Financial investments are fairly dependent on families, as they handle different investment accounts for trusts and individuals. While this creates more administrative burdens, it can also make you miss out on potential fee advantages. It is highly recommended to consolidate the idea into a family partnership or LLC, which helps to streamline management and allows you to navigate modern economic conditions. With such conditions, there can be a higher annual partnership tax return. It requires exploring the lesser-known Internal Revenue Code Section 761(a) that qualifies LLCs to elect out of the partnership tax treatment. Let’s take a better look.
Family Investments
A majority of investors have a hefty amount of family non-qualified accounts, and that needs to be managed. There can be several accounts, including your accounts, your spouse's accounts, your kids’ accounts, family trust accounts, and many others. With multiple investments, it can be difficult to manage all the accounts and to simplify the replicated small investments through multiple accounts; a lot of people focus on creating a limited liability company (LLC) or a family partnership to consolidate all the accounts into a common place.
While it is a common practice to create a trust as part of an estate plan, there can be multiple trusts as well, such as revocable trusts, life insurance trusts, marital trusts, and many others. It is more convenient to consolidate the investment assets from the trusts and turn family members into an entity. Instead of creating a separate investment account for each family member, one investment account through the LLC can be considered a significant simplification. This allows for good returns, and investment and financial management for a single account takes much less time and incurs fewer expenses than handling numerous small accounts.
It is safe to say that utilizing an investment LLC structure offers a simplified and convenient path for investment management and allows reducing the complexities of administration. While this simplified technique can make things easier, there is a potential drawback to it. When an LLC has several members, it is treated as a partnership for income tax purposes, and therefore, a partnership income tax return has to be filed. This disadvantage of the simplification technique of an LLC needs to be studied closely for better financial management.
Consolidation Comes with a Hidden Cost
There is a way to avoid the high tax returns for LLCs, but a majority of professionals are unaware of it. There is a rule for US (not foreign) LLCs where it is considered a partnership when there are two or more members. However, you can elect otherwise. It means an annual partnership income tax return, Form 1065, Schedules K-1, and related state filings; everything is required. In order to make these arrangements, you can find a potential way out with Internal Revenue Code Section 761(a).
This law allows LLCs or partnerships to elect to be excluded from partnership tax. The members of the LLC instead report their respective shares of the income when the exclusion from partnership tax remains valid and effective. They can directly pay their personal income tax returns instead of the computed amount for the partnership.
Who Qualifies for the Election?
In order to qualify under Treasury Regulations, Section 1.761-2, it requires participants to own the investment property as co-owners and should retain their rights separately for taking or disposing of their shares. They cannot actively conduct business and are also unable to sell or exchange any property within the entity. The partnership arrangement must comply with the rules, or else no member of the family would be able to control it.
