You need to protect your assets, especially during difficult times such of when the country was shut down during the pandemic due to COVID-19 or now with rising interest rates and higher inflation. The fragile economic conditions are a strong signal to protect your assets now before it is too late.
Many businesses had to close down and lay off employees even with government SBA support. During these uncertain times, people and companies may take to extreme measures 6 months to a year from now to protect themselves financially.
After this period, when the financial dust settles, that is when lawsuits may dramatically increase, don’t expect insurance companies to write a big check to help quickly. The time is now to protect your assets now.
The key is to avoid fraudulent conveyance transfers in an attempt to protect your assets. It is likely too late if you have any hint of litigation coming. Forming an LLC or corporation after the fact will likely result in the judge undoing your planning because the intent was to defraud creditors.
The good news is that all the recommendations below are protected steps you should take to protect your financial future, but now it is more important than ever. When the market and economy rebound and rebuild over time, you will at least be protected when you implement the recommended steps below.
The current financial conditions going into 2023 may compare or even exceed the 2008 financial crisis’s financial impact on the U.S. economy
The goal is to know that as the economy tightens up and sales are down for most, cash flow is tight, usually litigation, and the risk increases dramatically. That is why this is the best time to protect your assets and financial outlook with the support your business will need to survive this economic downturn.
There are several essential questions you must ask yourself when protecting your current and future net worth, especially during times of financial uncertainty, and rising interest rates and inflation have undoubtedly created one.
- Are you protected if your business is sued at the operating level? Do you have all your “business financial eggs” in one entity basket?
- Do you have “safe assets” unrelated to your at-risk assets? If so, are they protected?
- What would happen if you were sued at the personal level, unrelated to your operating business? Would you lose control of your company (this is a big one)?
- Even if you are an LLC and your partner is sued, would that disrupt the operating company?
- Does your living trust hold valuable assets that would be in jeopardy if you were sued personally?
- Do you have adequate insurance?
- Is real estate (not your residence) out of your name personally?
- Does your residence have a lot of equity? If so, is it protected?
- If you have a partner, do you have a buy/sell agreement?
- Do you have legal agreements with your independent contractors, employees, and joint venture partners?
Your Asset Protection Plan: Let’s address some key points about each group, so you can take the necessary steps to protect your assets in 2023 and beyond!
Are You Protected if Your Business was Sued at the Operating Level?
Are you running two or more profitable businesses out of one entity? If one gets sued, will you lose all your business assets? I would not quickly assume your business insurance policy (if you even have one) will kick in 100% to protect you. Make sure you understand the loopholes in the insurance policy. If you are operating two or more businesses that aren’t making it, that is a different subject. One entity may be fine. But if you have successful e-commerce, cannabis, technology, information product, or speaking business…., you may need three separate entities to protect all three individual companies. That way, if one comes under attack, it won’t bring down the other two.
Are your domain names worth protecting? Remember, when you register a domain name, it is free and clear. You put “cash” upfront for the name. Many of you may have thousands of visitors coming to your domain daily, which may be a precious asset for your business. Is your “virtual real estate,” your domain name, worth $100,000 + collectively? If it is, should it be owned by either you or your main operating company? Probably not. You may want to consider a separate legal entity to hold your domain names and then lease them back to your operating entity. Typically, an LLC taxed as a partnership, or single-member LLC will work for that situation. If you are new to your business and your domains have very little traffic or value, it may not be necessary to form a separate legal entity at this point.
Did you remember to connect your DBA names to your new entity? If you had a DBA (doing business as) with you as a sole proprietorship applicant, which means unlimited liability. You must refile the DBA name with your new entity as the applicant, not you personally!
Do You have “Safe Assets” Unrelated to Your at-Risk Assets? If so, Are They Protected?
Make sure you separate your safe from at-risk assets. A safe asset will not directly cause someone liability, like investments outside your retirement account, cryptocurrency, or cash in your personal checking account (above $50K). An at-risk asset, like real estate or operating a business, can cause direct liability. Do not put those two items in the same entity bucket out of convenience. If you have valuable, safe assets, typically an LLC taxed as a partnership or single-member LLC disregarded will make sense. Some states, like Florida and Colorado, do not recognize the charging order protection from a single-member LLC, so proper planning is required.
What would happen if you were Sued at the Personal Level, Unrelated to Your Operating Business? Would you Lose Control of Your Company?
If your operating entity is an S or C corporation, this may be a big concern for you that you were unaware of until now. This means if you get sued for something unrelated to your operating business, like a car accident, a contract currently in your name, another entity where the entity veil was pierced, and your insurance company does not pick up the entire tab. You may lose your most valuable personal asset, the stock of your S or C Corporation. Even if your living trust owns it, you may lose 100% control of the ownership of your company!
If the S or C corporation has no value (meaning the day you stop working, there is no value), it may not be that big of a concern if you lose control of your company. This is not a concern with consultants because no more revenue comes in the day they stop working, so there is very little value of your S corp stock to someone else. Many entrepreneurs and business owners know the dangers they face with these entities.
If you have a valuable C Corporation, the solution is that an LLC can hold the stock, either taxed as a partnership or a single-member LLC disregarded for tax purposes. Remember, with an S corporation, and there are restrictions on who can be the shareholder. Only a single-member LLC disregarded can own an S corporation’s stock. It cannot be an LLC taxed as a partnership. Why the LLC? Now instead of owning the stock of the S or C Corporation, you will own the membership interest in the LLC. When you own the LLC membership interest, that means if you get sued personally, the plaintiff may get a “charging order” against you, which means they get access to distributions of profits vs. a controlling interest in the stock of the S or C Corporation.
There is some discussion about the value of single-member LLC vs. multimember LLC regarding the charging order protection. Some argue that there is no protection with a single-member LLC because the charging order protection originally came from partnership law, which means at least two partners. Well, a single-member LLC only has one partner. Although most state statutes do not distinguish between how many members, it has come up as maybe a reason to have a multimember LLC vs. a single member.
Would Your Partner being Sued Disrupt the Operating Company?
The charging order is very powerful and will help protect the operating LLC’s ownership, but it can still be disruptive. Suppose your partner in the LLC is personally sued for something unrelated to the operating company before one gets a charging order. In that case, they may subpoena the LLC’s operating agreement, bank accounts, and account records. This can all be very disruptive to the operating business. Suppose you have an LLC with an outside partner (not your spouse or significant other). In that case, you may want to strongly consider EACH member having their own separate LLC ONLY to hold safe assets, which then become the owners of the operating business. Now, if you or your partner is sued personally, it will only affect the membership interest of your PERSONAL LLC, not the OPERATING LLC! This avoids any disruption to the operating business!
Does your Living Trust Holding Valuable Assets Protect You if You Were Sued Personally?
The living trust is essential for probate and estate planning to help you pass on your asset to your appropriate heirs. A living trust is revocable (99% of the time). A revocable trust means you can move assets in and out of the trust, which also means a creditor can access the assets inside your living trust (there are some exceptions, like retirement plan money). So many falsely believe that living trusts protect assets because they hear from their estate planners that a living trust protects your assets. Still, they do not understand “FROM WHAT” – not from liability, only from probate and estate taxes. That means that your assets titled to your living trust may be at significant risk in a lawsuit. That is a good move if your LLC membership interest is titled to your living trust!
Do you have Adequate insurance?
I am not a big fan of relying on insurance to protect you, but it is vital to reduce risk. Remember that insurance companies can go out of business, just like any other business. Plus, you need to be aware of the loopholes in your insurance policy that may cause you to be unprotected.
The rubber meets the road question for your insurance provider on your new million-dollar policy is… “Tell me, over the last three years, how many times any of your clients who have this policy were sued for anywhere between $800,000 and $1,000,000? And, of those times, how many times did you not pay out the claim? And when you did not pay out the claim, can you tell me the loopholes that caused your clients NOT to be covered, so I can anticipate similar areas where I would also NOT be covered by the policy you are attempting to sell me?” That is an important question!
You may need an umbrella insurance policy; personally, that may be $3 million- to $4 million of coverage, plus other business liability insurance for proper protection.
Is real estate (not your residence) out of your name personally?
Owning real estate in your name is like having your financial statement taped to your forehead, shouting, “I have assets, so sue me!” Even if the real estate you own has no equity, it makes sense not to own it in your name. It shouts to the world that you must have money to be in the position to own a home and other real estate. The big question that comes up is how much protection is necessary.
If you have three rental properties, do you need three separate LLCs? That depends on the amount of equity in each property and the overall percentage of your net worth it represents. For example, if you have three rentals, each with $300,000 of equity, and that $900,000 of equity represents 90% of your net worth, three separate LLCs (one for each rental) would make sense. If you get sued at the property level (entity level), you would only lose 33% of your equity, vs. 100% if owned by one entity. Issues that come up with real estate are transfer tax, due-on-sale clauses, and insurance issues.
Typically, there is no transfer tax if you own the real estate before and transfer it to an LLC. You will need to ask your local county clerk’s office for the rules and exceptions on the transfer tax. A due-on-sale clause means if you have a mortgage on the property and transfer it to a separate legal owner, like an LLC, which may trigger a due-on-sale, which means you record the new title in the name of the LLC, it appears there has been a sale. The banks may be able to call the note and say, “Since you sold it, you have to pay off the mortgage.” The fact is you did not sell it; you transferred the title. No bank will tell you they will waive the due-on-sale clause.
From the bank’s perspective, the key is whether they will get a monthly check to pay down the mortgage; 95% of the time, a due-on-sale does not come into play. The strategy is to form an LLC, either taxed as a partnership or single-member LLC, and quitclaim or warranty deed the property in the LLC name. Now, if you are sued personally, you do not personally own the real estate. You own a membership interest in the LLC that controls the real estate. That is a huge difference!
Does Your Residence have a lot of Equity? If so, is Your Equity Protected?
Your residence, on the other hand, is handled very differently. You do not want to transfer your principal residence into an LLC. Why? Several reasons. First, you would lose your $250,000 capital gain exclusion when you sell it. Second, your insurance company would have an issue when transferring the title to an LLC. This is when safe and at-risk assets need to be separated. The next step is to file for homestead protection to protect the equity in your house. Each state has different protection levels, ranging from unlimited in Texas and Florida to only $5,000 of equity in some states. The first step is to file for that protection.
If you have a lot of equity in your home, you may want to consider a personal residence trust for protection. This does not have the downside that a separate legal entity would have. We recommend you speak to an attorney in your area to explain the options that the personal resident rust may provide!
If You Have a Partner, Do You Have a Buy/Sell Agreement?
An essential part of your coronavirus asset protection plan to protect any businesses with partners. Do you have an outside partner as an owner in one of your entities? If so, you must have a buy/sell agreement. The buy/sell agreement will provide a smooth transition if one of the partners can no longer continue with the business.
The everyday events that may arise are death, divorce, or desire to sell to a third party. Not having this agreement in place typically results in unexpected situations and, many times, lawsuits (especially over the company’s value as one partner wants to sell out) or the destruction of the actual business.
Typically, life insurance is purchased for each owner to pay off the estate in case of death. One crucial clause that will come into play is an agreement on the accounting formula to determine your company’s value, so there are no arguments when determining the value. It s vital to have an attorney draft your buy/sell agreement, separate from the operating agreement in an LLC.
Do you have Legal Agreements with your Independent Contractors, Employees, or Joint Venture Partners?
One of the fastest ways to go out of business and get stuck in many lawsuits is not having agreements for several situations. If you use independent contractors to do work for you, make sure they sign an independent contractor agreement that tells the independent contractor that the work they do on your behalf is owned 100% by you, that they are responsible for their taxes—other vital provisions to establish the nature of the relationship.
Remember that just because they sign an independent contractor agreement does NOT mean they qualify as an independent contractor, according to the IRS. Could you make sure they are not an employee? Nothing is worse than firing an independent contractor, and they file for unemployment, thinking they were an employee, and now you have the labor division after you!
In conclusion, your coronavirus asset protection plan is critical to take the steps now before the coronavirus gets so far out of hand. You don’t have the cash to protect yourself and your family correctly. You will sleep better knowing your loved ones are safe. Please don’t wait until you are sued because it may be too late to protect yourself. You will sleep a lot better at night when everything is in order.