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What is an LLC? A limited liability company or a "LLC" is probably the most popular form of business
organization in Michigan these days. As the name implies, the enabling statute provides that the owners of an
LLC (called Members) will not be liable for the debts and obligations of the company. In this respect, it
provides limited liability like a corporation. However, one important advantage is that a limited liability
company can be taxed as a partnership, which means that profits and losses flow through to the Members, to
be reflected on their personal income tax returns. Therefore, there is only one level of income tax on profits.
The tax consequences of the sale of a business or business assets are simpler and less onerous than is
often the case with a corporation.
Types of LLCs. Of course, an LLC can be organized to hold and administer any kind of investment property
and engage in any type of business (with specific limitations in the cases of professions or enterprises which
have special licensing requirements, such as doctors, lawyers, securities dealers). An LLC with an a single
Member generally is not required to file separate tax returns and the operations of the LLC are reflected on
the individuals Schedule C attached to the Member’s personal income tax return. Multi-member LLC’s, being
taxed as a partnership, on the other hand, are required to file a partnership tax return and the individual
Members’ share of profits and losses is reflected on a Schedule K-1. A multi-member LLC will have a
separate Tax ID Number (whereas a single Member LLC uses the Member’s social security number).
Warning. The protective shield of the LLC is dependent upon observing normal business formalities. If these
operating formalities are ignored, courts will be likely pierce the shell of the LLC and impose personal liability
on Members for claims of LLC creditors. These formalities of operation will include keeping minutes, filing
annual reports, using LLC bank accounts only for business operations and not personal matters, and using
the proper business name in all communications, documents and contracts. Of course, all insurance
policies on LLC assets, including liability coverage, should be in the name of the LLC, but could include
Members as additional insureds.
Protection From the Other Direction. In addition to the limited liability of an LLC Member for debts of the LLC,
the LLC is touted as protection of the LLC assets against claims of the Members’ individual creditors. Thus,
in the case of a business conducted by an LLC owned by two or more people as Members, a creditor of one
Member could not reach the LLC assets to satisfy its claim. The creditor would have to rely on an attachment
of the Member’s LLC interest. The creditor could not force the liquidation of the LLC, but rather would have to
wait for any distributions which the managers of the LLC would care to make. As a practical matter, the
creditor would realize that the LLC would not make any distributions while the creditor sat in the position of
"an assignee of the Member’s interest". This inability to reach assets or income would be a great obstacle to
the creditor and an incentive to a reasonable settlement of the outstanding claim. The insulation of LLC
assets from the claims of a Member’s creditor will not exist in the case of a single Member LLC. Courts have
held that a creditor will assume 100% of the Member’s interest in the LLC and can force liquidation of the LLC
to satisfy its claim.
Operating Agreement. The rules governing the Member’s interest and the operation of the business of an
LLC are contained in an Operating Agreement. This document functions like the bylaws of a corporation and
provides such things as :
Management
Voting rights of Members
Restrictions on transfer of Member interests
Members’ rights to dissolve the LLC
In the case of a multi-member LLC, there are generally restrictions on assignment of the Member’s interest
which would provide that any assignee, voluntary or involuntary, cannot exercise the rights of a Member
without the consent of all of the Members of the LLC. That is a key factor in the asset protection aspect of LLC
operations. As pointed out above, a Member’s creditor may attach the membership interest, through a
"charging order", but the creditor would not be entitled to voting rights or to force liquidation of the entity without
the consent of the other Members (who naturally would not be too sympathetic to the creditor’s position).
Caveat! Family LLC’s or limited partnerships have been touted in many seminars and books as the panacea
to estate planning and asset protection. Like other panaceas sold at $2995 or more, these solutions seldom
work in practice because of either organizational or operating flaws. There’s no use buying an umbrella, no
matter how cheap, if it has holes in it. That kind of umbrella is fine, if it never rains, but by analogy, picking up
one of these off the shelf protection kits, which we have seen priced as high as $3,000, will generally be as
useful in crises as a defective umbrella in a thunderstorm.
Estate and Gift Tax Effects. Family LLC’s or Limited Partnerships have been a standard part of the estate
planners arsenal for many years. The non-tax purposes have often been seen as consolidating management
and facilitating gifts of fractional interests for wealth transfer purposes. One important underlying purpose has
been to obtain substantial discounts for the membership interests being transferred, during lifetime or at
death. Limited partnerships and LLC’s have been prominent both in the estate planner’s strategy and in the
gun sights of the IRS. We are informed that the IRS has set up a special division to review any transactions
involving a Limited Partnership or LLC. This scrutiny makes it all the more important to dot the i’s and cross
the t’s when tax benefits, as well as creditor protection, are the objectives.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
organization in Michigan these days. As the name implies, the enabling statute provides that the owners of an
LLC (called Members) will not be liable for the debts and obligations of the company. In this respect, it
provides limited liability like a corporation. However, one important advantage is that a limited liability
company can be taxed as a partnership, which means that profits and losses flow through to the Members, to
be reflected on their personal income tax returns. Therefore, there is only one level of income tax on profits.
The tax consequences of the sale of a business or business assets are simpler and less onerous than is
often the case with a corporation.
Types of LLCs. Of course, an LLC can be organized to hold and administer any kind of investment property
and engage in any type of business (with specific limitations in the cases of professions or enterprises which
have special licensing requirements, such as doctors, lawyers, securities dealers). An LLC with an a single
Member generally is not required to file separate tax returns and the operations of the LLC are reflected on
the individuals Schedule C attached to the Member’s personal income tax return. Multi-member LLC’s, being
taxed as a partnership, on the other hand, are required to file a partnership tax return and the individual
Members’ share of profits and losses is reflected on a Schedule K-1. A multi-member LLC will have a
separate Tax ID Number (whereas a single Member LLC uses the Member’s social security number).
Warning. The protective shield of the LLC is dependent upon observing normal business formalities. If these
operating formalities are ignored, courts will be likely pierce the shell of the LLC and impose personal liability
on Members for claims of LLC creditors. These formalities of operation will include keeping minutes, filing
annual reports, using LLC bank accounts only for business operations and not personal matters, and using
the proper business name in all communications, documents and contracts. Of course, all insurance
policies on LLC assets, including liability coverage, should be in the name of the LLC, but could include
Members as additional insureds.
Protection From the Other Direction. In addition to the limited liability of an LLC Member for debts of the LLC,
the LLC is touted as protection of the LLC assets against claims of the Members’ individual creditors. Thus,
in the case of a business conducted by an LLC owned by two or more people as Members, a creditor of one
Member could not reach the LLC assets to satisfy its claim. The creditor would have to rely on an attachment
of the Member’s LLC interest. The creditor could not force the liquidation of the LLC, but rather would have to
wait for any distributions which the managers of the LLC would care to make. As a practical matter, the
creditor would realize that the LLC would not make any distributions while the creditor sat in the position of
"an assignee of the Member’s interest". This inability to reach assets or income would be a great obstacle to
the creditor and an incentive to a reasonable settlement of the outstanding claim. The insulation of LLC
assets from the claims of a Member’s creditor will not exist in the case of a single Member LLC. Courts have
held that a creditor will assume 100% of the Member’s interest in the LLC and can force liquidation of the LLC
to satisfy its claim.
Operating Agreement. The rules governing the Member’s interest and the operation of the business of an
LLC are contained in an Operating Agreement. This document functions like the bylaws of a corporation and
provides such things as :
Management
Voting rights of Members
Restrictions on transfer of Member interests
Members’ rights to dissolve the LLC
In the case of a multi-member LLC, there are generally restrictions on assignment of the Member’s interest
which would provide that any assignee, voluntary or involuntary, cannot exercise the rights of a Member
without the consent of all of the Members of the LLC. That is a key factor in the asset protection aspect of LLC
operations. As pointed out above, a Member’s creditor may attach the membership interest, through a
"charging order", but the creditor would not be entitled to voting rights or to force liquidation of the entity without
the consent of the other Members (who naturally would not be too sympathetic to the creditor’s position).
Caveat! Family LLC’s or limited partnerships have been touted in many seminars and books as the panacea
to estate planning and asset protection. Like other panaceas sold at $2995 or more, these solutions seldom
work in practice because of either organizational or operating flaws. There’s no use buying an umbrella, no
matter how cheap, if it has holes in it. That kind of umbrella is fine, if it never rains, but by analogy, picking up
one of these off the shelf protection kits, which we have seen priced as high as $3,000, will generally be as
useful in crises as a defective umbrella in a thunderstorm.
Estate and Gift Tax Effects. Family LLC’s or Limited Partnerships have been a standard part of the estate
planners arsenal for many years. The non-tax purposes have often been seen as consolidating management
and facilitating gifts of fractional interests for wealth transfer purposes. One important underlying purpose has
been to obtain substantial discounts for the membership interests being transferred, during lifetime or at
death. Limited partnerships and LLC’s have been prominent both in the estate planner’s strategy and in the
gun sights of the IRS. We are informed that the IRS has set up a special division to review any transactions
involving a Limited Partnership or LLC. This scrutiny makes it all the more important to dot the i’s and cross
the t’s when tax benefits, as well as creditor protection, are the objectives.
©BRANDT, FISHER, ALWARD & ROY, P.C.
This newsletter is provided for informational purposes and should not be acted upon without professional
advice.
| WEALTH CONSERVATION: PROFESSIONAL ALERT Brandt, Fisher, Alward & Roy, P.C. |
| If you would like to receive future editions of the monthly Wealth Conservation Newsletter directly to your e-mail account, please e-mail our office using the following link: Estate Planning Newsletter |
| Brandt, Fisher, Alward & Roy, P.C. Attorneys at Law |
| February 2006 LIMITED LIABILITY COMPANIES - A HELPFUL TOOL by James R. Modrall III, J.D., C.P.A., David R. Appleford, J.D., L.L.M. (Taxation) |