CLIENT ALERTS

Is Your LLC A Time Bomb? – This article will demonstrate how to defuse it.

For the past 15 years or so, the Limited Liability Company (the “LLC”) has been the preferred business entity for tax and business purposes. The LLC has gained widespread use because it is a simpler tax and business structure to hold title to assets such as real property, business equipment and operating businesses. Although the LLC is owned by one or more Members, it can be managed by one or more of its Members or by someone who is not a member.

Like the limited partnership (the “LP”), the LLC has grown in popularity as a vehicle for asset protection. Under current law, when a Member of a LLC is sued, and a subsequent judgment is rendered against the Member, the remedy available to the holder of the judgment is called a “Charging Order” (the “CO”). The CO is unique to LLCs and limited partnerships, in that it restricts the judgment creditor’s ability to reach assets inside the LLC or LP. The judgment creditor cannot force the entity to sell assets or even make distributions. The judgment creditor only obtains a lien against future distributions that may be made to the Member against whom the judgment has been issued. The protection from the CO is that it prevents the judgment creditor from reaching inside the LLC and attaching its assets. Therefore, the CO limitation has made the LLC one of the most popular forms of business entity for planners who seek to provide protection from lawsuits and other third party claims for their clients.

However, in all but four states,1 a court can go beyond the CO and fashion a remedy to aid the judgment creditor in collecting on its judgment. For instance, a Court may grant the judgment creditor the right to foreclose on the Member’s LLC interest.2 Although the foreclosure would allow the judgment creditor to take over ownership of the Member’s LLC interest, the judgment creditor remains unable to reach inside the LLC or in any way interfere with the assets of the LLC itself. For the Member who loses his or her LLC Membership interest to a foreclosure proceeding, the consequences can be devastating. Beside the Member losing his or her capital account, for income tax purposes, the foreclosure will be treated as a “sale or exchange” of the membership interest, triggering the reporting of capital gain, recapture or other income, all of which could have adverse tax consequences in the form of phantom income.

Thus, those who formed their LLC(s) in other than the aforementioned four “sole remedy” states may find themselves in the unenviable position of having to settle their lawsuit for a far larger sum or risk the unintended income tax consequences of losing their LLC interest(s) to the foreclosure remedy.

THE SOLUTION

There are four states (as mentioned above) that limit the CO as the “sole remedy” and do not permit the Member’s LLC interest to be lost as a result of a foreclosure sale. One solution would be for the LLC to change its jurisdiction to one of the four states that have the CO as the “sole remedy.”

Another and perhaps more practical, solution would be for the Member to establish a newly formed LLC in Nevada (a sole remedy jurisdiction) and contribute the Membership interest to the Nevada LLC in exchange for the Nevada LLC Membership interest of equal value.3 If there are multiple Members of the non-Nevada LLC, each of the Members should consider exchanging their Membership interest for the Nevada LLC Membership interest.

A further reason to consider Nevada as the state of formation for your LLC is an amendment to take effect October 1, 2009. Steve Oshins, of the law firm of Oshins & Associates, LLC, and the firm to which this author is presently serving as Of Counsel, was responsible for the Nevada legislation. Senate Bill 350 was signed into law on May 29, 2009 and is effective as of October 1, 2009. A portion of the Bill creates a new form of business entity called a “Restricted Entity” (the “RE”). While the gift and estate tax planning opportunities are beyond the scope of this article,4 forming the LLC in Nevada as a RE would create a “business purpose” for the new NV LLC, an important element for successful asset protection planning. The new RE rules create a restriction on liquidating the LLC for up to 10 years, which, according to Mr. Oshins’ article, would result in additional transfer tax discounts of 10% to 30% or more, producing significant estate and gift tax benefits. If the Member of the NV LLC interest were sued and found liable, the judgment creditor would find itself applying Nevada law (regardless of the state the Member resides).5

Asset protection is generally one of the primary reasons for the formation of an LLC. Many individuals and their advisors, who have created the LLC, as the entity of choice, are unaware of the Foreclosure remedy available to judgment creditors seeking to enforce their claims against Members of LLCs not otherwise formed in one of the magnificent four states. This author offers a sensible and relatively easy solution to “defuse” this potential time bomb, should the Member find himself or herself involved in a nasty lawsuit and the LLC not domiciled in one of the States that has the Sole Remedy CO rules.

Client-Alert---LLC-Ticking-Time-Bomb-2

1 Nevada, Alask, New Jersey, and Oklahoma.

2 The CO with respect to LP interests are generally protected from the foreclosure remedy. General Partnerships do not enjoy the protection of hte CO at all.

3 Unless you live in Nevada, your Nevada LLC will require a Nevada registered agent. The Oshins & Associates, LLC law firm can serve as the resident agent of the Nevada LLC and ensure the LLC remains compliant.

4 For a detailed discussion on the new Restricted Entity law in Nevada and how it can be used to incorporate larger valuation discounts into your estate and gift tax planning, see: The New Nevada Restricted LLC and LP Legislation: A “Why” and “How to?” Guide: Communique, September 2009, by Steve J. Oshins, Esq.

5 Under the Full Faith and Credit laws of the US Constitution, despite the Member residing outside of Nevada, the Member’s state should apply Nevada law with respect to the CO rules.

Insurance Implications of Transferring Real Property To A Trust, Partnership, Or LLC

For those of you who have transferred real property to trusts, partnerships, or limited liability companies, a recent California appellate court decision emphasized the importance of updating your insurance policies to reflect the changes in ownership or risk not being covered by your existing insurance policies.

In Kee Kwok v. Transnation Title Insurance Company (2009), the California Court of Appeals held that the insurance policy covering an LLC did not cover a husband and wife when they transferred title to the property from the name of a LLC to themselves as trustees of a family trust. The court reasoned that the insured was the LLC and the policy did not cover the Kwoks because title was transferred from the LLC to the Kwoks as trustees of their family trust, a separate entity, and therefore they were not covered under their existing policy.

This same problem exists with regard to other forms of insurance such as general liability coverage. If you have general liability coverage in your own name and then transfer title to yourself as trustees of a trust, depending on the language of your policy, you may not be entitled to coverage in your new capacity as trustees under your existing policy.

The solution? If you have transferred property to a trust, partnership, or limited liability company, or vice versa, carefully review your policies to determine whether you are entitled to coverage under your existing policies and, if not, take appropriate steps to insure that you are covered by (1) obtaining endorsements adding yourself or the entity to the policy as insureds, or (2) obtaining new policies.

Some newer policies may cover transfers to trusts but not to other entities. Therefore, when transferring property, it is imperative that you review your existing policies to determine if the transferred person or entity is covered. If not, the insurer must be contacted to obtain an endorsement covering the new owner or issue a new policy. In California, most of the common transfers to and from family trusts and other entities can be covered under CLTA Endorsement 107.9, which is not expensive but you must go to your title insurer and ask for it.

Therefore, when transferring real property to a trust, partnership, or limited liability company, you must be careful to change your insurance policies to reflect the changes in ownership, or risk losing your insurance coverage.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group,LLP at jeff@jmvlaw.com or (949) 263-1133.

Protecting Assets & Lifestyle – Why “Going Offshore” May Be The Best Option

For over 30 years, our law firm’s approach to the estate planning process begins with solidly protecting the client’s wealth from unforeseen lawsuits and other third party claims before we turn our attention to the client’s desired estate planning objectives.

The recent economic downturn has substantially affected most everyone’s estate plan—both high-net worth and moderate taxpayers alike—making protecting one’s remaining assets critically important. Unfortunately, we still see very few estate planning professionals including asset protection options into their clients’ estate plans.

THE GOAL: ESTATE PLANNING WITH ASSET AND LIFESTYLE PROTECTION

Lawsuits settle for two primary reasons: Doubt as to liability and doubt as to collectability. One goal of asset protection planning is to create doubt as to collectability by reducing the economic incentives to bring the lawsuit. This can be accomplished by changing the manner in which legal title to the assets are held so that if sued, the assets will not be subject to being reached by the legal process by the successful plaintiff. Removing the profit motivation from the lawsuit will often remove the motivation to sue, or if sued, the likelihood of a quicker settlement at terms more favorable to you is increased.

Asset protection planning also lowers the financial profile of our clients by removing them from the “financial radar screen.” Since the passage of the Patriot Act after 9/11, it has become increasingly more difficult to be completely removed, but one may still achieve significant anonymity by intelligently titling their assets with these goals in mind.

While protecting assets is important, protecting lifestyle is no less important but often overlooked, even by professionals who practice in the area of asset protection. Cash flow from the assets which generate them is what is used to support lifestyle. Without protecting cash flow, in the face of a lawsuit, the judgment debtor will not be able to pay their bills and the case will likely settle for significantly greater amount than otherwise would be the case if “lifestyle” protection is accommodated in the planning.

In designing an asset protection strategy, income producing assets must be able to be legally removed from the reach of the court, or their use could severely be restricted. Thus, the offshore asset protection trust will provide the options to have the liquid assets placed beyond the reach of the U.S. court and allow a beneficiary’s lifestyle to be maintained while the lawyers attempt to reach a favorable settlement. Without the offshore trust mechanism, the chances of reaching a quick and favorable settlement would be far less likely.

THE OFFSHORE ASSET PROTECTION TRUST – THE CORNERSTONE OF ASSET PROTECTION

An offshore asset protection trust (“APT”) will typically be the cornerstone of any effective asset and lifestyle protection plan. The APT will be subject to the laws of another country that are far more protective than those of the client’s state. Moreover, the foreign country will not have “comity” with the offshore country, meaning the offshore country will not recognize the judgments from a U.S. judgment creditor. If a U.S. judgment creditor wishes to pursue a legal claim against the offshore trust, it must file the case de novo (from the beginning) in the offshore jurisdiction and litigate the issues anew in the foreign court, where lawyers are not permitted to take a case on a contingency fee basis and where the loser must pay the court costs and attorney fees.

Even if the U.S. creditor elects to go through this process and is successful in obtaining a judgment against the U.S. person, the creditor will not be able to invade the APT to reach assets due to the nature of the trust laws of the offshore country.

As a practical matter, when a U.S. person is threatened with a lawsuit, his or her trustee will move the liquid assets of the APT held in the U.S. bank or brokerage firms to an overseas bank or brokerage firm with no U.S. branches, thereby protecting the trust’s assets against a U.S. court order or judgment. The target of the U.S. lawsuit may send his or her bills and other obligations to the foreign trustee, which will use the liquid assets (safely held in the foreign bank) to provide the “lifestyle” support for the settlor of the APT while the settlor negotiates with his or her creditors. Eventually, the U.S. creditor will settle, on terms more favorable to the debtor (than without the APT), as the creditor determines that it will have no adverse impact on the debtor’s lifestyle despite having obtained a judgment.

SELECTING AN OFFSHORE JURISDICTION

Offshore trusts may be established in any foreign country that has statutory or common law that provides for asset protection trusts. There are many factors that must be carefully considered in selecting an offshore jurisdiction, some of which are listed below, and undertaking careful due diligence and obtaining advice from a recognized expert in the field is essential.

When selecting an offshore jurisdiction there are various considerations, including:

  • Does the country use a common law legal system? Common law legal systems are preferable to other law legal systems.
  • Are the country’s asset protection laws set by statute?
  • Does the country have a solid track record in offshore trusts? There are a number of countries that recently adopted asset protection trust laws, but may not have had any court cases which have tested it. Select one that has a track record of success.
  • Is the country stable—politically, economically, and socially?
  • Is English the primary language?
  • How do the country’s fraudulent transfer laws compare to the U.S.? Are they more favorable?

Of the 60 or so countries that purport to have asset protection laws, there are just a handful of countries that answer these questions affirmatively, making them ideal asset protection jurisdictions.

PROTECTING IMMOVABLE ASSETS

Effectively protecting assets like real estate, accounts receivable, and equipment (immovable assets) requires the implementation of an ancillary strategy. The belief that real estate (for example) can be effectively protected by placing title to it in a structure such as a limited liability company, limited partnership, or corporation does not take into account the reality that a “results-oriented” judge can disregard the entity. The only effective method available to protect an immovable asset is to make the asset unattractive to a creditor by removing its value, thereby making the asset not worth pursuing. Consider: Would you spend your time and money to sue someone if all they had was a piece of real property worth $5 million encumbered by a $4.5 million mortgage? This “equity-stripping” technique is implemented by pledging the immovable asset as collateral for a loan and protecting the loan proceeds by placing the proceeds in the offshore trust.

ENSURING U.S. TAX COMPLIANCE

Many people erroneously believe that participating in offshore activities is illegal and will get them into serious trouble if they do so. They read stories about the USB Swiss account holders who are being prosecuted by the government for not reporting their Swiss accounts, and about other U.S. citizens who attempted to evade taxes by using credit cards issued by an offshore bank.

The IRS would not print forms to report offshore activities if going offshore were illegal. The IRS does not mind if you go offshore, but they certainly do mind if you don’t tell them about your offshore activities to the extent you are required to do so. It is critically important that a client’s offshore planning remain tax compliant with federal reporting requirements. Therefore, anyone choosing to engage in offshore planning should consult with tax professionals who are experienced in offshore compliance.

CONCLUSION

There are many ways to protect assets, but only one real way to protect both assets and lifestyle—the offshore Asset Protection Trust. If you have assets worth protecting, especially significant liquid assets, the offshore APT is most likely going to be an extremely important and effective estate planning tool to be included as part of your overall estate plan.

© 2009 Jeffrey M. Verdon Law Group, LLP.

About the Author: Jeffrey M. Verdon, Esq. is a Managing Partner of Jeffrey M. Verdon Law Group, LLP, a boutique trusts and estates law firm located in Irvine, CA. The firm, which has specialized in asset and lifestyle protection planning for over 25 years, is rated “AV” by Martindale Hubbell.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group,LLP at jeff@jmvlaw.com or (949) 263-1133.

AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009

The much-anticipated economic stimulus package, the American Recovery and Reinvestment Act of 2009 (the “Act”), became law on February 17th. The $787 billion new law, which contains nearly $300 billion in tax relief, sets in motion a wave of direct spending and tax incentives. Although a significant part of the Act is aimed at low and middle income taxpayers, the bill contains several provisions that may be applicable to high-net-worth taxpayers and their families.

Click here for a Special Report on the Act’s tax provisions and its implications, provided by CCH.

For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact Jeffrey M. Verdon Law Group,LLP at jeff@jmvlaw.com or (949) 263-1133.