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ASSET PROTECTION FOR BUSINESS OWNERS

James C. Mulder
attorney at law

Recent Real Life Cautions

Recently, Colorado and Florida bankruptcy judges looked through a single owner LLC into the assets of the LLC for the owner who filed for bankruptcy on the theory that the purpose of the LLC statute in Colorado and Florida was to protect the business endeavor from disruption on the basis that it wouldn’t be fair to an owner of an LLC who had no creditor problems to be forced to liquidate the business because of the creditors of an another owner. In this case there was only one owner and the bankruptcy judge felt that the purpose for the protection in the statute didn’t apply and therefore ignored the LLC.

The original Texas LLC statute had similar purposes. Texas has since codified all businesses into the new Texas Business Organizations Code, which has no such language. Based upon these Colorado and Florida bankruptcy cases, many advisors recommend that an LLC should always have more than one owner. Personally, I don’t think that is necessary as Texas law is clear that an LLC can have a single owner and the sole remedy of a creditor is a charging order.

Other Advanced Tips

The preferred solution is for the registered Series LLC to be a holding company and have it own one or more subordinate series limited liability companies. An asset protection design can involve wholly-owned subordinate series LLCs (taxable as disregarded entities) to hold risky assets. or to conduct business activities that have inherent risk. By insulating a risky asset or business activity from the rest of the assets and non risky business activities, only that particular series LLC contains the risk and therefore this plan protects the other series LLCs and its assets and the Owners from attachment. In a real estate scenario, the series LLC is the owner of one single property, so only that property would be at risk.

You should create your own “Bank” Series holding LLC to be the lender to any other series LLCs for operating capital and take a lien back against the series LLC assets to secure the loan. A creditor of the series LLC will have to pay off the loan to your Bank Holding LLC first before satisfying its judgment.

Other Benefits

A Series LLC can be used to reduce the size of the estate of the owner through discounts for lack of marketability and, possibly, lack of control. This can result in lower estate tax exposure. Note, that there is a move in Congress and at Treasury to eliminate this benefit.

An LLC can be considered a security under Texas law, so contributing Uniform Transfers to Minors Account assets to an LLC before the minor attains the age of control can allow you to defer complete control over the funds at an inappropriate age or time for the minor.

An LLC can be an effective tool in which to put assets that are to be given to children by elderly parents that may want to qualify for Medicaid for nursing home assistance, instead of fractionalizing the funds between children who may or may not manage the funds well. This way the Manager of the LLC can keep control of the gifted assets to ensure availability for needs of the family as a whole.

How Many LLCs Should I Have?

I encounter many business owners that have formed their business as a limited liability company (LLC) and think they have protected themselves from creditors. Many of them think that since their business is in an LLC that they have protected it. It is true that putting your business in an entity will provide the owners with protection from a creditor of the business, but all of the assets of the business are still fair game for such a creditor. As I have discussed before, consideration needs to be given as to how many assets are vulnerable to the business and how they might be structured to better protect them from a business claim. This is also true of real estate investors who really aren’t operating a business, if all they do is collect rents. This type of income is considered passive income and not subject to earned income self employment and Medicare taxes, but they are just as vulnerable to a tenant claim as an operating business is to any other claim from its products or services. I am talking about here is structuring the “business” assets in such a way as to limit a creditor of the “business” from forcing a liquidation of all of those assets.

Let’s look at a common example.Let’s look at a common example.

Real Estate InvestorReal Estate Investor

Mr. Smith owns 5 single-family rent houses and two duplexes in one LLC. Each one has its own mortgage, but the equity in each property is building up. All properties are rented and Mr. Smith is the only one involved in collecting rents and taking care of tenant problems. In other words, he doesn’t have any employees or property managers. Mr. Smith does have a bank account in the LLC name and is depositing all lease payments in this account. Some of the leases however are in his name as Landlord, not the LLC. Several problems are present here:

  • Mr. Smith has all his eggs in one basket.
     
  • Mr. Smith is the named landlord on one or more leases.
     
  • How does Mr. Smith have his property insurance on these rental properties listed with his P&C insurance company?