The number of new businesses forming as traditional “S” corporations has decreased dramatically in recent years. That is due in large part to the popularity of limited liability entities such as Limited Partnerships or Limited Liability Companies (LLCs). An entity such as an LLC offers all of the same protection that a corporation offers from business creditors, but it has the added benefit of protecting the business assets from the personal creditors of the business owner.
As an asset protection planner, there are two types of creditors that I account for: inside creditors and outside creditors. An inside creditor is one that arises against the business such as a slip and fall on business property. The injured party may have a claim against the business itself, not against the owners of the business if it is established and run properly. Thus, if the injured party has a judgment, he or she can only have that judgment satisfied by business assets and not the personal assets of the owner.
An outside creditor is one that is not related to the operation of a business, rather the creditor has a claim against an individual. It is the outside creditor protection that makes an LLC a no-brainer over a corporation. A personal creditor with a judgment that is not related to the operation of the business may seize the debtor’s shares in a corporation and thus, control those shares and possibly the company itself. Once the creditor controls the shares it can liquidate the entity and satisfy its judgment.
If a LLC is used to own the business, however, a personal creditor of a business owner that owns a membership interest in an LLC will be limited to obtaining a charging order instead of seizing the membership interest itself. A charging order is an equitable remedy which allows a creditor to receive distributions if made from the entity. A charging order would not carry voting or liquidation rights and a creditor that holds a charging order cannot control the limited liability entity.
For tax purposes, limited liability entities are much more flexible than corporations. A corporation can be taxed one of two ways: as an S corporation or as a C corporation. An LLC, for example, can be taxed as an S corporation or a C corporation, however, it can also be taxed as a partnership or it can even be treated as a disregarded entity if it has only one member.
Traditional corporations are becoming obsolete, and due to the asset protection and tax flexibility it is almost always more advantageous to operate a business or own property through a limited liability entity. When starting a business or forming an entity to own real estate, a limited liability entity should be utilized. For those with existing entities already up and running, you can convert the entity into an LLC in a tax-free reorganization. Please contact our office for more details.
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