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Limited Liability Company – Questions and Answers
Asset Protection Planning
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Limited Liability Company – Questions and Answers

Asset Protection Planning

By Michael B Mangini, J.D.

 

 

Question 1: Should I consider using an LLC to protect my assets?

Answer: Whether or not an LLC is right for you depends on what you own, how you own it, your willingness to part with control, and your level of risk. It is beneficial to hold investment assets within an LLC. I would not suggest putting personal use property into an LLC. For example, if you own rental real estate outside of an LLC, e.g. in your name alone, the property and your other assets are open to attack from two directions. First, if a person is injured on the property and the judgment exceeds insurance coverage limits, the plaintiff may seize the real property or your brokerage and bank accounts to satisfy the judgment. Second, if a plaintiff sues you for something totally unrelated to the property and wins, the plaintiff may seize the property to satisfy the judgment. If the property were held in an LLC, the plaintiffs in the two examples above would be limited to what they could seize. In the first example, the plaintiff would be limited to satisfying the judgment out of the value of the rental property; he could not seize your personal assets. In the second example, the plaintiff could not seize the rental property; his only remedy would be a charging order against distributions that the LLC makes to you. If the LLC makes no distributions, the plaintiff gets nothing. The plaintiff cannot seize your membership interest.

Question 2: The LLC looks like a strong tool; are there risks?

Answer: There are always risks. (1) If the plaintiff can prove that the injury was due to your personal negligence, rather than to the negligence of someone you hired, he might sue you directly and get at your personal assets if he wins. This is why it’s usually better to hire a management company, employee, or independent contractor to work on investment property. (2) If you fail to respect the entity, a plaintiff might pierce the veil of protection and seize the asset held within an LLC. Some clients are just unable to see that they and the LLC are two different “persons” under the law. They use the LLC bank account as their own, they treat the property as their own, they fail to obey the terms of the operating agreement, and just generally ignore the LLC. In these cases, why should the plaintiff and judge respect the entity? (3) There is a Colorado Bankruptcy case that ignored a single-member LLC for asset-protection purposes. The judge opined that the statute was intended to protect innocent members from the consequences of a culpable member’s acts; since there was only one member, the culpable one, the judge denied LLC protection. This is why you may want to consider giving an interest in the company to someone else.

Question 3: To whom may I give LLC membership interests?

Answer: You can transfer membership interests to almost anyone or any entity, including your spouse, children, trusts for children, siblings, trusts for charities, friends, other LLCs, partnerships, and C Corporations. For example, let’s assume that you want to transfer a brokerage account into an LLC. You create the LLC and change the ownership of the account. You then create trusts for your children and transfer LLC membership interests into the trusts. The trustee exercises the rights of ownership on behalf of the children. You may manage the company or hire an independent manager. The income and dividends may be reinvested or distributed to you and the trusts for your children. The percentage of income and dividends that the trusts receive depends on the percentage of membership interest you transferred to them.

Question 4: What is a charging order?

Answer: The only remedy a creditor has against a debtor/LLC member is to obtain a charging order entitling the creditor to the debtor’s share of any actual current or liquidating distributions. The right to a charging order replaces any other method of attachment or garnishment otherwise available to the creditor with respect to the debtor/LLC member. Some courts have held that a partnership interest can be sold to satisfy the claims of a creditor when the charging order fails to do so, but the New Jersey LLC statute declares the charging order as the sole remedy.

Question 5: I know that I can form an LLC online by myself. Why do I need a professional advisor such as an attorney?

Answer: True, you can form the company online, but the mere existence of the LLC offers little protection. A professional can draft the Operating Agreement to include the provisions you want and need and can monitor activities that may cancel statutory protection. You need good documents and procedures to benefit from the statutory protection. Further, you may get significantly more protection from an LLC formed in a different state or country. An advisor familiar with the options can help you make the right decision.

Question 6: What is the difference between an LLC and a corporation?

Answer: The sole remedy of a creditor of a debtor/LLC member is the charging order against distributions. The creditor of a debtor/corporation shareholder may attach and gain ownership of the shares, thus giving the creditor significant management rights. For asset-protection purposes, the LLC is a better structure.

Question 7: Where should I form my LLC?

Answer: The jurisdiction of formation depends on a number of variables that include the nature of the asset, your goals, your comfort level, the laws of the various jurisdictions. With the Colorado bankruptcy court case that pierced a single-member LLC, a foreign LLC might be better than a domestic. If you are going to fund the LLC with real property, a local LLC might offer the same benefits as a foreign LLC. If the state where you live permits a creditor to attach your membership interest, you should consider forming the company in another state or country.

Question 8: May I put my personal residence in an LLC?

Answer: You may, but it might not be a good idea. First, you will lose capital-gains tax benefits. Second, if you fail to pay fair-market rent you will probably lose any protection. Third, a judge might look unfavorably on someone who has transferred all assets, including a personal residence, into protected entities, find that you made fraudulent transfers, and disregard the entity.

Question 9: May I use an LLC as a 3rd-party, asset-protection device?

Answer: Yes. One situation where the LLC might be helpful is when a child for whom you have funded a custodial account is reaching the age of majority (18 or 21). You can invest the custodial account funds in a family LLC into which you also have contributed funds. Your child will be a member; you will be a managing member with decisions over distributions. Thus, your child will not get control over the money at 18 or 21.

Question 10: Will I become personally liable for the liabilities of the LLC?

Answer: No member of an LLC is personally obligated for any debt, obligation or liability of the company, or for any debt, obligation or liability of any other member of the company, by reason of being a member of the LLC. However, if you personally assume liability or guarantee a debt, you will be personally liable. If possible, always sign as member or manager, and clearly acknowledge the entity on all correspondence.

Circular 230 disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax information contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. The information contained in this communication is not legal advice and shall not be considered as such. It is for information purposes only. The use of Limited Liability Companies is case specific. Whether or not this technique is appropriate for any individual depends on a complete analysis of the individual’s assets and liabilities and personal circumstances. Consult knowledgeable professionals before using a Limited Liability Company.

 

Prepared By Michael B Mangini, J.D.
35 Court Street
Freehold, New Jersey 07728

Tel: (732) 409-3209

www.newjerseyestatelaw.com

© 2007 Michael B. Mangini – All Rights Reserved

This article reproduced and published on this website with

Permission from the author Michael B Mangini, J.D.

 

© 2007 Michael B. Mangini – All Rights Reserved

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