[IMGCAP(1)][IMGCAP(2)]Limited liability companies have become the entity of choice for small business owners and are commonly utilized by professionals in asset protection planning.
Choosing to use the LLC over (for example) a corporation may be prudent but raises the question of where to form the LLC. There are several factors to consider in deciding where to establish the entity. Picking the right LLC jurisdiction may be as important as the decision to use an LLC.
In 2010, the Florida Supreme Court issued a ruling that eviscerated the effectiveness of the Florida single-member LLC for asset protection purposes. In Olmstead v. FTC, the Florida Court, using judicial acrobatics, ruled that a judgment creditor may foreclose the LLC membership interest of the debtor. Although the writing was already on the wall—after all, other court decisions had previously called into question the wealth protection effectiveness of the single-member LLC—the Olmstead decision sent many Florida planners scrambling for safety in other states.
States such as Nevada, Alaska and Wyoming provide express statutory language respecting the protection of single-member LLCs. Wyoming became a particular favorite because of its low cost and the fact that LLC members and managers were not required to be publicly disclosed. A recent decision by the Supreme Court of Wyoming, however, should give planners cause for concern.
In Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc., the Wyoming Supreme Court last year upheld a ruling that permitted the creditor of a corporation's wholly owned subsidiary to “pierce the corporate veil” of the subsidiary, making the parent company responsible for the debts of its subsidiary.
Veil piercing is an extraordinary remedy typically reserved for those cases involving fraudulent conduct. The remedy is rarely permitted unless a limited liability entity is found to be the mere “alter ego” of its owner such that it would be inequitable not to make the owner responsible for subsidiary's debts.
In Greenhunter, the Wyoming Supreme Court acknowledged that the two companies (parent and subsidiary) maintained separate bank accounts and business records. The court, however, took the unprecedented step of considering consolidated tax returns as a factor favoring the alter ego relationship and permitted the plaintiff to pierce the subsidiary (to reach the parent's assets).
IRS rules allow for a single-member LLC to be taxed as a disregarded entity. Indeed, the principal advantage of single-member LLCs has been their recognition as offering greater limited liability benefits than a corporation, coupled with “disregarded” tax treatment (avoiding the need for a tax return).
The Wyoming Supreme Court’s decision to confound tax treatment with legal liability is unprecedented and runs counter to proper application of LLC protections. This is a dangerous and surprising prospect from a state otherwise offering one of the most protective LLC statutes in the country.
Other factors should be considered as well. If stability is a concern, Delaware is a traditional choice and Nevada offers a sound alternative due to its reliance on Delaware’s longstanding body of favorable corporate law. If privacy is a concern, Delaware and Alaska are options. If the entity is to be owned by a single member and charging order protection is a concern, Nevada and Alaska offer a sound legal framework. If maximum asset protection is desired, the best options are often offshore.
And, finally, one should always consider the types of assets to be owned by the LLC. It makes little sense, for instance, to use a Delaware LLC to house Florida real estate for asset protection. The practical reality is that any litigation involving the property is likely to occur in Florida, where a Florida court could be expected to apply Florida law.
Entity selection is a fluid process. As reflected by the recent Wyoming decision, the Supreme Court of a favored state can quickly throw the state's law into a tailspin. Professional planning requires constant study and an awareness of legal trends and pitfalls.
Gary Forster and Eric Boughman are partners at the law firm of Forster Boughman & Lefkowitz, The Wealth Protection Group.
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