By Leo J. Cushing
Background
Limited liability companies clearly
are the entity of choice, particularly in cases where holding real estate is
involved.
By way of background, Massachusetts
first introduced limited liability companies in 1996.
As a result of a 2003 amendment, single member
LLCs became permissible.
Single member and multi-member
LLCs are clearly superior to other entity choices, including S corporations,
Massachusetts Business Trusts and nominee or “realty” trusts. For example, contributions of appreciated
property to limited liability companies are income tax free. More
importantly, distributions of appreciated property from an LLC to its owners
are generally income tax free. This is a particularly significant benefit,
inasmuch as a distribution of appreciated property from an S corporation will
be a taxable event.
Liability and Income
Tax Advantages
By statute, each member of an LLC
has limited liability. A single member LLC
does not file a separate income tax return.
Rather, all items of income, expenses, deductions, and credit are
reported to the owner on the individual income tax return for both federal and
state purposes.
Multiple Properties
In cases in which there are
multiple properties, it is common to form a parent LLC and have each of the
separate properties owned by a separate LLC.
Each separate title-holding LLC will be owned by the parent LLC. The separate, single purpose LLCs, which own
separate properties, are single member LLCs that do not have a separate income
tax filing obligation. Of course, each
LLC must pay the $500 annual filing fee.
Tax Filing Obligations
All income will be reported on
the parent LLC and, in such a case, if the parent LLC is a single member LLC,
all items of income, expense, deduction, and credit will be reported on the
individual’s owns personal income tax return.
Multi-member LLCs are treated as partnerships. No income taxes are paid at the entity
level. All items of income, expense,
deduction and credit will pass through to the members and will be taxed in
accordance with the partnership rules of Subchapter K of the Internal Revenue
Code.
Gifting of LLC
Membership Interests
LLCs are used extensively for
estate planning. In a typical case, a
senior family member will form an LLC and contribute substantial real estate
holdings to it. Thereafter, the senior
family member will transfer by gift LLC membership interests. These may be voting or nonvoting and could
represent a small or significant portion of the LLC-using non-voting shares. To
the extent that the membership interest transferred is either a minority
interest or non-voting shares, the gift tax value of the interest will be
discounted. This is because the interest
is nonvoting and nontransferable.
In the case of Pierre v. Commissioner, 133 T.C. 2 (2009), the IRS argued unsuccessfully that
the LLC should be disregarded and that the transfer of a membership interest
was essentially a distribution of the underlying asset to the transferor, a
gift by the transfer or to the transferee with a recontribution of that asset
by the transferee, and, as a result, no discount would be allowed. This was rejected by the Tax Court.
Changing Domicile
Limited liability companies are
also useful to minimize Massachusetts estate taxes in connection with a change
in domicile. Massachusetts residents are
subject to an estate tax that can be as high as 16%. For this reason, many Massachusetts residents
consider changing their domicile to Florida, New Hampshire or some other state
that does not have a state death tax.
Aside from the need to comply
with the various regulations in terms of changing voting registration, driver’s
license, physicians, and the like, it is also important to deal with
Massachusetts real estate that the taxpayer may own. The reason for this is that nonresidents are
subject to the Massachusetts estate tax based on a formula.
The computation involves first
computing the amount of the state death tax that otherwise would be due if the
Florida resident was a Massachusetts resident, and then multiplying that amount
by a fraction, the numerator of which is Massachusetts real estate and other
tangible personal property located in Massachusetts with the denominator being
the decedent’s adjusted gross estate.
G.L. c. 65C, § 4(g).
If we assume that a single
taxpayer dies with an estate of $5,000,000, which would be nontaxable to a
Florida resident, and we assume that 50% of the property is Massachusetts real
estate, then the Commonwealth of Massachusetts would be entitled to $195,800,
computed as follows:
Total tax due assuming decedent was $2,500,000
a Massachusetts resident: $391,600 x $5,000,000
= $195,800
If the Massachusetts property was
transferred to an LLC in connection with a change in domicile, even if the LLC
is owned by the Florida resident, the numerator would be zero since the LLC is
an intangible and not real estate. See Estate of Nielson v. Commissioner, Docket No. F232365; (Appellate
Tax Bd. Feb. 15, 2001) (stating that partnership interest not taxable, but
interest in realty trust taxable for Massachusetts estate tax purposes).
This planning opportunity has
been addressed by a number of states, most recently New York. In an advisory opinion, the New York State
Department of Taxation and Finance concluded that real estate owned by a single
member LLC will not be considered an intangible unless it elects to be taxed as
a corporation.
It is likely that other states
will follow suit but not likely in Massachusetts because the LLC statute
provides that an LLC interest is personal property and a member has no interest
in specific LLC property. Also, this issue was addressed in a DOR regulation, 830
Code Mass. Regs § 65C.2.1, which was repealed in its entirety as being obsolete
in 2014.
Avoiding Excise Stamp
Taxes
General Laws c. 64D, § 1,
imposes as stamp/excise tax on the sale of real estate; the amount is $4.56 per
$1,000 of sale price and is payable by the seller. Massachusetts has not taken the position that
a single member LLC is a property interest, at least for purposes of imposing
the $4.56 per $1,000 stamp tax. In
theory, then, this would permit a taxpayer to transfer their property to a single
member LLC and then sell the membership interest to avoid paying the $4.56 per
$1,000. See DOR Directive 95-5 (a sale
of benefits interest in a Massachusetts nominee trust is subject to the stamp tax).
Single Member LLC and
Asset Protection
One important asset protection
benefit to an LLC is the statutorily-limited remedy of a creditor to a
so-called charging order. See G.L. c. 156C,
§ 40. Generally, this means that unlike
an interest in another type of entity, the interest cannot be taken to satisfy
a judgment creditor. A word of
caution: this benefit does not exist in
the case of a single member LLC.
Conclusion
This article only scratches the
surface of the complex and vexing issue, not yet settled in all jurisdictions,
on whether a single member LLC is an intangible or an interest in real
estate. However, it is widely recognized
that for holding title to real estate, the limited liability company has
supplanted all other entities.
The founding partner
in the Waltham-based firm of Cushing & Dolan P.C., Leo Cushing has written
and lectured extensively on all aspects of taxation and estate planning. He also co-chairs REBA’s estate planning,
trusts and estate administration committee.
Leo can be contacted by email at lcushing@cushingdolan.com.
