The real goal and purpose of forming a business entity, whether it be for real estate investment, services, manufacturing, marketing, consulting, professional services, etc., is to protect both your business assets and your own assets from risk of loss.When planning for protection, there are two directions from which potential liability and risk can come. From the “front end” (the operating business) and from the “back end” (from your own potential creditors)
Asset Protection/Personal Liability Shield — Choosing the Entity Form
One of the primary concerns of most individuals contemplating starting a business is that of shielding the owners of the business from the debts and liabilities of the business. In reality, this is the main reason to set up a business entity. The shield of protection separating the individual from business liabilities is there to enable entrepreneurs with the ability and incentive to go out and engage in business enterprises without fear that their personal assets will be at risk from business liabilities that may arise. Not all business entity types offer the same protection however. And each entity type functions differently.
Let’s briefly take an overview of the different business entity types and the protections that each provides.
SOLE PROPRIETORSHIPS AND GENERAL PARTNERSHIPS
While Sole Proprietorships and General Partnerships are very simple and economical ways to begin engaging in business with some tax and other advantages, these types of business entities have the enormous drawback of providing no “front end” protection or shield to its owners from liability for the company’s debts and other liabilities. Therefore, doing business as a either a Sole Proprietorship or a General Partnership is almost always a bad idea.
LIMITED PARTNERSHIPS – FLP
Properly structured Limited Partnerships or Family Limited Partnerships can provide both “front end” and “back end” protection. A Limited Partnership is composed of a General Partner and Limited Partners. While the Limited Partners are shielded from the debts and liabilities of the Limited Partnership, the General Partner is fully exposed to the debts and liabilities of the partnership. Also, in a Limited Partnership, it is important realize that the Limited Partners are not allowed to participate in the management and operation of the business. Therefore, structuring of the Limited Partnership is critical, in order to ensure minimal exposure from the General Partner side and to ensure that the Limited Partners maintain their shield from the debts and liabilities of the business. The back end protection that a Limited Partnership (FLP) affords is essentially the same as that of an LLC (see below).
Properly formed and maintained Corporations can provide maximum “front end” protection or shielding of the owners/shareholders from the debts and liabilities of the corporation. As compared to Limited Liability Companies (LLC’s) and other business entities, Corporations generally have the drawback of having to comply with specific statutory “formality” requirements, such as organizational meetings, annual meetings, requiring designation of officers and directors. The failure to comply with the requisite business formalities may create some risk of the Corporation having its veil pierced and personal liability being attached to the shareholders/owners of the Corporation. Another drawback on the “back end”, as compared to partnerships and LLC’s, is that the shareholder’s stock may be attached by a shareholder’s personal creditors to satisfy a judgment. Because of this lack of back end protection for a Corporation, the Corporation is generally not a good choice from a Personal Asset Protection standpoint. [Note that the State of Nevada has recently passed a law that extends Charging Order Protection to Corporations with at least 2 and not more than 100 shareholders. (NRS 78.746). But, so far, Nevada is the only state that offers this “back-end” protection for Corporations. Charging Order Protection and what that means shall be discussed in more detail hereinafter.]
LIMITED LIABILITY COMPANIES – LLC
A Limited Liability Company (LLC) can offer some good Personal Asset Protection from the “back end”. Again, when we are talking about “back-end” protection, we are talking about the protection of your equity ownership interest in the LLC (called a “Membership Interest” – which is essentially the same as being a Stockholder in a Corporation) and the protection against a Judgment Creditor being able to get at the assets of the LLC.
A Nevada LLC offers particularly good back-end protection, because the Nevada LLC statute makes clear that a Charging Order is the exclusive remedy for a Judgment Creditor against a Judgment Debtor’s LLC membership interest. The charging order remedy in Nevada is of limited or no benefit to the judgment creditor, because all the judgment creditor can do is to wait and hope that the LLC makes a distribution to the member whose interest they have the charging order against. Because of the specific language in the Nevada LLC law, the door is not open for a judgment creditor to try to exercise any other remedy such as foreclosing the Charging Order (which is essentially a lien). Neither does the Judgment Creditor does not aquire any rights of the LLC member other than the right to receive the distributions made from the LLC when, and if, a distribution is made to the member that is the Judgment Debtor. The Judgment Creditor cannot force any distribution of profits. So, if no distribution is authorized and made, the Judgement Creditor will receive nothing from the LLC. With a carefully drafted operating agreement, the members and/or managers of the LLC can stay in control of when distributions are made and judgmen creditors cannot force any distributions.
There is also an inherent disincentive for a Judgment Creditor to want to get a charging order. That disincentive is a federal tax issue. Because the Charging Order gives the Judgment Creditor the right to receive the distribution of profits made to the Judgment Debtor member of LLC when such distributions are made, the IRS has taken the position that the Judgment Creditor with a Charging Order has effectively become the financial member of the LLC. The LLC, by default, is a “flow-through” tax entity (net profits and losses “flow-through” to the members and are attributed to the LLC members, regardless of whether or not any actual profit distributions are made). What this means for the Judgment Creditor is that, if there is a net profit made in the LLC, the Judgment Creditor that has a Charging Order against an LLC member’s membership interest may end up being required to pay taxes on profits that the Judgment Creditor will likely never see (IRS Revenue Ruling 77-137). Therefore, a Judgment Creditor that is not asleep at the wheel will not want to get a charging order. This results in effective protection from liens against your right as a member of the LLC to receive distributions of profits from the LLC. (this is commonly referred to as the “K-O by the K-1”)
Thus, the LLC is generally the preferable business entity choice, because it offers both Front-End protection and Back-End protection.
At R. D. Johnson Law Offices, we understand and are sensitive to your need for optimum asset protection and shielding from personal liability. Therefore, we offer a free initial half hour consultation, wherein we will discuss your business entity options and how we can best help to ensure that you and your business associates receive and maintain sufficient asset protection and are shielded from personal liability.
During your free consultation, R. D. Johnson Law Offices will be happy to explore the entity options with you and help you to ascertain which entity would best suit you and your new business.
Why Form a Business in Nevada?
Nevada (often called the “new Deleware”) currently has what is considered to be the most favorable business entity laws in the United States which provide real advantages to businesses of all types. Some of the advantages over many other states of forming a Corporation or Limited Liability Company (LLC) in Nevada include:
- No State Corporate Income Tax
- No State Taxes on Corporate Shares
- No State Franchise Tax
- No Personal Income Tax
- No Internal Revenue Service (I.R.S.) Information Sharing Agreement
- Relatively low Annual Fees
- Minimal Reporting and Disclosure Requirements
- Stockholders are not Public Record (i.e., bearer shares are allowed in Nevada) (maintaining maximum Stockholder anonymity & privacy)
- Only one person is needed to create and maintain a legal Corporation or LLC
- Stockholders, directors and officers need not live or hold meetings in Nevada, or even be U.S. citizens
- Directors need not be stockholders
- Officers and directors of a Nevada corporation or LLC can be protected from personal liability for lawful acts of the corporation or LLC
- Nevada corporations may purchase, hold, sell or transfer shares of its own stock
- Nevada corporations may issue stock for capital, services, personal property, or real estate, including leases and options.
The directors may determine the value of any of these transactions, and their decision is final.
Why Choose an Attorney to Incorporate My Business?
While there are currently many non-attorney incorporation services now available which tout their low incorporation fees, there a number of very real reasons why you should choose a licensed Attorney to form your new business, including:
- Non-Attorney individuals and companies cannot lawfully provide you with legal advice concerning the formation and maintenance of your company.
- Many of these individuals and companies fees are so low because they do not provide all of the services needed to complete the incorporation and formation filing and process for full compliance with the applicable Nevada statutes. This may lead to your paying even more fees in the long run.
- Some of these companies and individuals, while advertising that they are “incorporating” a company for you, actually only form an entity with themselves shown as legal owner and then “sell” the consumer a corporate or LLC “shell”. Some unwitting consumers are then left on their own, not knowing that additional filings and procedures are required until they discover that their entity charter has been revoked or that they may be subjected to personal liability and are then hit with additional fees and costs to bring the entity into compliance (if the deficiencies are discovered soon enough).
- Many of these entities only provide you with non-customized Forms that may or may not fit your company’s specific needs.
- An Attorney, on the other hand, can assess your specific needs and provide you with valuable legal advice and a customized entity formation that may save you hundreds or thousands of dollars in the long run.
- An Attorney can provide you with ongoing legal advice and assistance to help ensure that your company continues to provide you and your associates with the personal liability shield that is critical to ensure that the individuals are not saddled with costly personal judgments and other problems.
- An Attorney can provide your business with ongoing legal advice and assistance to help you make important decisions that may greatly impact your company.
To form a Nevada entity either give us a call or email for an appointment for a free consultation. Or, to start the process to form a Nevada Corporation or LLC now, click on the following link to complete the online formation questionnaire.