By Sarah G. McC. Moïse
Staff Writer

Everyone has heard scary stories about runaway juries and activist judges. As more people lose their hard earned property to huge court awards, others are trying to prevent it from happening to them.

Virginia M. Shuman of Evan, Carter, Kunes & Bennett, an attorney specializing in estate planning and tax law, says that certain business entities are more at risk for liability than others. “A lot of people start a business as a sole proprietorship and think that, because they’re small, they don’t need to consult with a lawyer or accountant. But for tax and liability reasons, they should consider that if they get sued, a plaintiff would be able to attack their personal as well as their business assets.”

A general partnership may be a hazardous way to set up a business, since each partner is liable if anything happens. “Anyone still set up that way should seek advice from a tax advisor,” says Shuman. “They could convert the general partnership to a limited liability company. They would continue to be taxed as a partnership, but, as members of an LLC, they have protected their personal assets.”

Stephen D. Kirkland’s CPA firm, Moore Kirkland & Beauston, helps physicians, business owners and others with wealth protect their assets from predatory lawsuits. “Most people are fairly familiar with corporations, both the ‘C’ and ‘S,’ as well as with professional corporations. Essentially, all of these entities are best used for operating businesses, as a corporation will be treated as a separate person under the law, effectively separating the liabilities of the corporation from the wealth of the business owners,” he says.

Limited liability companies are a kind of hybrid between corporations and partnerships, and aside from potential income and estate tax benefits, LLCs are given a special level of protection by most state laws. “These laws, providing what is called ‘charging order’ protections, are quite powerful,” says Kirkland. “First, they prevent a creditor from being able to penetrate an LLC and get to LLC-owned assets. Secondly, they prevent a creditor from becoming a member of the LLC itself.”

Kirkland suggests that business owners consider creating walls between their properties. For example, his accounting firm owns its office building in Columbia under a separate entity called MKB Investments. The firm’s office building in Charleston is owned by MKB2 Investments, and the third office in Hartsville is owned by MKB3 Investments.

“If somebody trips and falls on our property in Charleston, then they’re suing that one entity. And so the equity we have in that entity is exposed, but not the equity of the other entities,” he explains.

Another entity that protects assets is the Family Limited Partnership, which is simply a limited partnership owned by family members—although it could be owned by close associates or friends. As a limited partnership, it must have at least one general partner and at least one limited partner. The general partners control the FLP and the limited partners are, for the most part, passive.

In addition to corporations, LLCs and FLPs, there are many types of trusts, such as living trusts, grantor trusts, dynasty trusts and rabbi trusts. Each has a specific role and particular costs and benefits. “The general rule regarding trusts and asset protection is that only irrevocable trusts protect assets,” says Kirkland.

However, an irrevocable trust carries a heavy price. The client must give up control and ownership of the asset to gain protection. “The cost makes sense when the client would inevitably gift the assets to the beneficiaries and does not foresee needing the assets for the client’s own financial security.”

Other asset protection techniques are more involved, like putting property into an offshore trust or LLC. The idea is that the foreign jurisdictions may not recognize judgments of U.S. courts. The trust agreement may state that the trustees are to ignore any request the grantor makes while under duress (i.e. after losing his or her shirt in court). So when the grantor instructs the trustees to turn property over to a plaintiff, that request would be disregarded.

Kirkland says that these strategies are used to legally protect assets, but not to hide them. Attempting to protect assets from an estranged spouse, a bankruptcy court, or from any claim that is already pending can lead to serious trouble.

He reminds business owners that it is crucial to legally protect wealth before there is a problem. While there are legitimate planning tactics the client can take after being sued, courts frown upon transfers made “late in the game.” Asset protection is a specialized and complicated area and should be undertaken only with the close guidance of reputable advisors experienced in this field.

Sarah G. McC. Moïse covers legal issues for the Business Journal. E-mail her at smoise@crbj.com.

SIDEBAR:

Sole proprietorships, partnerships, LLCs and S-corporations are pass-through entities for federal income tax purposes. This means that these entities are not subject to income tax. Rather, the owners are directly taxed individually on the income, taking into account their share of the profits and losses. This avoids double taxation.

A C-corporation is a regular corporation that does not wish to be taxed as a pass-through entity. It is subject to two levels of taxes, one at the corporate level (for corporate profits) and one at the shareholder level (for dividends).

Profits of a corporation are taxed twice when the profits are distributed to shareholders as dividends. They are taxed first as income to the corporation, then as income to the shareholder. All reasonable business expenses, such as salaries, are deductions against ­corporate income and can minimize the double tax. Further, the double tax can be eliminated by making an S-corporation election.

An S-corporation is a corporation that elects to be taxed as a pass-through entity. In this case, the profits and losses are passed through directly to the shareholders. This eliminates the double taxation problem associated with C-corporations.

Source: www.bizfilings.com, www.legalzoom.com

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