Family Limited Partnership?

The first step in creating the Family Limited Partnership is the preparation and filing of the Certificate of Limited Partnership with the Secretary of State. The form asks for the name of the limited partnership. This name should be cleared in advance with the Secretary of State’s office because the filing will not be accepted if the name is similar to another name already on file. The Certificate of Limited Partnership also asks for the name of a designated Agent for the Service of Process, which is the name and address of a person (or company) who is authorized by the partnership to receive service of process if the partnership is sued for any reason. Any family member residing in the state can be designated as the agent. There are also companies that will, for a modest fee, act as the designated agent for these purposes.

The form also asks for the names and addresses of all general partners of the partnership. The names of the limited partners are not required. Since this document is a matter of public record, the names of the general partners will be publicly available but not the names of the limited partners. Along with the Certificate of Limited Partnership, each state requires a filing fee which is usually about $85–$125.

When the Secretary of State’s office receives the properly filled out form, with an acceptable partnership name, the Certificate will be filed. At this point, the partnership will be legally formed. You should request that a certified copy of the Certificate of Limited Partnership be returned to you, and your copy should be stamped with the filing date. It is essential that you have at least one certified copy for opening a bank or brokerage account, or for the purchase or sale of real estate in the name of the partnership.
The Partnership Agreement
Concurrently with the filing of the Certificate of Limited Partnership, a written partnership agreement must be prepared. This is the document that governs the affairs of the partnership. It sets out the purpose of the partnership, the duties of the general partners, matters on which the vote of the limited partners is required, the share of partnership capital and profits to which each partner is entitled, and all other matters affecting the relations between the partners. When creating a Family Limited Partnership for estate planning and asset protection purposes, the partnership agreement must also contain certain key provisions designed to accomplish your objectives. Taken together, these provisions must ensure that a creditor can never achieve any influence over partnership affairs and that Husband and Wife, as general partners, always maintain absolute control over the assets of the partnership. These provisions are unique and essential to a properly structured Family Limited Partnership.

Overview
In making the decision about funding the partnership, it is important that you understand the distinction between Safe Assets and Dangerous Assets.

Safe Assets are those which do not, by themselves, produce a high degree of lawsuit risk. For instance, if you own investment securities such as stocks, bonds, or mutual funds, it is unlikely that these assets will cause you to be sued. Mere ownership of investment assets, without some active involvement in the underlying business, would probably not cause a significant degree of lawsuit exposure.

Dangerous Assets, on the other hand, are those which, by their nature, create a substantial risk of liability. These are generally active business type assets, rental real estate, or motor vehicle ownership, any of which may cause you to be sued.

The reason for the distinction between Safe Assets and Dangerous Assets is that you do not wish to have the FLP incur liability because of its ownership of a Dangerous Asset. If the partnership does incur liability, it will be the target of a lawsuit and all of the assets in that partnership will be subject to the claims of the judgment creditor. This is exactly the situation you are trying to avoid. Dangerous Assets must either be left outside of the partnership or must be placed in one or more separate entities. Dangerous Assets must be isolated from each other and from Safe Assets, in order to avoid contaminating the Safe Assets.
Dangerous Assets
An example of a Dangerous Asset is an apartment building. The liability potential of apartment houses is particularly high. Although liability insurance coverage is usually available, the amount of coverage may not be sufficient. A fire in a densely populated building may cause severe injury or death to many tenants. The potential liability for such a tragedy could easily reach into the millions of dollars, exceeding by far the amount of your insurance coverage.

Apartment owners can also be held responsible for the acts of the resident managers. If the resident manager engages in race or sex discrimination in renting to tenants, or is guilty of sexual harassment, this liability may be imputed to you as the owner of the property. Acts such as these may not be covered under your standard insurance coverage.

If this asset is transferred to the same Family Limited Partnership that holds all of your other assets, that partnership, as the owner of the property, will face a high degree of lawsuit exposure and all of your assets will again be at risk.

Instead, the best approach for a Dangerous Asset such as an apartment building is to transfer that property to its own separate entity. Generally the Limited Liability Company is the proper way to hold Dangerous Assets. Since no individual member of an LLC can be sued for an LLC related obligation, the liability associated with the Dangerous Asset can be contained and insulated in the LLC. If a number of Dangerous Assets are owned, each should be placed in a separate entity. Once we formed thirty-two different LLCs for a client, each holding one apartment building. If a disaster occurred, only the LLC which owned that property would be sued. The other properties and family assets were safely insulated and shielded from liability under this arrangement.

Some types of commercial real estate may also constitute Dangerous Assets. Office buildings, hotels, restaurants, nightclubs, or any other building where many people work or gather, all have the potential to produce stratospheric liability in the event of some type of disaster.

A physician client owned a medical office building in his Professional Corporation. His medical practice and the property were both Dangerous Assets and a liability produced by either would jeopardize the other. For example, a problem arising from the building would produce a claim against the equipment, accounts receivable, and cash in the corporation. The office building should have been separated from the medical practice by holding it in a separate LLC. Dangerous Assets must be kept separate from each other asset. We will discuss details about the use and operation of the LLC.
Safe Assets
Safe Assets with a low probability of creating lawsuit liability can be maintained in a single Family Limited Partnership.

Although the family home is a Safe Asset, with liability issues generally covered by insurance, there are a number of tax issues which arise with respect to the transfer of the family home into the Family Limited Partnership. The first problem concerns the availability of the income tax deduction for home mortgage interest. Section 163 of the Internal Revenue Code permits a deduction for “qualified residence interest.” A “qualified residence” is defined as the “principal residence” of the taxpayer. The only requirements appear to be that (1) the house is the principal residence of the taxpayer; (2) interest is paid by the taxpayer; and (3) the taxpayer has a beneficial interest in any entity that holds legal title to the property. Based upon the language of the statute, the deduction for mortgage interest would, therefore, not seem to be adversely affected by a transfer into the Family Limited Partnership. However, until the law on this issue has been conclusively decided you should not risk the consequences of a disallowance of your mortgage interest deduction.

Similar tax issues concern the ability to avoid up to $500,000 of the gain from the sale of your home. It is likely that a transfer of your residence into the FLP would cause you to lose this tax advantage. For these reasons, we do not recommend using the FLP to hold the family residence.

An alternative is to use a specially designed trust to own the home. All of the tax benefits will be preserved and the highest level of protection can be maintained.
Bank and Brokerage Accounts
These types of accounts do not create any potential liability and can be transferred into the Family Limited Partnership. In order to open these accounts in the name of the partnership, you will present the financial institution with a certified copy of the Certificate of Limited Partnership. The institution will also require the Taxpayer Identification Number issued to the partnership by the Internal Revenue Service.
Interest in Other Entities
The Family Limited Partnership is an excellent vehicle for holding interests in other business entities. The reason that we mention these other business entities is that the Family Limited Partnership must not ever be engaged in any business activities. You do not want the partnership to buy or sell property or goods or to enter into contracts. If the partnership does business, then the partnership can get sued. And if the partnership gets sued and loses, all of the assets that it holds can be lost.
Interest in Other Entities
The Family Limited Partnership is an excellent vehicle for holding interests in other business entities. The reason that we mention these other business entities is that the Family Limited Partnership must not ever be engaged in any business activities. You do not want the partnership to buy or sell property or goods or to enter into contracts. If the partnership does business, then the partnership can get sued. And if the partnership gets sued and loses, all of the assets that it holds can be lost.
Case Example
For example, a client of ours entered into a contract to purchase a shopping center. Previously, we had set up a Family Limited Partnership for him. Without our knowledge, the “Buyer” under the purchase contract was the Family Limited Partnership. During the pre-closing escrow period, financing became unavailable and the client failed to complete the deal. The seller sued the partnership for damages for breach of contract and was awarded $600,000 wiping out a substantial portion of our client’s assets. The seller sued the partnership because the partnership was the named party to the contract.

This transaction should not have been handled in this manner. The proper way to conduct this type of business activity is through a separate LLC or partnership arrangement. By using the proper planning techniques, potential liability can be significantly reduced and valuable personal assets can be protected from a dangerous lawsuit. Had this arrangement been used, our client would not have lost $600,000. Instead, the buyer and seller would probably have re-negotiated the terms of the purchase in a way that was mutually satisfactory to each side.

This example illustrates the necessity for conducting business activities through an entity other than the Family Limited Partnership so that family assets are not exposed to the risk of liability. The proper role of the Family Limited Partnership in this context is to hold the interests in the business entities that are themselves subject to risk. The FLP can hold these interests, providing asset protection and estate planning advantages in a single integrated package.

Summary
The Family Limited Partnership offers a unique capability to realize a variety of planning goals.

Assets held in the FLP are effectively shielded from potential claims.

Income taxes can be shifted to lower bracket family members or entities such as corporations and trusts to take advantage of deferral and savings techniques.

Estate taxes on accumulated wealth and future appreciation can be minimized or eliminated by gifting discounted interests in the FLP to children or trusts established for their benefit.

The FLP provides a convenient and flexible format as the cornerstone of your overall plan. In the succeeding sections we will see how Limited Liability Companies and trusts can provide additional opportunities to create asset protection and tax savings strategies.

The Limited Liability Company (LLC) has become a powerful tool for accomplishing many asset protection goals. The LLC is the most versatile and convenient strategy for owning rental property, insulating Dangerous Assets, operating a business, and achieving an excellent level of financial privacy.

The LLC is a relatively new legal entity created by statute and recognized in all fifty states. The adoption of the LLC format began in Wyoming and Florida in the 1970s with approval in most other states only within the last ten years. The purpose of the legislation is to allow individuals to create a legal entity that avoids many of the tax and business problems inherent in the corporate and partnership structure. The intent of the law is to allow individuals to conduct their financial and business affairs in an efficient and convenient manner without the restrictions, formalities, and liabilities associated with those other entities.

More particularly, the LLC provides the protection from liability of a corporation without the formalities of corporate minutes, bylaws, directors, and shareholders. In contrast to corporate law, which allows shareholders and officers to be individually sued if the corporate formalities are not followed, the LLC law specifically bars a lawsuit against a member for the liabilities of the LLC. That is an important distinction which you should understand. The principle shareholders and officers of a corporation are routinely named as defendants in a lawsuit against the company-forcing them to incur attorney’s fees to defend themselves and rendering the corporate shield meaningless from a practical standpoint.

A primary goal of the LLC legislation was to change this result by clearly stating that the members and managers of the LLC could not be named in a lawsuit against the company. The new law was drawn specifically to provide a vehicle which would protect the owners from liability associated with the business-what the corporation was intended for but no longer accomplished.

The LLC is also convenient to maintain. The owners are permitted to adopt flexible rules regarding the administration and operation of the business. For tax purposes, it is treated like a partnership. That means the LLC itself pays no income tax. All of the income and deductions flow through directly to the members and is reported on their personal tax returns.

The LLC is formed by filing Articles of Organization with the Secretary of State’s office. Unlike the FLP, which requires the names of the general partners, the disclosure of the names of the principals can be avoided. The name of either the member or the manager must be provided in the articles. Also, many states, including Nevada and Delaware, permit a single member LLC to be formed. We will see that these provisions open the door for a variety of financial privacy strategies. Anonymous ownership of financial accounts, business interests, and real estate can be achieved with an LLC as an important component of the plan.

The bad news, for physicians and some other professionals, is that state law generally does not allow these practices to be operated as an LLC. The liability shield available to business owners has not been extended to doctors-due to opposition primarily from the trial lawyers. Although the LLC may be useful in protecting accumulated assets from lawsuits, it will not insulate the individual from the liability associated with a medical practice.

Inside and Outside Liability
To understand the benefits available from the LLC, let’s look at a typical example. John and Mary own an apartment building as tenants-in-common. We know that holding the property, as they do now, exposes them to great danger. Ownership of rental property creates more uncontrolled liability and lawsuit risk than any other business or profession we have seen. And because this potential liability usually cannot be covered by insurance, a single unpredictable event, a mistake, or just bad luck can wipe out everything built up over the years.

Injuries to tenants, problems with lenders, lawsuits from future buyers-all subject everything that John and Mary own to potential liabilities from the property. We call this type of liability-arising from the property itself-inside liability. John and Mary need to be protected from inside liability.

To make matters worse, a lawsuit or claim against John or Mary from a matter not related to the building exposes the equity in the apartment property to seizure in satisfaction of that claim. We call this type of liability outside liability. John and Mary’s interest in the property must be protected from outside liability. If one of them is involved in an auto accident causing serious injury, they do not want to lose the property because of this outside liability. Clearly, owning the apartment building in the current manner is not sound business planning. What other options are available to them?

LLC Versus Corporation
John and Mary could transfer the property to a corporation. Each would own 50 percent of the stock in the company. Since the law provides that the shareholders are not responsible for debts of the corporation, a liability arising out of the property would not subject John and Mary’s personal assets to danger.

The problem is that this protection against liability is only available if all of the corporate formalities are carefully followed. Since most people do not maintain proper corporate records and documentation, corporations often do not provide the intended level of protection. Further, corporations are subject to complex tax rules, which can cause severe and unintended consequences.

Finally, the corporation will not protect the property from outside liability-lawsuits against John or Mary unrelated to the property. A creditor can simply seize the stock that they own and reach the apartment building by dissolving the company. For these reasons, it is generally not advisable to hold investment real estate in a corporation.

LLC Versus Limited Partnership
If John and Mary form a limited partnership to hold the property, one or both of them will serve as general partner. Since the general partner has unlimited liability for the debts of the partnership, if a liability arises out of the operation of the building, the general partner’s assets will be exposed to that claim. The major problem with the limited partnership format is this unlimited liability of the general partner. From a tax standpoint, the limited partnership does not cause any difficulties and, as previously discussed, a creditor suing John or Mary for an outside liability would be limited to a charging order, which would not affect the property in the partnership. By forming an LLC, John and Mary can accomplish all of their objectives.

Inside Liability Protection
A member of an LLC is not responsible for claims or judgments against the company. When we are dealing with a rental property or an active business, the potential liability associated with the business is a primary concern. But as we have stated, the law specifically provides that the members of the LLC cannot be sued. In our previous case study, John and Mary transfer their apartment building to an LLC. If a tenant is injured in an accident, John and Mary, as members of the company, would be protected from any claim relating to the property.

Outside Liability Protection
Property held in an LLC cannot be seized by a creditor of a member. If there is a judgment or claim against John or Mary, the creditor cannot reach the property held in the LLC. As is the case with the Family Limited Partnership, assets of the LLC are protected from potential claims against a member. The creditor is limited to the ineffective charging order remedy. A creditor with a judgment against a member of the LLC is only permitted to take whatever actual cash distributions are made by the company. The creditor cannot force a distribution or demand any portion of the assets of the company.

No Formalities
An LLC is not required to maintain formal minutes and resolutions. Record keeping requirements can be minimized without a threat that the members will be sued individually for a liability of the company. Contrast this treatment with that of a corporation. If the proper formalities are not followed, the corporate protection will be pierced and the owners will have liability for company obligations. The LLC law is specifically intended to remedy this problem by providing that the entity cannot be pierced because of a failure to maintain any of the corporate type documents.

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cartier95 said

on February 13, 2010

The first step in creating the Family Limited Partnership is the preparation and filing of the Certificate of Limited Partnership with the Secretary of State. The form asks for the name of the limited partnership. This name should be cleared in advance with the Secretary of State’s office because the filing will not be accepted if the name is similar to another name already on file. The Certificate of Limited Partnership also asks for the name of a designated Agent for the Service of Process, which is the name and address of a person (or company) who is authorized by the partnership to receive service of process if the partnership is sued for any reason. Any family member residing in the state can be designated as the agent. There are also companies that will, for a modest fee, act as the designated agent for these purposes.

The form also asks for the names and addresses of all general partners of the partnership. The names of the limited partners are not required. Since this document is a matter of public record, the names of the general partners will be publicly available but not the names of the limited partners. Along with the Certificate of Limited Partnership, each state requires a filing fee which is usually about $85–$125.

When the Secretary of State’s office receives the properly filled out form, with an acceptable partnership name, the Certificate will be filed. At this point, the partnership will be legally formed. You should request that a certified copy of the Certificate of Limited Partnership be returned to you, and your copy should be stamped with the filing date. It is essential that you have at least one certified copy for opening a bank or brokerage account, or for the purchase or sale of real estate in the name of the partnership.
The Partnership Agreement
Concurrently with the filing of the Certificate of Limited Partnership, a written partnership agreement must be prepared. This is the document that governs the affairs of the partnership. It sets out the purpose of the partnership, the duties of the general partners, matters on which the vote of the limited partners is required, the share of partnership capital and profits to which each partner is entitled, and all other matters affecting the relations between the partners. When creating a Family Limited Partnership for estate planning and asset protection purposes, the partnership agreement must also contain certain key provisions designed to accomplish your objectives. Taken together, these provisions must ensure that a creditor can never achieve any influence over partnership affairs and that Husband and Wife, as general partners, always maintain absolute control over the assets of the partnership. These provisions are unique and essential to a properly structured Family Limited Partnership.

Overview
In making the decision about funding the partnership, it is important that you understand the distinction between Safe Assets and Dangerous Assets.

Safe Assets are those which do not, by themselves, produce a high degree of lawsuit risk. For instance, if you own investment securities such as stocks, bonds, or mutual funds, it is unlikely that these assets will cause you to be sued. Mere ownership of investment assets, without some active involvement in the underlying business, would probably not cause a significant degree of lawsuit exposure.

Dangerous Assets, on the other hand, are those which, by their nature, create a substantial risk of liability. These are generally active business type assets, rental real estate, or motor vehicle ownership, any of which may cause you to be sued.

The reason for the distinction between Safe Assets and Dangerous Assets is that you do not wish to have the FLP incur liability because of its ownership of a Dangerous Asset. If the partnership does incur liability, it will be the target of a lawsuit and all of the assets in that partnership will be subject to the claims of the judgment creditor. This is exactly the situation you are trying to avoid. Dangerous Assets must either be left outside of the partnership or must be placed in one or more separate entities. Dangerous Assets must be isolated from each other and from Safe Assets, in order to avoid contaminating the Safe Assets.
Dangerous Assets
An example of a Dangerous Asset is an apartment building. The liability potential of apartment houses is particularly high. Although liability insurance coverage is usually available, the amount of coverage may not be sufficient. A fire in a densely populated building may cause severe injury or death to many tenants. The potential liability for such a tragedy could easily reach into the millions of dollars, exceeding by far the amount of your insurance coverage.

Apartment owners can also be held responsible for the acts of the resident managers. If the resident manager engages in race or sex discrimination in renting to tenants, or is guilty of sexual harassment, this liability may be imputed to you as the owner of the property. Acts such as these may not be covered under your standard insurance coverage.

If this asset is transferred to the same Family Limited Partnership that holds all of your other assets, that partnership, as the owner of the property, will face a high degree of lawsuit exposure and all of your assets will again be at risk.

Instead, the best approach for a Dangerous Asset such as an apartment building is to transfer that property to its own separate entity. Generally the Limited Liability Company is the proper way to hold Dangerous Assets. Since no individual member of an LLC can be sued for an LLC related obligation, the liability associated with the Dangerous Asset can be contained and insulated in the LLC. If a number of Dangerous Assets are owned, each should be placed in a separate entity. Once we formed thirty-two different LLCs for a client, each holding one apartment building. If a disaster occurred, only the LLC which owned that property would be sued. The other properties and family assets were safely insulated and shielded from liability under this arrangement.

Some types of commercial real estate may also constitute Dangerous Assets. Office buildings, hotels, restaurants, nightclubs, or any other building where many people work or gather, all have the potential to produce stratospheric liability in the event of some type of disaster.

A physician client owned a medical office building in his Professional Corporation. His medical practice and the property were both Dangerous Assets and a liability produced by either would jeopardize the other. For example, a problem arising from the building would produce a claim against the equipment, accounts receivable, and cash in the corporation. The office building should have been separated from the medical practice by holding it in a separate LLC. Dangerous Assets must be kept separate from each other asset. We will discuss details about the use and operation of the LLC.
Safe Assets
Safe Assets with a low probability of creating lawsuit liability can be maintained in a single Family Limited Partnership.

Although the family home is a Safe Asset, with liability issues generally covered by insurance, there are a number of tax issues which arise with respect to the transfer of the family home into the Family Limited Partnership. The first problem concerns the availability of the income tax deduction for home mortgage interest. Section 163 of the Internal Revenue Code permits a deduction for “qualified residence interest.” A “qualified residence” is defined as the “principal residence” of the taxpayer. The only requirements appear to be that (1) the house is the principal residence of the taxpayer; (2) interest is paid by the taxpayer; and (3) the taxpayer has a beneficial interest in any entity that holds legal title to the property. Based upon the language of the statute, the deduction for mortgage interest would, therefore, not seem to be adversely affected by a transfer into the Family Limited Partnership. However, until the law on this issue has been conclusively decided you should not risk the consequences of a disallowance of your mortgage interest deduction.

Similar tax issues concern the ability to avoid up to $500,000 of the gain from the sale of your home. It is likely that a transfer of your residence into the FLP would cause you to lose this tax advantage. For these reasons, we do not recommend using the FLP to hold the family residence.

An alternative is to use a specially designed trust to own the home. All of the tax benefits will be preserved and the highest level of protection can be maintained.
Bank and Brokerage Accounts
These types of accounts do not create any potential liability and can be transferred into the Family Limited Partnership. In order to open these accounts in the name of the partnership, you will present the financial institution with a certified copy of the Certificate of Limited Partnership. The institution will also require the Taxpayer Identification Number issued to the partnership by the Internal Revenue Service.
Interest in Other Entities
The Family Limited Partnership is an excellent vehicle for holding interests in other business entities. The reason that we mention these other business entities is that the Family Limited Partnership must not ever be engaged in any business activities. You do not want the partnership to buy or sell property or goods or to enter into contracts. If the partnership does business, then the partnership can get sued. And if the partnership gets sued and loses, all of the assets that it holds can be lost.
Interest in Other Entities
The Family Limited Partnership is an excellent vehicle for holding interests in other business entities. The reason that we mention these other business entities is that the Family Limited Partnership must not ever be engaged in any business activities. You do not want the partnership to buy or sell property or goods or to enter into contracts. If the partnership does business, then the partnership can get sued. And if the partnership gets sued and loses, all of the assets that it holds can be lost.
Case Example
For example, a client of ours entered into a contract to purchase a shopping center. Previously, we had set up a Family Limited Partnership for him. Without our knowledge, the “Buyer” under the purchase contract was the Family Limited Partnership. During the pre-closing escrow period, financing became unavailable and the client failed to complete the deal. The seller sued the partnership for damages for breach of contract and was awarded $600,000 wiping out a substantial portion of our client’s assets. The seller sued the partnership because the partnership was the named party to the contract.

This transaction should not have been handled in this manner. The proper way to conduct this type of business activity is through a separate LLC or partnership arrangement. By using the proper planning techniques, potential liability can be significantly reduced and valuable personal assets can be protected from a dangerous lawsuit. Had this arrangement been used, our client would not have lost $600,000. Instead, the buyer and seller would probably have re-negotiated the terms of the purchase in a way that was mutually satisfactory to each side.

This example illustrates the necessity for conducting business activities through an entity other than the Family Limited Partnership so that family assets are not exposed to the risk of liability. The proper role of the Family Limited Partnership in this context is to hold the interests in the business entities that are themselves subject to risk. The FLP can hold these interests, providing asset protection and estate planning advantages in a single integrated package.

Summary
The Family Limited Partnership offers a unique capability to realize a variety of planning goals.

Assets held in the FLP are effectively shielded from potential claims.

Income taxes can be shifted to lower bracket family members or entities such as corporations and trusts to take advantage of deferral and savings techniques.

Estate taxes on accumulated wealth and future appreciation can be minimized or eliminated by gifting discounted interests in the FLP to children or trusts established for their benefit.

The FLP provides a convenient and flexible format as the cornerstone of your overall plan. In the succeeding sections we will see how Limited Liability Companies and trusts can provide additional opportunities to create asset protection and tax savings strategies.

The Limited Liability Company (LLC) has become a powerful tool for accomplishing many asset protection goals. The LLC is the most versatile and convenient strategy for owning rental property, insulating Dangerous Assets, operating a business, and achieving an excellent level of financial privacy.

The LLC is a relatively new legal entity created by statute and recognized in all fifty states. The adoption of the LLC format began in Wyoming and Florida in the 1970s with approval in most other states only within the last ten years. The purpose of the legislation is to allow individuals to create a legal entity that avoids many of the tax and business problems inherent in the corporate and partnership structure. The intent of the law is to allow individuals to conduct their financial and business affairs in an efficient and convenient manner without the restrictions, formalities, and liabilities associated with those other entities.

More particularly, the LLC provides the protection from liability of a corporation without the formalities of corporate minutes, bylaws, directors, and shareholders. In contrast to corporate law, which allows shareholders and officers to be individually sued if the corporate formalities are not followed, the LLC law specifically bars a lawsuit against a member for the liabilities of the LLC. That is an important distinction which you should understand. The principle shareholders and officers of a corporation are routinely named as defendants in a lawsuit against the company-forcing them to incur attorney’s fees to defend themselves and rendering the corporate shield meaningless from a practical standpoint.

A primary goal of the LLC legislation was to change this result by clearly stating that the members and managers of the LLC could not be named in a lawsuit against the company. The new law was drawn specifically to provide a vehicle which would protect the owners from liability associated with the business-what the corporation was intended for but no longer accomplished.

The LLC is also convenient to maintain. The owners are permitted to adopt flexible rules regarding the administration and operation of the business. For tax purposes, it is treated like a partnership. That means the LLC itself pays no income tax. All of the income and deductions flow through directly to the members and is reported on their personal tax returns.

The LLC is formed by filing Articles of Organization with the Secretary of State’s office. Unlike the FLP, which requires the names of the general partners, the disclosure of the names of the principals can be avoided. The name of either the member or the manager must be provided in the articles. Also, many states, including Nevada and Delaware, permit a single member LLC to be formed. We will see that these provisions open the door for a variety of financial privacy strategies. Anonymous ownership of financial accounts, business interests, and real estate can be achieved with an LLC as an important component of the plan.

The bad news, for physicians and some other professionals, is that state law generally does not allow these practices to be operated as an LLC. The liability shield available to business owners has not been extended to doctors-due to opposition primarily from the trial lawyers. Although the LLC may be useful in protecting accumulated assets from lawsuits, it will not insulate the individual from the liability associated with a medical practice.

Inside and Outside Liability
To understand the benefits available from the LLC, let’s look at a typical example. John and Mary own an apartment building as tenants-in-common. We know that holding the property, as they do now, exposes them to great danger. Ownership of rental property creates more uncontrolled liability and lawsuit risk than any other business or profession we have seen. And because this potential liability usually cannot be covered by insurance, a single unpredictable event, a mistake, or just bad luck can wipe out everything built up over the years.

Injuries to tenants, problems with lenders, lawsuits from future buyers-all subject everything that John and Mary own to potential liabilities from the property. We call this type of liability-arising from the property itself-inside liability. John and Mary need to be protected from inside liability.

To make matters worse, a lawsuit or claim against John or Mary from a matter not related to the building exposes the equity in the apartment property to seizure in satisfaction of that claim. We call this type of liability outside liability. John and Mary’s interest in the property must be protected from outside liability. If one of them is involved in an auto accident causing serious injury, they do not want to lose the property because of this outside liability. Clearly, owning the apartment building in the current manner is not sound business planning. What other options are available to them?

LLC Versus Corporation
John and Mary could transfer the property to a corporation. Each would own 50 percent of the stock in the company. Since the law provides that the shareholders are not responsible for debts of the corporation, a liability arising out of the property would not subject John and Mary’s personal assets to danger.

The problem is that this protection against liability is only available if all of the corporate formalities are carefully followed. Since most people do not maintain proper corporate records and documentation, corporations often do not provide the intended level of protection. Further, corporations are subject to complex tax rules, which can cause severe and unintended consequences.

Finally, the corporation will not protect the property from outside liability-lawsuits against John or Mary unrelated to the property. A creditor can simply seize the stock that they own and reach the apartment building by dissolving the company. For these reasons, it is generally not advisable to hold investment real estate in a corporation.

LLC Versus Limited Partnership
If John and Mary form a limited partnership to hold the property, one or both of them will serve as general partner. Since the general partner has unlimited liability for the debts of the partnership, if a liability arises out of the operation of the building, the general partner’s assets will be exposed to that claim. The major problem with the limited partnership format is this unlimited liability of the general partner. From a tax standpoint, the limited partnership does not cause any difficulties and, as previously discussed, a creditor suing John or Mary for an outside liability would be limited to a charging order, which would not affect the property in the partnership. By forming an LLC, John and Mary can accomplish all of their objectives.

Inside Liability Protection
A member of an LLC is not responsible for claims or judgments against the company. When we are dealing with a rental property or an active business, the potential liability associated with the business is a primary concern. But as we have stated, the law specifically provides that the members of the LLC cannot be sued. In our previous case study, John and Mary transfer their apartment building to an LLC. If a tenant is injured in an accident, John and Mary, as members of the company, would be protected from any claim relating to the property.

Outside Liability Protection
Property held in an LLC cannot be seized by a creditor of a member. If there is a judgment or claim against John or Mary, the creditor cannot reach the property held in the LLC. As is the case with the Family Limited Partnership, assets of the LLC are protected from potential claims against a member. The creditor is limited to the ineffective charging order remedy. A creditor with a judgment against a member of the LLC is only permitted to take whatever actual cash distributions are made by the company. The creditor cannot force a distribution or demand any portion of the assets of the company.

No Formalities
An LLC is not required to maintain formal minutes and resolutions. Record keeping requirements can be minimized without a threat that the members will be sued individually for a liability of the company. Contrast this treatment with that of a corporation. If the proper formalities are not followed, the corporate protection will be pierced and the owners will have liability for company obligations. The LLC law is specifically intended to remedy this problem by providing that the entity cannot be pierced because of a failure to maintain any of the corporate type documents.

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