BIG Problem with our LLC family trust

[Querem]

What is the name of your state? Washington State (for the LLC)

A few years ago, my parents in Washington State set up an LLC trust so that my brothers, sisters and me could inherit from our parents with a lot less probate and taxes. (My father passed away about two years ago.) It included mostly stocks and bonds that had been purchased decades ago and had grown a lot in value.

All went well until this past year went a new broker took over the account (which is with a major well-known brokerage). One day, he called my aging mother and persuaded her to change the investments in the LLC and a few other accounts she had into mutual funds. She wasn't even aware that this included the LLC, and though he was just talking about one of the other smaller accounts.

Anyway, he sold her ENTIRE portfolio and used the money to buy mutual funds, assuring her this was a better and safer investment. While that may be so for someone just starting out, what he did cost us about $100,000 in taxes!! -- all of it due last month. Though it was subjected to the IRS 15% capital gains tax, I now live in California which has no special rate for capital gains and had to pay an ADDITIONAL 9.3% (the top personal rate) on almost all of my LLC share.

Our LLC works by having our parents' share decrease a little each year, while ours goes up. It's my understanding that when both our parents are deceased, the value of the investments for tax purposes still in our parent's name will revert to the day of my mother's death (not when originally purchased decades ago). If so, our broker completely undid our LLC's tax strategy, and cost us a fortune.

This broker no longer works for the brokerage, and has left the company (though we still know where he is). In fairness, it was his job to buy and sell a very small percentage of whatever was underperforming in the LLC each year, but what he did seems WAY over the top to me. It took our accountant (unrelated to the broker's firm) quite a while to figure out all the capital gains. I think our broker should have had this done BEFORE he sold everything.

Is this malpractice, and should I be consulting with an attorney?

[Some Random Guy]

Since we are talking with a huge sum of money here, I would suggest talking to the brokerage and a lawyer about the "churning" of your account to generate fees with no benefit to the account holders.

What prior knowledge was the brokerage house given about the LLC's purpose and tax strategy? Were they ever informed that the investments should not hav been touched, or were they just given buy and sell orders?

[anteater]

Out of curiosity, what is an "LLC trust"? And how does it avoid probate and taxes?

[Querem]

The full name of LLC is "Limited Liability Company." Depending on what state you live in, and maybe some other factors as well, either an LLC or and FLP (Family Limited Partnership) is used to transfer assets from one generation to the next while minimizing probate and taxes.

LLC's are more well known as a means to protect business owners from liability. Both the business and family types of LLC's are set up similarly, despite the latter not directly involving running a business. See the LLC article on Wikipedia for futher explanation. (Unfortunately, the FLP article hasn't been written yet.)

Regarding our LLP tax problem, the broker was (and still is) authorized to trade investments in our LLC. He's also supposed to be a finanicial and tax advisor.

The first broker only sold a very small percentage of LLC's assets each each year (i.e. whatever he thought was underperforming or too risky to hold on to.) The next one in 2006, sold the entire portfolio and put the whole thing in mutual funds. He quit recently, and the current broker thought what he did was crazy, but stopped short of saying we should sue the guy.

Basically, the whole thing was sold without ANY regard to the tax consequences. My mother's current share is about 2/3 of the total, and upon her death, the BUY date on the investments in her share would be amended to the date when she passed away (not decades earlier when they were purchased). That makes a HUGE difference in the capital gains taxes. Also, my share was taxed at California's HIGHEST rate (9.3%). This could have been easily been avoided if the selling had been spread out over a period of years. (Washington State has no personal income tax, and everyone involved but myself lives there.)

So, out of the nearly $100,000 in taxes due last month, as I see it, roughly half could have been avoided entirely. The other half would have been due at some point in time as things were sold.

[Querem]

I should also add that LLC's can be set up either with or without an accompanying trust, though the combination of the two can be tricky. Be sure to seek professional advice.

Ours is with a trust, but the tax problem mentioned previously was exclusively in the LLC. The trust itself didn't make a bit of difference in this case.

[Querem]

Update. Our attorney is sending the former broker a letter asking compensation for a sizeable portion of the taxes. Basically, there's three different sets of taxes that have to be dealt with separately. For the federal taxes that my brothers & sisters and me paid, this would be due anyway as the stocks and bonds were sold, so we're not asking that he pay for this. Of course, we’re not happy about our huge tax bill a couple months ago, but we'd have to pay it eventually. This is from the portion of the LLC that had been already been transferred to us from our parents.

For my California taxes (same basis as above), we’re asking that he reimburse me for everything in the tax brackets above what I otherwise would have paid. California has the highest capital gain taxes in the nation, and it’s mixed together with all your other income. I was in the 4% bracket, so for everything taxed at 6%, 8%, and 9.3% (most of it), he’ll have to make up the difference. This could have been avoided by not selling everything in the same year.

We’re also asking that he reimburse my mother’s LLC taxes. As explained before, this is due to the BUY date on the capital gains reverting to the date of her passing away in the future. Now for the complicated part: Each year, my mother’s share of the LLC is reduced very slightly. This is passed on the next generation (including myself), and is NOT taxable in and of itself. It only increases our potential tax liability in the sense that our share of the LLC becomes a tiny bit bigger. Thus, the longer my mother lives, the small her share of the LLC is, and less tax impact from the broker selling everything last year (i.e. we’d have to pay when we sold it). About 25% of this part of the settlement will have to be placed in an FDIC insured escrow account which pays 3% annual interest (more if inflation heats up). A very small amount of this will be refunded to the broker each year that my mother is still living based of her LLC share declining. However, she’d have to live past 110 years for him to get back all of the 25%! With the other 75% gone for good (and probably more), this will undoubtably be a rather expensive lesson for him. Nevertheless, it will be nice to know our ex-broker quite literally has a vested interest in my mother living a long life.

[tranquility]

Unless there are other facts involved, I think the odds of you getting much money from the broker are low. Your mom gave permission for the sale and had the right to do so. While "churning" can sometimes be a problem which is compensable, that's not what happened here. Also, stocks go up and they go down. I don't think you can claim a tax loss damage by using the value when sold and calculate the tax savings if you would have received a step-up in basis at some future date.

Good luck with the suit. I don't think there is going to be a big pot of money sitting at the end of this complex rainbow.

[Querem]

So far, this is just a letter from our attorney to our ex-broker, with no court or formal suit involved. We’ll have to wait and see if and how he responds.

The basis of us going after him for the money, is that part of his job was as a “tax advisor.” Obviously, he didn’t give any consideration to the tax consequences at all. This really has nothing to do with the price of stocks going up and down or something that could not be foreseen. All he had to do was get an accountant to calculate the capital gains, then ask us if we really wanted to pay almost $100,000 to switch to mutual funds. As stated previous, about half of that would be due someday in the future regardless. The other half is lost to the government, but could have been avoided by not selling until my mother passes away.

My mother and the rest of us feel we were not properly informed of what the broker wanted to do and how much it would cost. Apparently, he was after a big commission, and didn’t manage the account properly.

[tranquility]

The basis of us going after him for the money, is that part of his job was as a “tax advisor.”

No, your tax advisor is your tax advisor.

This

really has nothing to do with the price of stocks going up and down or something that could not be foreseen.

Therein lies a big part of your problem, what are your damages? Heck, selling now may have been a *good* thing.

All he had to do was get an accountant to calculate the capital gains, then ask us if we really wanted to pay almost $100,000 to switch to mutual funds.

This is exactly what mother should have done before approving the sale. The broker does not have a duty to do this. Think about it, the broker has an idea, runs it by legal and accounting professionals and finds it was not going to fit into your financial plan. Does he get to send you a bill for the cost?

As stated previous, about half of that would be due someday in the future regardless. The other half is lost to the government, but could have been avoided by not selling until my mother passes away.

As I said, stocks go up and stocks go down. You may not have "lost" *anything* to the government if they went down enough in your waiting for the step-up.

My mother and the rest of us feel we were not properly informed of what the broker wanted to do and how much it would cost. Apparently, he was after a big commission, and didn’t manage the account properly.

Obviously that's your claim. However, brokers usually have a duty to not get people into situations/investments they don't understand. (Stradles, short sales, etc.) Buying a mutual fund is not a complex transaction. I don't get involved with securities work much, so don't express an opinion, but I don't see a great chance for much compensation here. Even if you can find liability, you have a very speculative amount of damages.

[chitown]

Forget about the individual broker, go after the Brokerage House the broker was an agent/representative of for your damages. Let them go after their former employee after that. Depending on the size of the Brokerage House they may quickly settle for a percent you're seeking just to avoid a potentially long, expensive and PUBLIC trial. GL

[tranquility]

I find it unlikely there will be a trial. Most large brokerages have an arbitration agreement with clients. Also, think about reading the business pages. How many stories have you read about lawsuits by individual investors against the brokers? Unless the brokerage business is the cleanest busines in history, brokerage disputes are not that newsworthy.