Planning with LLCs: LLCs offer asset protection, business flexibility, and tax advantages.

• Author: Stein, Jacob
• Position: TAX PLANNING - Limited liability companies

From the time limited liability companies came into prominence, practitioners have been working to maximize their asset protection, business flexibility and tax advantages, among other benefits.

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CHARGING-ORDER PROTECTION

Liability protection is a main reason for forming an LLC. The LLC protects the members from lawsuits directed against the entity [California Corp. Code Sec. 17101(a)] and protects the assets within the LLC from lawsuits against the members. This is often called an outside-in versus inside-out asset protection.

Protection of the entity's assets from lawsuits against the members, afforded by the so-called charging-order, is an advantage LLCs have over corporations [California Corp. Code Sec. 17302(a)]. Corporations offer liability protection only if the lawsuit is directed against the entity, not if it's directed against the shareholder.

The charging order limits the creditor to an economic interest in the LLC without transferring the membership interest or any control over the entity to the creditor. As a result, the creditor often receives phantom income--no cash is distributed to the creditor, but income is allocated to the creditor for tax purposes.

Though California statutes extend charging-order protection to all LLCs, whether multi-member (more than one person or entity holds a membership interest) or single-member [California Corp. Code Sec. 17302(a)], be aware that one court has found that charging orders do not apply to single-member LLCs [In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003)].

Clients with single-member LLCs that want to maximize the protection of the entity's assets from lawsuits against the sole member should consider adding members. The new members must have a capital interest in the LLC, but not necessarily a profit interest [California Corp. Code Secs. 17001(x) and (z)].

For LLCs set up by family members, a so-called poison pill provision should be considered. This provision usually allows either the LLC or other members to buy out the debtor-member for a nominal amount.

The poison pill has the effect of substituting the debtor-member's membership interest with a nominal amount of cash, which limits the assets a creditor can collect against. In some cases the provision eliminates the need for charging-order protection, which is particularly effective when the LLC is holding depreciable real estate and is passing through losses.

The charging-order protection is critical for...