All About the LLCs
As people accumulate property or businesses, limited liability companies (LLCs) become a regular topic of discussion. In fact, I work with one client who has created four LLCs in just the last two years.
What is an LLC? As the name suggests, it’s a special-purpose company intended to limit your liability, or exposure, to losses should somebody sue you. For example, if somebody falls down the stairs of your apartment complex owned by an LLC, assuming the LLC is structured and maintained properly, the injured person’s damages should be limited to the value of the property in the LLC, rather than your entire estate.
You can put a variety of assets into an LLC, including real estate, publicly traded securities and business entities. The name of the LLC can be just about anything you want as long as someone else hasn’t already secured it. It could be named after your family or trust, or be something simple or creative to keep the owner anonymous. For example, it’s common for real estate LLCs to be named after the address, such as 123 Main St. LLC.
LLCs may be a viable alternative to large umbrella insurance policies. They can also be useful for estate planning and privacy. But an LLC is complex and has its own unique costs, so it definitely requires careful review of your personal situation to see if it’s right for you.
Here’s what you need to know as you make that decision.
Forming an LLC
There are two types of LLC structures: single-member and multi-member. Single-member LLCs are pretty straightforward. You (and your spouse) or your revocable trust own the LLC. You’re responsible for all the taxes and funding of it to cover expenses. Single-member LLCs are typically used to protect assets and your privacy.
Multi-member LLCs are for, obviously, multiple owners of the asset or business. This structure is useful for property owned by several family members, such as vacation homes, or business ventures.
You must also decide where to base your LLC. Often, it will be in the state where the property or business is located. Some states, like California, require you to file if there is any connection to the state (location of property, residency of member/manager). But other states, such as Delaware and Nevada, may offer greater privacy and protection from liability for the owner. Thus, you may be able to file in one of those states instead. Or you could choose to file in two states, if you and your advisors feel its worth the management and extra costs.
Forming an LLC requires:
- Articles of Organization (filed with the Secretary of State)
- An operating agreement
- A manager
- Annual state filings
- Special taxes
- A separate bank account
- Integrity (treating the LLC as a separate entity that is properly maintained and pays its own expenses)
Benefits of an LLC
LLCs offer a number of benefits.
- Liability protection — As mentioned above, one important benefit of an LLC is to limit losses. While an umbrella insurance policy may be able to cover a majority of your potential losses, an unexpected incident could expose your personal assets. The important thing is to consider the level of liability you face. For example, your personal vacation home in Aspen that you sometimes let family use will have less liability risk than a multi-unit rental property. And at some point, depending on the size of your overall portfolio, you just may not be able to get enough insurance coverage or it would be cost prohibitive.
- Privacy — Putting property and business interests in an LLC offers greater privacy. While your personal information behind the LLC may be more accessible in some states than in others, it’s still harder to find than in ordinary public records such as deeds and business licenses.
- Estate planning — An LLC allows you to transfer the value of assets out of your estate, but you can still maintain control of them in some cases. You can even transfer partial interests of the entity to family members or trusts, then those interests can be passed down to heirs or sold. For example, you could divide the interests of a stock portfolio among your children and keep voting control so you can continue to make investment decisions as the LLC manager.
Pitfalls of an LLC
On the other hand, LLCs have certain aspects to carefully consider.
- Costs — LLCs require legal fees to set up, which typically range from $2,000 to $5,000, but could be higher in more complex situations. Then there are annual taxes and a gross receipts tax in some states. In California, for example, you’ll pay an $800 annual state tax, plus potentially between $900 and $12,000 of gross receipts tax.
- Administration — Once you create it, you have to keep up with state filings. And all costs related to that property need to be paid from the LLC’s own bank account, not your personal funds.
- Financing — You may end up paying a higher interest rate for a mortgage or business loan, and some banks are reluctant to lend to LLCs.
Get team advice
Because setting up an LLC involves many components, you’ll likely need the help of an estate attorney. But you should also consult your other advisors including your wealth manager, accountant and insurance agent to be sure you have clarity on all the advantages and disadvantages before deciding whether an LLC is right for you.