If you decide to form a Limited Liability Company (LLC), one primary concern is liability protection for your personal assets from your LLC’s creditors and legal liabilities. Excluding your financial contributions to your business, the general rule is that your LLC is considered a separate legal entity and as its owner, you are not personally liable for its debts or legal liabilities. Yet there are numerous exceptions from this basic adage under state and federal laws. For example, despite your LLC status, you may still be personally responsible for your own conduct that harms third parties, LLC loans that you personally guaranteed, or payroll taxes that your LLC failed to pay to the IRS. It is essential to put together asset protection strategies before any claim or judgment surfaces against your LLC. If you try to protect your personal assets after a claim or judgment has arisen, a court will likely determine that they are fraudulent transfers and strike down these efforts. Early planning can help you adopt strategies that will minimize remaining risks to your personal assets from your LLC’s debts and liabilities. For more information on LLCs and liability protection, including state law variations, see LLC Asset Protection and Charging Orders: A 50 State Guide.
As an LLC owner, here are several potential options to consider that will help lessen the risks to your personal assets from your LLC's business activities.
- Run Your LLC as an Independent Entity. Some recent case law contends that LLC owners may lose the LLC’s limited liability protections under an “alter ego” theory if the owners fail to properly operate the LLC as independent, bona fide business. To avoid piercing this liability shield, you must make certain to run your LLC as a bona fide, independent business entity. Mixing together business and personal duties and assets or neglecting to maintain separate financial records for the LLC may lead a court to determine that your LLC is a sham and hold the owners personally responsible for its debts and liabilities. In addition, the failure to properly capitalize your LLC to meet its obligations to third parties may also end up stripping your LLC of its protective status. Taking your business seriously and running it as a bona fide, independent business will help to protect your personal assets.
- Buy Appropriate Levels of Insurance. No one wants to get into an accident or make a professional mistake, but it does happen every day in the business world. Every individual and business should look at their business situation and seek out adequate liability and professional insurance to help protect personal and business assets. You may want to check with industry or professional associations for their recommendations on appropriate types and levels of insurance and any likely policy exclusions from insurance coverage. Also these organizations may have discount insurance rates for their members. Although premiums can be costly, carrying little or no insurance could be financially devastating for you and your business.
- Elect Corporate Status for Your LLC. In creating your business, you might want to opt for corporate status as an LLC. The IRS allows LLCs to determine whether they will be taxed as a corporation or as a sole proprietorship. Under IRS Form 8832, you can elect to operate as an S Corporation or a C Corporation if you meet certain qualifications. As a corporation, your LLC will have to undertake more complicated filing, reporting, and meeting requirements as well as contend with double taxation. Yet if your LLC is classified as a corporation, you can help shield your personal assets from LLC debt and liabilities along with responsibility for unpaid LLC payroll and other taxes. However, as indicated above, you must maintain your LLC as a separate business entity to be eligible for these liability protections.
- Explore Trusts Options to Protect Assets. Placing your home, cash, stocks, and other valuable property into an irrevocable trust can help protect your assets from LLC debts and other legal obligations. Under a typical irrevocable trust, the trust owns your assets and an independent trustee administers it for the benefit of your designated beneficiaries, such as your children. Some states will also require that these trusts contain spendthrift clauses restricting asset transfers before distributions are made to intended beneficiaries. While you may be giving up your control of these assets, these trust vehicles are normally protected from creditors and will advantage your designated beneficiaries in the future. A few states recognize Domestic Asset Protection Trusts (DAPTs) or “self-settled trusts” which permit individuals to name themselves as beneficiaries and retain some control over trust assets without losing protection from creditors. State laws and requirements vary widely on trusts so consult an estate planning professional for assistance. Keep in mind that courts may look back up to ten years under bankruptcy law to examine previous transfers for their validity, so it is important to plan early in structuring a trust.
- Put Your Revenues toward Certain Assets. If your business is generating profits, you may want to think about putting your funds into a primary residence or certain accounts that are often protected to some degree from creditors. Many states allow residents to place a homestead exemption on their primary residence within the state up to certain dollar amounts. The state of Florida is particularly generous and largely shields primary residences in total from debts, even if the purchase was made to avoid creditor liability. Tax-qualified retirement plans, like IRAs, 529 college savings plan for children and grandchildren, and the cash value of life insurance policies are also usually protected at varying levels from LLC debts under applicable laws. Check into your state laws to determine your options for exempt or partially-exempt property and accounts.
There is no surefire method to protect all of your personal assets as an LLC owner. It makes sense to consult early on with a tax and legal professional to help you assess your individual situation and fully navigate applicable laws when developing your asset protection strategies.