Albert B. Ellentuck, Esq.
Asset Protection Planning with Limited Liability
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
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
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.
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.
t h e ta x a d v i s e r O c tO ber 2008 6 9 9