One Entity May Not Be Enough

We are frequently asked: “What type of entity shall I utilize?” The answer to that is a lot more complicated than it first appears. And, the question really doesn’t get to the main issue. The correct question should be: “Will one entity fulfill all my requirements for asset protection and tax reduction?” The answer to that question is: “Probably not, for one entity will not give you all the benefits you desire. In order to determine what, and how many entities you need for asset protection, you must look at the problem through both an asset protection perspective and a tax perspective.

For instance, a corporation will provide asset protection for the officers, directors and stockholders. But, the courts permit the “piercing of the corporate veil.” This occurs when the trier of fact determines that the corporation is a “sham and a farce” and is acting as the “alter ego” of the stockholder. When that occurs, the judgment creditor is permitted to collect a judgment entered against a corporation directly from the stockholders of the corporation.

The limited liability company (LLC) statutes state that neither the members (the “stockholders” of the LLC) nor the manager (the “officers” of the LLC) are liable for the debts of the LLC. So, a judgment against an LLC may not be collected from either the managers or the members of the LLC. Compare this with the limited partnership where the limited partners are not liable for the debts of the limited partnership, but the general partner is liable for those debts. So, if the entity is holding high risk assets (those assets which are likely to generate a lawsuit) an LLC will be preferable over a limited partnership.

As mentioned above, you must also take into consideration the tax issues that each entity will face. A C corporation pays its own taxes. The corporate tax rate is generally lower that the personal tax rate on the same amount of income. But, a C corporation also has the dreaded “double taxation” issue as well as the problem of taking money from the C corporation. In order to take money from the C corporation, it must be either direct income or salary which is subject to social security tax withholding, a loan which must be repaid with taxable interest upon which taxes have already been paid, stock dividends which result in “double taxation” or by pretax business expenses. However, in both the LLC and the limited partnership, the members or limited partners take their profits from the entity as ‘passive income.” Passive income requires the payment of income taxes, but not social security taxes, which total 15.3% when paid by both the employer and the employee. So, obviously, an LLC or a limited partnership would be the better entity to use in order to personally take the profits from the business.

However, a C corporation provides the most pretax business expenses of any entity. So, you will be able to deduct more expenses from a C corporation than an LLC or a limited partnership. A quandary arises here. Do you want the pretax business expenses, or do you want “passive income” as opposed to “direct income?” The correct answer is: “Both.” For that to occur, you must use more than one entity.

Form an LLC and have it managed by a C corporation. The profits will be earned in the LLC and will flow to you as the member of the LLC. This income will be passive income, and not subjected to social security tax withholdings. However, prior to taking all the profit from the LLC, pay the C corporation a management fee. The amount paid to the corporation will be earned income to the C corporation and a business deduction to the LLC. So, for every dollar paid to the corporation as management fees, you personally will pay taxes on one dollar less. A management fee of $2,000 per month will permit you to reduce your personal taxable income by $24,000. This will become taxable income to the C corporation. Now, the C corporation will utilize this income and turn it into pretax business expenses, such as an insurance policy, medical reimbursement, travel expenses, etc. The total amount of expenses incurred during the fiscal year may well equal $20,000. The C corporation will now pay taxes on the balance remaining ($4,000) and you will have received, tax free, the use of $20,000 as business expenses.

If you decide that a limited partnership is the entity which will hold the income producing assets, it is recommended that you use a C corporation as the general partner of the limited partnership. This will both give you the tax breaks mentioned above, but will also increase the liability protection of the limited partnership. The general partner is now a C corporation. A judgment against the limited partnership may also be enforced upon the general partner. But, since it is a C corporation without any assets, you will not be personally affected, because you are not the general partner, the C corporation is. Therefore, the judgment creditor cannot attempt to collect the judgment from you personally.

The discussions above are merely scratching the surface of the issues to be reviewed in order to properly form an asset protection structure. Each structure formed by CSS Nevada will achieve the individual goals of our client and will permit him to protect those assets as his estate grows in the future.

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