By: Stephen L. Nelson

Protecting Assets With a Limited Liability Company

Business owners and investors often worry about protecting assets from creditors and lawsuits. Of course, sometimes, people worry too much. And careful management of a business or investment coupled with up-to-date liability insurance policies may, in some circumstances, be all a person needs.

However, most business owners and investors should consider the three powerful forms of asset protection that the limited liability company provides. In some circumstances the asset protection provided by a limited liability company can prevent personal or business catastrophe.

Protecting Against Internal Business and Investment Risks

Putting a business or an investment into a limited liability company is the most popular LLC asset protection technique.

By putting your business or an investment into an LLC, for example, you won’t be personally liable for things that happen to or inside the business or investment simply because you own the business or investment.

In comparison, if you directly own or you together with other partners own a business or investment–in a worst case scenario–you can find yourself liable for bad stuff that happens merely because of ownership or co-ownership.

For example, suppose a business you directly own breaches a contract. If the party damaged by the breach sues the business and you’re operating as a sole proprietorship or a general partnership, you might be forced to pay personally any damages because you’re an owner or co-owner.

In comparison, if you own an interest in an LLC that, in turn, owns the business, you probably won’t be liable for the business’s debts (unless you personally promised to guarantee the LLC’s debts or to guarantee the contract).

Segregating Internal Business and Investment Risks

A slightly more sophisticated asset protection technique uses multiple limited liability companies to segregate business or investment risks into different containers.

For example, suppose that you’re a real estate investor that owns six rental properties, and you’ve placed all six rental properties into one limited liability company. In this situation, you won’t find yourself liable for bad things that happen inside the LLC merely because you own the LLC.

For example, if someone slips and falls at one of your rental properties, you probably won’t individually be held liable for any damages that the LLC has to pay because of the accident. However, if you have significant wealth stored inside the LLC–the equity in the six properties–something bad happening at just one of the six properties could wipe out all the wealth you’ve stored in the LLC.

In other words, if legally the LLC has done something “wrong,” all of the assets owned by the LLC may be used to satisfy a creditor or to resolve an actual or threatened lawsuit.

In comparison, if you put each property into its own separate LLC, or if you setup a parent LLC and then put each individual property into a separate child LLC, a worst-case scenario means you lose only what’s inside an individual LLC–which means only a single property.

Obviously, losing a single property might still be a disaster. But invariably losing just one property would be (using my example) better than losing six properties.

And, just to make this point, note that this segregation of assets into different LLCs isn’t applicable only to real estate investors. A business owner might also segregate assets into different LLCs. A restaurant owner with three locations might put each location into its own limited liability company. A business might group product lines, business units or even customer groups into different LLCs.

Protecting Against External Business and Investment Risks

One remaining asset protection technique provided by a limited liability company should be mentioned.

In a worst-case scenario, a personal creditor or personal lawsuit can seize or gain ownership of property you own. Such property might include the assets of a business or real estate. And such property might even include a small business you own or the stock you own in a small business you operate as a corporation.

Note: Often state debtor protection laws and federal bankruptcy laws mean that some of your personal assets are protected. Retirement accounts, life insurance, a modest amount of home equity, and your work tools are probably protected, for example.

In many states, however, an ownership interest in a limited liability company often can’t be seized or transferred. Often, the best a creditor can do, for example, may be to get a “charging order” from a court. A charging order simply (and only) says any payments which should go from the LLC to the LLC owner should instead go to, say, the creditor. The “charging order” protection isn’t perfect. But “charging order” protection does mean that you improve your negotiating position in any worst case scenario situation.

Neither the court nor the creditor with a charging can interfere with the operation of the LLC, for example. The court can’t, for example, force the LLC to make payments to the LLC owner.

What this all means is that by owning assets or a small business through a limited liability company, you reduce the possibility that some external, personal event will foul up the stuff going on inside the limited liability company.

About the author:

Seattle tax accountant Stephen L. Nelson is the author of two ebooks about Nevada incorporation: Incorporating in Nevada and Forming a Nevada Limited Liability Company. Nelson is also the author of the small business best-seller QuickBooks for Dummies.

By: Stephen L. Nelson

Starting a business requires capital. Money you use for inventory, fixtures, equipment and the other stuff required to operate a firm. You can find this money in all sorts of places, but one of the places you can sometimes look is inside your individual retirement accounts, or IRAs. Unfortunately, you do need to tap an IRA with care in order to minimize any tax consequences. But here are five tips about how to do just that:

Tip #1 for Using IRA Money to Start a Business: Net the Withdrawal with a Deduction

Here’s a first tip for using IRA money to start a business. If your new business will in the beginning lose money, you can largely offset the taxes owed on the IRA withdrawal by netting your withdrawal with the business deductions you get from spending the money. For example, if you withdraw $10,000 from an IRA and then spend this $10,000 on business expenses, you won’t owe income taxes once you net the withdrawal and the deduction.

Note: If you haven’t yet reached age 59 and a half, you will still owe a 10% withdrawal penalty unless you qualify for one of the penalty exceptions such as for disability, qualified medical expenses, and so forth.

Tip #2 for Using IRA Money to Start a Business: Borrow and Repay the IRA

Another way to use IRA money–and penalty free–is by borrowing your IRA money for just sixty days. For example, if you borrow $10,000 from your IRA on day 1 and then replace the $10,000 IRA on day 60 (by depositing the funds into another IRA account), you won’t owe income taxes or penalties on the withdrawal. Two quick cautions about this technique, however: First, you must meet the 60-day deadline. The IRS is very unforgiving in this area. A second caution: If you withdraw $10,000 from your IRA, you typically won’t get the full $10,000 because some of the withdrawal will be held as a tax deposit. For example, you might get $8,000 and the remaining $2,000 may be withheld for income taxes. However, you will need to re-deposit the full $10,000.

Using an IRA for 60-day, interest-free loans means, then, that you need to have enough extra cash to make up for any withholding the IRA custodian takes out of your withdrawal. You will eventually get any amount “held back” for taxes when you file your federal or state income tax return.

Tip #3 for Using IRA Money to Start a Business: Do Tip #2 Several Times in a Row

The IRS was recently asked whether, in effect, someone could do a series of 60-day interest-free loans with their IRAs. The answer was “yes” as long as the rules were precisely followed. What’s neat about a series of 60-day withdrawals is that in combination the withdrawals allow the taxpayer to stretch out the repayment period. For example, if a taxpayer takes a $120,000 IRA and splits the IRA into twelve smaller $10,000 IRAs, the taxpayer can borrow $10,000 from his or her collective IRA accounts for a year without much trouble.

Here’s how. On day 1, the taxpayer draws $10,000 from IRA #1. On day 60, he draws $10,000 from IRA #2 but uses those funds to re-deposit $10,000 into IRA #1. Note that technically the $10,000 taken out of IRA #1 has been replaced within 60 days. On day 120, he $10,000 from IRA #3 but uses those funds to re-deposit $10,000 into IRA #2. And so the “borrowing” continues. If you want to consider this, please confer with a local tax practitioner to make sure you get the mechanics just right. As noted, the IRS will allow you to play this game. But you must follow the rules precisely.

Tip #4 for Using IRA Money to Start a Business: Self-directed IRA Investments

A quick point: In some circumstances you can use the money inside an IRA to invest in non-traditional, self-directed investments. For example, you can invest in real estate through your individual retirement account. If you want to invest in real estate through your IRA, find an IRA custodian, or trustee, who allows for direct real estate investment. You can do this by Googling or Yahooing on a phrase like “real estate investment inside an IRA.”

Caution: If you invest in real estate through an individual retirement account and you use both IRA money and mortgages to buy the real estate, your IRA needs to file a tax return. Furthermore, at some point in the future, the IRA will actually owe income taxes on its real estate investment profits because of something called the unrelated business income tax. Confer with your tax advisor if you have questions about this.

Tip #5 for Using IRA Money to Start a Business: Just Do It

You obviously want to be careful about mucking up your retirement years by risking IRA money in an entrepreneurial venture. But that caution made, if a small business opportunity is good enough, a withdrawal may still make sense in spite of the penalty and taxes. For example, suppose you withdraw $150,000 from an IRA where the money earns annual earns 10%, or $15,000.

If you pay a $15,000 early withdrawal penalty on the money and then pay another $45,000 in income taxes, you have only $90,000 left over to invest in a business. But if that $90,000 generates, say, 40% a year in profits, or $36,000 annually, you may come out way ahead even if you do pay the penalties and taxes.

About the author:
Seattle tax accountant Stephen L. Nelson is the author of two ebooks about Nevada incorporation: Incorporating in Nevada and Forming a Nevada Limited Liability Company. Nelson is also the author of the small business best-seller QuickBooks for Dummies.