As a business owner, your company is likely your most valuable asset. And you know that you must account for it in your estate plan to help ensure that it remains a valuable asset for your heirs. Thus, a key goal should be to insulate your company and other assets from the claims of creditors and lawsuits.
When you create an asset protection plan proactively, you add a layer of protection before any claims or lawsuits arise. This can deter creditors and possibly thwart the seizure of assets.
Ownership structure matters
Depending on the structure of your business, you may have adequate protection from creditors, minimal protection or none at all. Thus, you might consider changing the ownership structure to create a corporate shield. Here are the three primary forms of ownership:
C corporation. Generally, a C corporation provides limited liability exposure to the personal assets of its principals. C corporations help protect personal liability for corporate debts, contract breaches or personal injuries to third parties caused by the corporation or its employees. So, a creditor can’t seize your personal assets if the corporation can’t pay its bills. This is a distinct advantage over traditional partnerships.
However, the liability protection provided by a C corporation is limited to the corporation meeting specific requirements to treat the actions of the corporation as separate from the actions of its shareholders, also referred to as “piercing the corporate veil”. In order to maintain this distinction, the corporation must have adequate capitalization, not be formed or operated for fraudulent purposes, nor be operated as an alter ego of its shareholders. If a C corporation fails to meet even one of these requirements, the shareholders may find themselves personally liable for actions of the corporation.
Additionally, be aware of an exception for certain personal services. For example, a physician might be held personally liable for damages incurred while performing services on behalf of a medical practice.
S corporation. With an S corporation, income and losses are passed through to shareholders on a personal level, thereby avoiding “double taxation” faced by C corporations. Like a C corporation, however, shareholders benefit from some corporate liability protection, albeit with additional limits as to the number and type of shareholders, allocation of profits and losses among shareholders, and the type of stock that may be issued to investors. For many business owners, an S corporation is the preferred choice, however, the taxpayer(s) selecting S-status must strictly follow the IRS’ requirements, or may risk losing the S corporation election permanently.
Limited liability company (LLC). An LLC operates much like an S corporation without some of the extra formalities. Significantly, LLC principals are afforded the same liability protection as those in a C corporation, however, LLCs are also subject to the same “corporate veil” requirements that a C corporation must meet to maintain its status as an entity separate from its shareholders. Additionally, LLCs also receive the favorable “pass-through” tax benefits available to an S corporation, although LLCs are not required to meet the IRS’ stringent requirements to achieve pass-through status.
Note that filing requirements and creditor protections for LLCs may vary from state to state. Nevertheless, state laws generally protect personal assets of LLC owners from claims based on LLC activities.
Build asset barriers
Most asset protection strategies for businesses involve putting up walls between a company and its assets. One way to do this is to divide the business into separate entities.
For example, you may want to form separate entities to conduct any business activities that are riskier than others. Doing so allows you to limit the liability risk associated with them. Provided the entities are structured and operated properly, you can prevent creditors from going after assets owned by other entities within the group, even if they have common ownership.
Another way to protect valuable business assets is to sell them to another entity created by the company’s owners and then lease them back. If done right, these assets no longer belong to your company, so they’re beyond the reach of the company’s creditors.
Talk to the professionals
Owning a business is a big responsibility, and you want your children to benefit from your hard work after you’re gone. Thus, it’s important to implement business asset protection strategies. Because these strategies can be complex, make sure to discuss with your business and estate planning attorney any of the mentioned strategies to determine your best course of action to ensure your interests are adequately protected for you and for generations to come.