What’s “Limited” in a Limited Liability Company and Other LLC Questions Answered

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moneyMaybe it’s the business protection version of “How much does a pound of feathers weigh?” The clients asked, “If a limited liability company is a great way to protect assets, then why is it limited?”

Great question.

It’s easy for anyone talking to assume that the listener knows what we’re talking about. Especially when we think that the subject is common knowledge. At least to us. Remember when you didn’t know what a water closet was?  It actually sounded kinda dumb.

Professionals sometimes omit whole parts of a process. Not out of malice, the surgeon assures us that, “You’ll be as good as new” without talking about just how much fun the recovery will be. Not.

Lawyers are not exempt, but you knew that already.

But since limited liability companies are great, protective things, let’s take the clients’ question and give you the crash course as to why LLCs are so useful.

What’s limited in an LLC and why is it limited?
First, a creditor cannot reach your personal assets if the LLC has become liable for something.

Second, a creditor’s access to what’s in the LLC is really limited. A creditor is limited in what he, she or it can reach to satisfy a claim.

Think of a corporation: it’s the same idea. But don’t think this applies to general partnerships, tenancies-in-common, sole proprietorships, limited partnerships, et al. It doesn’t. These entities do not protect personal assets the same way as corporations and LLCs.

Isn’t a corporation just as good, then?
Nope. With the right structuring, a creditor cannot take your shares in the LLC.

In a corporation, however, a creditor can take your shares – and then vote to dissolve it or do other things you won’t like.

I know what you’re thinking: “Then why not always use an LLC? Why mess with a corporation?” The answer: it’s a tax thing. Sometimes one is better than the other under the Internal Revenue Code. That’s a topic for another day.

What exactly is protected in an LLC?
The LLC shields what’s in it. An LLC doesn’t shield what is not in it.

So if you put investments in a particular type of LLC – stocks, bonds, real estate, most any investment – then those assets are shielded. If you keep these investments in an account, in a personal or joint name, what’s in this account is not protected in the slightest.

Oh, figure you’ll wait until you learn of a claim or lawsuit against you before you’ll move your assets into an LLC? To quote from the ’80s movie Donnie Brasco: fuggedaboutit.

What’s this ‘particular type of LLC’ language?
We’re dealing with two types of LLC structures. If an LLC is going to do something with risk – own rental property, for example – then that LLC could be sued if something went wrong. And what’s in that “risk” LLC is vulnerable.

(Imagine: your tenant invited someone over who was injured on the front porch and sued.  And the liability insurance company said “No coverage.”  In this case, the LLC, and what it owns, is exposed.)

But if the LLC is not going to be doing something with risk – such as managing stocks, owning CDs,  etc. – then it’s a different story. This LLC isn’t doing anything it can be sued for. So what’s in this LLC is safe. Which is why you often have one LLC for safe assets, and another for dangerous assets.

It’s all a matter of design and documentation.  There is no “One Size Fits All” form LLC.

So an LLC can protect me from being sued?
Nope. But it can protect you and certain assets in case you are.

Isn’t there a tax bite when I put assets into an LLC, or take them out? What if I want my money?
Unless your documents are gunked up, or you’re not treating the LLC like a real business, there is no tax consequence at all to putting assets in or taking them out.

I think I understand.
But if not, we’re always happy to answer your questions, especially if you’ve read this far. Send an email and we’ll try.

This was easy.
Good.  Next month we’ll talk about the calculus of annuities.  Just kidding.