Limited Liability Companies are a fairly new legal
development, and a great addition to our asset protection
arsenal. A limited liability company (LLC) is an entity
under state law that offers limited liability to its owners
(known as members), but also allows maximum flexibility
under federal income tax law, as an LLC may choose to be
taxed as a disregarded entity, a sole proprietorship, a
partnership, a C-corporation, or an S-corporation.
Florida passed its first LLC statute about twenty years ago,
but until clarification of the statute occurred about ten
years ago, LLCs did not get much use in Florida. Not all
states allow LLCs.
LLCs may be member-managed, or manager-managed. We typically
prefer manager-managed LLCs for asset protection purposes,
because the operating agreement clearly states that various
and sundry members have limited liability and no control,
and that only the manager may bind the LLC. Member-managed
LLCs may confuse creditors and predators into thinking that
any member may control the LLC.
LLCs are unique in that they offer charging order protection
under Florida law similar to a partnership, but do not lock
the LLC into Subchapter K (partnership) taxation under
federal law.
What is a charging order and how does it protect you? Let's
assume that your daughter was at fault in a car accident.
This is an outside liability, meaning it did not occur
within an entity. The injured party sued your daughter, went
to trial, and won a $1 million dollar judgment against your
daughter. Bless her heart, perhaps your daughter is lovely,
absolutely charming, kind to children and pets, but is not
much of a go-getter, and the only asset your daughter owns
is the 20% of the limited liability company units that you
gifted to her. The assets of the LLC include $1 million of
rental real property.
Logically, your daughter's creditor would think that your
daughter is worth $200,000, and would want to take ownership
of the LLC units away from your daughter in partial
satisfaction of the judgment against your daughter. However,
the injured party cannot take title of your daughter's LLC
units. Instead, your daughter's creditor would have to go
back to court to get something called a "charging order". A
charging order is a piece of paper that says in essence,
"Dear Manager of the LLC. Daughter owes me money. Instead of
writing distribution checks to Daughter, please write them
to me instead. Sincerely, Injured Party."
You as Manager are in charge of what? Determining
distribution checks! So, while the charging order is valid,
what do you do? Don't write distribution checks to your
daughter!
Does this mean that no money can come out of the LLC while
any member has a charging order against him/her? No. You as
manager may continue business as usual. You may pay the
mortgage on the property in the LLC, pay the real estate
taxes, collect rents, loan money, borrow money, pay wages,
sell assets, buy assets-there are many ways to get money out
of an LLC. You just don't want to make a distribution,
because if you did, your daughter's pro-rata share would
have to be paid to your daughter's creditor.
If your LLC is taxed as an S-Corp or as a partnership, under
US Federal income tax law, the LLC files each year an
informational income tax return known as Form 1120-S for an
S-Corp or a Form 1065 for a partnership. The LLC pays no
income tax itself, but is considered a "flow-through
entity". The Form 1120-S or Form 1065 has attached to it
Forms K-1. Each member gets a K-1 that reflects his/her
income tax from the activities of the partnership. Each
partner includes the numbers from the K-1 on his/her
personal income tax return, Form 1040.
And here is the part where you may stand up and sing. While
the judgment creditor holds a charging order against your
daughter, your daughter's judgment creditor gets your
daughter's K-1, and your daughter's judgment creditor has to
include on his 1040 the income tax items as a result of the
activities of the LLC. In other words, although the judgment
creditor is not getting any cash flow because the manager is
not writing distribution checks to the members, the judgment
creditor will have to pay income tax on income attributable
to your daughter from the LLC.
What does this mean in the big picture? If you have your
family wealth tied up in a LLC, it will be much easier to
convince creditors or predators to settle immediately for
whatever cash you offer them rather than fight in court.
Personal injury attorneys are less apt to take on as a
client someone who wants to sue you. If the personal injury
attorney does take the client, s/he likely will counsel the
injured party to settle, and quickly. The personal injury
attorney knows that his client will be the most unhappy
person in the world if the client goes all the way through
trial, wins the trial, goes back to court, gets a charging
order, and then, instead of getting cash, sits around
waiting, and at the end of the year gets a K-1 that means he
has to pay income tax to the IRS. The personal injury
attorney's client now has lost money by winning-and the
personal injury attorney, who most often gets a percentage
of the winnings, has been paid nothing.
LLCs may have only one member. However, single member LLCs (SMLLCs)
may not offer the asset protection that the owner expects.
Do not count on an SMLLC for asset protection!
First, the public policy of a charging order is predicated
on protecting the interests of the innocent member. If there
is only one member, there is no innocent member to protect.
Judges may (and have in other states) disregard the entity
entirely and look to the member individually to satisfy
creditors. Second, SMLLCs very often choose to be taxed
under federal income tax rules as disregarded entities. Our
experience is that SMLLCs very often do not bother to open
up their own bank account. They do not separate their
operations from that of the single owner. They do not have
annual meetings, do not produce financial statements on a
regular basis, and in general, do not respect any of the
formalities of an entity. If you do not respect your entity,
why should the courts? And if the courts do not respect the
entity, the lawsuit has now just breached the LLC veil,
opening up your personal assets to collection in the
lawsuit. Finally, an LLC does not offer an individual person
protection from the individual's negligent acts. If you are
the single member in an SMLLC, and you do something
negligent or heinous, no LLC in the world is going to
shelter you.
Remember also that, for an inside liability, a creditor may
attach the assets within the LLC. We often will suggest
nested LLCs, or multiple LLCs, to limit the amount of assets
available for an inside creditor. For example, if you have
three rental properties, we most likely would recommend that
each piece of real property be placed in its own LLC, and
that the management operations for handling the rentals be
placed in a fourth entity. If someone slips and falls on
property two, he/she only would be able to take property
two, not property one or three, and not the cash that
maintains the properties. |
