John K. McGill, JD, MBA, CPA Andrew Tucker, JD, CFP
It's no secret that owning your office building in a limited liability company (LLC) simplifies building ownership and creates a layer of asset protection between you, your business, and your building. However, an office building LLC can also serve as a powerful tax-planning tool for doctors seeking to slash estate and income taxes, all while maintaining management authority over the assets. Here are four reasons why your office building LLC could be one of your most powerful wealth-planning tools.
1. Shift unearned income.
Have a child in college? A doctor with an office building LLC can gift a portion of the ownership interests in the LLC to his or her children, shifting the income to the child's tax return. From ages 18 to 23, as long as the children generate more than 50% of their support from their own earnings, all unearned income generated by their LLC interests will be taxed at the child's rate (typically 10% to 15%). Furthermore, transferring additional investments into the LLC is an excellent way to reduce or eliminate the 3.8% Medicare payroll taxes on the doctor's personal investment income. Likewise, transferring appreciated stocks, bonds, or real estate into the LLC prior to the sale can eliminate federal income taxes on the capital gains and dividends, since a 0% capital gains tax rate applies for those in the 10%-to-15% tax bracket.
2. Have your LLC engage in new business ventures.
Rather than entering into new ventures personally, have the LLC undertake the business opportunity with cash flow generated by the LLC. This accomplishes two goals. First, the doctor can slash income taxes since any income attributed to the children through their LLC interests will be taxed at the child's rate, as long as you follow the rules above. Moreover, at death, any interest owned by the children is excluded from the estate of the doctor, meaning it will not be subject to the estate tax. By carefully planning how to participate in new ventures before entering into them, a doctor can grow assets outside of the estate without using any of his or her gift exemption.
3. Divert expected inheritances to the LLC to avoid estate taxes.
Are your anticipated inheritance and net worth in excess of the estate tax limit? Work with the anticipated benefactor to direct some or all of the inheritance directly to the LLC. This may require a considerable amount of work with an accountant or attorney. The prototypical LLC arrangement for estate-tax planning involves the doctor making gifts of LLC interests to children and retaining a 5% interest in the LLC. However, the dividends for this strategy can be huge. For every $1,000,000 diverted, doctors can expect to save their own estate over $400,000 in federal estate taxes.
4. Protect assets in a divorce.
When assets are contributed to an LLC and 95% of the LLC interests are gifted to children, those assets are removed from the financial statement of the doctor who made the gift. In the event of divorce, only the 5% management interest owned by the doctor is included in the marital assets to be divided in the divorce. Meanwhile, the doctor retains control over the remaining LLC assets due to his or her ongoing status as a managing member.
When executed correctly, these strategies have the potential to create a tremendous amount of income tax and estate tax savings. Transferring membership interests in an LLC is complicated, and the gift tax consequences must be considered prior to transferring the interests. As a result, doctors should consult with an accountant or attorney before attempting to implement any of the strategies mentioned in this article.
Andrew Tucker and John McGill provide tax and business planning for the dental profession and publish the McGill Advisory newsletter through John K. McGill & Company Inc., a member of the McGill & Hill Group LLC. The McGill and Hill Group is your one-stop resource for tax and business planning, practice transition, legal, retirement plan administration, CPA, and investment advisory services. Visit www.mcgillhillgroup.com.
