Death is one of the things that makes a limited liability company different from a corporation. When a corporate stockholder dies, the stock becomes an asset of their estate. When an LLC owner dies, the transfer on death of the LLC membership interest can get more complicated.
If the LLC operating agreement covers the death of a member, those instructions control what happens. Otherwise, it's up to state law, which may require anything from the deceased's heir inheriting the membership to dissolving the company.
Just like a corporation, setting up a business as an LLC protects the owners from personal liability for business debts. However, an LLC is a much simpler business structure to set up. Unlike a C-corporation, an LLC doesn't pay tax: Business income is divided among the owners, who report it as personal income on their tax returns.
Another corporation/LLC difference is ownership. Corporations can sell stock, then sell more stock, increasing the number of people with an ownership stake. LLCs have to state the number and names of the owners when they file the paperwork to create the company.
An LLC can have a single owner, aka member, though not all states allow this. If there are multiple members, they may all have equal shares in the company. Alternatively, the operating agreement may give members a larger stake if they invest more or contribute more work.
You draw up your LLC's operating agreement when you establish the company. One way to avoid problems when a member dies is to include an LLC operating agreement death clause. This spells out exactly what happens when an LLC member dies.
In a single-member LLC this may not be necessary. If you're happy naming someone in your will as the LLC beneficiary, they can take over the business when you die. If you don't have a will or don't specify who inherits, the LLC may become divided up as part of your estate.
Alternatively, you can name an LLC beneficiary in the operating agreement. If state law allows it, the agreement can set up the transfer on death of the LLC membership interest. A transfer on death avoids probate.
If an LLC has more than one member, your partners may want a say in how you dispose of your membership. Like a single-member LLC, this is something you can and should determine in the operating agreement.
- The membership interest passes to your estate and eventually to your heir. Depending on the agreement they may assume your role in managing the company. This has drawbacks as the other members may not welcome the newcomer.
- The other members buy out your membership. This gives your heirs extra income and avoids the problem of a new, unwanted member. Depending on the agreement, the buyout may be optional or it may be a mandatory requirement.
- The LLC dissolves if one of the members dies. This is an extreme solution, and if the business is doing well, most members would prefer to avoid this option.
- The transfer on death of the LLC membership interest.
If you and your partners didn't cover death in the operating agreement, state law determines what happens when one of the members dies. That's why an LLC operating agreement is essential: State law may not steer things in a direction anyone wants to go.
- In the worst-case situation for a successful business, your LLC dissolves when one of the members dies. If there's no operating agreement and state law says death equals dissolution, the survivors have no choice but to shut the doors.
- The executor for your estate takes over your interest, possibly without the right to a say in management.
- In a single-member LLC, the company may dissolve, or pass automatically to your heirs.
Even if state law delivers your membership to the person you want to receive it, an operating agreement is still a better alternative. That avoids the time and costs of going through probate.