Case Study: LLP and LLC
Again, we’ll continue with case studies rather than questions from readers as this time of year during harvest, I don’t get a lot of questions. So case files will be fun as they cover things I’ve been involved in over the years.
Wendal and Mary Jane K. had two children. Their son, Bob, had been farming on the farm with Wendal and Mary Jane for many years and had developed a comparable estate – in value – to Wendal and Mary Jane. Bob had help from his parents over the years with small loans and help in acquiring more land and Wendal and Mary Jane were quite satisfied with what Bob had acquired. They now wanted to be equitable with their daughter, Jenny.
After a recent visit to an attorney, Wendal and Mary Jane talked about using an LLP or LLC to own their business to both pass their assets on to Bob and Jenny, as well as possibly lower any future estate tax potential. Their estate was in the eight and half million dollar range at this point in time.
Issues: Wendal and Mary Jane want a simple method of transferring their property to their children as well as eliminate estate taxes.
The solution discussed was using an LLP or LLC to make this a simple task as each year Wendal and Mary Jane could gift ownership percentages – in the case of the LLP or stock in the case of an LLC – to their children, Bob and Jenny, by making gifts. If they didn’t exceed the $13,000 limitation per year per person, they would not even have to file gift taxes. The attorney also noted that if the $13,000 wasn’t enough Wendal and Mary Jane could use spouses of the children and grandchildren to gift additional stock or percentage.
Possible Advantages: An easy way to transfer business ownership and gain some estate tax advantage down the road.
Possible Disadvantages: Any time we take a business that is solely owned and begin to fracture the ownership – by giving shares or percentages over time – we have to look at the entire business model to be sure this is the right thing to do.
First of all, setting up an LLP or LLC is setting up another tax entity. This should tell you additional recordkeeping will be needed as well as reporting taxes, keeping track of this separate tax ID#, and sharing net income with all of the different ‘owners’ of the business.
For people who like to keep life simple, this can be a bit of a challenge to maintain – especially as the gifts continue and income is going to seven or eight different sources. How does this affect your borrowing ability, reporting to ASCS, etc? Decide for yourself –as you look at the years coming – if this is something you’ll be able to and want to stay up to date on.
Second, when I fracture ownership of a sole business by using an LLP or LLC, I am giving percentages of ownership to people rather than acres of land or pieces of equipment, etc. Each share or percentage represents whatever you put into the LLP or LLC. If it’s only going to be land, then ultimately we will have undivided joint ownership of land someday.
If I used children, grandchildren, spouses of my children, how do I protect those shares from being attached with liens by divorces, medical costs or long-term care costs, bankruptcies, bad business decisions, etc? The more I spread out the ownership of an asset, the more possible exposure I bring to the assets because, people being people, someone sooner or later is going to mess up.
The answer to this is to have a properly written business agreement and stay within certain confines on your gifting. A properly written business agreement (LLP or LLC) defines exactly what happens if one of the owners wishes to sell, who they can sell to (normally the other co-owners), what happens if they are forced to sell (liens), and how they have say or no say in the business (voting or no voting stock in the LLC).
Gifting should be limited to the people you want to have a voice within the ownership of this asset. If you have a son-in-law or daughter-in-law or grandchildren who are minors or are someday going to be teenagers or young adults (thirty is the new eighteen), none of these classes would be good candidates for gifting. Why? Because a gift given is a gift lost. And all of them can make your life miserable in the business if they turn a different way in life than you expect them to.
In this case, Wendal and Mary Jane have two children. Because their son, Bob, has built his own estate to almost as large as theirs, an LLP or LLC might be acceptable for use with Bob and Jenny – as long as they have an incredibly strong business agreement including who has first option to farm, what happens when one of them dies or wants to sell, etc., etc. If Bob were dependent on receiving the farmland for his future agri-business success, then no, the LLC and LLP would not be a good answer. No one wants to be partners with a non-farming sibling in their business.
“Keeping the Family Farm in the Family”
Great Plains Diversified Services, Inc.
1424 W. Century Ave., Suite 208
Bismarck, ND 58503-0917
Toll Free: 1-800-373-4078