Domestic Asset Protection:
The Use of LLCs and FLPs

What is “domestic” asset protection?

The obvious answer is asset protection that is not done “offshore.”

Domestic asset protection comes in many flavors. When you have an asset protection question, you will get a different answer depending on who you talk with.

See if the following makes sense.

If you ask insurance agents about asset protection (in many states), their answer is to put your money into life insurance and annuities.

If you ask pension consultants about asset protection, their answer is to put as much money as possible in an ERISA qualified plan.

If you ask the typical CPA/accountant or attorney about asset protection (as a general statement) they may tell you that they don’t really understand the question or that they remember reading something about using LLCs for “asset protection.”

As a general statement, domestic asset protection revolves around the concept that you should never own valuable assets in your own name (bank/brokerage accounts, real estate, private stock, etc). Much of proper domestic planning revolves around the use of family limited partnerships (FLPs) and limited liability companies (LLCs).

Why not a C- or S-Corporation?

Because of the remedy a creditor can obtain when asking a judge to make a debtor pay off a judgment or settlement.

IF assets are owned by a properly structured LLC or FLP in the correct jurisdiction, a creditor that is asking the court to have those assets turned over to the creditor should only be able to obtain a “charging order” from the court.

What can’t a creditor get with a charging order?

1. A charging order does not transfer the interest in the LLC to the creditor or force the debtor to sell his/her interest and turn over the sale proceeds to the creditor.
2. A creditor cannot force the LLC to sell assets.
3. A creditor cannot force an LLC to distribute income.
4. A creditor is not able to vote or participate in management of the FLP/LLC (or otherwise control the entity).

What does a creditor get with a charging order?

1. The right to pay income taxes on income generated in the LLC or FLP, even if the profits are NOT distributed. This is known as “phantom income” which, as you can guess, is quite undesirable.

   There was a revenue ruling issued in 1977 (77-173) which states that a creditor who obtains a charging order can be treated as a partner for federal income tax purposes There has been no case law yet on the charging order, but it is still a nice deterrent.

What if assets are owned by the client individually or by a C- or S-Corporation?

The judge can direct the debtor (you) to hand over assets in your own name directly to the creditor (i.e. no asset protection).

What if you have your assets are owned by an S- or C-Corporation?

The judge can:

1. Make you liquidate your interest and give the proceeds to the creditor.
2. Make you transfer your interest in the C- or S-Corporation to the creditor.
3. Let the creditor vote your interest in the company and participate in its affairs.

Basically a C- or S-Corporation is NOT a good tool when trying to protect personal assets such as the following from a personal liability suit (which differs from an entity/corporate level suit):

Family Home or Condominium
Rental Property
Non-Rental Property
IRA
Stocks or Mutual Funds
Life Insurance
Bank Account or CD’s
Planes, Boats, Automobiles, Waverunners or Motorcycles
Other business entity (especially S or C-Corp stock)
Any other collectible items that have value

If you have any assets that you own in your own name (or that of your spouse or co-owned with your spouse), they are at risk from creditors. If you are sued and lose, you stand to lose all such assets.

Summary on “core” Domestic Asset Protection

99%+ of the people with money in this country are not asset protected correctly. While the topics of domestic asset protection merits 50+ pages, the above is a quick little summary of the bread and butter asset protection tool (which is an FLP or LLC).

While an FLP or LLC is not a magic pill to be used as a cure-all, it is the foundation for any domestic asset protection plan and something that can start all clients on their way to protecting themselves from both business creditors and personal creditors.

Regards,

Bob J. Baker
Asset Strategies, LLC
www.assetstrategiesonline.com

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© 2008 Asset Strategies, LLC