Chapter 17
Using LLCs to Cover Your Assets
IN THIS CHAPTER
Recognizing who can come after your assets
Understanding how LLCs protect your assets
Looking at some easy asset protection strategies
This chapter very well may be the most important one you read. After all, why would you want to work so hard to build your future only to have someone else take away all the assets you’ve accumulated? If you think the fact that you observe good business practices means this chapter doesn’t apply to you, think again. Lawsuits are getting out of hand in this society, and no one is exempt. Simply owning something of value puts you at a much higher risk than even the shadiest businessman. After all, the term frivolous lawsuits exists for a reason; lawsuits don’t need to be soundly based or even well intentioned.
A lot of people are looking to get something for nothing. Unfortunately, that means that hardworking folks like you, who have built up a sizeable nest egg, are a target. Aside from buying expensive insurance policies that, when it comes down to it, may or may not have your back, the only thing that you can really do to protect yourself is to plan ahead and structure your assets so they’re safe. Doing so now is important because when you’re in a lawsuit, it’s too late. From here on out, you must take steps to protect your assets every time you save money, start a new venture, register intellectual property, make any big purchases, get married, plan your estate, and so on.
Because LLCs have dual liability protection (where the company is also protected from the owner’s personal lawsuits), they’ve been revolutionary for asset protection, especially personal asset protection. LLCs are such a big piece of the puzzle that, when an attorney sees you’re protecting your assets in an LLC, she’ll often advise her client not to sue you in the first place. No insurance company can match that sort of protection!
In this chapter, I show you how you can protect your assets for the rest of your life by forming an LLC and how you can safely own high-risk assets (assets that are very likely to be sued) while protecting everything else you’ve worked for.
Knowing the Dangers: What Can Happen without LLC Protection
More than 50,000 lawsuits are filed in the United States every day, and the numbers keep growing. Litigation has become a way of life for Americans; the collective mindset is shifting to that of “get somethin’ for nothin’,” and small businesses — the lifeblood of the American dream — can pay a heavy price. Although a large corporation may be able to cover the costs of an everyday lawsuit relatively easily, these legal fees may be debilitating to a small business.
You may think you’re exempt, but chances are that if you haven’t been sued yet, it won’t be long. Although businesses tend to get sued most often, you’re also likely to be sued personally. Actually, the law of averages say that within your lifetime, you’ll be sued twice. And that’s at today’s numbers; can you imagine tomorrow’s? As hard as paying the $75,000 legal bill on a frivolous lawsuit can be for a small business, it can be even harder for an individual. Even if you win, you may have nothing left! This fact is why using LLCs to protect assets and deter lawsuits is just as important for individuals as it is for businesses.
Often, attorneys tie in asset protection with estate planning. Although protecting your estate is imperative — making sure that it actually makes it to your kids and not into the hands of some Joe Schmo who tripped over a sprinkler on your front lawn — estate planning doesn’t really have much bearing on protecting your assets from litigators. In other words, just because you have an estate plan does not mean that your assets are protected while you’re alive. Find out more about using an LLC for estate planning at www.dummies.com/extras/limitedliabilitycompanies.
Lawyers and creditors come calling
The saddest thing about lawsuits is that even if you win, you lose. A lot of these lawyers who take on frivolous cases work on a contingency basis, meaning they don’t charge the client unless they win the case. So ultimately you may be the victor, but you’re the only one paying legal fees. Legal fees for defending a frivolous case can easily amount to hundreds of thousands of dollars, which can be debilitating for a small business. The only way to protect against having to pay outrageous sums of money for seemingly petty arguments is to stay out of court in the first place. I’m not saying that you should settle a lawsuit brought against you. I’m saying that you should make your assets either unapparent or unattractive to the wolves that are scoping them out. LLCs can do just that.
The people and businesses who loan you money — your creditors — also have their eyes on your hard-earned assets. Had a bad month and didn’t keep up with your debt? Your creditors will no doubt be looking at how they can capitalize on their loss — and rightfully so. They lent you the money, and they need to get it back. If you let an angry creditor have his way with your assets, you’ll be in a huge hole. To prevent this situation, make sure that you have an LLC in place that protects your assets. When you’re in control of your assets, attractive creditor settlements are pretty easy to come by.
The IRS stakes a claim
If you aren’t at enough risk from lawsuits and creditors (see the preceding section), remember that you still have to worry about the IRS. When given the right authority, the IRS can impact your financial life more than any individual creditor can. It gets free reign, including seizing your belongings and bank accounts.
Now, although the IRS is part of the government — especially where individuals are concerned — it’s subject to a few rules, all of which you can use to your advantage. When the IRS deals with an LLC, it must follow the same laws and restrictions as most creditors, except with a little bit more knowledge and disclosure. For instance, if the IRS goes after you personally, it can’t seize your interests in the LLC and liquidate your company. It can only lay claim to your economic interest and must wait for you to pay out. This aspect is unique to the limited liability company and is due to the charging order protection benefit of LLCs I mention throughout this chapter. (Hit the later section “Taking charge of charging order protection” for a specific definition.)
Hiding your assets from the IRS can be difficult because you’re most likely reporting them and/or depreciating them on your tax returns. You don’t want to hide from the IRS (that’s tax evasion), and you shouldn’t have to. Your asset protection plan should be so solid that the IRS doesn’t have the ability or, better yet, the justification to go after your assets to settle an IRS debt.
Liens are lurking
Some lawyers are really good, and the worst thing that can happen is to get sued by one of them without having any sort of asset protection plan in place. Imagine you get taken to court over a contract dispute, and the attorney talks the judge into placing a prejudgment lien on your assets; now you can’t move, touch, or transfer your assets or even conduct business with them until the lawsuit has been decided.
Say the amount of the lien covers the entire amount due on a ten-year contract, and it’s a pretty hefty amount. Your assets don’t quite cover it, so your bank account is attached to the lien, and you aren’t even able to write checks. If this happens, you may have a hard time buying necessities, such as gas and food, but the worst thing of all is that you most likely won’t be able to pay your attorney to defend the case. Eek! You’re trapped! If this happens, you may find yourself in a position to settle immediately and for unfavorable terms.
What about when this happens to your business? What if you’re unable to move money, write checks, pay bills, pay your rent, pay on your business loans, or make payroll for two months or longer? Where would your business be then? Unless you have significant personal savings, this could be debilitating.
Even if you get through the lawsuit without a prejudgment lien, you aren’t necessarily in the clear. If you win the lawsuit, you’re okay, but what if you lose? Say someone gets a judgment on you for more than you can afford to pay at the moment. Unless you can immediately write a check for a big chunk of change, the judgment creditor can request to have a judgment lien placed on your assets, which leaves your bank account completely frozen. Your home, rental property, savings account, mutual funds, CDs, kid’s college fund, everything is frozen and can be liquidated to pay the lien. Have equity in your house that you want to use to pay for the lawsuit? You can’t refinance or sell your house to take advantage of the equity; you can’t even collect income from your investment properties or invoice your clients in your business! Instead, your home will be put on the auction block, right before your eyes. Liens are the worst thing that can happen to you in business. Unless you have an LLC, that is. Read on to find out what strategies to use to protect you and your business.
You don’t have to lose a lawsuit to have a judge impose a lien. Anyone can request a lien on your assets, including creditors or the IRS.
Getting the Best Asset Protection with LLCs
Some asset protection plans just try to hide your assets from prying creditors and potential plaintiffs. Although that should be the first line of defense, it isn’t nearly enough. You see, if you do get dragged into court, you’ll probably be subpoenaed for the information or asked about it while on the stand. In either case, you shouldn’t lie. If you do, you’ll have a lot more to lose than your assets; you can lose your freedom.
If predators see that you have hordes of cash and real estate sitting in an LLC, they very well may not go after the assets in the first place. Why? Because LLCs are very tough nuts to crack, and the predators know this. They also know that if you’re smart enough, you can trap them in a situation where they’re paying out money for you! And because most credit agencies work on commission and attorneys work on a contingency basis (as I describe in the earlier section “Lawyers and creditors come calling”), they don’t want to waste their time on you if they know they aren’t going to get paid.
Setting up a Fort Knox for your personal assets
As the old adage goes, “You aren’t in business until you’ve been sued.” Nowadays, as litigious as society is, you don’t even need to be one of the bad guys to be dragged into court. By simply transacting business with the general public, you open yourself up for myriad potential lawsuits, and no matter how arbitrary the complaint is, the destruction it leaves in its wake can be crippling.
The states know that many fewer businesses would be started if entrepreneurs were forced to put their livelihoods at stake every time they began new ventures. Therefore, certain entity types are afforded limited liability, which protects the owners and managers of the business from being held personally responsible for the debts, obligations, and misdeeds of the business. Out of all the entities, LLCs offer the most comprehensive form of this protection (hence the name limited liability company).
An LLC protects you from the liabilities that you inevitably come across during the normal, everyday course of business. Should your business get sued or go bankrupt, your personal assets (home, car, investments, and so on) and other businesses (if they’re in different LLCs) can’t be taken away. Only the assets included in the LLC that got sued are at risk.
The one exception to the normal protection of LLCs is professional limited liability companies (PLLCs), because personal responsibility is essential to being a licensed professional. I discuss this unique entity type at length in Chapter 2.
If you want to use an LLC to protect your personal assets, you must do so in advance, not after you’ve already been sued. Too many victims of frivolous lawsuits have shown up at my office wondering what they can do to get out of them — asking how they can save their homes and bank accounts that are about to be taken away. Unfortunately, at that point, it’s always too late. If only they had spent some time planning, such as reading this book or working with an advisor, they could’ve saved everything.
By establishing your new business or placing your existing business in an LLC, you sign your company up for the most cost-effective, ironclad insurance policy around. A business insurance policy may still have a role in keeping the business itself from having to pay for its own misdeeds. However, insurance policies are only effective in lawsuits arising from product or service liability and usually don’t pay out to unsatisfied creditors if the company can’t meet its debt obligations. Also, whereas insurance companies can be wishy-washy about paying out, the LLC is pretty fail-safe.
Here’s the clincher: LLCs are so foolproof that most attorneys often avoid the time and cost of suing them in the first place and instead opt to negotiate a settlement. Now, that’s protection!
An LLC’s veil of liability protection isn’t infallible. If you don’t take certain measures to establish and maintain that your LLC isn’t simply an extension of you (your alter ego), a court can disregard the LLC and allow the plaintiff or creditor access to your personal assets. This situation is called piercing the veil of liability protection. In Chapter 20, I show you ten important steps you can take to protect your veil of limited liability.
Although an LLC shields you from being held personally responsible for minor negligent acts, it does nothing for egregious criminal acts or willful misconduct. Also, the LLC does offer some protection against certain government creditors, such as the IRS, with one main exception: As a member or manager of an LLC, you can be held personally responsible for the failure to pay payroll taxes. Therefore, if you’re withholding taxes from your employees’ checks and for some reason fail to submit that money to the tax man, you’re putting your personal assets at risk.
Taking charge of charging order protection
Many moons ago, when a creditor obtained a judgment against a partner of a partnership, the creditor could simply take the partner’s interest in the business (and, proportionally, all related assets) and liquidate them to get paid, often leaving a ravaged business in his wake. Clearly, this scenario wasn’t fair to the other, innocent, partner(s) in the partnership just going about their business when suddenly everything they worked for was destroyed!
To remedy these unfair acts, the courts amended the laws so that partners in an LLC, unlike owners of corporations, have another layer of liability protection called charging order protection. A member can have two different rights in an LLC: economic rights (the right to receive profit allocations and distributions from the company) and other rights (which include the right to vote on important matters or be involved in the management of the day-to-day business). Charging order protection grants only economic rights to the assignee, unless the operating agreement specifies otherwise. In other words, the creditor has no other choice but to shut his trap and sit back and receive whatever distributions you decide to grant him. You can stop profit distributions altogether, and the creditor has no say in the matter. Read on to find out how this arrangement works.
Seeing how corporations leave you vulnerable
To understand how a lack of charging order protection can leave you vulnerable, consider the example of Josh, who started a business, J.R. Marine, Inc., when he was only 23. To get started, he borrowed some money from his grandfather by selling him a 5 percent share in the business. He was smart and good with numbers, and the business grew steadily over the years. Ten years in, J.R. Marine had taken over the market. It was good timing too, because Josh had just met the love of his life and was eager to start a family.
One day, he was in the parking lot of the local supermarket and accidentally backed into a woman’s car. The woman was friendly; they traded insurance information, and he helped her on her way. Two months later, Josh was served with a lawsuit. The woman claimed that she was severely injured in the accident and was unable to work and support her four kids (she was a single mom). She was suing Josh for wages and emotional trauma.
Josh found a decent litigation attorney and was forced to slap down $20,000 as a retainer to defend the case. Four months later, the case went to trial. They were counting on a settlement, but the woman wouldn’t budge. Josh had to pay out another $40,000 for attorney fees. At trial, Josh couldn’t believe how the woman’s attorney made him seem like the big, wealthy, bad guy who thinks he can “drive all over” a struggling cocktail waitress/single mother, who can’t afford to feed her kids and now will never get ahead in life. The woman, wearing a neck brace, cried on the stand. Her attorney asked the jury to “do the right thing.” Of course, their idea of the “right thing” was to award the woman more than $2 million of Josh’s money.
At first Josh thought he was okay; after all, he didn’t have too much money in his bank account. However, what he did have was his stock of J.R. Marine, Inc., a corporation, which is considered a personal asset. Before long, the business was seized. They liquidated the inventory, the building, everything, just to pay off his judgment. Josh’s livelihood and all his assets were destroyed.
If J.R. Marine, Inc., had been J.R. Marine LLC, Josh may not have been sued in the first place. As I note throughout this chapter, attorneys know that LLCs are notoriously hard to get to, and the smart ones will avoid them at any cost. When the waitress’s personal-injury lawyer did an asset search to determine whether Josh had any seizable assets, he would’ve seen that Josh’s business (or his share of the business) was held in an LLC.
Setting up the booby trap
Imagine it: a naïve creditor, instead of receiving her check in the mail, gets a notice that she has to pay thousands of dollars in taxes. But that’s exactly what can happen if an attorney tries to seize assets in an LLC.
Take Josh’s example from the preceding section. If Josh had set up an LLC and the plaintiff’s attorney had never been bitten by an LLC before, the attorney may have tried to seize the LLC interests anyway. In that case, he would’ve hit a brick wall called a charging order. After the attorney obtained the charging order, his client would’ve received only the distributions that the LLC’s manager (in this case, Josh’s grandfather) decided to give to her. Josh — being the smart guy that he is — would’ve decided that instead of distributing the profits, he would just keep them in the company. (If the other members complain about having to pay taxes and not receiving any income for a while, they can just borrow money from the LLC and sort it out at a later date.)
This situation is the worst place for Josh’s judgment creditor to be in because although profit distributions are being withheld from her, she’s still required to pay taxes on whatever share of the profits are allocated to her. This share is called phantom income, which I dive into in Chapter 14, and it usually isn’t a good thing. In this case, however it works in Josh’s favor, allowing him to easily run a trap, forcing the whiny actress (ahem, waitress) to end up with nothing except the pleasure of paying down his tax bill! It’s funny how this arrangement can make even the most bull-headed creditors call up, ready to negotiate an extremely favorable settlement! Josh’s business would be safe.
You, too, can lay such a trap for someone trying to frivolously worm her way into your LLC. To ensure the creditor (also known as the unwelcome member) knows what’s going on, here’s what you do:
- Send a letter to the creditor making her aware of the tax debt that she owes and is obligated to pay.
Send a letter to the IRS folks letting them know how much the creditor owes.
Include in the letter a point stating that you want to keep your LLC current on its tax debt, and you suggest that, should the IRS not receive payment, an audit on the creditor may be required.
- Make sure to send a copy of the IRS letter to the creditor.
I guarantee you that before long, the creditor will approach you with a settlement amount that is definitely in your favor.
Remembering that even charging order protection comes with rules
Charging order protection is pretty straightforward and comprehensive. The laws do vary substantially from state to state, so be sure to review your state’s laws on the issue before forming an LLC for asset protection purposes. If you don’t like what you see, you can always form your LLC in a state with more favorable laws and then register to transact business in your home state. I have collected a list of state laws addressing charging order protection at www.docrun.com/dummies/charging_order_protection (password is onesmartdummy).
However, you do have to play by a few rules, which I explain in the following sections. For charging order protection to be effective, you must have certain provisions in your LLC’s operating agreement that provide for it. Don’t leave it up to your state’s laws to be in your favor when it comes to this. I show you how to draw up an ironclad operating agreement all through Part 3 of this book. Though making sure you guard your LLC’s charging order protection may seem overwhelming or troublesome, it’s worth it. By taking a few days to educate yourself and/or by hiring a qualified attorney to draft your LLC’s operating agreement, you can establish an LLC that will provide an indomitable safe harbor for your business for years to come. No other entity offers dual-layer liability protection, protecting both your personal assets from the business liabilities and protecting your business from your personal liabilities. No wonder the LLC is by far the most popular entity formed today!
You must be a true partnership
If you’re a single-member LLC (that is, an LLC with only one owner), you face a drawback: Substantiating case law from a Colorado bankruptcy case some years back established that single-member LLCs aren’t afforded charging order protection. The logic is that because there isn’t another partner in the partnership who needs protection, charging orders shouldn’t be applicable for single-member LLCs. In certain states, this precedent should make you wary of forming an LLC for any sort of business or asset protection purposes with only one member. In community property states, adding your spouse as a second member doesn’t count, so I recommend issuing a small percentage of your LLC to a close friend or relative as a safeguard (preferably someone who isn’t the greedy or difficult type).
Membership can’t be freely transferrable
Charging order protection relies heavily on restricting membership from easy access to the other rights — the management and control in the business. Each state has a default statute that dictates how membership interests are to be transferred and which rights are afforded to the new member (which is, on average, pretty restrictive). However, all states also give you some leeway, allowing you to lay out your own set of rules in your LLC’s operating agreement. Just be careful that you aren’t using this extra rope to hang yourself by allowing the free transference of membership shares and, in the process, inadvertently destroying your own charging order protection. When drafting your operating agreement, keep an eye out for this potential problem. In Chapter 9, I give you some suggestions for special rules and provisions you can add to the operating agreement to doubly uphold charging order protection for your LLC.
Your LLC must be manager-managed
Using charging order protection is a really powerful strategy for LLCs; however, a common mistake is for member-managed LLCs to rely on this strategy. The manager determines the profit and loss allocations, so if the LLC is manager-managed, then a creditor stepping in as a member may be able to actually determine these allocations on his own (depending on the operating agreement and the judge’s decision). To avoid this risk entirely, don’t make your LLC member-managed. Even if all the current members are managing, you should still designate your LLC as manager-managed; then name all the current members as individual managers.
The lawsuit prevention trap is based on charging order protection and therefore only works if your LLC has elected some form of pass-through taxation. So, though corporate taxation may appeal to you for other reasons (see Chapters 8 and 14), you may want to think twice before electing corporate taxation for your LLC because it doesn’t allow taxes to be passed through.
Like regular liability protection (which protects the owners from the debts of the business), charging order protection depends on your maintaining a proper separation of your LLC from yourself and keeping your records in an orderly manner. Chapter 13 is devoted to record keeping.
Exploring Strategies for Increased Security
Protecting your assets is so simple that I challenge you to come up with one good reason why you shouldn’t do it — not later in the year, not in a couple of months, but now. Asset protection strategies work only if you do them before you ever get into trouble. After you’re sued by a creditor (or if the IRS is after you), you can’t transfer your assets into an LLC to protect them. Otherwise, you can be found guilty of fraudulent conveyance of assets, which means you set up your asset protection plan to defraud your creditors and prevent a specific claim. In this case, not only will you hand over your assets to the creditor on a silver platter, but you also may face some pretty steep fines and maybe even some jail time.
So you need to set up your asset protection plan when you don’t have any lawsuits pending or creditors looming. After all, you never know what tomorrow may bring. Set up your defenses early and make sure that as you accumulate more and more in life, no one can take it away.
In the following sections, I go over a few simple strategies that you can use:
- Using a nominee to make it harder for others to find your assets
- Using multiple LLCs to segregate your assets from one another so that if one asset, such as a piece of property, is engaged in a lawsuit, the others are safe from seizure
- Forming two companies in different states to separate your business’s assets from the actual operations of the company
- Transferring all your personal assets into a family LLC that keeps financial instruments, such as stocks, bonds, cash, and mutual funds, safe
Electing a nominee to protect yourself with privacy
Privacy is the first line of defense when it comes to asset protection. If people don’t think you have anything, then they won’t bother suing you in the first place. The saying goes, “Own nothing, control everything,” but that doesn’t mean that just because people will try to take your things, you shouldn’t own and enjoy the finer things in life. You work hard, and you deserve to enjoy the fruits of your labor. And even if the world can see that you have money, you can keep people from knowing where it is. That’s where privacy comes in handy.
Some states, such as Nevada, protect the privacy of the LLC’s members. This protection means that the members don’t need to be publicly listed in the articles of organization or the annual reports your company files with the secretary of state; only the managers have to be listed. If the members don’t need to be listed in your state, then you can just hire a nominee to serve as your LLC’s manager. A nominee is a person who can truthfully state on the stand that she’s unrelated and unknown to you. Doing that ensures that your name, as owner of the LLC, remains private and off public record. You can hire a nominee from a nominee company, usually for less than $500 per year. Keep in mind, though, that this move works only if your LLC is manager-managed.
If you’re in a state that doesn’t allow privacy protection for members, consider forming your LLC in another state, such as Nevada, that does allow it.
After you have a nominee manager in place, unless you broadcast to the world that you own the LLC, people won’t even think to look into the issue further. Your name won’t be on public record, and unless they ask you directly, creditors will have no way of knowing that you’re even associated with the LLC.
If your LLC is currently member-managed, you need to amend your articles of organization to make it manager-managed. Otherwise, you have to list your members (namely, you) on your annual report — which is public record.
Privacy won’t fully protect you. It’s not a strategy in and of itself, per se, but more like an add-on. If you solely use a manager-nominee and think that you’re completely protected, you’ll get the shock of your life when you get dragged into court. The lawyers will ask you about your assets, and at that point, you have two choices: Give up the goods or perjure yourself. Considering that perjury is a pretty serious criminal offense, I would take door No. 1 — and that leads to you revealing the location of your assets so they can be taken.
Setting up multiple LLCs: The more, the merrier!
With an LLC, your business is protected from you, and you’re protected from your business. But what protects your business from itself? When your business is sued, the creditors may not be able to go after your personal assets, but they can still go after the business’s assets! You can fix that.
Any business or property that operates directly with the public is at risk of being sued. If you have all your business assets in your operating company and you get sued, all your business assets can be seized. The same goes for personal assets. If you own ten properties and put them all in the same LLC, and then someone slips and falls on your first property and sues you, everything in that LLC is up for grabs — all ten properties.
The best and easiest way to protect what’s yours is by insulating each of your major assets in its own LLC. Doing so can be somewhat costly, but on large assets, it’s a small price to pay. For instance, New York taxi cab companies often place each taxi in a separate LLC. That way, if one driver gets into an accident and the cab company gets sued, only that one cab can be seized and liquidated to pay off the claim. That LLC can then be dissolved, and the taxi company is still standing. You don’t have to worry about million-dollar judgments now!
Make sure you aren’t already facing a lawsuit when setting up a structure like this one. If you’ve been sued and start transferring entities to different LLCs to protect them from the creditor, you’re engaging in fraudulent conveyance. Not only will it not hold up in court, but it’s also illegal.
Following the dual-entity strategy
An easy way to protect your business’s assets is to simply not keep them in the LLC that operates with the public. You can do so by creating a separate LLC that holds your primary LLC’s assets, making this approach a dual-entity strategy. This protection strategy is my favorite by far; in addition to keeping your assets safe, you also save on some of your state and local taxes. You can set up your LLC this way no matter the tax or management structure.
An example of how dual entities work
Say you decide to start a local pizza delivery company. You live in the high-tax state of California. In this case, you form your LLC in the state of California (not much you can do about this; if you’re located there, you have to register and pay taxes there, no matter what), but you then place all your assets, such as your pizza ovens, cash registers, and so on, into a Nevada LLC that has elected corporate taxation (see Chapter 8 to find out how to make tax elections). For extra protection, you make this Nevada LLC a completely private entity by hiring a nominee (see the “Electing a nominee to protect yourself with privacy” section earlier in the chapter).
Your Nevada LLC that owns the assets then leases them to your California LLC (your operating company — the one that deals with the customers, vendors, and so on). This way, your company’s assets are 100 percent protected. Why? Because they’re in a completely separate entity. Your California LLC controls the assets, but doesn’t own them, which is the most powerful position to be in. If your California company gets into a legal predicament — for example if a customer gets injured — the inquiring attorney will see that it’s completely devoid of assets. Even if he finds out that you own the Nevada LLC, he can’t do anything.
If you choose to use this strategy, make sure the lease between the California LLC and the Nevada LLC is legitimate. You need to write up a contract and pay a reasonable leasing fee to the Nevada LLC every month or every quarter. This step may seem like a pain in the butt, but believe me, it ensures that your strategy is legitimate if you ever go to court.
The tax advantages
One of the main reasons you should form your LLC in Nevada is because Nevada has absolutely zero taxes. Zero business taxes, zero franchise taxes, zero personal income taxes — zilch. And you have to elect corporate taxation on that Nevada LLC because if you try this plan with an LLC with pass-through taxation, your assets are still protected, but the profits flow through to you personally, and you have to pay taxes on them in whatever state you live in.
So, here’s how the tax reduction goes. If you have $100,000 in profit at the end of the year that you want to keep in the company, you can have the profit go to your Nevada LLC as a lease payment for the use of the assets instead of having it flow through to you and your partners and paying state and federal taxes on it. This $100,000 payment is a legitimate tax deduction, so it eliminates the profit in your LLC. After the money is in your Nevada LLC, it’s only taxed at the federal corporate tax rate (which is usually just above 15 percent), as opposed to the personal income tax rate (which can be 35 percent or more!). This strategy is great if you want to save money for assets or other business-related items.
Nevada isn’t the only state with a favorable tax climate. In Chapter 5, I list other pro-business states and show you how to select the one that works best for you.
Protecting your family with the family LLC
Although a family LLC sounds official, it’s really just an LLC like any other; you don’t have to do anything different when you file your articles of organization. It just serves a different purpose. The family LLC protects the assets you and your family will need in the future. If you’re like the majority of folks, you have a savings or money-market account that is coupled with your checking account. Maybe you have some mutual funds. Regardless, everything is in your name. That’s not good. Remember: Own nothing, control everything. Instead, your assets should grow under the protection of an LLC.
The usual arrangement for a family LLC is that you and your spouse both own 50 percent of the membership. After the LLC is set up, all savings accounts, insurance policies, brokerage accounts, mutual funds, CDs, bonds, and so on are transferred into the LLC in a nontaxable event.
Don’t place your home in your family LLC. Your home can be the source of many lawsuits. For example, if a neighborhood kid sneaks onto your property and accidentally drowns in the pool (God forbid!), all the assets in the LLC can be taken. Instead, form a separate LLC for your home or get a homestead exemption (which I discuss in Chapter 18).
Now, if you or your spouse is sued, the assets are safe in the entity, and the creditor can only obtain a charging order. In this case, you use the booby-trap method I outline in the “Setting up the booby trap” section earlier in the chapter to resolve the situation.
Also, if your LLC acquires any debts or obligations, you (and your spouse) aren’t liable for them. For instance, say you’re extended a margin on your brokerage account and you make a few bad trades; unless you personally guaranteed the loan, you aren’t responsible for it — although all your other assets in the LLC may be at risk of being liquidated to repay the debt.
The more that your family LLC is legally separated from you, the safer it is. You can use nominees and find a way to make your personal assets seem like a normal course of business. Create a paper trail that separates you from the assets in the LLC. For instance, if your vehicles are in the LLC, make sure to lease them to your family. This strategy is also a good way to have a legitimate purpose for transferring savings into the LLC on a regular basis. Make sure to document everything; have legitimate contracts and keep your records in order as if it were a real business. The less obvious it is that the LLC only serves to protect your assets, the more certain you can be that the LLC will be rock solid in the courtroom.