Recently I've run across some significant issues with the single member
LLC's with courts handing down noteworthy judgement decisions in favor
of creditors using the theory of "fraudulent transfers" and "civil
conspiracy." I ran across two such individuals that have made me more
caution on client advice regarding single member LLCs.
SINGLE MEMBER LLC - LIMITED LIABILITY COMPANY PASS-THROUGH LEGAL ENTITY
The LLC is a TAX HYBRID "pass-through" legal entity similar to a
partnership but with the limited liability of a corporation. The LLC is
tax-driven and was classified legally by the IRS on January 1, 1997
when the IRS threw out its old, and unnecessarily complicated, business
entity tax classification regulations and agreed that LLCs should be
taxed as partnerships (or sole proprietorships if they have one owner)
without jumping through a number of technical hoops. Moreover, the IRS
now lets an LLC elect to pay taxes as a sole proprietorship, as a
partnership, or as a corporation by filing IRS Form 8832.
For "Income Tax purposes" income and expenses of the LLC "pass-through"
directly to your income tax return proportionate to your percentage of
ownership, or if there is more than one member, whatever percentage you
decide, for example, 50/50 or 75/25. Irrespective of your equity
ownership percentage, this is a significant advantage over other forms
of business entities, and the LLC also has another significant
advantage; members decide how they want to be taxed or, in other words,
as sole proprietor, partnership, or corporation. The LLC will obtain
it's own Federal Identification Number (similar to a social security
number), operate as a business, and maintain it's own bank account.
SINGLE MEMBER LLC MAY NOT BE PROTECTED FROM CREDITORS
Ninety percent of financial advisors give the wrong advice regarding
single member LLC formations. Single member LLC are mistakenly assumed
to protect the member from the creditor. Most financial LLC advisors
state that a Limited Liability Company (LLC) protects the owner (i.e.
single member LLC) against present, past, and future creditors because
the creditor may not step into the shoes of the LLC and has to look at
the LLC member for collection.
The advisors point to an IRS Revenue Ruling (77-137), where the
creditor holding the "Charging Order" will receive the "K-1." They
further explain, the creditor must pay the taxes on the income
generated by the LLC, even though the creditor never receives any
actual cash from the business. The creditor saddled by the charging
order is treated as a "substituted limited partner for tax purposes"
and will suffer the tax consequences without capacity to force payment,
dissolution, or distribution of the LLC.
CHARGING ORDER DEFINES CREDITOR AS SUBSTITUTED LIMITED PARTNER FOR TAX PURPOSES TO PROTECT SINGLE MEMBER LLC
The area of the laws surrounding the issues of the charging order to
protect the single member LLC is dynamic and evolving. There's no legal
reasoning for a charging order protection for single member, even
though most state statutes call for such protection. The charging order
protection cannot create a "personal legal liability" out of a legal
business entity for "the acts" of the LLC.
There are several litigation issues unique to the LLC that are
beginning to emerge in trial forums. State LLC laws, when written, were
primarily tax driven, and accordingly, they defined key terms and
concepts in accounting and tax terms, and not with thought of contract
tort law issues. When the LLC is in financial distress, litigation will
usually focus on:
A. Dissolution issues,
B. Capitalization issues,
C. Failure to comply with state statutory and regulatory requirements, and
D. Violation of one or more provisions of the entity's documents.
FRAUDULENT CONVEYANCE, CIVIL CONSPIRACY WITH SINGLE MEMBER LLC
The central issue to single member LLCs (one owner) is "FRAUDULENT
CONVEYANCE" which, if not handled properly may become part of a "civil
conspiracy" to fraudulently act against creditor claims. In some cases
the financial planner, lawyer, or accountant becomes part of the
conspiracy and in some cases such advisors have been reprimanded.
Single shareholder corporation, single shareholder of Sub "S", and
single member LLCs can provide the owner with protection against
liabilities arising from "the conduct of the LLC" but not the owner of
the LLC membership shares. In other words, "if" the LLC does something
wrong, the owner is not necessarily responsible. To reach the owner's
personal assets, a plaintiff would have to "pierce the veil" of the
entity showing that:
A. The LLC, the corporation, or the Sub "S" was undercapitalized for it's intended business purpose,
B. Formalities were not followed,
C. The owner used the LLC, Corporation or Sub "S" mostly for personal purposes,
D. It did not serve a "bona fide" commercial purpose,
E. It lacked in economic substance and was merely an alter ego of the
owner whose sole intention is to frustrate the creditor(s), etc.
A single member LLC (one owner), Corporation, or Sub "S" will not
protect the owner, because the charging order protection that is much
touted, is based on protecting the "innocent" non-debtor.
Under the Uniform Fraudulent Transfer Act you would be committing a crime, see Section 19.40.041:
"...(a) a transfer made or obligation incurred by a debtor is
fraudulent as to a creditor whether the creditor's claim arose before
or after the transfer was made or the obligation was incurred, if the
debtor made the transfer or incurred the obligation: (1) with
actual intent to hinder, delay, or defraud any creditor of the
debtor..."
Rocco and his team of bonded professional attorneys, CPAs and
accountants help affluent individuals and companies retain control of
their domestic and foreign/offshore assets, protect their assets, build
& preserve their wealth and financially structure their money to
reduce capital gains taxes, estate taxes, inheritance taxes, avoid the
probate process and decrease income taxes.
--------------------------------------------------------------------------------
Rocco Beatrice, CPA, MST, MBA, Award-winning trust & estate-planning expert
71 Commercial Street #150 Boston, MA 02109 tel: 508.429.0011 fax: 508.429.3034
Click here for more info: http://www.UltraTrust.com, http://ultratrust.com/fraudulent-conveyance-civil-conspiracy.html
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