ASSET PROTECTION TOOLS
Limited Liability Company (LLC)
LLCs are designed to provide liability protection in ways simpler and less formal than corporations.
An LLC protects the owners from liability for any debts or obligations incurred as part of the business or venture captured by the LLC. For example, if you own a car wash center and the business goes bankrupt, the LLC would protect you from being personally liable for the debts associated with the insolvent car wash enterprise. As long as you do not personally guarantee obligations by your business held by an LLC, your personal wealth is not jeopardized by business liabilities.
Another scenario may help to appreciate the advantages of an LLC-structured business. If, for example, an employee or competitor sues your LLC and wins a judgment against your company, the enforcement of that judgment could be hindered by what is called a charging order.
A creditor cannot seize membership interests because the LLC-structure protects from creditor foreclosure. Creditors cannot take over control of the LLC or force the LLC to enroll them as members. If properly structured, LLC creditors will always remain "outsiders" and will have only few options to collect despite the existence of an enforceable judgment. In fact, if the LLC in light of creditor enforcement risks ceases distributions, there is a chance that creditors will never enjoy proceeds from the LLC.
However, various high court decisions have recently put setbacks to the enormous success story of LLCs. These decisions have in common that they critically analyze and ultimately stop what has become the most commonly used LLC-model, the single member LLC.
Concretely, the Florida Supreme Court in Olmstead v. FTC (2010) ruled that an LLC membership interest is subject to seizure by creditors in the same manner as corporate stock. Contrary to past practice, creditors are now permitted to seize membership interests under Florida law.
Several important state Supreme Courts have followed this conclusion and thus significantly challenged the idea of the "invincible LLC."
Because of the demotion of LLC as an effective asset protection tool, we recommend alternative asset protection tools.
• Family Limited Partnership (FLP)
• Trusts
• Offshore LLCs
Family Limited Partnership (FLP)
Operating Principle
FLPs have two goals: to protect your assets and to minimize taxes.The FLP acts as a holding company that owns assets in other entities. The FLP, and no longer Husband and Wife, own the assets. Husband and Wife own a controlling interest in the FLP. General Partners are in charge of the management and the distribution. They can buy and sell shares and have an unlimited liability. Typically, Husband and Wife each have a 1% General Partner interest. Limited Partners do not have control and do not participate in the management. Their liability is restricted to the extent of amount of contribution to the partnership. Depending on the partnership agreement, Limited Partners may or may not have voting rights.Advantages
Does an FLP Protect Me Against Lawsuits?Yes, an FLP bars plaintiffs and creditors from seizing your bank accounts or other assets because you don’t hold title to those assets anymore. You onlyhold an interest in the FLP. If this realization is not enough for a creditor to stop pursuing the enforcement of the judgment against you, the creditor must ask the court for a so-called charging order against your partnership interest. A charging order is a lien on the judgment creditor’s (i.e. in this case your) transferable interest. This is not uncomplicated. If the court refuses to grant such an order, the creditor is out of luck. If the court grants the charging order, the Manager can simply restrict distribution to the hostile creditor. Nonetheless, and this is the real deterrence, the hostile creditor becomes obliged to pay taxes on his phantom income. In other words, the creditor does not receive money, but has to pay taxes on the non-received income. Not many creditors want to do it. While the creditor (if at all, temporarily) interrupts the distribution to you, the other member of the FLP (such as your spouse, child, or a separate LLC) will do the distribution.
Do FLPs Need To File Separate Tax Returns?
No, FLPs are not taxpaying entities. An FLP files annual informational tax returns setting forth its income and losses as pass-through from the partnership. Each partner claims his share of deductions and income on his own private tax return.
Disadvantages
How Can Assets Be Transferred?Two steps are necessary. First, you need to open new accounts. Open a bank account in the FLP’s name and open a bank account in the LLC’s name. Second, we need capital contribution. Write a check or transfer 99% of the balance of the cash accounts directly from you to the new FLP account; then write a check or transfer to the LLC for 1% of the account balance. Finally, the LLC writes a check from its account to the FLP as an additional capital contribution to the LP. You then no longer own a direct interest in your assets. Instead, you own a controlling interest in the FLP and the FLP owns the assets for you.
What Assets Should Be Transferred Into the FLP?
We recommend distinguishing between Good Assets that should be transferred into the FLP and Bad Assets (with high lawsuit and liability risk) that should remain outside the FLP.
Good Assets
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• Cash
• Bank & Brokerage Accounts
• Titles to Businesses
• Non-Homestead Real Estate
• Life Insurance
• Partnership
• Limited Partnership
Bad Assets
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• Motor Vehicles
• Homestead
• IRAs
• Annuities
• Qualified Plans
• Stock of S-Corporations
• Tangible Personal Property
• Heavily Encumbered Assets
Irrevocable Trust
A trust is an arrangement in which someone, the Settlor, transfers property to a Trustee. The trustee agrees to hold the property for the benefit of one or more individuals, called the beneficiaries.
In order to protect the settlor’s assets, the trust must be irrevocable and the Settlor must not be a beneficiary. This construction is called a “Spendthrift trust”. A Spendthrift trust prevents the beneficiary of a trust from voluntarily or involuntarily transferring any current or future rights in the trust. In other words, among other things, it prevents the creditors of the beneficiary from reaching the trust's assets.
Spendthrift trusts are usually established to fund life expenses of another person while also protecting the trust against the beneficiary’s incompetence, imprudence, or inability to manage financial affairs. In terms of solid protection, creditors cannot compel the trustee to distribute funds to them even if the creditors have an enforceable judgment.
Offshore LLCs
Some lawyers recommend boosting the protection by moving the assets to an offshore country to benefit from lower taxes and arguably the escape of U.S. jurisdiction and U.S. creditors.
For example, we would form an FLP to hold your savings and brokerage accounts, then the limited partnership interests in the FLP will be held by an Offshore LLC, to then protect the ownership of the Offshore LLC by holding membership interests in the Family Savings Trust.
In most cases, we recommend against this model. As U.S. citizens or residents, you must assume that the IRS is watching such transfers closely and may want to intervene. Further, the model requires clients to hire counsel in these foreign countries, which may create linguistic, logistical, and monetary complications.
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