Statutory employees with W2 income have fewer tax planning tools at their disposal than business owners. Generally W2 employees are pretty limited in their available tax deductions – (1) Home mortgage interest taken on Schedule A (2) Salary deferral into a employer’s 401(k) plan (3) Charitable contributions on Schedule A (4) Unreimbursed employee expenses. A number of itemized deductions are subject to phaseout or are preference items for the alternative minimum tax calculation. What can you do if most of your income is salary and bonus from your employer?
The Charitable Limited Liability Company (LLC) is a single member LLC established in a state like Nevada or Delaware. The business purpose for the LLC is the consolidation and management of investment assets. This business purpose is valid for state law purposes as well as federal tax purposes. The taxpayer has established a legitimate business that is no different than setting up an internet business, home business or plumbing business. The LLC may last one or multiple generations for the benefit of the taxpayer’s family. The Charitable LLC technique is a long-term philanthropic tax strategy for the reluctant donor.
The taxpayer contributes cash or marketable securites or some other capital asset to the LLC. The taxpayer retains a one percent managing member interest in the LLC and contributes up to a 99 percent interest to one or more public charities (aka 501(c)(3) organization. The taxpayer can also donate the LLC interests to a donor advised fund which is a form of public foundation or charity.
The taxpayer is able to take a deduction up to 50 percent of adjusted gross income on Schedule A of the Form 1040. Any deduction amount that exceeds 50 percent of AGI may be carried forward for use in the following five tax years. If the gift exceeds 5,000, the taxpayer must complete Form 8283 which is a certified valuation of the gift – the LLC interest. The gift is not subject to the Alternative Minimum Tax (AMT). The gift is a completed gift for tax purposes and fully eligible for an income and charitable gift tax deduction. The gift to the public charity is memorialized with a gift letter issued by the public charity.
As managing member of the LLC, the taxpayer retains full management control and discretion over the LLC assets. This control allows the taxpayer to control investment of the LLC assets. This control allows the taxpayer to determine when distributions should be made to the charity as a LLC member. This control allows the manger to decide how much to distribute to the charity on an annual basis. The LLC’s operating agreement provides the manager with a signficant amount of discretion including the ability to make loans to the Manager or Manager-controlled entities using LLC assets. These loans must be arms-length loans with an interest rate equal to or greater than the applicable federal rate based on the term of the loan. Therefore, the Manager could make an investment for the LLC by making an arms-length loan to himself ort an entity that he controls. This loan might provide premium financing for the purchase of life insurance. The LLC might make a loan as a LLC investment for a real estate acquisition by the Manager personally.
What is the tax result or benefit of the charitable donation of LLC interests to a public charity.
(1) Income tax deduction up to 50 percent of AGI.
(2) Carryover of excess deductions for an additional five tax years.
(3) The majority of the LLC income (99%) is tax-free.
(4) The majority of the LLC assets (99%) are outside of the taxpayer’s taxable estate.
(5) Taxpayer retains management control over the LLC and LLC assets.
(6) The taxpayer as manager continues to manage the LLC assets.
(7) The taxpayer as manager is able to retain full discretion over the distribution of income to the public charity. How much? When?
(8) The taxpayer as manager is able to earn a management fee. The taxapyer may defer the management fee on a tax deferred basis.
(9) The LLC assets are protected (99%) from the claims of the the taxpayer’s personal creditors.
(10) The charity in entitled to annual distributions at the discretion of the Manager. When the decision is made to liquidate the LLC, the charity will receive 99% of the LLC’s assets. The taxpayer may replace this wealth through the purchase of life insurance in an irrevocable life insurance trust (ILIT) with the smith children and grandchildren as beneficiaries of the ILIT.
Bob Smith, age 40, is a managing director at Silverman Sox, the investment banking firm. His salary and bonus income in 2011 is projected to be $1 million. Bob lives and works in New York City. His combined federal, state and city income tax bracket is 47%. He has had $500,000 withheld in taxes in 2011.
Bob forms Smith Investment Holdings, LLC, a Delaware single member LLC. He contributes $500,000 of cash and marketable securities to the LLC. Bob retains a one percent managing member interest and donates a 99 percent interest in the LLC to the Army Powerlifting Team at the United States Military Academy. The valuation of the LLC interest on Form 8283 reflects a ten percent discount for lack of marketability and control. The gift for tax purposes is valued at $450,000. the deduction is taken on Schedule A of Form 1040. The tax benefit is $211, 500.
As managing member, Bob will manage the LLC’s investments in a balanced investment portfolio. He plans to make annual distributions of $15,000 to the Army Powerlifting Team to fund the team’s participation in the NCAA Championship meet each year. Bob retains a management fee of $15,000 per year but elects to defer recognition.
All of the LLC’s income (99%) is earned on a tax-free basis. The LLC assets are beyond the control of Bob’s personal creditors. Bob submits a new W4 to his HR to reduce his tax withholding in 2012. Instead, he will fund the LLC with additional capital contributions and elect to issue and donate additional LLC interests to Army Rugby.
It is all charity! Either you donate your money to charity or the Government will take your money and donate it public programs. The Charitable LLC technique is a long-term philanthropic strategies to accumulate assets for public charity while retaining management control over the investment and disposition of those assets. The LLC assets will accumulate over time to a substantial level providing for a large ultimate endowment to the charity in the future. The value of the deferred management fee will also be substantial in the future. It may be the most useful tax planning technique beyond the available limits of qualified retirement plans limits – 401(k) deferrals- for the statutory employee.
Over the coming days, I will show how the Charitable LLC can work effectively using all kinds of capital assets.
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