Consider a Family LLC to Simplify Investment Accounts
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Simplifying Your Investment Accounts Might Be as Easy as an LLC
There are many options to consider in planning a family legacy. Families tend to manage numerous investment accounts across individuals and trusts which can create administrative burdens. One option to streamline your investments is to consolidate into a family LLC or partnership. A family limited liability company (LLC) is formed by family members to conduct business in states that allow LLCs. Members must be related by blood, adoption, or marriage. The family LLC is a popular way to protect the assets of a family business against claims by creditors. It also serves to divide income among generations and assist in estate planning.
It can be convenient to consolidate investment assets from various trusts into an entity, such as an LLC so that there can be one investment account for the overall family relationship instead of separate investment accounts for every person and family trust. Doing so may facilitate an account being over a certain dollar figure to qualify for investment management fee discounts or break points or aggregate the account to a level where new investment options become available. This can create the need for an annual partnership tax return (Form 1065), adding complexity and cost.
A solution to this is to use Revenue Code Section 761(a), allowing qualifying investment LLCs to elect out of partnership tax treatment with members reporting income directly on their personal returns, avoiding the entity-level filing. To qualify, the LLC must be solely for investment, members must be co-owners with separate disposal rights, and no active business can be conducted. The election requires a specific one-time Form 1065 filing with an attached statement. This simplifies compliance but requires careful legal and tax professional guidance to ensure the LLC’s structure and operations meet the strict requirements for exclusion.
How Can a Family LLC Help?
The Internal Revenue Code Section 761(a) offers qualifying unincorporated organizations, like a Family LLC or partnership, to elect to be excluded from the partnership income tax rules (Subchapter K of the Internal Revenue Code). If the exclusion from partnership tax is valid and remains effective, the members of the LLC (or partners in a partnership) instead report their respective shares of income and other tax items directly on their own personal income tax returns (Form 1040 for individuals and Form 1041 for trusts), rather than having the LLC compute partnership taxable income and file recurring partnership returns. (The extra entity tax filing is avoided entirely at the federal level.)
Not every Family LLC or partnership can qualify. For an investment arrangement to qualify the Treasury Regulations, Section 1.761-2, requires that the participants own the investment property as co-owners, retain the right separately to take or dispose of their shares (membership or partnership interest in the entity), and not actively conduct business. They also cannot irrevocably authorize a representative to purchase, sell or exchange the entity property. Each member must be able to compute his, her or its income without the organization first computing partnership taxable income.
Once effective, the election generally remains irrevocable while the organization continues to qualify, unless the IRS approves the entity’s revocation of the election out of partnership tax reporting. Using an entity, like a Family LLC and the special election to avoid a tax filing for that entity can be a valuable housekeeping tool for the right family investment arrangement. Used carefully, the election may preserve the benefits of consolidated investment management while reducing recurring compliance expense and administrative burden. Contact our office to discuss this option for your family.