To establish a family LLC, you file Articles of Organization with the Secretary of State (e.g., in California, under the Revised Uniform Limited Liability Company Act, Cal. Corp. Code §17701.01 et seq.) and draft an Operating Agreement.
For estate planning, the LLC’s equity is divided into two distinct classes:
Typically representing 1% to 2% of the total equity. The senior generation retains these units, giving them absolute management authority over investments, acquisitions, and pro rata distributions.
Representing 98% to 99% of the equity. These units hold economic rights to distributions but have no management, voting, or liquidation rights.
The senior generation can gift these non-voting units to children, grandchildren, or trusts for their benefit. Because the Operating Agreement restricts transferability (alienation is limited to blood lineage) and requires a supermajority (e.g., 75%) to liquidate the entity, the gifted non-voting units are highly illiquid.
At a net worth below $3 million, the overhead of an LLC—including California’s $800 annual franchise tax, accounting fees for filing Form 1065, and Schedule K-1 distribution—generally outweighs the benefits. At this level, a revocable living trust is more cost-effective. However, for estates exceeding $5 million, the tax leverage of valuation discounts and entity-level asset segregation justifies the maintenance cost.
Upon the death of a member, default state laws often dictate the dissolution of the LLC. To prevent this, the Operating Agreement must explicitly provide for continuity.
A buy-sell agreement does double duty: it provides liquidity to the estate and, ideally, it fixes the value of the business interest for estate-tax purposes so the IRS cannot argue for a higher number. But fixing value only works if the agreement satisfies IRC §2703, “Certain rights and restrictions disregarded”: the price must be a bona fide business arrangement, not a disguised gift to family, and—when family members are involved—the terms must be comparable to what unrelated parties would negotiate at arm’s length. A stale formula price scribbled into an operating agreement a decade ago will not bind the IRS.
The structure also matters more than owners realize, and the Supreme Court just proved it.
The owners individually buy insurance on each other and use the proceeds to buy a deceased owner’s shares. Administratively clumsy with more than a few owners (the number of policies explodes), but clean for valuation.
The company owns the policies and redeems the deceased owner’s shares. Simple to administer—and now dangerous.
In Connelly v. United States (2024), a unanimous Supreme Court held that life-insurance proceeds a company receives to fund a redemption increase the company’s fair market value for estate-tax purposes, and the obligation to redeem the shares does not offset that value. A company worth $3.86 million that collected $3 million of insurance was valued at $6.86 million; the deceased owner’s share was taxed on the inflated figure. The redemption the family thought was tax-neutral generated a six-figure surprise. If you own a closely held business with an insurance-funded redemption buy-sell, revisit it now: a cross-purchase structure, or an insurance LLC or partnership that holds the policies outside the operating company, keeps the death benefit from inflating the estate-taxable value.