Taxes: Entity Planning Considerations For Family Business
By: D. Michael Trainotti
Entity Planning Considerations For Family Business
I attended a valuation seminar in September 2015. One of the main topics addressed was what the IRS is planning to do with proposed regulations to eliminate the discounts for certain family businesses that would be subject to estate tax. The speaker mentioned that the date when the proposed regulation would actually be issued is still up in the air from sometime in September 2015 to maybe never. However, please keep reading below regarding restrictions designed to restrict transfers of business interest.
I am currently drafting different family business documents dealing with transfer restrictions among shareholder, partners and members depending upon whether or not the family business owner’s estate will eventually be subject to estate tax or not. In 2015, the estate and gift tax is $5.430 million for an individual and $10.86 million for a couple.
Buy sell provisions are very common in closely held businesses to control the transfer of shares of stock, partnership and or membership interests depending upon the business entity used by the owner(s). They typically are used to determine the value of the transferred interest based upon various types of formula clauses when a transfer occurs based upon either a lifetime event or at death.
I was involved in a gift tax audit in 2014 where the IRS challenged certain restrictions contained in a limited liability company (“LLC”) operating agreement dealing with valuation issues. The LLC has only family members. If the LLC had two equal non-related business owners the IRS would not have challenged the restrictions dealing with valuations assuming the valuation formula was valid.
Based upon the current estate and gift tax exclusion amounts mentioned above, certain restrictions that I would always include in any buy sell arrangement I am recommending to be eliminated for a family business where everyone is related family members and subject to either a gift or estate tax. An example is where a minority interest owner wants to sell his or her interest to a bona fide third party but the business entity or its owners is given the first right of refusal to purchase the interest before the sale is completed.
Besides this gift tax audit starting, January 1, 2014 the California Revised Uniform Limited Liability Company Act (RULLCA) revises the rules for formation and operation of LLCs in the state of California. If you LLC operating agreement has some restrictions regarding valuation matters on transfers you should give serious consideration to have it reviewed by your attorney besides dealing with two of the RULLA concerns mentioned below.
For a member managed LLC where there are only two equal voting members or for a single member LLC, RULLCA many not have that much of an impact on the current LLC operating agreement. However, In a manger managed LLC where there are more than two members, a review of RULLCA is necessary to determine what existing operating agreement provisions may need to be updated under RULLCA
One of the simplest examples that I give to a manager of a manger managed LLC deals with the restrictions imposed on a manager before the manager can act upon behalf the LLC. Usually the manager must obtain the member’s approval of a certain percentage before the manager can act. Typically, some of the normal restrictions on a manager are as follows:
(a) Any act that would make it impossible to carry on the ordinary business of the LLC;
(b) The disposition of all or a substantial part of the LLC’s assets not in the ordinary course of business;
(c) The incurring of any debt not in the ordinary course of business;
(d) The incurring of any contractual obligation or the making of any capital expenditure with a total cost of more than $XXXXX.
Depending on the family business situation and whether or not you use a LLC as the business entity for the family business, you should review your buy sell provisions with your advisors to make certain they make sense today.
Michael Trainotti
D. Michael Trainotti has a general tax practice in Long Beach which emphasizes real estate, closely held businesses and estate planning matters. He has a master’s degree in taxation and is a member of the tax sections of the State Bar of California dealing with real estate, pass-through entities and estate planning. He is also a member of the same tax sections of the Los Angeles County Bar Association and the American Bar Association. Mr. Trainotti would be pleased to hear from you regarding future topics of interest or comments on this article. Please contact him directly at his office at (562) 590-8621 or by e-mail at [email protected]. You can also visit his website at http://www.trainottilaw.com
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