Asset Protection: How to Separate Safe and Dangerous Assets
There are numerous elements involved in owning a business. Not only must you be concerned with making a profit, but also protect the assets you have. Businesses are more likely to be sued than individuals, and individuals are frequently sued as well, so in the event of a lawsuit, you want to make sure you know how to protect your assets. As such, you will want to separate your safe assets from your dangerous assets. There are several vehicles that can help you do so, but first it’s important to understand the difference between the two.
What is a Safe Asset?
Safe assets are items you own that are unlikely to cause a lawsuit. These items are considered safe because they won’t likely cause harm to others. Your bank account is an example of a safe asset, as are jewelry, artwork, gold and personal collections. Intangible items – such as stock and bond investments – are also considered safe assets.
What is a Dangerous Asset?
As the name implies, dangerous assets are pieces of property that can a danger to others. This includes real estate, such as your home, rental properties and construction equipment. Vehicles – such as cars and trucks – are considered very dangerous assets.
Dangerous assets increase your personal and professional liability and risk, which make lawsuits more likely. As such, it is often recommended that you own no more than one dangerous asset per company.
Safe and Dangerous Assets Don’t Mix
By keeping safe assets – your personal items – with the dangerous assets for business and personal use, you risk losing all of them in the event of a lawsuit. A person injured due to an accident while driving your car (a dangerous asset) where you are sued for more for more than your insurance covers, may seek possession of all of the money in your bank account (a safe asset). By keeping your safe assets separate, you increase their protection if you were to get sued.
Who Needs Asset Protection?
Every business – small and large – and nearly every person, needs asset protection. Often, people lack protection because they are unaware of the risks. What they don’t know is that a lawsuit can wipe out everything they own – both business and personal assets.
The truth is that no person or company is immune from risk. If you fail to make payments on an asset, the creditors will come after you and take whatever they can get their hands on. If you have money or investment accounts mixed in with dangerous assets, be prepared to kiss them goodbye.
By keeping your assets protected – and knowing how to separate them – you can create a successful business and continue to improve your bottom line.
Types of Asset Protection
So now you know what safe assets and dangerous assets are and why they need to be kept in separate entities, here are some vehicles to consider:
US corporations are generally based on state law. They are legally owned by shareholders, who each receive shares of stock. Each shareholder has the power to choose a board of directors, who will oversee the company as whole. The board of directors then chooses officers who will run the day-to-day operations of the company. These officers include a president, treasurer and secretary. These roles may be held by separate people, but in most states, it is legal for one person to hold all roles.
Corporations are considered good forms of asset protection because liability is limited. If established and operated properly, the shareholders are not liable in the event of personal injuries, corporate debts and breaches of contract. The corporation as a whole will be responsible for any of these occurrences. However, in terms of seizing assets, creditors are limited to assets owned by the corporation. No personal assets of the can be taken to satisfy a debt. The assets of the shareholders and officers are protected, which makes a corporation stand out from the other forms of business ownership such as a partnership or sole proprietorship.
• Limited Liability Company (LLC):
While corporations are powerful vehicles for asset protection, many professional practices and small businesses are choosing limited liability companies (LLCs). LLCs work well as an alternative to sole proprietorships and partnerships due to the protections and tax advantages they offer. They are considered legal business entities, but they are not considered corporations.
The rules governing LLCs vary from state to state. As such, the protections they offer vary as well. For the most part, however, your business and personal assets will stay separate.
Like a corporation, an LLC can protect a business owner from lawsuits against the enterprise. While company assets may be at risk of seizure, personal assets can stay protected, as they can be kept separate from company property. Some LLCs even have lawsuit protection principles in place, so even if you were to get sued, your loss would be minimal.
What this means is that if you are sued personally and you and your business associate(s) own an LLC, the company itself and the assets therein can be protected from seizure. If you and your spouse own an LLC that holds rental property, for example, the judgment creditor may be forbidden from taking the company or the rental house.
Thus, LLCs work well for protecting real estate and other high-risk assets. That’s because you won’t be held responsible if someone were to fall and injure themselves at one of your rental properties, for example. Plus, assets held in your LLC can be kept safe from seizure in the event of a personal lawsuit. Therefore, properly structured LLCs can offer protection from a lawsuit against your business or one against you personally.
However, if you own multiple assets or properties, the best way to use an LLC is to have one for each asset. So if you have five rental properties, you should have five LLCs – one for each property. That way, if you have an issue with one property, your four other ones would not be affected. Each would be protected in its own individual LLC.
In some aspects, professional LLCs, where offered, also work well for medical professionals such as physicians, dentists and psychiatrists. While they cannot protect against malpractice suits, they can protect these professionals against company debts. LLCs may also offer protection against claims brought about by employees, suppliers and vendors. Medical professionals can also use LLCs to protect themselves by separating personal property from business assets.
• Family Limited Partnership (FLP):
A family limited partnership (FLP) works similarly to a family business, but offers protection as well as estate planning benefits. Bank accounts, real estate and equipment are all protected in the event of a lawsuit or judgment.
While many business owners may be unfamiliar with an FLP, this vehicle has been around for a century now. Created in 1916, FLPs have the ability to make a business unattractive to attorneys, therefore reducing the risk of lawsuits. In an FLP, the company is controlled by one or more general partners. There are also limited partners, but they have no control of the company. They receive income from the LP due to the profit generated by the general partners. FLPs do not pay taxes. Taxes are paid by the partners.
It’s important to make sure the FLP is drafted properly. If a limited partner of an FLP is sued, the plaintiff cannot seize any FLP assets, according to the law in all 50 states. The only remedy is a charging order. This charging order only offers the plaintiff distributions of the income.
FLPs are unique in that they can contain a clause that allows the general partners to distribute income to themselves and the limited partners. They can also exclude distributions to judgment creditors. This means that a judgment creditor would receive no assets or income. This is called phantom income, now get this, the judgment creditor would have to pay taxes on the income that they do not receive. (Rev. Rul. 77-137)
This means that creditors will be deterred from suing partners of FLPs. Plus, since many lawsuits are contingent on the plaintiff winning the case, an FLP removes incentive for attorneys bringing a suit in the first place. This makes an FLP an excellent form of asset protection for family businesses.
FLPs also have estate planning advantages. They are different from conventional trusts. Each partner owns shares in the business, and these shares can be transferred from one generation to the next. This lowers the taxation rates because family members are able to take advantage of annual gift tax exemptions. So, Mom and Dad can remain in control as general partners as Bobby and Susie own an increasing majority.
So, Mom and Dad can remain in control as general partners as Bobby and Susie own an increasing majority.
• Other Asset Protection Tools
The above is not an exhaustive list of the legal tools that can be used to separate safe and dangerous assets. There is the offshore corporation and offshore LLC, the domestic and offshore asset protection trust, the LLLP and many others you can research and utilize to strengthen your legal shield.
Hang Onto Your Assets
While keeping all your assets together may be convenient, it’s not a smart legal move. Consider one of the options listed above to protect yourself, your family and your business for many years to come. As an entrepreneur, you’ve worked hard to attain your assets. You may have hundreds of thousands of dollars or even millions of dollars in assets. Don’t let one wrong move let them slip away.
Spend the time and money up front to secure your assets into multiple vehicles. It’ll be worth it in the long run. All it takes is one lawsuit to wipe out everything you worked hard to achieve.
Make the Right Choice
Not sure which vehicle is right for your business? Do your research. Get help from a professional. Make an appointment to ensure your company is able to move in the right direction for years to come. Take the time to discuss the various aspects of your business, as well as the assets you own. A professional in this field can help you make the right choice for protection and peace of mind. You can also get advice about which vehicles to avoid, like a general partnership, which can actually do more harm than good if your goal is to protect your assets.
As a business owner, you have a lot on your plate. With the right form of asset protection, you’ll sleep better knowing that you’ll be protected in the event of a lawsuit or creditor judgment.
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Linsay Thomas, Technical Editor, contributing author