Both LLC’s and Corporations will generally shield their owners (i.e. Members or Shareholders respectively) from liabilities incurred inside the LLC or Corporation. For example, if an LLC owns an apartment building and a tenant in the apartment slips, falls, & sues, the lawsuit would be directed at the entity (i.e. the LLC) and not the individual owners of the LLC (absent piercing the veil arguments). The same personal liability shield would apply to shareholders of a corporation as to debts or liabilities incurred inside that corporation.
The primary difference between the liability protection of a corporation versus an LLC arises in the context of liabilities and claims directed specifically at the owners of these entities. Lawyers call this “outside liabilities” because the claim or liability occurs outside of the entity.
For example, if the owner of a corporation is involved in an auto accident unrelated to the business of the corporation and the injured party obtains a judgment against the owner personally, the judgment creditor may be able to obtain a “turnover order” from a court ordering the owner of the corporation to “turn over” his/her shares in the corporation to satisfy the judgment.
On the other hand, depending on the state, a judgment creditor of a member of an LLC does not automatically have the right to order the LLC member to turn over his/her membership interests.
The exclusive remedy available to a judgment creditor in many states as to interests in an LLC is a “charging order.”This is essentially a lien on the member’s interest in the LLC, and unless the state allows for foreclosure of this lien, the only value that a creditor gets from a charging order is any distribution of property from the LLC to that debtor-member.
Since the LLC can usually control the number of distributions to a member, this can be a significant impediment for a judgment creditor and one of the reasons that KKOS generally recommends for rental properties, land, and any sort of liquid assets to be held by an LLC as opposed to a corporation.
Furthermore, there can be many onerous tax ramifications by trying to hold assets in a corporation and the LLC can be much more flexible. The ‘trick’ in this entire process is to ensure the following:
- Choose the right entity
In some states, a Limited Partnership may be a better choice than a Limited Liability Company. It will depend on the type of asset, the tax ramifications, and the rules for charging orders in that state.
- Choose the correct state
- The proper ownership structure for the entity
Are you going to own this entity with a master or ‘parent’ holding company, are you going to have your revocable living trust in the mix, etc… A lot of people set up the wrong entity as the ultimate owner of their assets that can again cause tax problems, even though it may provide superior asset protection. There is a balance. Oftentimes you can’t have your ‘cake and eat it too’.
- Not getting ripped off
Many ‘incorporation services’ and self-professed asset protection gurus will claim that Nevada is the panacea for asset protection, and also sell one-size fits all structures. This is where even more problems occur because it can be expensive to unravel a bad structure and the money spent on the front end was a loss.
In summary, please ‘tailor’ your asset protection plan to you. Charging Order protection is real and it really works. But if the proper structure isn’t established and maintained, it won’t be worth the paper it is printed on.
Be cautious of one-size fits all non-lawyer companies, and get a second opinion if something sounds too good to be true or you have an uneasy feeling in your stomach.
Please give us a call at KKOS at 888-801-0010 to set up a personal consultation over the phone in any State to tailor a plan to you.
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.