Legal Article
Use Of Limited Liability Companies (“LLC’s”)
In Virginia
By: Joseph T. “Chip” Buxton, III, J.D., C.E.L.A.
In 1991, the General Assembly of Virginia enacted the Virginia
Limited Liability Company Act which permitted individuals and other
entities to create a business entity, referred to as a Limited Liability
Company (“LLC”), that had the limited liability characteristics
of a corporation, i.e., the individual owners were not responsible
for the debts of the business, and had the tax characteristics of
a partnership, (income flows through to the owners for income tax
purposes). An LLC pays no income taxes.
Since 1991, the Virginia Limited Liability Statutes have been
amended several times. Today, a single individual may create an
LLC for any purpose, avoiding liability for debts and obligations
of the company, and still be taxed as a sole proprietorship (or
a partnership, where there is more than one LLC owner ).
An LLC is particularly useful in holding title to real estate and
can facilitate the making of gifts, especially annual exclusion
gifts of $11,000 or less to children or other family members. For
gifting purposes, holding real estate in an LLC avoids the need
to prepare and record numerous real estate deeds since the real
estate remains in the LLC. The gift is an interest in the LLC. Therefore,
for individuals desiring to gift interests in real estate to other
members of their family, they can, over time, remove the value of
the real estate from their estate for tax or other purposes. The
owner would simply create a Virginia LLC and transfer by deed the
real property to the company. The owners would own the LLC.
For estate planning purposes, the LLC could then be put into a
living trust. Thereafter, the owners could gift percentages in the
LLC to their children or other family members by a simple deed of
gift or assignment of interest. Gifts valued at $11,000 or less,
per year, per donee, ($22,000 per couple) can be made without any
federal gift tax consequences or liability. Therefore, a family,
over time, could gift substantial assets to the next generation
or to a trust created for the benefit of the next generation. The
value of the gift should be established by a qualified appraisal.
Furthermore, since the donee, i.e., the receiver of the gift, would,
in most cases, be unable to easily sell or transfer their interest
in the LLC, the value for gift purposes could be reduced by appraisal
for the “lack of control” and “marketability”
of the LLC interest since control remains in the original owner
as managers of the LLC. The owners may eventually gift virtually
all of their interest in the company to their children or other
family members, thus reducing the value of the estate and possibly
reducing taxes. In many cases, provisions are included in the LLC
Operating Agreement which prevents a LLC member from cashing in
his or her interest, thereby, keeping the property in the LLC “in
the family.”
Various provisions and regulations of the Internal Revenue Code
apply to transfers between family members and a CPA should be consulted
when gifting interest in an LLC. In addition to the IRS regulations,
under the Virginia LLC Act, a member of an LLC is not entitled to
withdraw from the LLC and receive any value for his or her interest
unless the Articles of Organization or Operating Agreement give
the member such a right .
Beyond estate planning and tax benefits, there are, however, a
number of other reasons why planners have looked to the LLC as very
valuable tool in their arsenal. Some of these are discussed below:
1. Retention of Control. Transferring assets
to an LLC allows older family members to retain control of the
assets. If the assets were transferred directly to family members,
rather than to the LLC, the younger family members would have
control of the asset. Creditors of the younger family members
would have direct access to the asset, in other words, could sue
the younger family member and obtain a judgment for the asset.
The younger family member’s spouse may have rights in the
asset upon a divorce or upon the younger family member’s
death unless they have been kept entirely separate from the marital
estate. If the younger family dies prematurely, the asset may
pass to someone other than a person whom the older family member
would choose to have the property. And, finally, the younger family
member has the ability to immediately sell the asset. On the other
hand, the older family members can retain control of the property
by simply being the only managing members of LLC.
2. Restrictions on Transfer. By using an LLC,
older family members may restrict the right of other owners to
transfer their interest, either involuntarily or voluntarily to
non-family members. For example, parents could place real estate
in an LLC and retain a right of first refusal to purchase any
interest in the LLC that another family member attempts to transfer
or sell. Furthermore, the younger family member can keep the LLC
interest as separate property, thereby excluding the interest
from inclusion in their marital estate in the event of a divorce
or death. In other words, a child’s spouse would not have
a claim against the LLC upon the child’s divorce or death.
3. Flexibility. An LLC is more flexible than
either a corporation or an irrevocable trust. To change provisions
in connection with a corporation, for example, certain formalities
must be followed. Furthermore, if the family decides to liquidate
a corporation adverse tax consequences may result. On the other
hand, an Operation Agreement of an LLC may be changed at any time
by a simple majority of members in interest and the entity can
usually dissolved or liquidated without any adverse tax consequences.
By definition an irrevocable trust cannot be amended, although
there are ways to provide flexibility through the use of powers-of-appointment.
4. Minimizing Costs. Ownership of real property
by an LLC will avoid , for example, ancillary (out-of-state) estate
administration for real property upon the death of the owners
located outside the state of Virginia. And, by using an LLC, undivided
interests in real property can be given away more easily than
if the undivided interest were conveyed directly to the donee
by deed of gift, thereby avoiding recording fees and other costs
associated with the transfer of real estate.
5. Protection from Creditors. One of the principal
reasons for using an LLC to hold rental or business real property
or other active business interests is to protect the owners of
the LLC from creditors or individuals who are injured because
the operation of the business or the rental of the real property.
All members of the LLC are insulated from the entity’s liabilities.
Finally, owning real property in an LLC may limit the potential
exposure to environmental liability which may arise under environmental
laws. It should be noted, however, that a member of an LLC could
be personal liable for his or her own negligence or for debts
personally guaranteed by the individual. However, when a creditor
of a member of an LLC tries to attach the member’s interest
in the LLC it is often very difficult to recover the member’s
interest from the LLC. In most states, a judgment creditor of
a member of an LLC is only entitled to what is known as a “charging
order” which gives the creditor the right to receive distributions
to which the member would have been entitled, it does not give
a creditor the right to manage the business or to cause a liquidation
of the LLC. In other words, if the LLC makes no distributions
to the member, the creditor gets zero.
Protecting an individual’s assets from the claims of creditors
is particularly important with respect to business rental real estate.
For example, often owners of rental real estate will create a separate
LLC for each rental property, thereby limiting the liability to
a tenant, in a law suit, to the assets held in the LLC, i.e. the
individual real property. The creditor should not be able to reach
the owner’s personal assets or the assets in the owner’s
revocable living trust. Moreover, if the real estate in the LLC
is subject to a mortgage, the mortgage would have to be paid off
before the creditor could reach the assets of the LLC. This is a
particularly useful way to protect landlords from the claims of
their tenants. The LLC is the landlord and the lease is with the
LLC. The tenant would have to sue the LLC on any claim they may
have. Recommending the use of an LLC, however, is not to suggest
that the owners should not continue to carry the full level of insurance
protection for their individual rental properties. In fact, we suggest
that most owners of real estate or businesses, whether or not in
an LLC, obtain an umbrella liability insurance policy for excess
liability to third parties, (including tenants) in the event of
a law suit.
The use of an LLC may be useful in reducing the overall value
of an estate for federal estate tax purposes. Furthermore, the LLC
can be also used to protect the owners from liability arising out
of the property transferred to the LLC. Moreover, in 2004 the Virginia
General Assembly modified the Virginia LLC Act to provide that a
LLC could be set up for non-business purposes, therefore, individuals
could utilize an LLC to hold title to their personal real estate,
for their personal aircraft or water craft, in order to limit the
family’s exposure to the liability arising out of the use
of such property . The Code states: “Every LLC formed under
this chapter has the purpose of engaging in any lawful business,
purpose or activity, whether or not such business, purpose, or activity
is carried on for profit…” In conclusion, using an LLC
for estate planning purposes achieves many of the goals that most
clients will have when planning their estates.
Revised 9/14/05 – ars – D3
Section 13.1-1008 of the Code of Virginia 1950 as amended
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