easy part, and establishing the
partnership is relatively simple as well. Partners simply have an attorney
draw up a partnership agreement. The hard part is determining the content
of the partnership agreement and the decisions that must be made.
For example, you decide to form a family partnership. Your thinking the
hard part is over because you have decided to face the reality that you will
die. Sorry, but that decision was the easy part. Now, you must set
the stipulations of the partnership agreement.
The partnership agreement defines why the partnership was formed and how it
will make decisions in the future. You must be very clear in your
directives about the decision making process for the future. This process
will have a direct affect on your land management legacy. If you state
that wildlife habitat is the primary purpose of the land management, which
wildlife? How do the future general partners know whether the property
should be managed for early successional species that would entail patch
clearcuts, or for mature forest species that would require the formation of old
growth forests? The establishment of an adequate partnership agreement
requires a fine balancing act. You must be clear enough to insure the land
is managed for its intended purpose, but also allow the future general managers
the flexibility to adapt to changes in land management theories and practices.
Once you define the purpose and reason for the formation of the partnership,
then you must make the difficult decision of designating who will be the general
partner(s) after you step out of that position. This decision can involve
a very difficult process because it will require you to honestly evaluate the
strengths and weaknesses of the pool of potential general partners, i.e. your
children or other relatives. Pick a person who is willing to execute the
terms of the partnership agreement while treating other partners fairly. A
successful family partnership is completely in the hands of the general partner.
Careful consideration must be given on how future general partners are selected.
Limited Liability Companies (LLC)
A Limited Liability Company (LLC) works much like a corporation, in that the
partners avoid some of the liability for the debts of the partnership; however,
it is different in that the LLC structure requires that at least two of the four
conditions of a corporation are not true. These conditions are:
1. Limited liability for the owners.
2. Centralized management.
3. No restrictions on ownership interests.
4. Continuity of existence.
For most LLCs set up to hold family lands, conditions 3 and 4 will not be
true. Most family land LLCs will want to have limited liability for the
owners (condition 1) and have a centralized manager(s) (condition 2).
Therefore, in order to meet the LLC requirements, the LLC needs to have
restrictions on ownership, i.e. only family members, and must have a finite
Like a family partnership, a partnership agreement must be drawn up. In
the case of an LLC, this document is called an Operating Agreement. It
sets forth in detail the conditions of the company, the purpose of the LLC, and
a membership role with conditions for membership. The Operating Agreement
is a private document of the LLC, and every member should have one.
Additionally, the founder of the LLC must file Articles of Organization, usually
with the Secretary of State. This process is a relatively simple process
Like the family partnership, once the LLC is established, parents can vest
children shares in the LLC up to the maximum annual gift limit without paying a
gift tax. Doing so allows the parents to reduce their estate value while
maintaining control of the asset.
In most cases, the founder of the LLC will be the manager. However,
unlike the family partnership, the manager of the LLC can be a non-vested
individual or company. For example, it is practical for a timberland LLC
to be managed by a forestry consulting firm. This option essentially
allows the parents to avoid having to evaluate their children and select a
general manager. The manager of the LLC must follow the stipulations of
the Operating Agreement that should contain the forest management plan of the
Differences Between the Family Partnership and the LLC
The primary differences between the Family Partnership and the LLC are
liability and taxes. In a Family Partnership, all partners are liable for
the decisions of the partnership. Profits are distributed directly to the
individual partners; however, all debts are also the responsibility of the
individuals. In the LLC, the LLC itself is liable for the decisions of the
manager. Essentially, the LLC is considered a separate entity. It is
a taxpayer without a body; therefore, the individual members are not
individually liable for the actions of the LLC.
As far as taxes are concerned, the advantage lies with the Family
Partnership. Because profits are passed directly to the individual and
their personal tax returns, the profits are taxed only once.
The news is
not as good for the LLC. Because the LLC is a separate entity, it is taxed
as such. The profits that are paid out to the members are taxed a second
time on the member's individual tax return. (see a further clarification below.)
When choosing which option is best for you, carefully consider which
advantage is most important, the liability protection or avoiding double
The Family Partnership and the Limited Liability Company are both practical
options when planning your estate. Both alternatives allow you to lessen
your estate value in order to avoid the "death tax", and continue to maintain
control of the asset. They also allow you to insure that your monetary and
sweat investments do not go to waste. Also, allowing your children the
opportunity to acquire a vested interest in your woodlands, over a period of
time, will cause them to develop an interest in the management and long-term
care of the asset. It will encourage your heirs to continue the land
management tradition you started, rather than selling the asset due to lack of
interest or estate taxes. For more information pertaining to your estate
planning needs, please feel free to contact your nearest NEFCo forester.
Tony Lamberton, Manchester Center Manager
Since the writing of this article, I have received two messages
from readers disputing the above-mentioned information. This has resulted
in me doing additional research and speaking directly to the IRS. I must
concur (sort of) with the readers.
Factually, the above statement (highlighted
in orange) is correct, but it is not the complete story. According
to my additional research, as well as my conversations with the IRS, a Limited
Liability Corporation may be taxed like a partnership (i.e. no double taxation)
or like a corporation (i.e. double taxation). Here is the rest of the
For federal tax purposes, an LLC has to have a classification,
with the exception of a single person LLC which receives no classification.
Also please understand, this information pertains to federal taxes and not state
taxes. States may have their own separate laws concerning LLC taxation.
A single person LLC is considered as a non-entity. The LLC
does not pay taxes on income, as the single person will declare income on
his/her personal income taxes.
A multi-person LLC will either be classified as a partnership or
a corporation. Tax treatment for each respective classification is
different. For the partnership classification, there is no double
taxation. The LLC is not subject to federal income taxes; however, the
individual owners are subject to federal income taxes on the income they earn.
They are also subject to social security taxes and medicare taxes (this is
called the "self-employment tax"). Additional concerns with the
partnership classification have to do with "disguised sales" and distribution of
contributed property; however, this is quite complicated and is beyond the scope
of the NEFCo newsletter.
If an LLC is classified as a corporation for tax purposes, the
LLC is subject to federal income taxes and the income generated to the owners is
also subject to federal income taxes (i.e. double taxation). The LLC would
pay a portion of the social security taxes and medicare taxes that, in a
partnership classification, would have been paid by the owners. The owners
would also receive a Form W-2 from the LLC at the end of the year. These
expenses are deducted from the bottom line of the LLC and according to my
discussions with the IRS, any profits remaining after these expenses would not
be subject to social security and medicare taxes. Therefore, if the LLC
has times where it produces a substantial income, there could be a significant
amount of tax savings.
A multi-person LLC may chose either tax classification.
The IRS default classification is that of a partnership, and the IRS must be
notified if an LLC would prefer the corporation classification. The best
classification is dependent on the specific circumstances as to why the LLC was
formed, and the purpose of the LLC.
It is impractical to believe that all of the information that is
necessary to make a decision concerning estate planning can be contained in a
semi-annual newsletter. That is not our intent. It is however, our
intent to briefly review various options in order to get the reader to think
about his/her estate plan. With that being said, unquestionably, the
original article was deficient. Additional clarifying information should
have been included in the article, and for that I personally apologize.
Tony Lamberton, Manchester Center Manager