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  Using Limited Liability Companies In Estate Planning
By ProGuide™

NEW - COMING 2011!

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ProGuide™ - Legal Forms is pleased to make these continuing legal education materials available to you. However, please note that while still quite useful, portions of the materials discuss issues which have been clarified by the "check_a_box" and other regulations subsequently adopted by the Internal Revenue Service. Thus, the materials, as set forth, should not be relied upon as reflecting the current state of the law and great care should be used to ensure that all legal references and all conclusions reached are still correct and have not been rendered obsolete by statutes, regulations, rulings and other pronouncements of the Internal Revenue Service, the courts, and various state agencies.

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    1.   Introduction.  In the area of general business planning, the limited  

         liability company (LLC) has become a significant addition in the arsenal

       of tools available for the business planner. Likewise, it has become a

       significant tool in the area of estate planning.  However, like all new

       tools, until it is clear precisely how it should be used, it should be

       used cautiously so as to avoid undue injury.  Because, however, it is

       potentially avery powerful tool, its use should be given careful


  2.   Objectives of Estate Planning 

       a.   In general the goals of estate planning are: 

            i.   To manage and conserve assets during life 

            ii.  To transfer those assets upon death or some earlier time to

                 the persons or entities desired by the owner 

            iii. To allow the transfer of the assets to be accomplished under

                 the terms and conditions selected by the transferor, and  

            iv.  To minimize taxes on the transfer of those assets 

       b.   These objectives often conflict.  However, the selection of the

            right tools can help a transferor to more nearly achieve his or her


  3.   Characteristics of the LLC Which Affect Its Uses - Generally. 

       a.   Limited Liability 

            i.   All members shielded from personal liability 

                 (1)  like corporation 

                 (2)  uncertainty in some states - but number declining

        b.   Flexible Management

             i.   All members can actively participate - member managed 

                 (1)  no loss of limited liability as in the case of a limited


            ii.  Management can be restricted: 

                 (1)  "manager managed" 

                      (a)  can be by members or non-members 

                 (2)  member managed, but leave authority to manage in all

                      members but have smaller group of members actually

                      administer it 

                 (3)  Those without expertise need not be involved in


       c.   Flexible Ownership

             i.   Generally there are no restrictions 

                 (1)  Different than S corporation's restrictions on ownership 

                      (a)  eliminates constant monitoring and/or complex

                           agreements restricting ownership 

                 (2)  No legal restriction on number of owners 

                      (a)  May get unwieldy if too large 

                      (b)  May have more complex securities rules and fall into

                           special tax rules re large and/or publicly traded


                 (3)  Generally, no legal restriction on nature of owners 

                      (a)  foreigners (resident or non-resident), corporations,

                           partnerships, trusts, charitable institutions,

                           pension plans, estates, and other LLCs may all be


                      (b)  An S corporation can use an LLC 

                           (i)  may give it some of the same advantages that C

                                corporations can get from owning a subsidiary 

                           (ii) can insulate some assets from the remaining


                           (iii)     Since need two members, must be another

                                     person or entity involved 

                                1)   S corporation should be able to own almost


                                2)   Could structure arrangement to allow S

                                     corporation's shareholder(s) to own

                                     remaining interests.  

                      (c)  A complex trust can be a shareholder 

                           (i)  thus, we can control to whom and when

                                distributions to people occur. 

                 (4)  Sometimes, licensing requirements of a particular

                      business or profession will require limitations on

                      ownership which are not required by LLC law or tax rules 

       d.   Ownership Easily Controllable 

            i.   Statute restricts ability to transfer ownership and/or

                 management rights 

                 (1)  Can not become a member without the approval of at least

                      some others 

                      (a)  Fewer negotiations may be needed as the statutory

                           default may be ok 

                 (2)  May be able to pre-approve transfer of some interests and

                      still avoid IRC "free transferability" characteristic. 

       e.   Flexible Organization Structure 

            i.    May be simple 

                 (1)  All ownership interests can be identical 

                 (2)  No need for general and limited partners 

            ii.  May be complex 

                 (1)  Can differ the economic and voting rights of members and

                      create numerous classes of ownership rights 

                      (a)  flexibility in allocation of rights: 

                           (i)  on liquidation

                           (ii) profits & losses

                           (iii)     cash flow

                           (iv) priorities in dissolution 

                      (b)  Watch IRC 704(b) allocation Regs. 

       f.   Flexibility In Types of Capital Contributions 

            i.   Capital contributions can be in cash, property, services,

                 promissory notes or other obligations to contribute cash or

                 property or to render services in the future 

       g.   Readily Transferable Economic Interests 

            i.   Statute allows assignment of rights to profits, losses, and

                 all distributions without any approvals 

            ii.  Free transferability of interests will still not exist. 

       h.   LLCs Can Have "Subsidiaries" 

            i.   LLC may own other entities, including: 

                 (1)  corporation,

                 (2)  general partnership

                 (3)  limited partnership

                 (4)  another LLC 

            ii.  Allows protection of limited group of  assets 

                 (1)  Use corporation or another LLC 

            iii. May allow "consolidation" of profits and losses for tax


                 (1)  Use another "pass through" entity 

            iv.  May allow preservation of limited liability in states without

                 a limited liability statute 

                 (1)  use corporation 

       i.   Familiar to Foreign Investors 

            i.   Similar to a GmbH and other entities used throughout Europe

                 and South America 

       j.   Uncertainty As to How Treated Under Substantive State & Federal Law  

            i.   Questions exist regarding: 

                 (1)  Will the limited liability provisions contained in the

                      state of organization's LLC statute be accepted in the

                      other states in which the LLC operates? 

                 (2)  Can an LLC sue or be sued in its own right in such other


                 (3)  Since there is little law regarding LLCs, how will the

                      organizational state and other states apply case law or

                      legal precedent in other areas to LLCs, since there is

                      little authority actually pertaining to LLCs 

                 (4)  How will state securities laws apply to the transfer of

                      an LLC? 

                      (a)  Transfer of interest as member? 

                      (b)  Transfer of interest in economic rights only? 

       k.   Uncertain State Tax Treatment 

            i.   Some uncertainty as to how the organizational state will

                 handle some tax issues. 

            ii.  Great uncertainty as to how states without LLC statutes will

                 handle taxation issues. 

            iii. Some issues are: 

                 (1)  How will the entity be treated for multi-state tax

                      allocation purposes? 

                 (2)  Will a sale of an interest be treated as intangible

                      personal property, similar to the sale of stock, so that

                      gain is taxed to the members state of residency? 

                      (a)  Most LLC statutes classify an LLC interest as

                           personal property so expect similar treatment to

                           that of stock 

                      (b)  Liquidation of the LLC and distribution of assets to

                           the members can avoid LLC level taxation and can

                           change the source of the intangible assets 

                           (i)  How will LLCs be treated? 

                           (ii) Will it be effected by whether state taxes LLC

                                as a corporation? 

                      (c)  Many other issues. 


  4.   Some Federal Income Tax Considerations Affecting Use of the LLC 

       a.   Caution - the discussion which follows in this section IV was

            drafted prior to the publication of Rev. Proc.95-10 and contains an

            analysis of the impact of the uncertainty surrounding the

            categorization of an LLC member as a general partner, limited

            partner, or limited entrepreneur.  The categorization is

            important as it effects the application of the passive loss rules

            and any other tax provision which establishes different standards

            for limited partners.  While these issues remain un-resolved, much

            of the controversay was exaserbated by the IRS' defining a _limited

            partnership_ in Rev. Proc. 89-12 as _an organization formed as a

            limited partnership ... and any other organization formed under a

            law that limits the liability of the member for the organizations's

            debts or other obligations to a determinable fixed amount._

            (emphasis added).  Rev. Proc. 95-10 now provides that Rev. Proc.

            89-12 does not apply to an LLC.  As such, the confusing definition

            of limited partnership no longer applies and, presumably, the

            common meaning of the word limited partnership will be applied in

            the future. 

       b.   General 

            i.   To claim a deduction for a loss generated by a pass-through

                 entity on his or her individual income tax return, taxpayers

                 must have the loss allocated to them by either operation of

                 law or by agreement.  However, in addition, certain types of

                 taxpayers (it varies with the statute) must meet additional

                 requirements.  More specifically: 

                 (1)  his or her basis in the investment must be sufficient to

                      allow the use of the deduction, 

                 (2)  he or she must be at risk with regard to the amount of

                      the loss 

                 (3)  and if the loss is a passive activity loss, it may only

                      be used to offset income from passive activities. 

       c.   Allocation of Profits and Losses - IRC 704 

            i.   Generally, the Wisconsin LLC statute provides that profits and

                 losses will be divided between members in proportion to the

                 respective values of their interests as required to be

                 maintained in the records of the LLC.  It also allows the

                 members to vary that arrangement in any way they wish in an

                 operating agreement, 

            ii.  However, sections 704(a) and (b) of the IRC sets forth very

                 lengthy and complex rules regarding the allocation of profits

                 and losses between partners.  These rules allow IRS to

                 disregard the agreed upon allocation if they do not have a

                 "substantial economic effect" - that is, an economic loss

                 consistent with the allocated loss. (Essentially, a safe

                 harbor exists if certain criteria are met and either a deficit

                 restoration agreement exists or qualified income offset will

                 be made. A discussion of these rules is beyond the scope of

                 these materials.) 

            iii. Since the basic set of "substantial economic effect" rules

                 contained in the regulations do not apply to non-recourse

                 debt, it is necessary to distinguish between categories of

                 debt.  In this instance, several different categories of debt,

                 other than recourse debt, are considered by the regulations.

                 All of them have a bearing on LLCs and their members. 

                 (1)  Essentially, debt is divided into non-recourse and

                      recourse liabilities, as tested by reference to the

                      members and certain related persons - not the LLC. 

                      (a)  Non-recourse liabilities are then subdivided into: 

                           (i)  secured non-recourse liabilities and

                           (ii) exculpatory liabilities 

                      (b)  Recourse liabilities are divided into 

                           (i)  partnership non-recourse liabilities and

                           (ii) other recourse liabilities 

            iv.  Because of the limited liability attribute of the LLC, it will

                 generally be considered as having non-recourse debt. If,

                 however, a member guarantees the LLC's debt or the LLC borrows

                 the funds from a member or a person related to the member, the

                 debt will be treated as partner non-recourse debt.  See Treas.

                 Reg.  1.752-2. 

                 (1)  Non-recourse liabilities are treated as not having actual

                      economic effect since only the creditor bears any

                      economic risk.  Thus, the regulations artificially

                      allocate non-recourse debts to the members as if they had

                      economic effect if certain requirements are met,

                      including the minimum chargeback requirement which

                      allocates to those receiving the deductions, gains from

                      the sale of the asset or the repayment of the debt, etc. 

                 (2)  If there is partner nonrecourse debt, the rules allocate

                      the deductions attributable to the liability to the

                      person who bears the economic risk of loss.  Rules

                      similar to the minimum chargeback rules also apply. 

            v.   Although the rules are detailed and complex, the important

                 thing to remember is that the allocations of losses and gains,

                 etc., will be influenced by the categorization of the debt and

                 compliance with the allocable rules.  Because most debt of an

                 LLC will likely be non-recourse debt, the negotiation of the

                 terms of a bank loan will take on greater significance to

                 members than they might to partners, etc. 

       d.   At Risk Rules - IRC 465 

            i.   In general,  a person is "at risk" for the amount of money

                 they contributed to the entity, the adjusted basis of any

                 property they contributed to the entity, and the amount of any

                 debt of the entity for which they are personally liable. (IRC

                 465(a) and (b)).  This amount is also increased by any income

                 allocable to the person plus any additional contributions made

                 by him or her.  It is reduced, however, by the amount of any

                 losses taken and distributions received. 

            ii.  Under normal conditions, the owner of an LLC will not be

                 liable for the debt of the LLC because of the limited

                 liability attribute of LLCs. 

            iii. While it is not completely certain, a loan by a partner to a

                 partnership should be treated as at risk to the extent of

                 their allocable share of the debt.  Prop. Reg. 1.465-7 

                 (1)  It is not clear, however, what the rule is in the case of

                      a limited partnership or LLC, where the members or

                      limited partners have no direct liability for the debt

                      and the member making the loan may bear all of the actual


                 (2)  Similarly, it is not clear what the result is if the

                      member of the LLC guarantees the debt of the LLC. 

                      (a)  Logic would say that the member is at risk, however,

                           subchapter S shareholders are not treated as at risk

                           when they guarantee the corporation's loan. See

                           Prop. Reg. 1.465-24. 

                 (3)  This issue is important since in many small business

                      operations, the bank will require a personal guarantee of

                      the loan.  It might be wise to make the loan to the

                      members rather than the entity if the member will not be

                      at risk for the guaranteed amount. 

            iv.  Another issue arises in connection with the financing of real

                 estate and pertains what is referred to in the at risk rules

                 as qualified non-recourse financing." 

                 (1)  Under this rule, if an entity incurs debt in connection

                      with a real estate activity and the financing is

                      qualified non-recourse financing, then the owners may be

                      treated as being at risk for a share of the debt even

                      though none of the owners are actually liable.  In

                      general, qualified non-recourse financing is financing

                      borrowed from a bank or other similar qualified lender

                      for which no one is personally liable and which is

                      secured by the real estate. 

                 (2)  The issue that arises in connection with LLCs is the

                      question of whether the LLC is a "person" which may be

                      liable on the debt or whether it should be disregarded.  

                      (a)  Susan Hamill, a member of the staff of the IRS

                           Office of the Chief Counsel, while expressing her

                           own personal views, indicated that if the loan were

                           only secured by the real estate being financed, the

                           members of the LLC would likely be treated as at

                           risk with respect to the debt.  However, she

                           expressed uncertainty as to the result if the LLC

                           secured the loan with all of its assets. 

       e.   Passive Activity Rules - IRC 469 

            i.   There are at least four "issues" involving the "passive loss"

                 provisions of the IRC which are unique to LLCs.  All four turn

                 on the meaning of the term "limited partner" or "general

                 partner" within the context of the various sections of IRC

                 469.  Three of them pertain to rental real estate activities

                 and are discussed, below, in that section. 

            ii.  The first issue is, "What level of participation must an LLC

                 member have in order to be treated as "materially

                 participating" under IRC 469(h)(2)." 

                      (a)  Generally, IRC 469 provides that for certain

                           specified persons and entities, passive activity

                           losses and credits will not be allowed. IRC


                      (b)  IRC 469 (c)(1) requires that the conduct of a trade

                           or business will be passive if the taxpayer does not

                           "materially participate" in it . 

                      (c)  IRC 469(h) defines material participation. It

                           provides that "A taxpayer shall be treated as

                           materially participating in an activity only if the

                           taxpayer is involved in the operations of the

                           activity on a basis which is-- (A) regular, (B)

                           continuous, and (C) substantial. 

                      (d)  Treas. Reg. 1.469-5T expands upon this general rule

                           and provides that, with two exceptions which are

                           found in paragraphs (e) and (h)(2) of the

                           regulation, one of seven (7) conditions must be met

                           in order for an individual to be treated as

                           materially participating.  Those 7 tests are: 

                           "(1) The individual participates in the activity for

                           more than 500 hours during such year; 

                           (2) The individual's participation in the activity

                           for the taxable year constitutes substantially all

                           of the participation in such activity of all

                           individuals (including individuals who are not

                           owners of interests in the activity) for such year; 

                           (3) The individual participates in the activity for

                           more than 100 hours during the taxable year, and

                           such individual's participation in the activity for

                           the taxable year is not less than the participation

                           in the activity of any other individual (including

                           individuals who are not owners of interests in the

                           activity) for such year; 

                           (4) The activity is a significant participation

                           activity (within the meaning of paragraph (c) of

                           this section) for the taxable year, and the

                           individual's aggregate participation in all

                           significant participation activities during such

                           year exceeds 500 hours;  

                           (5) The individual materially participated in the

                           activity (determined without regard to this

                           paragraph (a)(5)) for any five taxable years

                           (whether or not consecutive) during the ten taxable

                           years that immediately precede the taxable year; 

                           (6) The activity is a personal service activity

                           (within the meaning of paragraph (d) of this

                           section), and the individual materially participated

                           in the activity for any three taxable years (whether

                           or not consecutive) preceding the taxable year; or 

                           (7) Based on all of the facts and circumstances

                           (taking into account the rules in paragraph (b) of

                           this section), the individual participates in the

                           activity on a regular, continuous, and substantial

                           basis during such year. 

                      (e)  Thus, it would appear that whether a general or

                           limited partner for tax purposes, meeting any of the

                           above 7 tests would cause a taxpayer to meet  the

                           "material " participation" requirement. 

                      (f)  However, IRC section 469(h)(2) also provides that: 

                                Except as provided in regulations, no interest

                                in a limited partnership as a limited partner

                                shall be treated as an interest with respect to

                                which a taxpayer materially participates

                                (Emphasis added). 

                           The term limited partner is not defined in the IRC

                           and other sources must be looked to for assistance. 

                      (g)  Treas. Reg. 1.469-5T(e) provides that, except as

                           provided in paragraph (e)(3)(ii) of 1.469-5T, for

                           purposes of section 469(h)(2) and paragraph (e) of

                           that regulation, a partnership interest will be

                           treated as a "limited partnership" interest if


                           (i)  the interest is designated a limited

                                partnership interest in the limited partnership

                                agreement or the certificate of limited

                                partnership (whether or not there is actual

                                limited liability under state law), or  

                           (ii) there is actual limited liability under state


                      (h)  Under this definition of a limited partnership

                           interest, all interests of members of an LLC would

                           appear to be "limited partnership interests" for

                           purposes of section 469(h)(2) and (e) of Treas. Reg.

                           1.469-5T and a member would not be treated as

                           "materially participating", even if one of the 7

                           tests described above were met. IRC 469(h)(2) and

                           Treas. Reg. 1.469-5T(e)(1)(i). 

                      (i)  Treas. Reg. 1.469-5T(e)(2) provides some minimal

                           relief, however, to holders of a "limited

                           partnership interest" by providing that the holder

                           will still be treated as materially participating if

                           they meet tests (1), (5) or(6) set forth above.

                           Those tests are: 

                                (1) The individual participates in the activity

                                for more than 500 hours during such year; 

                                (5) The individual materially participated in

                                the activity (determined without regard to this

                                paragraph (a)(5)) for any five taxable years

                                (whether or not consecutive) during the ten

                                taxable years that immediately precede the

                                taxable year; 

                                (6) The activity is a personal service activity

                                (within the meaning of paragraph (d) of this

                                section), and the individual materially

                                participated in the activity for any three

                                taxable years (whether or not consecutive)

                                preceding the taxable year; 

                           These tests are very restrictive; much more so than

                           those provided in the remainder of the 7 tests, and

                           substantially restricts the use of losses. etc. by

                           holders of "limited partnership interests."

                           Fortunately, other relief is, perhaps, available. 

                      (j)  Treas. Reg. 1.469-5T(3)(ii) provides that: 

                           A partnership interest of an individual shall not be

                           treated as a limited partnership interest for the

                           individual's taxable year if the individual is a

                           general partner in the partnership at all times

                           during the partnership's taxable year ending with or

                           within the individual's taxable year (or the

                           portion of the partnership's taxable year during

                           which the individual (directly or indirectly) owns

                           such limited partnership interest). 

                      (k)  No definition of "general partner", however, appears

                           in either the IRC or the regulations. 

                      (l)  Rev. Pro. 89-12, dealing with the classification of

                           an entity, provides in section 1.02 that: 

                                Any reference to a "limited partnership"

                                includes an organization formed as a limited

                                partnership under applicable state law  and any

                                other organization formed under a law that

                                limits the liability of any member for the

                                organization's debts and other obligations to a

                                determinable fixed amount. References to

                                "general partners" and "limited partners"

                                [apply] also to comparable members of an

                                organization not designated as a partnership

                                under controlling law and documents; the

                                "general partners" of such an organization will

                                ordinarily be those with significant management

                                authority relative to the other members.

                                (Emphasis and underlining added.) 


                      (m)  This definition, or the lack of a real definition,

                           leaves a great deal of uncertainty regarding which

                           of the requirements of the 7 tests must be met by a

                           member of an LLC.  However, some additional analysis

                           may be useful. Consider the following: 

                           (i)  The IRC 469(h) requirement that persons holding

                                limited partnership interests be treated as not

                                materially participating in an activity, and

                                the more restrictive position taken by the IRS

                                in the regulations, are both consistent with

                                the general state law requirements which

                                prevent a limited partner from actively

                                participating in the management of the limited


                           (ii) IRC 469(h) and its legislative history

                                specifically contemplate that IRS will

                                promulgate regulations which handle these

                                situations.  However, no such regulations have

                                been drafted. 

                           (iii)     IRC 469(h), by its language, also

                                     addresses only limited partnerships.  The

                                     legislative history suggests that it is

                                     the management characteristic, not the

                                     limited liability characteristic, which is

                                     pertinent to the issue of "material


                           (iv) Treas. Reg. 1.469-5T(e)(2), Treas. Reg. 1.469-

                                5T(3)(ii) and Rev. Proc. 89-12 all look to the

                                level of management activity which is attached

                                to the interest in determining the difference

                                between a general partnership interest and a

                                limited partnership interest.  Even where the

                                interest is a "limited partnership interest",

                                material participation is found and the passive

                                loss allowed when the amount of activity is


                           (v)  Perhaps more importantly, shareholders in

                                Subchapter S corporations need only meet any of

                                the seven tests to qualify for the use of the

                                passive loss and there seems no reason to

                                distinguish between a Sub. S corporation and an


                           (vi) Members in a member managed LLC would seem more

                                like general partners than do Subchapter S


                           (vii)     LLC members in a manager managed LLC

                                     should be more cautious since they have

                                     restricted management authority (but not

                                     necessarily compared with other members,

                                     if none are managers) and come more

                                     readily within the concepts of Rev.Proc.


                           (viii)    Notwithstanding the fact that there may be

                                     no logical reason for distinguishing

                                     between Sub. S corporation shareholders

                                     and LLC members, LLC members in a manager

                                     managed LLC whose managers are members but

                                     consist of less than all of the members,

                                     fall almost squarely within the

                                     description of the relationships contained

                                     in Rev. Proc. 89-12 and are most readily

                                     separated into categories of general and

                                     limited partnership interests under the

                                     existing available guidelines. 

                      (n)  Regardless of the possible arguments regarding why

                           LLC members should not be treated as holders of

                           limited liability interests, until there is

                           clarification caution would dictate that any LLC

                           member desiring to avoid losses being characterized

                           as passive should have at least 500 hours of

                           activity or meet one of the other two more

                           restrictive tests.  Those desiring to ensure that

                           losses will be treated as passive should make sure

                           that they do not exceed 100 hours of participation

                           and avoid any of the 7 other tests. 

            iii. For further confusion on this subject, see the discussion of

                 "limited entrepreneur" under the topic of "Agriculture",

                 below.  This concept, introduced in IRC 464, defines a

                 "limited entrepreneur" as a person who: 

                      (A) has an interest in an enterprise other than as a

                      limited partner, and 

                      (B) does not actively participate in the management of

                      such enterprise. 

  5.   Comparison of LLC With Subchapter S Corp, Limited Partnership, and

       Trusts in an Estate Planning Context. 

       a.   LLC v. Subchapter S Corporations 

            i.   LLCs are more flexible than S corporations and have many


            ii.  These advantages are likely to continue even if Congress

                 follows through with its proposed liberalization of the S Corp


            iii. No restrictions on number or types of members 

                 (1)  Publicly traded partnership rules of I.R.C. 7704 will

                      apply to LLCs and, thus, will impose practical limits. -

                      See Rev. Proc. 95-10, Section 1.05 provides that ruling

                      request guidelines not applicable to IRC 7704 entities. 

                 (2)  Even complex trusts can be members and may afford some

                      flexability with regard to restricting the distribution

                      of income or affecting the selection of the beneficiaries

                      to whom it is distributed. 

                      (a)  Changes brought about by the 1993 tax legislation

                           now penalize the accumulation of income in the trust

                           by imposing higher rates. 

                 (3)  Less pre-death and post-death planning required to ensure

                      that only qualified persons_ become owners of the

                      Subchapter S stock - or election may be unexpectedly lost

                      with very adverse consequences. 

                 (4)  May act as a general partner in a family limited

                      partnership to further limit liability. 

            iv.  May have more than one class of ownership interest, with

                 different distribution rights 

                 (1)  To be valid, they must have substantial economic effect -

                      see IRC 704(b). 

            v.   Can get the effect of a _consolidated_ income tax return; no

                 prohibitions on LLC like those prohibiting S Corp from being

                 part of an affiliated group 

            vi.  No requirement that distributions be pro rata for all members. 

            vii. Members of LLCs get full benefit of LLC debt in computing

                 their basis in their stock. 

                 (1)  Since all an LLC's debt is all nonrecourse for tax

                      purposes, members generally obtain an increase in the

                      basis of their interests which reflects their share of

                      the debt.  This may affect the amount of the losses they

                      may deduct.  (Passive loss rules and At Risk rules also

                      have an impact. Additionally, by assuming some liability

                      for the debt, the manner in which the debt is allocated

                      may be altered for some purposes.) 

            viii.     As a partner, members of an LLC may also take advantage

                      of the IRC 743 and 754 elections and adjust the inside

                      basis of the assets of the LLC. 

                 (1)  S corporation shareholder receives a step-up in basis

                      when they acquire their S Corp stock (whether at death or

                      in a taxable transfer), 

                      (a)  basis adjustment is only made to the stock itself

                           (outside basis). 

                      (b)  there is no adjustment to the inside basis (that

                           is the basis of the assets of the entity) for an S

                           or C corporation. 

                           (i)  Net effect is that although fair market value

                                is reflected in the outside basis at the time

                                of the transfer, the acquiring shareholder must

                                still pay tax on his or her share of the gain

                                recognized on the sale by entity. 

                           (ii) Shareholder pays tax on the inside' gain in

                                the year in which the entity's gain is treated

                                as distributable to him for federal income tax


                           (iii)     Usually, shareholder must await

                                     liquidation of the entity or the sale of

                                     his stock before receiving an offsetting


                                1)   Usually the deduction will be a capital

                                     loss deduction subject to the capital loss


            ix.  Usually, LLCs may distribute appreciated property to members

                 without recognizing gain at the LLC level or income to the

                 recipient members.  See IRC 731.  

                 (1)  IRC 336 would produce a very different result for


            x.   IRC section 2036(b), the "anti-Byrum" rule do not apply to

                 partnership interests 

                 (1)  thus, it should be possible to gift an economic interest

                      in an LLC without gifting the voting control while still

                      avoiding the inclusion of the value of the transferred

                      interest in the taxable estate 

                 (2)  Other valuation discount rules will continue to apply. 

       b.   LLC's v. Limited Partnerships 

            i.   No member of an LLC need be personally liable for the debts of

                 the entity. 

                 (1)  In Limited Partnership, general partners are liable. 

            ii.  All members of the LLC may participate in management without

                 becoming liable as a general partner. 

                 (1)  A member's liability is generally limited to the amount

                      of its capital contributions plus any contributions which

                      it agreed to make but which remain unpaid. 

                 (2)  May have exposure if functioning in a jurisdiction with-

                      out LLC statute 

                      (a)  risk becoming minimal as most states adopt LLC


                 (3)  Ability to actively participate may have a positive

                      effect on avoiding adverse effect of the passive loss


            iii. Limited Partnership must carry on a business;  

                 (1)  Wisconsin LLC may be formed for any lawful purpose

                 (2)  Some states require the operation of a business. 

       c.   LLCs v. Trusts 

            i.   Trust income tax rates are much higher if income is not

                 distributed annually - raised by the Revenue Reconciliation

                 Act of 1993. 

            ii.  If a trust's income is used to meet a support obligation of

                 the grantor, the income is taxed to the grantor. IRC 677 

                 (1)  A similar result could arise as a partnership also.

                      (a)  IRS could merely recharacterize the payment as a

                           distribution for a particular partner. 

            iii. May be better protection of assets than that available with a

                 trust, even a spendthrift  trust - particularly against

                 federal income tax claims. 

            iv.  Limited Partnerships and LLCs may be a viable alternative to

                 an irrevocable life insurance trust or any other type of

                 irrevocable trust established for gifting purposes. 

       d.   Disadvantages to the LLC 

            i.   Must have more than one person to form a LLC since partnership

                 classification requires that there be "associates". 

                 (1)  Rev. Proc. 95-10 confirms prior IRS releases and allows,

                      at least for some purposes, 99%-1% ownership splits. 

                 (2)  Sudden end - surprise results 

                      (a)  Some states, such as Arkansas, Georgia, Idaho,

                           Montana, N.Y., North Carolina  & Texas allow one

                           person LLC's 

                      (b)  Federal tax consequences are uncertain since

                           definition of partnership requires more than one


            ii.  The law is very complex, causing uncertainty as to results,

                 higher expense, and traps for the unwary. 

                 (1)  Franchise tax and other burdens may apply. 

            iii. There may be uncertainties as to foreign recognition and

                 qualification to do business. 

            iv.  Disparate state income tax treatment can create substantial

                 administrative complexity if owners are located in many


            v.   There is a general lack of familiarity and lack of precedent

                 concerning LLCS. 

  6.   Using the LLC in Estate Planning. 

       a.   Major features making LLC desirable for estate planning purposes: 

            i.   Limited liability for all members 

            ii.  Generally, taxed only at the member level; income and losses

                 passed through to the members - not applicable to publicly

                 traded LLCs 

            iii. Unlimited members of all types 

            iv.  Can have centralized management 

                 (1)  Management not tied directly to economic interests 

                 (2)  Control can remain with senior family members 

            v.   Can have varying economic interests 

                 (1)  can facilitate transfer of future growth 

                 (2)  can provide for succession to people who will have

                      varying degrees of activity in a business 

            vi.  Need not operate a business? 

                 (1)  statute says any lawful purpose

                 (2)  however, heading is nature of business 

            vii. Allows active participation by all members 

                 (1)  can minimize adverse effect of passive loss and certain

                      other tax rules 

            viii.     Relationship can be modified from time to time 

            ix.  Can create minority interests and obtain minority discounts 

            x.   Comparatively good creditor protection 

                 (1)  Creditor does not get at assets of LLC - merely gets a

                      Charging Order 

                      (a)  Probably gets pass through of income and obligation

                           to pay tax because of status as an assignee. 

                           (i)  May get no cash 

            xi.  Can have all members essentially get an undivided interest in

                 all of the assets 

            xii. Upon liquidation or at any time, appreciated assets may be

                 distributed without the recognition of gain 

            xiii.     Entity and members can get step up in both inside and

                      outside basis 

                 (1)  because of present value of money, this is a very

                      valuable right 

       b.   Major disadvantages 

            i.   Possibly confusing and adverse taxation by different states 

            ii.  Legal uncertainty because of lack of precedent. 

  7.   Classification For Income Tax Purposes. (See detailed discussion


       a.   An unincorporated entity will not be treated as an association

            taxable as a corporation unless it has more corporate char-

            acteristics than noncorporate characteristics. Treas. Reg.


       b.   These regulations are based on case law and must be viewed in light

            of that case law. 

       c.   The Treasury Regulations identify six major corporate

            characteristics.  They are: 

            i.   have associates

            ii.  an objective to carry on business and divide gain

            iii. liability for debts limited to corporate property

            iv.  centralization of management

            v.   free transferability of interests

            vi.  continuity of life 

       d.   Treas. Reg.s and cases say other characteristics exist. 

       e.   Note - If the LLC is not operating a business and has no profit

            motive, the general analysis most often presented is not adequate. 

            i.   Watch out for what it means to run a business & have a profit


                 (1)  See PLR 9313025 and 9313026 - corp. and public utility

                      join to develop new energy efficient process 

            ii.  Treas. Reg. 301.7701-2 (a)(2) provides that absent an intent

                 to make a joint profit, the entity can not be taxed as an


            iii. Treas. Reg. 301.7701-3 provides: 

                 (a) IN GENERAL. The term "partnership" is broader in scope

                 than the common law meaning of partnership and may include

                 groups not commonly called partnerships. Thus, the term

                 "partnership" includes a syndicate, group, pool, joint

                 venture, or other unincorporated organization through or by

                 means of which any business, financial operation, or venture

                 is carried on, and which is not a corporation or a trust or

                 estate within the meaning of the Internal Revenue Code of

                 1954. A joint undertaking merely to share expenses is not a

                 partnership. For example, if two or more persons jointly

                 construct a ditch merely to drain surface water from their

                 properties, they are not partners. Mere co-ownership of

                 property which is maintained, kept in repair, and rented or

                 leased does not constitute a partnership. For example, if an

                 individual owner, or tenants in common, of farm property lease

                 it to a farmer for a cash rental or a share of the crops, they

                 do not necessarily create a partnership thereby. Tenants in

                 common, however, may be partners if they actively carry on a

                 trade, business, financial operation, or venture and divide

                 the profits thereof. For example, a partnership exists if

                 co-owners of an apartment building lease space and in addition

                 provide services to the occupants either directly or through

                 an agent. 

       f.   So may not have an association or a partnership. 

            i.   Watch out for vacation homes.  

       g.   Since the presence of associates and the objective to carry on

            business for joint profit is common to all organizations organized

            for profit, those two common characteristics are disregarded in

            determining whether an entity is a partnership or an association

            for federal tax purposes 

       h.   Review of Characteristics Affecting Tax Classification  

            i.   Limited Liability - Always Present 

            ii.  So, for "partnership" classification, can only have one more

                 of the following characteristics: (frequently centralized

                 management is desired - then must avoid free transferability

                 of interests and continuity of life.) 

                 (1)  Free Transferability of Interests - heavily facts &


                      (a)  all but 20% can probably be freely transferable - see

                           attached analysis and Rev. Proc. 95-10 

                      (b)  if member managed, no free transferability if at

                           least a majority of the non-transferring member-

                           managers must approve person becoming a partner 

                      (c)  may exist if, in fact, a small group actually

                           controls the entity -  see attached discussion at

                           4(F)6  & Rev. Rul 93-4. 

                           (i)  Watch out if all controlled entities are


                           (ii) Unknown impact if owners are parent & child &

                                parent has actual control. 

                           (iii)     IRS suggests that documents can provide

                                     for restricted transfer rights &/or

                                     dissolution on attempted transfer and

                                     avoid free transferability even if the

                                     entity is controlled by a small group 

                 (2)  Centralized Management 

                      (a)  Requires that management be concentrated in a small


                           (i)  IRS current view (Rev.Proc. 95-3, 5.03) is if

                                entity is manager managed, it probably has

                                centralized management unless: 

                                1)   managers own at least 20% of the total


                                2)   and other factors do not indicate that the

                                     members control the managers in which case

                                     centralized management may still exist. 

                                3)   IRS says won't issue ruling if managers

                                     can be replaced at periodic elections or

                                     if non-managing members can remove

                                     managing members 

                                     a)   These rules are ideal for a family

                                          LLC as seniors can have interests >

                                          than 20% and not be subject to

                                          removal except under limited

                                          circumstances eg. cause. 

                           (ii) possible to have a smaller group actually carry

                                out management activities so long as all

                                members have actual management authority 

                      (b)  An issue arises when transferors exercise managerial

                           control in the context of an LLC taxed as a


                           (i)  IRC sections 2036 (Transfers With Retained Life

                                Estate),  2038 (Revocable Transfers), and

                                2503(b) (Taxable Gifts)(Present interests) and

                                other similar provisions can all be triggered

                                if the manager has too much control and is not

                                subject to what the IRS might consider to be

                                standard fiduciary duties. 

                                1)   See PLR 9131006 and 9415007.  Both suggest

                                     that the LLC is probably O.K., but there

                                     is no case law clarifying the extent of

                                     the fiduciary duties.  The operating

                                     agreement should clarify that such duties

                                     exist. Query how IRS requirement of few

                                     limitations on removal of managers ties

                                     with ordinary fiduciary duties.  Consider

                                     at least removal for cause or breach of

                                     fiduciary duty. 

                 (3)  Continuity of Life 

                      (a)  Rev. Proc 95-10, Sect. 5.01 provides new guidelines. 

                           (i)  No continuity of life if death, insanity,

                                bankruptcy, retirement, resignation or

                                expulsion of any member causes dissolution,

                                even if business can be continued thereafter

                                with consent. 

                           (ii) If majority vote needed to continue, dissident

                                family members could block this. 

                           (iii)     Rev Proc 95-10 provides almost no relief.

                                     It requires a vote of the majority in

                                     interest of all members to continue. But

                                     it allows the events of dissolution to be

                                     tied solely to all of the member managers

                                     (smaller group so fewer events.) 

                           (iv) If the statute allows less than all of the

                                enumerated events (death, insanity etc) to

                                trigger dissolution & LLC operating agreement

                                ties to less than all such events, then IRS

                                won't rule unless LLC establishes to IRS

                                satisfaction that the event is meaningful. 

  8.   Valuation Issues 

       a.   General. 

            i.   Obviously, one significant use of the LLC is to transfer

                 interests by gift or at death in a manner which minimizes the

                 tax liability. 

            ii.  Short of exempting the transfer from tax, the best savings can

                 be achieved by having a low valuation of the asset


            iii. This is often achieved by transferring minority interests in an

                 entity or by otherwise restricting marketability. 

            iv.  IRS has finally acknowledged in Rev. Rul. 93-12 that stock in

                 a family owned corporation was entitled to to be evaluated

                 without regard to the fact that control existed within the


                 (1)  A similar rationale should apply to partnerships,

                      including LLCs 

       b.   Marketability Discount 

            i.   A discount in value should apply to an interest in an LLC

                 because of a lack of marketability. 

                 (1)  Since an LLC is likely to be both closely held and its

                      interests not freely transferable, the marketability of

                      the interest will likely be impaired and, thus,  a

                      discount for lack of marketability should apply. If few

                      possible buyers exist the discount could be in the range

                      of 10-25% or more. 

                 (2)  Note - free transferability here refers to the actual

                      legal right to transfer an interest..  It is only

                      tangentially related to the free transferability test

                      used for classification purposes. 

                 (3)  Note also that if an LLC has no operating agreement in

                      effect or one which provides for a buyout of the LLC

                      interest, marketability of an LLC interest may, in fact,

                      be enhanced and, thus, no discount applied. 

                      (a)  Wis. Stat. 183.0604, Distribution upon Dissociation,

                           generally provides that, upon an event of

                           dissociation under s. 183.0802 that does not cause

                           dissolution of the limited liability company, a

                           dissociating member is entitled to receive any

                           distribution to which the member is entitled under

                           an operating agreement and, if not otherwise

                           provided in an operating agreement, within a

                           reasonable time after dissociation, the dissociating

                           member is entitled to receive a distribution in

                           complete redemption of the fair value of the

                           member's interest in the limited liability company

                           as of the date of dissociation based on the member's

                           right to share in distributions from the limited

                           liability company.  

       c.   Minority Interest Discount 

            i.   A discount may also be applicable if the interest transferred

                 is a minority interest.  This is true because the lack of

                 control decreases the value of the interest considerably. 

                 (1)  Particularly true in the case of LLC and other pass

                      through entities since they may cause the owner of the

                      interest to incur a tax liability without receiving any

                      cash to pay it. 

       d.   Premium for Control 

            i.   Where control is transferred, there may be a premium added

                 to the value. Rev. Rul 59-60. 

                 (1)  could impact more heavily on manager members 

                 (2)  Query what the impact is in situations where the managers

                      are not members 

                      (a)  may be like stock 

       e.   Transfers with Retained Interests - IRC 2701 

            i.   If a person transfers an interest in a family partnership

                 but retains certain types of interests and control exists in

                 the hands of all of the family members, then IRC 2701 provides

                 that the value of the retained interest is $0.00 - thus,

                 putting all value on the transferred interest, unless the

                 arrangement provides for the transferor to get a qualified


                 (1)  A qualified payment is one which requires payments at a

                      fixed rate on a periodic basis and are cumulative if not


                 (2)  The retained interest must be: 

                      (a)  a right to distribution - other than one which is

                           junior to all other such rights, or 

                      (b)  a put, call, liquidation right, or conversion right

                           other than one which must be exercised at a specific

                           time for a specific amount, or 

                      (c)  certain rights to convert into interests of the same


                 (3)  Retained interests arise in recapitalizations and when

                      certain liquidation rights exist.  eg. older family

                      member transfers assets to an LLC for preferred and com-

                      mon interests, and transfers the common interests to

                      younger family members.  Generally, the retained interest

                      will be have a zero value, unless the preferred interest

                      has a fixed right for payment which is cumulative. 

            ii.  There is an open question as to how Section 2701(b) applies to

                 an LLC.  Section 2701 applies when control exist within the

                 transferor and the rest of the family. 

                 (1)  Control, for a partnership, means holding 50% or more of

                      capital or profits interests, 

                 (2)  Control, for a limited partnership, means holding an

                      interest as a general partner. 

                      (a)  It is not clear what an LLC is for these purposes. 

                           (i)  However, the fact that new Rev. Proc. 95-3

                                removed LLCs from definitions in Rev. Proc. 89-

                                12 may suggest that the LLC will be a

                                partnership not a limited partnership. 

                                1)   Will member-manager status vs. member have

                                     any impact. 

       f.   Lapses of Voting or Liquidation Rights - IRC 2704 

            i.   Two cases arose, Estate of Watts v. Comm., TC Memo 1985-595

                 (1985) and Harrison v. Commissioner, 52 TCM (CCH) 1306 (1987),

                 in which substantial discounts in the value of an interest in

                 a controlled entity arose because the transferor, by contract,

                 could not force a liquidation of the enterprise or exercise

                 certain other rights . (The going concern value was lower.) 

            ii.  Proposed Treas. Reg. 25.2704-1 provides that the lapse of a

                 voting right or a liquidation right will constitute a transfer

                 giving rise to a gift if during lifetime or a transfer tax if

                 the lapse is at death. 


            iii. To deal with contractually based restrictions, Congress also

                 enacted 2704(b) which essentially ignores the existence of the


                 (1)  these rules are complex and there breadth is subject to


                 (2)  there is also a disparity between the statute and the,

                      regulations with the regulations. See Treas. Reg.


                 (3)  When solving the problem of how to avoid the application

                      of these provisions when a liquidation right is involved,

                      it will be important to also consider the continuity of

                      life test for classification purposes. 

                 (4)  If an operating agreement contains provisions which are

                      more restrictive regarding a member's right to cause a

                      dissolution or a liquidation, the restrictions may be

                      ignored in computing the value of the interest under

                      I.R.C.  2704(b). 

  9.   Estate Freezes. 

       a.   Subject to many of the restrictions referred to above with regard

            to retained interests, many opportunities exist for freezing the

            value of a retained interest and passing on the future growth. 

            i.   could include a transfer to an LLC in exchange for common and

                 preferred interests and subsequent gifting of preferred


            ii.  might include a transfer of assets to LLC in exchange for an

                 interest which provides for a fixed payment which is


            iii. could be an arrangement where there is a transfer to to the

                 LLC for a note or other fixed obligation, where transferor has

                 no other interest but is a manager

            iv.  many other alternatives exist.


  10.  Family Partnership Rules


       a.   If an LLC is partnership for federal income tax purposes, the

            family partnership rules of  IRC Section 704(e) will apply. 

            i.   The details are found in Treas. Reg. 1.704-1(e) 

            ii.  The rules apply to all transfers of partnership capital

                 interests by gift, regardless of whether the person is a

                 family member or not. 

       b.   The purpose of the rules are to outline the circumstances under

            which a person or entity receiving a capital interest in a

            partnership in which capital is a material income producing factor

            will be treated as a partner and when they will not be so treated.

            It also provides rule for the allocation of income under certain


       c.   Section 704(e)(1) provides: 

            i.   A person shall be recognized as a partner... if he owns a

                 capital interest in a partnership in which capital is a

                 material income was derived by purchase or gift from any other


                 (1)  If so qualify, then the donee's distributive share of the

                      income will be allocated to him provided that the donor,

                      if providing services, is receiving adequate compensation

                      and provided that the amount received by the donee in

                      respect of his capital is proportionate to the amount the

                      donor is receiving in respect of his capital. 

                      (a)  In other word, you can't shift income. 

            ii.  If capital is not a material income producing factor then

                 Section 704(e) does not apply.  Instead, case law will apply. 

            iii. Section 704(e) only applies if the donee-partner actually own

                 his interest. 

                 (1)  The Treas. Regs. set out criteria for testing ownership

                      of a capital interest in a partnership and in a limited

                      partnership.  These rules look to the following factors

                      in connection with partnerships (not limited


                      (a)  Whether an alleged partner who is a donee of a

                           capital interest in a partnership is the real owner

                           of such capital interest, and whether the donee has

                           dominion and control over such interest 

                      (b)  The execution of legally sufficient and irrevocable

                           deeds or other instruments of gift under State law 

                      (c)  the conduct of the parties with respect to the

                           alleged gift and not by any mechanical or formal


                      (d)  Whether the donor retained controls over the

                           interest such as: 

                           (i)  control of the distribution of amounts of

                                income or restrictions on the distributions of

                                amounts of income 

                                1)   If there is a partnership agreement

                                     providing for a managing partner or

                                     partners, then amounts of income may be

                                     retained in the partnership without the

                                     acquiescence of all the partners if such

                                     amounts are retained for the reasonable

                                     needs of the business. 

                           (ii) Limitation of the right of the donee to

                                liquidate or sell his interest in the

                                partnership at his discretion without

                                financial detriment. 

                           (iii)     Retention of control of assets essential

                                     to the (for example, through

                                     retention of assets leased to the alleged


                           (iv) Retention of management powers inconsistent

                                with normal relationships among partners. 

                           (v)  Retention by the donor of control of business

                                management or of voting control, such as is

                                common in ordinary business relationships, is

                                not by itself to be considered as inconsistent

                                with normal relationships among partners,

                                provided the donee is free to liquidate his

                                interest at his discretion without financial

                                detriment. (Emphasis Added.) 

                           (vi) Controls inconsistent with ownership by the

                                donee may be exercised indirectly as well as

                                directly, for example, through a separate

                                business organization, estate, trust,

                                individual, or other partnership. Where such

                                indirect controls exist, the reality of the

                                donee's interest will be determined as if such

                                controls were exercisable directly. 

                      (e)  Substantial participation by the donee in the

                           control and management of the business (including

                           participation in the major policy decisions

                           affecting the business) is strong evidence of a

                           donee partner's exercise of dominion and control

                           over his interest. 

                 (2)  As to limited partners it provides: 

                      (a)  The recognition of a donee's interest in a limited

                           partnership will depend, as in the case of other

                           donated interests, on whether the transfer of

                           property is real and on whether the donee has

                           acquired dominion and control over the interest

                           purportedly transferred to him. 

                      (b)  To be recognized for Federal income tax purposes, a

                           limited partnership must be organized and conducted

                           in accordance with the requirements of the

                           applicable State limited-partnership law. 

                      (c)  The absence of services and participation in

                           management by a donee in a limited partnership is

                           immaterial if the limited partnership meets all the

                           other requirements prescribed in this paragraph. 

                      (d)  If the limited partner's right to transfer or

                           liquidate his interest is subject to substantial

                           restrictions (for example, where the interest of the

                           limited partner is not assignable in a real sense or

                           where such interest may be required to be left in

                           the business for a long term of years), or if the

                           general partner retains any other control which

                           substantially  limits any of the rights which would

                           ordinarily be exercisable by unrelated limited

                           partners in normal business relationships, such

                           restrictions on the right to transfer or liquidate,

                           or retention of other control, will be    

                           considered strong evidence as to the lack of reality

                           of ownership by the donee. 

            iv.  The regs. also provide that: 

                 If the reality of the transfer of interest is satisfactorily

                 established, the motives for the transaction are generally

                 immaterial. However, the presence or absence of a

                 tax-avoidance motive is one of many factors to be considered

                 in determining the reality of the ownership of a capital

                 interest acquired by gift. 

            v.   It will be important to keep these rules in mind when drafting

                 an operating agreement.  Particularly the safe harbor provided

                 if their is a right to liquidate the interest. 

            vi.  The issue of whether an LLC is a partnership or a limited

                 partnership is also at issue as the regs were not drfated with

                 LLCs in mind. 

  11.  Insurance 

       a.   LLCs may be used to hold life insurance contracts. 

            i.   Can avoid the transfer rules

            ii.  Can avoid the corporate alternative minimum tax which could

                 arise if the insurance proceeds are paid to the corporation.

                 See Treas. Reg. 1.56(g) 

       b.   Gross income will not, generally,  include amounts received under a

            life insurance contract, if the amounts are paid by reason of the

            death of the insured. (IRC 101(a)(1). 

       c.   If a life insurance contract, or interest in one, is transferred

            for a value, gross income will include all of the policy proceed

            received except for an amount equal to the sum of the actual value

            paid plus the amount of any premiums or other amounts paid by the

            transferee. IRC 101(a)(2). 

       d.   Excluded from the transfer for value rules are transfers of a life

            insurance contract to the insured, a partner of the insured, a

            partnership in which the insured is a partner, or a corporation if

            the insured is a shareholder or officer of it.  IRC 101 (a) (2)


            i.   Partnership has greater flexibility than corporation since

                 other co-shareholders are not within the excepted group. 

            ii.  Can be used  to fund cross purchase agreements. 

                 (1)  LLC can generally distribute the policies into joint

                      ownership since transfers to partners are exempt. 

            iii. The insurance policy proceeds should be allocated to the

                 partners who will purchase the deceased partner's interest. 

                 (1)  increases the basis of the purchasing partner to reflect

                      the tax exempt income generated by the payment of death

                      benefits.  Treas Reg 1.704-1(b)(2)(iv)(i) and should

                      avoid increasing value of deceased partners interest 

                      (a)  Watch timing of distributions of proceeds since

                           basis is not stepped up till last day of year and

                           distribution in excess of basis could have extremely

                           adverse tax consequences. 

                      (b)  Treat pre-year end distributions as an advance or

                           loan, not a distribution. See IRC  731 (a) (1). 

                           (i)  Not clear whether the insurance proceeds

                                transferred to a partnership will be included

                                in the decedent's estate as coming from a

                                policy owned by the deceased.  See IRC 2042.

                                Issue arises if policy proceeds are paid "other

                                than for the benefit of the partnership,".

                                then incidents of ownership may exist. 


  12.  Miscellaneous Other Matters To Consider. 

       a.   Use of LLC as general partner in Limited Partnership 

       b.   Special Elections 

            i.   Redemptions to pay death taxes under I.R.C. 303 

            ii.  Deferral of payment of estate tax under  6166 

       c.   LLC may help avoid an ancillary probate of real property


  13.  Summary of Some Family Estate Planning Considerations 

            i.   Family partnerships and corporations have frequently been used

                 for estate planning purposes.  LLCs may help to facilitate

                 that planning. 

                 (1)  While estate freezes have been restricted by changes to

                      the IRC in recent years, many estate planning objectives

                      can still be accomplished. 

                 (2)  Older family member owners of corporations, partnerships

                      and LLCs can make annual gifts to younger members of the

                      family and gradually divest themselves of ownership while

                      avoiding gift taxes if the gift has a value which is less

                      than the amount of the gift tax exclusion. 

                      (a)  The shifting of these interests from the older

                           generation to a younger generation affords both

                           generations some protection from creditors and, if a

                           majority of the interests are shifted, allows for

                           the application of some discounting of the value of

                           the ownership interests which are included in the

                           deceased owner's estate. 

                      (b)  If gifts are given to younger family members who are

                           active in a "partnership" or LLC operated business,

                           emphasis can be placed on giving interests in

                           "capital" rather than profits. (Interests in future

                           profits can be obtained tax free by the younger

                           members in exchange for contributions of future

                           services and any increase in the future profits

                           interest of a younger member has the effect of

                           decreasing the value of the profits interest of the

                           older members.) 

                      (c)  If a controlling family member has gifted LLC

                           interests to noncontrolling family members, then the

                           non-controlling members should be able to liquidate

                           their interests without financial penalty so that

                           the LLC income is not taxed to the donor under


                           (i)  A controlling shareholder could, however,

                                consider the obligation to pay the tax as an

                                additional estate planning mechanism,

                                particularly if there is little disparity in tax


            ii.  Since a properly structured LLC is a partnership for tax

                 purposes, a natural person's basis in his/her interest in the

                 LLC will be stepped upon the death of the owner.  IRC 1014.

                 If the LLC allows the adjustment of its inside basis under IRC

                 754, the assets of the LLC will also be stepped up to reduce

                 the amount of gain recognized by the LLC on the disposition of

                 the LLC's assets. 

            iii. There are numerous provisions of the IRC pertaining to estate

                 and gift taxes which impact on family held partnerships and

                 corporations which will also pertain to LLCs.  Provisions such

                 as those found in IRC 2701--2704 are of particular concern

                 because of the characteristics of the LLC. 

                 (1)  The Wisconsin LLC statute, like most others, grants

                      certain rights to members of LLCs with regard to voting,

                      withdrawing and obtaining payment for the interest, etc. 

                 (2)  These provisions are particularly important when estate

                      planning for LLCs.  Many of these rights affect issues

                      such as fair market value of the LLC interest and the

                      legitimacy of applying a discount. 

                      (a)  For example, although it is common to discount a

                           minority interest in an enterprise because of the

                           lack of marketability of the interest, the existence

                           of a statutory right to be bought out certainly

                           impacts on the the argument that there is no market

                           or that the value should be discounted. Similar

                           issues arise because of the rights granted LLC

                           members and the lapse of those rights (particularly

                           voting rights.)   

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