LLCs are a popular choice for businesses due to their flexibility and the protection they can offer from liabilities. When deciding which type of LLC is best for you, it’s important to understand the different LLC structures available and the advantages and disadvantages of each.
Consider Your Asset Protection Needs.
When exploring different types of LLCs, it’s important to understand how the entity will protect your assets. Your chosen LLC should provide you with maximum protection from lawsuits and other financial liabilities. Depending on the type of business you are running and the state in which it is located, some LLCs may be more advantageous than others when it comes to asset protection.
It’s best to use an LLC with charging order limitation.
An LLC with charging order limitation provides additional protection against creditors. It prevents creditors from forcing a company entity into dissolution or foreclosing on it in order to satisfy a debt. Instead, the court will issue a “charging order.” That is a lien that attaches to an LLC member’s distributional interest or profits and requires repayment of the debt through these distributions. This may still put pressure on the company but it will avoid outright seizure of assets or dissolution of the LLC.
Also, the manager of the company is not required to make distributions. So, if the manager allows the profits to accumulate within the company, the creditor with the charging order has to pay tax on the profits (even though no money is going to the creditor). That is called phantom income. That’s a powerful disincentive against pursuing a charging order — the prospect of paying tax on money that the creditor doesn’t receive!
Single-member LLC does not have charging order limitation.
Single-member LLCs, unlike multi-member LLCs, do not have charging order limitation and are therefore more vulnerable to claims by a member’s creditors. A member’s creditors that are owed money can attempt to seize the member’s ownership interest in the company in order to satisfy a debt. Additionally, creditors may be able to attach liens on any assets owned by the LLC. For these reasons, personally owning a single-member LLC is generally not an appropriate for people wanting to protect their personal assets from potential liabilities.
We use single-member LLCs to isolate “dangerous assets” like rental properties or motorboats. Then we have that company owned by a family limited partnership (FLP). The FLP also has charging order protection. We put “non-dangerous assets” like investment accounts in the FLP. By doing this, we protect your “dangerous assets” from your personal creditors.
When does LLC charging order limitation fail?
In some cases, the charging order limitation may not provide sufficient protection for LLCs. For example, if a lender or creditor has the ability to foreclose on a specific asset such as real property or inventory, the creditor may be able to legally take it away from the company in satisfaction of a debt.
Choosing a Tax Status for Your LLC
Choosing the right tax status for your LLC is a critical decision. It can have long-term implications on the financial performance of your business. People most often elect to have their LLCs taxed as disregarded entities or “pass-through” entities. That means profits and losses are passed through to the owners and taxed at their individual rates. Other options include being taxed as a corporation, electing to be an S Corporation, or being allowed to be taxed under partnership rules. Understanding the associated tax implications can help identify which one will work best for your business in the long run.
Get Professional Legal Advice if Necessary
Deciding which LLC is best is usually not as simple as picking a state to form it in. You need to decide whether it needs to be a single-member or multi-member limited liability company. Then figure out how it should be taxed. And finally figure out how it fits within your overall estate and asset protection plan. We recommend getting advice to help ensure that you are making the right decisions when it comes to forming your business.
Arizona is a great state for setting up limited liability companies. We have charging order protection here. The filing cost is low.
And you can easily set it up to provide privacy. If you want help setting up your limited liability company, give us a call at 602-443-4888.