A family limited liability company (LLC) is a type of LLC generally used to protect family assets and assist in estate planning. The owners of a family LLC must be related by blood, marriage, or adoption.
What is an LLC?
An LLC is an increasingly popular business structure for startups, offering liability protection for ownership and greater flexibility than a corporation, particularly in terms of taxes. The LLC itself does not pay taxes. As a “pass-through” entity, income passes through the business to the owner or owners, who report it on their personal tax returns. An LLC is created by filing paperwork with your state, and nominal fees are involved.
An LLC offers its owner or owners, who are called members, considerable flexibility in terms of management. You can choose your management and operational structure and decide how you want to be taxed. Your LLC can have a single member or multiple members, all of whom have personal liability protection, meaning your personal assets are not at risk if you cannot pay business debts or are involved in a lawsuit.
In a family LLC, assets held by the LLC are protected from creditors and other claims against family members. For example, if the family home is owned by the LLC and one of the family members is sued personally, the home cannot be seized to pay the obligation of the lawsuit.
However, if a lawsuit is pending before the home or other assets are put into the LLC, the family cannot transfer the home or other assets to the LLC to shield it from the lawsuit. The same is true for any other obligations.
A family LLC is often used to transfer assets to heirs while avoiding estate taxes and gift taxes. The heirs are members of the LLC, and therefore can receive distributions of the assets at times specified in the LLC’s operating agreement, so they are not received as an inheritance or a gift.
Family LLC Operating Agreement
The operating agreement defines LLC ownership and management. The operating agreement should clearly define:
- The percentage of each member’s interests in the LLC
- How profits and losses will be allocated to each member
- Each member’s rights and responsibilities
- The management structure and management roles of members
- The voting rights of each member
- Rules for meetings and voting
- What happens when a member sells their interest, becomes disabled, or dies
A family LLC operating agreement will also specify restrictions on distributions. For example, distributions may be prohibited until a specified member dies.
Forming a Family LLC
Forming a family LLC is similar to forming a non-family LLC. Usually, however, a family LLC is formed by one member who will be the managing member of the LLC. The managing member’s role will be specified in the operating agreement, and the operating agreement will also usually specify restrictions on what other members are authorized to do. For example, the managing member may be the only one authorized to sign documents on behalf of the LLC.
Here are the steps to form a family LLC.
1. Choose Your State
The first step is to choose the state in which you plan to do business. LLC processes and requirements vary by state, so visit your state’s website for details. Generally, you can form your LLC with an online application.
2. Choose Your Family LLC Name
You may want to choose a name that includes your family name such as “Smith Family LLC”. Once you’ve chosen a name, you’ll need to make sure that it’s not already taken. You can do a search on your state’s website. You should also check the US Patent and Trademark Office to make sure the name hasn’t been trademarked.
3. Choose a Registered Agent
In many cases for a family LLC, the managing member will be the registered agent. A registered agent is the person or company that sends and receives official documents on behalf of your LLC. The registered agent can be a member of the LLC, or a third party such as an attorney, or a company that offers registered agent services. Most states require you to have a registered agent. The agent must be a resident of the state where you do business, or a corporation authorized to do business in your state.
4. File Articles of Organization
The articles of organization is the form you file to create your LLC. These forms vary by state but can generally be filed online. You’ll need to fill out the family LLC name, the name and address of the registered agent, the names of the LLC owners, and in some states, the way the LLC will be managed. Fees are generally around $100.
5. Draft an Operating Agreement
This has been explained above. Note that it’s a good idea to have an attorney’s help when creating your operating agreement so that you cover all bases to protect family members and avoid future issues.
6. Obtain an EIN
EIN stands for Employer Identification Number and is like a social security number for your business, allowing the IRS to easily identify your business. It is also known as a Federal Tax Identification Number (FTIN), or sometimes for corporations a Tax Identification Number (TIN). An EIN is required if your LLC has more than one member. The application is free and can be found on the IRS website. The application is form SS-4, and it can be mailed to the IRS or submitted electronically, and once your information on the application has been validated, the EIN is assigned immediately.
7. File Annual Reports
Your state may require you to file annual reports for your LLC, which may involve a fee. Check your state for requirements.
Family LLCs can have many benefits in terms of asset protection and estate planning. They are a bit complicated, however, so it’s highly recommended that you have an attorney’s help with the formation and drafting of the operating agreement. You also should enlist the help of your tax advisor to make sure you remain in full compliance with the relevant laws.