Another reason to Beware of LLC’s

Still getting advice to form an LLC?

Lawyers accountants and business advisors still routinely suggest most small start-ups form an LLC and they even fill out the forms to do it. LLC’s and S-corps almost never give the benefits of a C-Corp in tax deductions, withholding of assets, employment plans for health, education and retirement, Etc.!!! I have already blogged against the “llc one size fits all” practice below and will not repeat all that here. But there is MORE. An LLC may be even worse than a sole proprietorship or family partnership business!

Hiring Family Members in a Family Business

In today’s tough job market a family business may be the only place for some family members to find work. Rather than supporting them you can hire them and pay them with tax-deductible dollars for legitimate work with pay reasonably commensurate with the hours and job.

If you employ a child(ren) under the age of 19 or a student under age 24 who is claimed as a dependent of the parent, his earned income is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $300 or the regular standard deduction, $5,700 in 2010. Assuming that a child has no other income, the child could be paid $5,700 and incur no income tax. If paid more, the next $8,375 earned by the child is taxed at only10% . This is almost always far less than the parent’s rate if you simply paid the child an allowance, college fund or other savings after paying your own taxes on the same money! Plus you could put even more earned and currently untaxed money in the child’s deductible IRA and any qualifying, deductible College fund from the child’s earned income. Make the tax man subsidize your child rearing budget even more!

Remember, a child’s investment income can still be taxed at the same rate as the parent’s top marginal rate using a lower $950 standard deduction. Most would be better off putting their money in a business and hiring the kids rather than creating trusts or gifting then Investing for them and paying a high marginal rate.

All of the above is available whether you incorporate or not, use an S-Corp, C-Corp or LLC. Here is the kicker and why an LLC can be worse than no corporate business entity at all: FICA and FUTA!

If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Medicare taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Neither the employee’s (Child’s) share of the FICA taxes or the business half need to be paid: roughly 18% of the total child’s income saved! In addition, by paying the child and reducing the business’s net income, both the parent’s Income Tax and FICA on net self-employment is also reduced.

An even more liberal exemption applies for FUTA, which exempts a child under age 21 from federal unemployment tax while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.

These exemptions do not apply to businesses that are incorporated including LLCs or a partnership that includes non-parent partners. Did the guy who set up your LLC even ask if you would be hiring the kids????? I doubt it.

Land Trusts for the Real Estate Investor

I recently received an Ad concerning the 7 reasons to use a Land Trust from a real estate site. A land trust is a revocable, living trust used specifically for holding title to real estate and can be a powerful tool for holding investment real estate. The land trust is a very powerful tool for the savvy real estate investor. Each property is titled in a separate trust, affording maximum privacy and some protection. As a “revocable” trust, it is not a perfect Asset protection vehicle because it is still subject to seizure upon judgment against the person with the power to revoke. But there are benefits. I heartily agree with 5 of the seven ( watch out for the last 2).

1. Privacy. Privacy is extremely important to most people but anyone with an internet connection can look up your ownership of real estate. Land Trust ownership may make it harder for someone suing you or even city code enforcement to find who the owner is, since the trust agreement is not a public record.

2. Protection from Liens. Real estate titled in a trust name is not subject to liens against the beneficiary of the trust. Personal judgments or liens of the seller may not attach to the property effectively separating the owner or seller from the property.

3. Protection from Title Claims. If you sign a warranty deed in your own name, you are subject to potential title claims against you if there is a problem with title to the property (Indian Claims in CT for example). You warrant and agree to Defend the title in a warranty Deed. A land trust as seller will protect you personally against many types of title claims because the claim will be limited to the trust. If the trust already sold the property, well, no assets either!

4. Discouraging Litigation. People tend to only sue those who appear to have money. Attorneys who work on contingency need to collect. If your investment properties are hard to find, you will appear less worthy of suing

5. Protection from HOA Claims. When you take title to a property in a homeowner’s association (HOA), you become personally liable for all dues and assessments. With a condo in your own name the association can lien the property and/or sue you PERSONALLY! With a land trust, the trust is the sole recourse for the homeowner’s association’s assessments and debts.

6. Making Contracts Assignable. The ownership of a land trust (called the "beneficial interest") is assignable, similar to the way stock in a corporation is assignable. Once property is titled in trust, the beneficiary of the trust can be changed without changing title to the property. This can be very advantageous in the case of a real estate contract that is non-assignable, such as in the case of a bank-owned or HUD property. Instead of making your offer in your own name, make the offer in the name of a land trust, then assign your interest in the land trust to a third party. BUT There is always the danger of being charged with a conspiracy to defraud, especially if this becomes a regular practice.

AND be very careful about this one!!!!

7. Making Loans "Assumable". A non-assumable loan can become effectively assumed by using a land trust. The seller transfers title into a land trust, with himself as a beneficiary. This transfer usually does not trigger the due-on-sale clause of the mortgage. After the fact, he transfers his beneficial interest to you. This latter transaction does trigger the due-on-sale, but such transfer does not come to the attention of the lender because it is not recorded anywhere in public records. This effectively makes a non-assumable loan "assumable". CAREFUL!!! THIS CAN BE, at least, CLOSE TO (bank) FRAUD, also, if you are the seller of a property with a mortgage, remember YOU SIGNED THE NOTE. If the buyer, your assignee, takes out a big 2^nd mortgage or big insurance policy and the house “accidentally” burns down; he goes to Brazil while the bank sues you on the note.

There you have it, Real estate trusts can be very useful if you know their limits. An Irrevocable trust made to your Family Limited Partnership can be even more effective from an asset protection viewpoint.

How is your Long Term Care getting Paid?

Long Term Care Trap

Experts say anyone 80 and over has a 100% chance of requiring long term care in the next five years. Long Term care is not just for the elderly either. Anyone at any age can get sick or have an accident and be laid up for months or more.

People assume the State will help. It may. Medicare, Medicaid and private insurance may be available at least for a while but only private insurance and Medicaid pay for long term care. Very importantly, your private medical or “medigap” insurance will generally not cover long term care so don’t assume you are protected just because you have insurance. You have to buy a specific Long Term care Insurance policy or a rider to have it!

No insurance? I’ll just apply for Title 19 (Medicare-Medicaid) right?

Yes, after you’ve spent everything and had your home (were your spouse still lives) liened. Spend everything, You qualify.

The asset protection trap in long term care comes when you pass assets on to the family either through irrevocable trusts, family limited partnerships, simple gifts and even transfers of that $13,000 per person per year the IRS allows. I have an eighty two year old client. We set up an FLP. He has two homes and some other assets probably worth just about $750,000 total in the FLP. With 16 children, grandchildren and great-grandchildren and $13,000 each year from himself and his wife, It took just two years to transfer all the assets, avoid probate, assume much greater asset protection for the whole family and do it absolutely income and estate tax free. Best part, from his point of view, he remained in control of the assets as general partner and continued to live in the two homes “caretaking” them for the partnership.

Sounds good? So where is the long term care trap?

Title 19 doesn’t recognize the $13,000 per person, per year exemption of the IRS. It has different rules entirely. ANY gift or transfer for less than value within five years of needing long term care (receipt or even pre-application) creates a long term care penalty

equal to the amount of the gift(s). So, keeping it simple, for this example he transfers $750,000 to his heirs. He cannot receive Medicaid until he has paid $750,000, for his long term care. But he doesn’t have that money any more its been given away! Catch 22: needs care now! Has no money! Can’t get state aid!

There are several solutions. Connecticut was one of the first four states in the USA to offer the Long Term Care Partnership. Buy LTC Insurance and the policy payments for LTC will cancel out prior gifts dollar for dollar. Insurance is Too expensive? It may be, especially if you’re 82!

Another option is to make all gifts conditional upon a five year, third party lien in favor of the as yet unknown long term care provider. Gifts must be irrevocable and not have a reversionary possibility (be revocable or otherwise go back to the donor) to achieve asset protection goals. Gifts do not have to be unconditional so Make ‘conditional gifts.’ How about Trusts for the proceeds to donees which have a contingent benefit to third parties (LTC providers of the donor). If care isn’t needed, the trust(s) expire after five years and a day when the gifts become unchallengeable and Title 19 becomes available. Simple and non-public contracts between donor and donees may accomplish the same effect though there is not much direct case law.

Best yet, if you’re still young and have a business, how about a post retirement long term care benefit package while you can still afford it? It may even be tax deductible to the business!

Long term care must be fitted into a complete estate and asset protection plan. EARLIER THE BETTER!

The State of Connecticut has a Long Term Care Ombudsman program to advocate for the needs of residents in assisted living facilities, nursing homes and residential care homes.

State Ombudsman: 1-866-388-1888 or 860-424-5200. He won’t give you a plan though!

Philosophical questioning

Deep philiosophical thoughts don't normally enter into asset protection issues but I received two such questions at a civic club talk today.

Advantages of Raising onseself up by the bootstrap

First a doctor asked if, like Warren Buffet, we wouldn't be better off as society if we just cut our kids loose to fend for themselves, in effect what's the point of protecting our assets for them, They and society would be better off and more productive by letting them do it (life) for themselves.

I certainly have to agree that Fear of starvation can be a great motivator. Even so, Warren Buffet's sons probably have a leg up on most kids; best schools, training, experience of living with a successful man, name recognition in a job hunt, things most kids probably will not have, even if denied a few billions in inheritance.

I answered that when my dad needed more money he took a second job. In the 1950s a second job could pay the rent. Today, do something menial for an extra 20 hours and you probably wouldn't pay for the electric. New College grads are taking jobs for $25,000 despite being $20, $40 or even $100k in debt for education loans for training seldom translating into job specific readiness. In 1950, $2,000 a year prepped many to buy a starter house for $6 to $10k. In 1960 my aunt's employer was an 80 year old who invented the automatic gas pump handle. He made a fortune worth $200,000! When I met him he had two homes, one in Bridgeport, Ct and the other in Seattle and had spent 20 years traveling the globe, Probably on less than $4,000 a year. We grew up in a different age, before the dollar was worth less than a nickle.

Can kids be cut loose to earn a career? Some certainly. Most, I think, will never be able to acquire our standard of living. God willing, we won't go back to the hopelessness of the 1930s, the last time a generation earned less than its parents, but I think protecting my assets for my kids to have a better life makes so much more sense than letting the tax man or some sue happy lawyer take it all. I'll still have some left over for charity. Just a thought.

It's Unfair to our "Victims" to protect our assets

I have never seen this complaint before. One man asked about the morality of protecting one's wealth from someone we injured. Putting aside the kinds of frivolous suits that might keep one up at night for years and then take away everything you've worked for, Is there a moral imperative against protecting ones's family from a "Valid claim"?

This is an interesting question. In areas of the far east and some ancient cultures taking one's life meant you owed yours in service in return. Saving a life might mean taking responsibility for that life, for life. The American legal system doesn't require that of course, just "just compensation." Certainly, maintaing adequate insurance to provide such compensation is a requirement mentioned many times in this blog. Indeed failure to maintain adequate insurance opens the door for a court to undo asset protection entities upon finding of undercapitalization, ultra vires and/or various theories of equity. But what about the idea that our assets, above and beyond insurance, should be held for payment to our victims should such an dark eventuality arise?

Good question and one I can only answer like this: Isn't our first responsibility to our own families? Even if we agree to live in car to make good on a valid judgment, do we, and our families, have to assume such risks for bogus claims too? And If, for moral reasons, we believe we should pay everything for our mistakes, doesn't it make sense for that to be our decision rather than the system's. If you have an asset protection plan the decision becomes yours. Like Warren Buffet and his idea of the "underpaid" Tax Man, Warren can volunteer extra money to the IRS any time he wants (Notice that he doesn't). Guilt or "fairness" may lead people to help those who we've hurt and to me it means even more if voluntary, meaning from protected assets.

I understand the fairness concept. My neighbor once prayed that God stop a rival welder from taking unfair advantage of her business by parking his mobile unit across the street from her shop and taking business and food from the family table. When his truck went into a ditch and he was injured she felt so guilty she visited him daily in the hospital and helped pay his expenses. They became good friends and went on to work together.

I have never seen that result from a lawsuit, meritorious or not, but have seen runaway jury awards, predatory even extortionate claims, claimants who view the "no cost" aspect of suing like a free lottery ticket, and the high cost of defense leading some to settle even when "right."

Protect your assets. You can always pay voluntarily if you think that's fair.

Professional Corp: just a piece of the Plan

I had an interesting discussion about Professional corporations today. It appeared to me that a young professional had been steered into a PC without much thought or planning. This assumption, which I hope is unfair, is partly from experience. Tell your lawyer you’re starting a business and he will pull out an LLC filing form. You’re a professional, it will be a PC form. That’s it. You have your company, The lawyer, accountant or adviser act like they have blinders on. Were you asked or advised on the following:

· Where will your income come from, just professional services or will you be selling anything else, such as books, guides, gear, tools, any specialized non-professional reports?
o The IRS function test requires that substantially all (95 percent) of the business activities involve services within specific occupations
· Where will you put business assets for the best tax results?
o You don’t have to keep it in the PC
· Which type of organization costs the less to form and operate?
o Must it even be a PC in this state
· Will you have multi-state operations?
o The other state may be better
· How will you get the most tax deductions?
o You are not in a box do not limit thinking to the PC
· Who else will you employ and how?
o All owners must be professionals, retired professionals or heirs
o Address avoiding often overlooked potential employee claims
· Will your personal and family assets be safe?
o Don’t have any yet? What’s the plan for when you do?
· Will you buy or rent your office? From whom?

And those are just a handful of the things that should be thoroughly thought through.
Sadly, the typical answer is often NO and not just in the creation of legal entities. Back in 1983, a house builder acquaintance of mine ran out of money. He went to one of the most respected lawyers in town. He heard the tale and pulled out a bankruptcy questionnaire. No real advice. No assessment of other options. Maybe lawyers are held in such disrepute because they just fill out the forms, sometimes doing no more than the client asks, as though the client already knows all his legal options.
That client went to another lawyer got refinanced and went on to create a multi-million dollar home building company, got greedy then lost everything in the economic downturn of 1989. If the first lawyer had made a personal instead of legal assessment of the client he was prescient. Most likely, and all too common, he just didn’t do his job.

Back to the young lady professional I met and what I think should have been done (and mostly still can be). I’ll keep it generic because I have not examined her situation.

Back in the olden days professionals could not incorporate at all. Their services were special and personal. They were expected to stand behind their work and remain personally liable. When Professional Corporations, PCs, were introduced they retained this personal liability component but allowed the benefits of continuity and a few tax and accounting benefits.

In a PC, Individual liability may be somewhat less than Partnerships and may protect against personal liability for purely business, not professional, claims but, as a practical matter, there is very little liability protection. Like a sole member LLC, the PC will be sued, the professional who did the wrong will be sued and most everybody else will be sued on such theories as failure to supervise, failure to train, wrongful hiring (he did the same thing at the last five companies where he worked, Oh Yes, and He’s a felon), etc., and that’s not even addressing the many ways your employees could sue you.

The PC offers very little liability protection. Was this explained? Maybe, but then were her assets discussed? What kinds of assets are held in the PC or in her own equally vulnerable name? It better be NONE.

If there are few liability benefits, what about tax deductions of business expenses in a PC? Unlike a sole proprietorship or S-Corp or most LLCs, PC income is not passed through to the professional and can be double taxed. Most PCs , like many C-Corps pay everything “left over” as salary or bonuses. Most C-Corporate deductions and medical, retirement and other advantages are also available except for retained earnings. A C-Corp (2009) tax on the first $50,000 net profit is just 15% and the next $25,000 is just 25%. Over time, significant money can be put aside at these lower tax rates. You can then fund many things, training junkets, Insurance, retirement benefits such as a 419e plan, etc. The PC is taxed at a flat 35% from the first Dollar so don’t keep money there. Legitimately move income to your C-Corp by leases or other service agreements and pay much less tax than a PC (35%) or the individual rate (39%).

You want a PC or already have one, what do you as a young professional do? Fully review your options. When you fully understand your situation and options, Go ahead, create the PC, if it is better than a partnership or sole proprietorship for you, then:

1. Have as little money as possible in the PC. Move as much income as possible into your C-Corp where you can retain earnings, gain more and better audit proof deductibility. Buy Insurance and Protect business assets from suits by moving them to the C-Corp then lease them back to the PC achieving a lower tax rate AND asset protection..

2. Set up a family limited partnership (FLP) to hold all your safe assets and some mildly “dangerous” assets like a real estate trust for your house. This is where your closely held C-Corp stock goes too. Never keep the C-Corp stock in your name, a claimant can take it from you as easily as they could raid your bank account.
3. Don’t EVER own the building in a PC. Real estate owned by a PC are particularly vulnerable to suit. Worse, when you are ready to retire and sell the depreciated Real Estate from the PC it may be taxed as regular income not capital gain, AND likely be double taxed to the PC and then to you as a dividend. Never, Never, Never waste an appreciating asset like realty on taxes. Put it in an LLC under the C-Corp and let the PC lease it back adding corporate income and taking it out of the tax inflexible PC.

4. Never get caught in bad legal advice. You are a professional, yes you may be restricted in what you can do with your business entity, but do not let your advisor box you in because he has a form to fill out. You are also a person, you have a family, you can have other businesses, you can create family holding companies, FLPs, LLCs, special purpose Trusts, retirement plans (401(k), 419(e), etc.). You can isolate liabilities, firewall assets, shift income, use tax code advantages. Review your whole situation and PLAN.

Sue Happy

Just met someone, I don’t really like her very much, her name is Sue Happy. She wants a relationship that will last for years. I don’t think it will be a close relationship though, after all, most of our conversations are through legal counsel. She must be old fashioned because she expects me, the “man,” to pay for everything. I understand she belongs to a growing minority: people suing. There are 70,000 new Sue Happy people nationwide every day that the courts are open. She’s no beauty but really keeps my attention. I can’t sleep without thinking about her, my stomach constantly churns like a first love, and I wake up in cold sweats throughout the night. It must be an emotional attachment. My insurance company wrote me advising I get my own attorney as her claim exceeds the policy limit. Sure hope my wife doesn’t find out about her.

Foreign Asset Protection Trusts

Beware of Greeks bearing gifts. Troy might still be with us if they had turned down that damned horse. Some good, but perhaps a little greedy, people might have avoided an IRS "Perp Walk" if they had followed comparable advice when it came to tax and so called "asset protection" scams to hide assets oversees. Not that most of those scams came cheap. Some "put your money in a Cook Islands trust or Republic of Tonga ("where???!") account" scam cost tens of thousands of dollars. The guarantees of safety and maybe even pre-paid legal representation at any audit offered by such promoters disappeared with them. I will list some of the scams and scammers in a future post but for now here's what to look out for:

Forget promises that foreign accounts, corporations, Limited partnerships or trusts, or most anything else are free of US taxes. THEY ARE NOT. As USA residents all global income is taxable. There are a few jobs, like for the United Nations overseas, where no US income taxes are due, but even if you work for the UN the interest on your bank account in say, Saudi Arabia, IS fully taxable. Even some very sophisticated people got caught in this convenient mistake. "I didn't know I had to pay on that, I was working for the UN!" Whoops--Perp Walk.

Hiding assets overseas? Forget Secrecy laws. They may work in old spy movies but not today. Caribbean nations such as the Cayman Islands, Nevis and the Bahamas were the first to give up bank secrecy in the war against drug money laundering. The rest of the world, including secretive Switzerland, joined international conventions and treaties of full reciprocal disclosure as the Tax men caught up with the drug warriors. Last hold-out Austria is folding its secrecy tent. Don't count on your trusted banker-broker to protect your either; Swiss banker UBS located in Stamford, Connecticut turned over 4,450 client names to the IRS. Connecticut Attorney General Blumenthal is curious if any of them ducked Connecticut taxes too.

Promises that hiding assets in a "Safe" place overseas don't cut it. Even if that scam somebody is selling can place enough false names or fraudulent entities between yourself and your overseas money to make bank disclosure problematic, ALWAYS remember the first rule of asset protection, PROTECT YOUR ASS. You will be questioned under oath about any foreign assets by your creditor, the tax man, your tort victim's attorney, etc. Unless your name is William Jefferson Clinton, lying under oath is a felony that will bring serious criminal trouble.

Forget schemes that involve putting your money here or abroad with anyone who tells you that the IRS has no constitutional right to tax you. There are several theories used. They are wrong! You will lose more than just money, your reputation and maybe even your freedom.

Lastly, do you want to risk your wealth in some corrupt, backwater, half-baked country that is a dictatorship, was a dictatorship and/or may be a dictatorship tomorrow afternoon? Do you want to trust a bank with no depository insurance, a broker with no oversight, some guy on the phone with a strange accent, or perhaps, Alan Stanford, with your wealth? Still unsure? Will you be happy to have to fight in their courts, in their country and under their laws with their lawyers if anything ever does go wrong? Probably not- SO STAY HOME ALREADY!

Now that we are over the Caveat Emptor part of the post, GOOD NEWS, foreign asset protection entities generally are not illegal if you follow all the rules, pay all the Taxes and don't act to defraud and can be a marvelous asset protection vehicle for certain high net worth folks.

Let me give you an example. You are concerned about an out of control Washington, the debt, the deficits and a looming default with a potential collapse of the US economy and the US Dollar. You are rich why should you just wait and see your assets blow up with the country?

First of All, "you are such a pessimist." Having said that, I can't say you are wrong. What can you do? You could leave the country, give up US citizenship and hope the place you go to is better than what you expect for the good old US of A. But here is one thing that I could do:

First, take not more than 1/3 of your wealth, any more and it will look like a fraudulent conveyance, depletion of assets, etc and may (likely) trigger a 30% exit/withholding tax. Place it in a Switzerland account denominated in Swiss Francs. Near term Swiss Franc futures are today at $.9433 to the Dollar. The Swissey, as its called, has been over parity to the Dollar several times in the past couple of years for a potential 8% profit plus interest if nothing at all happens. If the US economy implodes its value Vis a vis the greenback could run up a lot. Note: A Swiss bank account is no longer secret and gives nearly no asset protection (It will be a pain for a creditor to go there to claim it, but he certainly can as with any other account(s) in your name).

You can add an asset protection component by creating a Bahamian trust or Family Limited partnership which would own the bank account. Bahamas law protects against most any claim (not the IRS), including a claim of fraudulent conveyance unless made within two years of creation. This is a very powerful legal protection. The money isn't subject to whims of the Bahamian Government (though by offshore standards they are close to golden) since the money is in Switzerland, one of the most secure places on earth. Alternatives would be Singapore, Japan, Australia and New Zealand currency denominated accounts in a safe country. Spreading some money around may protect you a bit more from a global economic disaster.

Is it safe? As safe as anything can be if the US collapses. Is it legal? Yes, IF you document the lawful purpose of the transfer, currency hedging is certainly lawful, foreign accounts are lawful, a Bahamian (or most any other place) legal entity is OK too if done for a legal purpose. Do all the paperwork. Document the transfer of funds. Report the interest or any other income and pay all foreign and US taxes. File the proper forms with the IRS and the US Treasury Department showing your interest in any foreign entity and account(s). Keep all records for the audit.

See, it's Simple. Its not for everyone but if you're rich and paranoid it is doable (and someone MAY really be out to get you). The cost of doing it is $10,000 to $20,000 plus nominal annual trustee fees in the Bahamas and possibly Switzerland. Using a corporate trust department of a bank with branches in both Switzerland and the Bahamas (USA too) is recommended.