Articles Posted in Estate/Business Succession Planning

Family Cabin
It might come as a surprise to non-Hoosiers that several parts of Indiana are popular locations for vacation cabins.  The best known are probably Brown County and the area around the Indiana Dunes.  Other locales include Lake Maxinkuckee, Lake Monroe, and Lake Patoka; the Amish country and the smaller lakes of northern Indiana; the wooded hills in other parts of southern Indiana; and the small towns on the northern bank of the Ohio River.  Saving the Family Cottage:  A Guide to Succession Planning for your Cottage, Cabin, or Vacation Home, by Stuart J. Hollander, David S. Fry, and Rose Hollander, 4th ed., 2013, is an excellent resource for owners of family vacation homes or other property to be preserved for shared use by future generations.  However, the principles are not restricted to leisure property.  For example, owners of family farms will also find useful advice for keeping the farm in the family for generation after generation.

One of the central concepts of Saving the Family Cottage is to avoid problems of real property owned jointly by several individuals — a situation that, of course, can arise when property is passed from one generation to the next. When property has multiple owners, disagreements between them can result in the property being partitioned. For some types of property, such as undeveloped land, the partitioning may mean that the property is divided into multiple parcels, like cutting a pie into pieces, with each owner receiving a piece of the whole.  In other cases, such as a vacation cottage, a dispute may result in the property being sold and the proceeds divided among the owners.

The authors’ primary solution to that problem — one that we and many estate planning attorneys heartily endorse — is to create a limited liability company to be owned by the family members and to transfer ownership of the property to the LLC. One reason is that transferring ownership of LLC interest from one person to another, unlike transferring ownership of real property, is generally not a matter of public record. A more compelling reason is that the law provides very few rules to govern the relationship between multiple owners of real property (or most personal property, for that matter) and very few mechanisms for resolving disputes that do not result in the termination of the joint ownership.  In contrast, the flexibility of LLCs (which we have touted in this blog multiple times) permits the owners to decide in advance who will make decisions concerning the property and how they will be made and how disputes among heirs will be resolved while keeping the property in the family.

iStock_000017700348Small.jpgOwners of Indiana LLCs (and their lawyers) can learn some lessons from a recent case involving an Alabama LLC. The case is L.B. Whitfield, III Family LLC v. Virginia Ann Whitfield, et al.

The Whitfield Case

L.B. Whitfield, III owned half of the voting stock in a business that had been in his family for generations. The other half had belonged to L.B.’s brother, who died and left the stock to a trust for the benefit of his son.

L.B. had four children, his son Louie, and three daughters. After his brother’s death, L.B. became concerned that the 50/50 voting balance might be disturbed if, after he died, his stock were to be divided among his four children. To prevent that from happening, L.B. created a manager-managed Alabama limited liability company to hold his half of the voting stock. L.B. was the sole member, and he and Louie were the two managers. His will provided that his interest in the LLC would pass to his four children in four equal shares.

After L.B. died, Louie continued as manager, and the four children were treated as members of the LLC, with each of them holding 25% of the interest in the LLC. About 10 years later, a dispute arose between Louie and his sisters, and the dispute escalated into litigation. Ultimately, the litigation was resolved on a theory that was not argued in the original pleadings and apparently did not even occur to the parties’ lawyers until several months into the case.

The Alabama Supreme Court noted that L.B. had been the sole member of the LLC and that, after he died, the LLC had no members. Although L.B.’s will gave his children equal shares of his economic rights in the LLC (his “interest”), economic rights in an LLC and membership are two different things, and the will did not make his children members. The Court further noted that, under the Alabama LLC statute, a limited liability company that has no members is dissolved and its affairs must be wound up, a process which includes payment of its debt and distribution of its remaining assets to the holders of interest in the LLC. Accordingly, the Court held that the assets of the LLC should be distributed in four equal shares to Louie and his sisters.

Interestingly, the Alabama statute provides a way that L.B.’s heirs could have become members and avoided the dissolution of the LLC, but they had to do it by mutual written agreement within 90 days of L.B.’s death, and there was no such written agreement.

How does it work in Indiana?

If the Whitfield case had involved an Indiana LLC, the results might well have been the same. Unless other provisions (discussed below) have been made to avoid the result, when the single member of an LLC dies, that member will be dissociated (i.e., will cease to be a member, Ind. Code 23-18-6-5(a)(4)), the LLC will have no members, and, as a result, it will be dissolved, at least if the LLC was formed after June 30, 1999, (Ind. Code 23-18-9-1.1(c)). As a result, the member’s heirs will not receive an ongoing business; instead, they will receive only the rights to receive distributions from the dissolved LLC after all obligations are satisfied — which may be far less valuable than the business would have been as an ongoing concern.

Note that there are other scenarios that can create a similar result. Under Ind. Code 23-18-6-4.1(e) (which applies only to LLC’s formed after June 30, 1999), a member who assigns her entire interest to another person ceases to be a member. If the person making the assignment is the sole member, the person who receives the interest can become a member under Ind. Code 23-18-6-4.1(b), which provides that the person who receives the interest can become a member “in accordance with the terms of an agreement between the assignor and the assignee.” But what if there are no such terms? What if the agreement simply says, “Seller hereby assigns her interest in the LLC to Buyer,” but doesn’t mention membership? In that case (unless the operating agreement already deals with the situation some other way), the LLC will have no members, and it will be dissolved. In other words, the person who thought he bought an ongoing business may well have bought only the rights to receive distributions from a dissolved LLC.

Now, what if there are multiple members and one of them dies? In that case, the LLC is not dissolved, at least not if it was formed after June 30, 1999, but the member’s heirs may not become members. Although they may inherit the deceased member’s interest (i.e., rights to receive distributions), they will become members (and therefore have the right to participate in the management of the company), only if the operating agreement makes them members or the other members unanimously consent.

What should you do?

If you own an LLC, or if you own part of an LLC, and these possibilities make you uncomfortable, you need a business succession plan that includes two different components. First, it should include appropriate estate planning tools to make sure that your economic interest in the LLC goes to the people you want to taken care of after your death. For example, you may want to designate a transfer-on-death beneficiary to inherit your interest in the LLC. Second, the LLC should have an operating agreement with appropriate provisions to ensure that your heirs benefit not only from the right to receive distributions from the LLC but also receive the other rights of membership, including the right to participate in the management of the business. There are different ways to do that; an attorney with experience in business succession planning, particularly with Indiana LLCs, can help you choose the best one for you.
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100_3698.JPGEarlier this year the Indiana General Assembly passed House Enrolled Act 1394, which takes effect today, July 1, and makes several amendments to the Indiana LLC statute, officially known as the Indiana Business Flexibility Act. This is the first of two articles discussing those changes. This first article addresses some amendments that should enhance the use of LLCs for estate planning purposes, and the second will discuss changes that expressly address the use of officers in the management of limited liability companies.

Permissible Purposes for LLCs
With the new amendments, Section 6 of the Indiana Business Flexibility Act now explicitly states that LLCs may be used not only for business purposes but also for personal and nonprofit purposes. For an example of a personal purpose, a married couple who own a vacation cabin and want it to remain in the family after they are gone might place the cabin in a limited liability company and then, by gift, by will, or by other means, transfer the ownership of the LLC to their children or grandchildren. Because the cabin is not used to generate income, the purpose of the LLC is personal, not business.

Although the circumstances in which the IRS will grant an LLC recognition of tax-exempt status under Section 501(c)(3) are limited, the change to the Indiana Business Flexibility Act confirms that Indiana LLCs may be used for those purposes.

It is debatable whether the amendment actually expands the purposes for which an LLC may be used because the prior language was in fact quite broad; however the new language reduces the uncertainty behind permissible purposes by expressly authorizing personal and nonprofit purposes.

Transferring LLC Interests to Heirs
There are two other changes that should increase the use of LLCs for estate planning, both to Section 10 of the Indiana Business Flexibility Act. One of the changes expressly permits LLC interests to be held in what is known as “joint tenancy with right of survivorship” or simply a “joint tenancy.” A joint tenancy involves two or more people who both own property but with one key difference from other forms of common ownership: the right, upon death of one of the tenants, for the remaining tenant(s) to take the entire property as an undivided whole. In a simple scenario, two spouses own a home as joint tenants – when one dies, the other takes title to the entire home — without going through the sometimes costly probate process.

The other change expressly permits LLC interests to be held as Transfer-upon-death property. This simply means that upon the holder’s death the member interest can pass to one or more named beneficiaries, again without having to go through probate. However, unlike joint tenancy, the beneficiary does not own any interest in the property until the death of the original owner.

Estate Planning with the New Amendments
Historically, a corporation was the standard entity of choice for businesses, and limited partnerships have been one of the frequently used tools of estate ploanning. In recent years, however, LLC’s have overtaken corporations in popularity for businesses. With changes such as the ones to the Indiana Business Flexibility Act, LLCs may also replace limited partnerships in popularity for estate plans.
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On June 26, 2013, from 11:00 am until 12:30 pm EDT, I’ll be teaching a National Business Institute teleconference seminar, “What Estate Planners Need to Know About LLC Formation.”

Limited liability companies are incorporated more and more frequently into estate plans. A common structure is a limited liability company owned by a living trust, with a business or other assets held by the LLC. The living trust provides the mechanism for the business or other assets to be passed to the grantor’s heirs without going through probate, and the LLC provides a liability shield to protect the grantor’s other assets from creditors with a claim against the LLC. Another common estate planning tool is a family limited partnership, and a limited liability company can often be used to serve the same purposes while providing additional advantages.

The seminar is designed (surprise!) for estate planners who want to know more about the issues associated with creating and setting up LLCs. Click here to register for the seminar.
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