Corporations are the traditional way to limit personal liability in a business.
A corporation has a separate legal personality from its owners, officers, and directors. This legal personality provides a “corporate veil” that may insulate these individuals from corporate liabilities.
But maintaining the corporate veil requires significant legal formalities that owners of small businesses often neglect.
More importantly, the corporate veil is irrelevant if you do something that results in a judgment against you personally. In that event, you’re responsible for paying the creditor out of your own personal assets.
Corporations vs LLCs
Let’s suppose that you own a 30% interest in a corporation that owns an apartment building. You (not the corporation) get sued personally and lose. Basically, the creditor can seize anything you own, other than what’s called “exempt property” (e.g., your home, if you live in a state with a strong “homestead exemption” law, such as Florida). Since you own that 30% interest in the form of corporate stock, you lose it. Your creditor simply forecloses against your interest in the corporation.
Is there a better way to own this asset? Yes, in a business entity called a limited liability company (LLC).
An LLC is a hybrid of a partnership and a corporation. Its owners, which are called members, are shielded from personal liability and all profits and losses pass directly to the owners without taxation of the entity itself. LLC managers are also shielded from personal liability for the LLC’s actions.
Charging Order Protections Offered by LLCs
The principal reason LLCs are superior to corporations at protecting assets is because of a legal concept called the charging order.
The charging order represents only a right to assets distributed by the LLC. It doesn’t give a creditor the right to dissolve the LLC or to force the manager of the LLC to make a distribution.
This often makes it possible to convince a creditor to settle on more reasonable terms than might otherwise be possible.
LLCs: Simpler Management and Estate Planning Benefits
LLCs are also easier to administer than corporations. They are better for estate planning because they allow for “valuation discounts” for gift and estate tax purposes.
About the only situation in which a corporation is more suitable than an LLC is if free transferability of ownership interests—lacking in an LLC—is essential. This might be the case, e.g., if you plan to take the corporation public and offer its shares on a securities exchange.
LLCs organized in an offshore jurisdiction such as Nevis offer even more asset protection. That’s because the charging order concept sometimes breaks down, and a creditor of a member of a US-registered LLC may be able to get a court order forcing the LLC manager to make distributions.
But, a creditor of a member of an offshore LLC with a non-US manager may find it impossible to obtain jurisdiction over the manager. Even if a US court orders the non-US manager to redeem the member’s interest, to make a mandatory distribution, or even to dissolve the partnership, that order won’t generally be enforceable in the United States.
Instead, the creditor will need to go to the offshore jurisdiction where the LLC is registered and convince a local court it’s entitled to the assets in question. Needless to say, this is a difficult and expensive undertaking.
All About Nevis LLCs
Find out exactly how Nevis LLCs provide asset protection, who is the right fit for this structure, and whether you might consider this entity the next time you update your wealth protection plan. Get the full story here: Nevis LLC.
Limitations and Legal Considerations for LLCs
That’s not to say that LLCs are asset protection panaceas. They’re not, and there are significant pitfalls to avoid, particularly for LLCs with a single owner or that hold a purely passive asset portfolio.
It’s possible to engage in creative planning to avoid these pitfalls, and others. But it’s important to engage the services of a qualified legal practitioner rather than engaging in “do-it-yourself” asset protection planning.
Need Help?
Over the past 40+ years, we’ve helped thousands of clients build better wealth protection plans. Structures that “de-risk” your assets and make you virtually immune to lawsuits is a big part of that.
If you’re wondering what type or structure is right for you, or you realize your plan needs some work, please get in touch to see if our services are right for you. It starts with a free, no-obligation consultation with one of our Associates to see if you qualify. You can do that here.
