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CaseStudy
                                                                                                    Albert B. Ellentuck, Esq.




Asset Protection Planning with Limited Liability
Companies


                                      When consulting with a client regard-            she may be allocated the debtor member’s
                                      ing forming a limited liability company          share of LLC taxable income but receive
                                      (LLC) for business and tax reasons, it is        no distribution to pay the income taxes
                                      common to address the issue of asset pro-        due on that income.
                                      tection. The basic objective of asset pro-
                                      tection engagements is to transfer assets        Fraudulent Transfers
                                      to reduce or eliminate any exposure to           Any asset protection plan must consider
                                      liabilities in conjunction with the client’s     the possible application of fraudulent
                                      estate plan or other financial concerns.         transfer laws. The purpose of these laws
                                      Care must be taken to avoid transfers            is to prevent debtors from transferring as-
                                      specifically to avoid creditors, which can       sets for the primary purpose of defraud-
                                      be considered fraudulent.                        ing creditors. If a court determines an
                                          Practitioners often are in an excellent      asset transfer to be fraudulent, the trans-
                                      position to identify the need for an asset       fer will be voided, exposing the asset to a
                                      protection strategy and recommend pos-           creditor’s claim.
                                      sible methods of implementation. For                 Fraudulent transfer laws vary from
                                      example, suggesting the formation of an          state to state and are also addressed in the
                                      LLC before a client acquires a parcel of         U.S. Bankruptcy Code and the Internal
                                      commercial real estate may protect the           Revenue Code. Three common questions
                                      client from liability exposure. The prac-        considered by most jurisdictions when
                                      titioner may also suggest that the client        applying fraudulent transfer laws are:
                                      restructure his or her existing holdings to      1. Did the transferor intend to hinder,
                                      protect assets.                                      delay, or defraud a creditor at the time
                                          Caution: Restructuring a client’s ex-            the transfer was made?
                                      isting asset holdings for asset protection       2. Was the transferor solvent at the time
                                      purposes has many legal implications that            of the transfer?
                                      must be considered with the assistance of        3. Was the transfer made in exchange for
                                      an experienced attorney.                             reasonably equivalent consideration?
                                          In general, a transfer of assets to an           While formulating asset protection
                                      LLC protects the assets from the LLC             plans that involve the transfer of assets,
This case study has been adapted      member’s creditors. However, a mem-              practitioners must objectively consider a
from PPC’s Guide to Limited           ber’s creditors can obtain a charging order      possible challenge from the point of view
Liability Companies, 13th Edition,    against the member’s interest and become         of the client’s creditors. The business
by Michael E. Mares, Sara S.
                                      entitled to receive any profits, losses, and     purpose for the transfer should be docu-
McMurrian, Stephen E. Pascarella
                                      distributions to which the member would          mented in order to prove that the trans-
II, Gregory A. Porcaro, Virginia R.
Bergman, William R. Bischoff, and     otherwise be entitled. The creditor does         feror did not intend (actually or construc-
Linda A. Markwood, published by       not, however, have the right to participate      tively) to defraud a creditor.
Thomson Tax & Accounting, Ft.         in LLC management, including the right               The evaluation of the transferor’s
Worth, TX, 2007 ((800) 323-8724;      to force a distribution. This may put the        intent is based on the facts and circum-
ppc.thomson.com).                     creditor in a difficult position, since he or    stances at the time of the transfer. Though

                                                                                  t h e ta x a d v i s e r   O c tO b er 2008 6 9 7
CaseStudy
fraudulent transfer laws vary from one         Principal Residence Protection                 asset protection, the Alaska statute en-
jurisdiction to another, indications of        From an asset protection standpoint,           ables individuals to make completed gifts
fraudulent intent (commonly called             the use of an LLC to hold a personal           for estate tax purposes while remaining
badges of fraud) include:                      residence may provide liability protection     an eligible beneficiary of the trust.)
1. Retaining control or possession of the      that is superior to the typical tenant by
    transferred property;                      the entirety title generally used by mar-      Enforcement Issues Involving
2. Concealing the transfer;                    ried individuals to own a personal resi-       Alaska and Delaware Trusts
3. Transferring assets after litigation        dence. A single person would clearly have          While Alaska and Delaware trusts
    began or under the threat of litigation;   additional protection when compared to         provide better protection than trusts gov-
4. Transferring substantially all the cli-     individual ownership.                          erned by the laws of other states without
    ent’s assets;                                  Basic estate planning for married indi-    similar provisions, several significant en-
5. Receiving inadequate consideration          viduals generally requires the segregation     forcement issues may arise.
    from the transferee; and                   of assets in order to maximize the use of          Generally, the Full Faith and Credit
6. Transferring assets in an amount that       each person’s unified credit amount. The       Clause of the U.S. Constitution requires
    results in the transferor’s insolvency     use of an LLC makes it easier to fragment      state courts to recognize judgments of
    at the time of the transfer or shortly     ownership of a personal residence without      courts in other states. Accordingly, a plain-
    thereafter.                                increasing exposure to possible liabilities.   tiff seeking to set aside a transfer to an
    Practitioners should prepare a de-             While it appears that the use of an LLC    Alaska trust may be able to sue in a credi-
tailed solvency analysis at the outset of      to hold a personal residence may offer a va-   tor-friendly state. Once a judgment is ob-
an asset protection engagement to docu-        riety of advantages to the property owner      tained, it can be brought before an Alaska
ment their client’s financial position prior   or owners, it is important to note that the    court for enforcement purposes only; the
to any asset transfer. This is an impor-       IRS has taken a position that the period of    merits of the case would not be retried.
tant step because the transferor’s insol-      time a personal residence is held by a part-       Observation: Generally, the law gov-
vency at the time of an asset transfer (or     nership (including an LLC) will not qualify    erning the trust (i.e., Alaska law in the case
shortly thereafter) is an important indi-      as a personal period of ownership under        of an Alaska trust) is applied in litigation
cation of fraudulent intent. The Uniform       the gain exclusion rules of Sec. 121 (Letter   involving the trust, even if the dispute is
Fraudulent Transfer Act (UFTA) and the         Ruling 200119014, revoking Letter Ruling       being tried in another state. Accordingly,
Uniform Fraudulent Conveyance Act              200004022). Accordingly, practitioners         advocates of using such trusts argue that
(UFCA) provide similar definitions of in-      should analyze the owners’ tax positions       state laws will protect trust assets even
solvency. Both acts consider transferors       carefully before putting a personal resi-      if disputes are being tried in other states.
insolvent if their debts exceed the fair       dence into a multimember LLC.                  However, there are exceptions to the gen-
market value of their assets and exclude                                                      eral rule that a court must apply the law
any assets that are exempt from credi-         Alaska and Delaware Trusts                     governing the trust. One such exception
tor claims when determining solvency.          Alaska and Delaware provide a domestic         occurs when the law governing the trust
Under the UFTA, a debtor is presumed to        alternative to offshore asset protection.      violates the public policy of the state in
be insolvent if he or she cannot pay debts     (Many other states have similar provi-         which the litigation is taking place. Most
as they become due.                            sions.) The Alaska asset protection trust      states have laws expressly invalidating
    Both acts take into account contingent     can provide distributions to the grantor       self-settled spendthrift trust provisions.
liabilities; however, the UFCA consid-         (as a beneficiary) at the discretion of        In many states, it seems that courts would
ers them at face value. Under the UFTA,        the trustee without exposing the trust         have little problem ignoring the Alaska
contingent liabilities are considered at the   to claims of the grantor’s creditors. The      and Delaware-type self-settled spendthrift
amount they are most likely to be settled      Delaware law extends spendthrift pro-          trust laws as contrary to public policy.
for. The UFTA provision generally benefits     tection to an irrevocable trust of which           Alaska and Delaware trusts also must
debtors. However, due to a lack of guid-       the grantor remains a discretionary ben-       contend with constitutional issues aris-
ance, care must be taken to document the       eficiary, as long as the trustee is neither    ing under the Supremacy Clause, which
calculation of the discounted liabilities.     the grantor nor a related or subordinate       generally provides that state statutes that
    Caution: A practitioner who rec-           party.                                         contradict a federal law are not valid. For
ommends a fraudulent transfer may be               The Alaska Trust Act does not prevent      example, a (federal) bankruptcy court
subject to legal sanctions and/or may be       a creditor from voiding a transfer to an       will likely try to attach assets held in one
in violation of professional ethics. Practi-   asset protection trust on grounds of fraud.    of these types of trusts. In addition, other
tioners should not engage in formulating       However, it does provide substantial pro-      state laws (such as the Uniform Enforce-
asset protection plans unless they have        tection from the claims of certain of the      ment of Foreign Judgments Act) may
sufficient knowledge of the underlying         grantor’s creditors. This level of protec-     contradict the trust statutes, raising ques-
law. In addition, an attorney with experi-     tion for self-settled trusts is rare in the    tions about whether the trust statutes will
ence in this area should be consulted.         United States. (In addition to providing       be enforced.

698 th e tax adviser          Oct O ber 2008
Delaware Series Partnerships                    3. The ownership interest of the share-
and LLCs                                            holders of an LLC series will be limited
    Delaware and many other states allow            to the assets of that LLC series upon
for the creation of “series limited part-           redemption, liquidation, or termina-
nerships” (SLP). These rules also apply             tion of that LLC series.
to LLCs classified as partnerships. This        4. The payment of the expenses, charges,
type of partnership or LLC can designate            and liabilities of an LLC series will be
separate series (or divisions) within the           limited to that LLC series’ assets.
entity into which assets and ownership          5. The creditors of an LLC series are
interests can be segregated (Del. Code              limited to the assets of that LLC series
§§17-218(a), 18-215(a)). The SLP can                for recovery of expenses, charges, and
be structured to take advantage of the              liabilities.
segregation possibilities under the stat-       6. Each LLC series will have its own
ute—allowing each series to stand alone             investment objectives, policies, and
as a separate entity. Each series within            restrictions.
the series partnership or LLC can have          7. Votes of shareholders may be con-
its own business or investment purpose,             ducted by each LLC series separately
classes of ownership interest, and liabil-          with respect to matters that affect only
ity limitations.                                    that particular LLC series.
    Originally, these provisions were in-       8. The shares of each LLC series are not,
tended to allow the creation of multiple            and will not be, traded on an estab-
hedge funds or similar investment fund se-          lished securities market or regularly
ries within a single state law entity. How-         quoted by any person, such as a bro-
ever, SLPs may be used for any type of              ker or dealer, making a market in the
business—real estate interests, operating           shares.
business, or any other assets. Although         9. No person regularly makes available,
an SLP is considered a single legal entity          and will not make available, to the
for state purposes, the federal income tax          public (including customers or sub-
treatment is a gray area.                           scribers) bid or offer quotes with re-
    In its first ruling on the treatment of         spect to the shares or stands ready, or
series LLCs (Letter Ruling 200803004),              will stand ready, to effect buy or sell
the IRS indicated that a separate series in         transactions at the quoted prices for
an LLC with more than one owner will                itself or on behalf of others.
be treated as a separate partnership if the     10. No shareholder has, or will have, a
election to be classified as a corporation          readily available, regular, and ongo-
is not made. A separate series with one             ing opportunity to sell or exchange
owner is taxed as a disregarded entity.             the shares through a public means of
    It is important to note that the ruling         obtaining or providing information of
in this case was based on a structure with          offers to buy, sell, or exchange shares.
the following proposed operation:
1. Each LLC series will consist of a sep-                                              TTA
    arate pool of assets, liabilities, and
                                                      EditorNotes
    stream of earnings.
2. The shareholders of an LLC series may              Albert B. Ellentuck is of counsel
    share in the income only of that LLC              with King & Nordlinger, L.L.P., in
    series.                                           Arlington, VA.


     Clarification
     The September Case Study, “Benefiting from a Fiscal Tax Year,” should have noted that
     it was adapted from PPC’s Tax Planning Guide—Closely Held Corporations, 21st Edi-
     tion, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard
     L. Burris, Mary C. Danylak, Timothy Fontenot, James A. Keller, and Michael E. Mares,
     published by Thomson Tax & Accounting, Ft. Worth, TX, 2008 ((800) 323-8724; ppc.
     thomson.com).

                                                                                               t h e ta x a d v i s e r   O c tO ber 2008 6 9 9

				
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