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Structuring an
Offshore Multi-Member LLC to be taxed as a
Single Member LLC
The Best of
Both Worlds: Structuring an
Offshore Multi-Member LLC to be taxed as
a Single Member LLC
One advantage of a single member
LLC (SMLLC) is that it generally files no
entity-level income tax return. However, a
multi-member LLC provides enhanced charging
order protection. Thus we have an apparent
dilemma: we seem to be forced to choose between
the less cumbersome filing requirements of an
SMLLC, and the enhanced protection of a
multi-member LLC, which is required to annually
file IRS form 1065. Fortunately there is a way
to get the best of both worlds.
Enter the Disregarded Entity
Multi-Member LLC (DEMMLLC.) This is a
multi-member LLC that is taxed as a disregarded
entity instead of a partnership.1
A DEMMLLC is created by
structuring an LLC so that, although it has more
than one member, all underlying tax
liability lies with a single individual. To do
this, one uses a (preferably irrevocable)
grantor trust or another SMLLC as an additional
member. In the case of a grantor trust, the
grantor is the same person as the original LLC’s
first member, however the fact that a
trustee is now involved (who should hold
discretionary powers so as to hold voting
rights within the LLC) makes the trust “count”
for determining whether this LLC has
the enhanced charging order protection of a
multimember LLC. In the case of using a
second SMLLC, the member of this second LLC should be the same person as the
first member of the first LLC, and ideally this
2nd
LLC should have a manager other than
its member. This manager, therefore, would also
be able to have a ‘vote’ in regards
to how the first LLC is run. Thus in both
instances we have at least two people who may
vote as LLC members, yet only one person with
any underlying tax liability.
The Advantages of Using an
Offshore DEMMLLC
The advantages of disregarded
entity tax status become especially apparent
with offshore LLCs. If an offshore
LLC elects to be taxed as a disregarded entity
(by filing IRS form 8832) then it may avoid
painful tax consequences. For example, U.S.
owners of offshore corporations or
partnerships must have 30% of their share of
company gains withheld and turned over to the
U.S. government. Transfers of appreciated
property to the offshore entity may result in a
35% excise tax being assessed on any
appreciation. In addition, there may be
additional reporting requirements for certain
offshore entities, such as IRS form 5471 for
offshore corporations with a U.S. citizen who
holds 10% or more company stock. A
disregarded entity offshore LLC avoids all of
the above, other than the requirement to elect
disregarded entity status via form 8832.
In addition to tax savings and
reduced reporting requirements, the DEMMLLC allows for additional planning
opportunities that are not available to SMLLCs
taxed as disregarded entities. For example, a
DEMMLLC will have the enhanced charging order
protection typical of multi-member LLCs if it is
structured properly. Furthermore, a carefully
structured DEMMLLC could allow for a transfer of
a debtor-assignee’s voting rights to a
creditor-assignee of a member’s interest, while
insuring that the LLC’s management could not be
replaced by a the creditor-assignee’s exercise
of his newly acquired power. This would allow a
clever planner to lay a painful trap for any
creditor who obtains a charging order.
Essentially, we could structure a plan so that
the charging order assignee receives no money
from the LLC, but becomes liable for the
debtor/assignor’s share of LLC taxes.2
Because of the obscurity of the underlying law
that allows such a trap to be laid, the creditor
will almost certainly not suspect such a trap
until it is too late. At that point, the
creditor will probably be very eager to offer a
pennies-on-the-dollar settlement!
Footnotes
1 The
possibility of a DEMMLLC is confirmed by IRS
Rev. Ruling 2004-77.
2 See Laying a
Trap to Make a Judgment Creditor Cry “Uncle!”
By W.
Ryan Fowler.
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