As we have previously discussed on this blog, limited liability companies (LLCs) have many benefits for business owners. We will now examine one of those benefits more in depth—the protection of your personal assets.
In a sole proprietorship or partnership, there is no legal distinction between business assets and personal assets or business debts and personal debts. For example, if the sole proprietor:
- Cannot pay business debts, creditors may go after personal assets to satisfy the debt
- Cannot pay personal debts, creditors may go after business assets to satisfy the debt
Owners of an LLC, on the other hand, enjoy a significant amount of asset protection because, generally speaking, a creditor can only go after the assets an owner has invested in the business. Additionally, if a creditor wishes to go after the interests of one owner/member of an LLC, it cannot actually levy on the interests (as it could with a corporation), but must instead place a lien on that member’s interest. The lien will remain until the debt is satisfied, though the creditor will never outright seize the member’s interests. This is referred to “charging order protection.”
Asset protection in an LLC is not absolute, however, and there are numerous circumstances under which your personal assets may still be at risk. For this reason, it is important to consult with an experienced business attorney to ensure that your assets are properly protected.
The following are only some of the ways an LLC owner can work to ensure that personal assets are protected from business creditors of legal liability:
Operate your LLC as a completely separate entity. Too many LLC owners fail to run their company as a completely independent business. For example, they may use LLC funds for personal expenses or co-mingle funds with personal assets. In some cases, if you combine personal and business finances, creditors may claim that your LLC is simply an “alter ego” and an attempt to shield assets, and creditors may be able to seize your personal assets.
Failing to properly capitalize your LLC. Too many people form an LLC, take out business debts, but fail to put enough capital into the business to adequately meet its obligations. In such cases, creditors may claim that your LLC is a sham and they may be able to strip you of the asset protection provided by the LLC name.
Elect to be taxed as a corporation. LLC owners have the option to select pass-through taxation (profits are reported on personal tax returns) or to be taxed as a corporate entity. Though corporate status can result in double taxes, it does help further establish your LLC as a separate entity and assist in protecting your personal assets.
Purchase necessary levels of insurance. Many business owners believe that they will not make costly mistakes or get into accidents, however such events can happen to anyone. If your LLC faces legal liability for your actions, your personal assets may often be at risk to cover any resulting judgments. If you have the proper level of liability insurance to cover the judgment, your personal assets will be protected. If you are not sure of the necessary level of insurance for your LLC, it is wise to consult with an attorney regarding proper insurance for your type of business.
Consider forming a trust. Trusts are legal devices that can be used to protect your personal assets from creditors. When you form an irrevocable trust, you can place your home, investments, liquid assets, and more into the trust, which will be administered by a third party called a “trustee.” Though you relinquish direct control of these assets, you will know they will be protected and properly handled so they may be passed on to your beneficiaries and will not be seized by business creditors.
These are only some of the methods of ensuring that your personal assets are protected from the creditors of your LLC. Every business is different, therefore every business will have different needs for asset protection planning. An experienced business attorney can evaluate your particular situation and help you design a comprehensive asset protection plan for your LLC. Do not hesitate to contact a California small business lawyer for assistance today.