Can Forming an LLC Protect Your Personal Property?

by David Carnes
LLCs were designed with small businesses in mind.

LLCs were designed with small businesses in mind.

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The limited liability company is one of several types of legal entities that people often use to protect their personal assets from business creditors. Since an LLC is created by filing a document with the state government, LLC laws vary somewhat from state to state. Nevertheless, the basic principles are the same throughout the United States.

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LLC Independence

LLCs are designed primarily as business vehicles, not asset protection plans. Nevertheless, some features of the LLC render it advantageous for asset protection. Since it is an independent legal entity, it can do business in much the same way as an individual can. It can sign contracts, sue and be sued, and own both real estate and personal property in its own name. It must even file its own tax return every year.

Limited Liability

Like corporate shareholders, LLC owners, known as members, enjoy limited liability. This means that if the LLC is sued or files for bankruptcy, the assets of an LLC member cannot normally be seized to satisfy debts taken out in the name of the LLC, unless the member personally guaranteed the debt. Likewise, LLC assets normally cannot be seized to satisfy the personal debts of a member, even if the assets originally belonged to that member.

Contributions

An LLC can be formed to hold title to property that was once held in the name of an individual member. Such property can include not only personal property but also real estate and even intangible property such as patents. You can either sell your property to the LLC or give your property to it. Since every state allows one-member LLCs, you can own 100 percent of the membership interest in the LLC, allowing you to control your asset by controlling the LLC.

Undoing the Limited Liability

Although forming an LLC erects a legal wall between your debts and the LLC's assets, and vice versa, there are two ways creditors can breach this wall. One way is called ”piercing the corporate veil.” This occurs when LLC creditors place a lien on your personal assets to satisfy LLC debts because you co-mingled LLC assets with your personal assets or committed fraud related to the debt or failed to contribute sufficient assets to the LLC. The second way, known as fraudulent conveyance, may be used by your creditors to place a lien on LLC assets if you transferred property into your LLC for the purpose of evading current creditors. This might happen if, for example, the transfer leaves you insolvent. A court can look back as far as six months to determine the intent of the transfer.

Tax Conseqences

Transferring your property into an LLC should not result in negative tax consequences. LLC property is not taxed unless it produces income, and unless you choose otherwise, even income generated by LLC property is taxed to you at ordinary individual income tax rates. If you find it advantageous to do so, you can elect to have your LLC taxed as a corporation. Remember that tax authorities count as creditors for the purpose of breaching the legal wall between you and your LLC.