Other Considerations
in
Choosing the Best Entity - Especially
from an Asset Protection Point of View
Let’s, take the example of a group
of investors. They all want to put money into an entity and invest in
the stock market or a project. Would a corporation or LLC be better
in this case? In this case the decision would be an LLC. Why?
1. All the profits or losses would flow through at
the end of the year not subject to self-employment taxes. Under Section
1402 there are three exceptions concerning distributions which will
not be subject to self-employment taxes. They are;
- 1402 (a)1 rental income
- 1402 (a)2 interest and dividends
- 1402 (a)3 capital gains and losses
2. If the investors formed a corporation they have
to deal with double taxation and how to handle that. In other words
at the end of the year the profits and losses would stay in the corporation
and if any distributions were made, in the form of dividends, double
taxation would occur. Also, the Personal Holding Corporation rules
may come into effect, which would be a disastrous tax effect!
3. If the investors were doing long term trades, and
the amount was over $100,000 per year, in a corporate tax bracket
that would be taxed at about 22.25%, but flowing to you personally
it would be taxed at 20%, the new long term capital gain rate!
4. The LLC will offer more asset protection than the
corporation. If you are running a business as a corporation or an
LLC and the business gets sued, you will get the same result. You
would worse case scenario, lose as many assets in the corporation
as the LLC. There would be no difference. There is a major difference
if you were sued personally. Let’s diagram it out:
Again, if the Corporation or LLC
gets sued, it is the same worse case scenario result.
The corporation or LLC will lose all of its business assets. That is
why you never have many assets in your main operating company.
If you as a shareholder of the corporation
or member of the LLC gets sued personally, there is a different result!
When a creditor sues you personally and your insurance doesn’t
cover it, like punitive damages, you can lose your percentage
of stock in the corporation to satisfy the judgement. If you owned a
controlling interest in the corporation and lost, you would lose control
of your entire company. This is how an individual lost his entire
$3 million dollar California corporation recently! Typically, when
a creditor gets control of your company he/she doesn’t want to
run the company. He/she just liquidates it and takes the money or sells
it! A corporation’s stock must be protected. An LLC would be an
ideal vehicle if it were taxed as a partnership. Let’s explain
if you were sued as a member of an LLC why that would be different and
you would not lose control of your company.
Now, let’s say you form an LLC and
it is a year from now and you owe a creditor money. As most creditors
do, they will try anything to get the money out of you. First, it is
important to understand what creditors rights are in this situation.
LLCs act like limited partnerships when it comes to the rights of creditors
to impose claims against the property of the LLC or against a Member’s
personal property. If LLC property is held in its name, the member has
no rights to it other than when it is distributed. Distribution in turn
is allocated and timed according to the operating agreement, usually
upon the vote of the members.
You will learn that the LLC is the best
entity to protect investments. What about rental property? The LLC would
be better for the same reasons. Again, what if you owned 3 restaurants
in your hometown and you formed 3 separate corporations because you
wanted to separate out liability from a business lawsuit.
The reason you would do this is because
if one restaurant were sued it would not affect the other two restaurants!
But what if you owned the stock personally in all three restaurants
and you were sued personally and lost? You would lose control of all
three restaurants! Some people think their state laws will protect their
stock. That is true, but only to a certain amount. Click
here to determine how much of your stock is protected by your state
laws. Also, many believe their insurance will protect them in every
situation, that is simply not true. Click
here to learn what typical insurance policies do not cover.
How would you prevent that from happening? Transfer your stock into
an LLC as a management company and have it formed as a partnership (you
would need one other partner; your wife or business partner would be
ideal). Now if you were sued personally, you don’t own stock in
the corporation. The LLC does and the legal remedy is back to the charging
order! Here is how that looks in a diagram:
Here is a test question: Would you want
the LLC that is managing the stock of those three corporation to do
business with the public, i.e. own title to a piece of rental property?
NO! Absolutely not! Why? Remember earlier, we discussed the difference
between an LLC and a corporation operating a business and if either
one was to be sued as a business, you would get the same worst case
scenario result, a loss of all the assets! Currently in this example,
the LLC is only managing corporate stock and is not doing business with
the outside public! When you title the piece of rental property to the
LLC it is now doing business with the public and if someone sues the
owner of the rental property and finds out it is an LLC and the LLC
also owns 100% controlling interest of 3 successful corporations operating
restaurants, you can then lose control of all three restaurants!
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