Investment & Financial Articles
Title: Using an LLC to Protect Your Wealth
Author: James O'Keefe
Article:
Bulletproof Your Wealth with Family Limited Partnerships and LLC's
A limited partnership is a partnership that has at least one
limited partner and one general partner. Most states require the
filing of a certificate with the state in order to be recognized
as a limited partnership.
The limited partners generally have no liability beyond their
contribution to the partnership. If the limited partnership
business fails, the creditor cannot go after the limited
partners for debts (there are a few minor exceptions to this
rule that are not difficult to avoid). Furthermore, limited
partners are not personally liable for wrongful acts committed
by the other partners. In exchange for this limited liability,
the limited partners give up their right to participate in the
control and management of the partnership.
The general partners run the management of the partnership. The
general partners control the cash distributions to the partners.
The general partners also have unlimited liability, as in a
general partnership. Creditors of the partnership can look to
the general partners' personal assets if the limited
partnership's assets are insufficient. Furthermore, the general
partners are liable to third parties for wrongful conduct within
the partnership business (e.g., a "slip and fall lawsuit").
Thus, a corporation is usually better for pure liability
protection for its owners.
The limited partnership does not pay taxes as an "entity." It
files an informational tax return to the IRS. It issues a form
K-1 to the partners who include the partnership income or loss
on their personal tax returns. The partners must pay income tax
on all gains whether or not the profit is distributed.
Creditors of individual partners cannot take a partner's place
in the partnership. A creditor may garnish the partner's share
of income (called a "charging order"), but has no right to
participate in the management or utilize partnership property.
Thus, if a limited partner's income is garnished by a creditor,
the general partner (who should be under the limited partner's
control) can frustrate the creditor by not distributing income
to the partners. Since a partner is required to pay taxes on his
share of the income whether or not the income is distributed,
guess who gets the tax bill? You guessed it, the creditor! If
your assets are held in a limited partnership, they are
virtually judgment-proof!
The Family Limited Partnership
Let's look at a variation known as a "family" limited
partnership. Suppose that you and your spouse create a limited
partnership to hold your family's liquid assets. Your limited
partnership contributions are all of your stocks, cash, CD's and
mutual funds totaling $300,000. Your partnership agreement could
state that your spouse will act as general partner with a 2%
share (the size of the general partnership share does not affect
the general partner's power to manage the partnership's
affairs). You agree in writing that your contributions
constitute a 98% limited partnership interest.
The partnership agreement could further state that the limited
partnership shall have the right to buy out the general partner
for his share of the partnership and appoint a new general
partner to replace her (the "you" in this example is the
husband; we are making the wife general partner because we
assume that husband's risk of getting sued is higher; if the
opposite were true, then we would arrange the partnership
accordingly).
Let's say that you are sued and a creditor obtains a $50,000
judgment against your name. The creditor can attach your limited
partnership interest but only to the extent of your income as a
limited partner (called a "charging order"). The creditor who
attaches a limited partnership interest cannot participate in
the management of the partnership, and thus cannot force the
general partner, your spouse, to distribute income. As general
partner, your spouse stops paying the limited partners'
distributions, because in her discretion the limited partnership
would be better served to reinvest the capital.
One year later, the creditor still has a $50,000 unsatisfied
judgment. Just to top it off, the partnership sends the creditor
a form "K-1" for the creditor's share of your "phantom" income
(In our example, the partnership assets are worth $300,000. At a
10% annual return, your share of income would be approximately
$30,000 - the creditor would have to pay income taxes in the
ballpark of $10,000! If the creditor does not pay the tax due on
your undistributed share of income, the IRS may come after the
creditor!). You will be in a strong position to force your
creditor to settle his claim for a fraction of its value.
Let's say a creditor sues your spouse and tries to attack your
spouse's general partnership interest. At that point, the
partnership exercises its power under the partnership agreement
to buy out her general partnership interest in the amount of
$2,000 or 2%. The partnership then finds a new general partner.
With proper planning, this may not be considered a "fraudulent"
conveyance because the general partner received full
compensation for her partnership share.
"Family" LLC's - To Good to be True?
Another similar tool for protecting your wealth is the LLC or
"
Limited Liability Company." An LLC is like a cross between a
corporation and a limited partnership. All of its partners
(called "members") have limited liability and all of its members
can participate in the management of the LLC without suffering
any liability.
Any assets you hold in an LLC are protected from creditors in
the same way your assets are protecting in a limited partnership
(i.e., the creditor's remedy is limited to a "charging order").
In addition, since all members are shielded from liability, an
LLC may be an excellent device for holding investment real
estate - the members are protected from tenant lawsuits and the
equity of the members is protected from other creditors.
About the author:
James O'Keefe is the owner of My Millionaire Friend
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