Many Pennsylvanians look to the almighty LLC to protect their business from personal debts and their personal assets from business debts, but they may be in for a surprise. Others, may not even be looking towards an LLC and could be making an even bigger mistake of holding their business as a sole proprietorship. Either way, Pennsylvanians can do a better job of protecting their assets.
The Sole Proprietorship
A sole proprietorship is just what it seems to be: a business owned by one person in totality. A sole proprietorship may be the worst way to hold a business, because running a business in this manner is like waving a $100 dollar bill at the Louvre in Paris; just not safe. Similar to owning a car, if you owe money to someone, they can take the car to pay the debt. If one has an accident with the car, the people who were injured can acquire other assets, for example assets in a savings account, to pay off the judgment in the lawsuit. In the same way, with a business owned solely, if one owes debt the creditor can go after the business assets. Additionally, if the business is sued, the plaintiff can attach personal assets. An LLC is by far a better choice, although not the best choice.
The Pennsylvania LLC
A Pennsylvania LLC offers better asset protection than a sole proprietorship for several reasons. First the LLC is protected from personal debts of the LLC’s owners. This means that if one of the owner’s are sued personally, the LLC is not required to pay the owner’s debt. The creditor may, however, attach any profits that the LLC is paying to the debtor. This is called a “charging order” [Zokaites v. Pittsburgh Irish Pubs, LLC, 962 A.2d 1220 (PA Super. 2008)]
and is the only remedy available to creditors. So although the indebted owner will not lose his business, he won’t profit from it either. The reasoning behind this Pennsylvania law is that it protects the other owners of the LLC from having a creditor as owner with voting rights.
Pennsylvania and the Single Member LLC
But what if there is only a single member of an LLC. A lot of people don’t want to give up part of their business, even to protect it. Well, in a single member LLC, all bets are off [In re Albright, No. 01-11367 (Colo. Bkrpt. April 4, 2003)]
. There aren’t any other owners to protect, so a creditor may well be able to take over the ownership of an LLC to satisfy the debt or judgment. This type of LLC probably doesn’t protect much better than a sole proprietorship.
The Better Asset Protection Choice in PA
So what is the better asset protection choice? Don’t own the business directly at all. Keep working for yourself, but don’t own the business. It’s not as confusing as it sounds. Change the sole proprietorship to an LLC owned by a proven and properly drafted, executed and funded irrevocable trust such as the Ultra Trust. Many believe that an irrevocable trust is for estate planning and has nothing to do with a business. Well, an irrevocable trust, drafted in the correct way, can be an excellent vehicle to hold an LLC to add another layer of protection. An irrevocable trust is like a safe at the bank. The LLC goes into the trust and is owned by the trust. Whenever the ex-owner wishes to access funds, they get paid from their job as the manager of the business or they drive up to the teller (trustee) and ask for assets. The teller (trustee) then gives out the assets. When a creditor drives up to the teller window and asks for assets, the teller (trustee) says, “No way. Get out of here.” The creditor has no recourse because the debtor (the ex-owner) doesn’t legally own the business anymore. The trustee is under instructions to stop paying if there is a lawsuit, a divorce or in the case of severe debts. The LLC is safely tucked inside the trust and the ex-owner is safely outside the trust. Similarly, if the LLC falls on hard times, the creditors can try to “pierce the corporate veil” but will only make it to the trust, not the ex-owners personal assets.
Bonus Benefits of Irrevocable Trusts
As an added bonus, there are estate planning benefits. If the LLC is an asset that is growing, then placing the LLC in an irrevocable trust could save thousands of dollars of estate tax for your heirs. This is how it works. The owner owns a business that is worth $100,000 when placed in the trust. Because it is already owned by the trust, and $100,000 is well below the gift tax exemption, no gift tax will be paid. Now, the business grows to an $8 million business. The ex-owner dies and the trust passes the $8 million business to the beneficiaries that he chose in the trust instrument. Because the trust owns the LLC and the trust is the entity passing the LLC to the heirs (whom already had and interest when it was worth $100,000), the LLC is outside of the estate and not subject to estate tax.
Keeping with the added bonus theme, the trust doesn’t have to end at the ex-owner’s death. Unlike a will, a trust is its own entity and can carry on many years past the death of the ex-owner. In a will, the assets are “given” to whomever a person chooses or the will creates a trust. With a pre-existing irrevocable trust, assets are held with instructions to “give” the asset at any given time or under any given circumstances that the ex-owner can imagine. A trust could hold the business and give out the proceeds to the ex-owner’s children a little at a time or hold back payment should a child develop a substance abuse problem or get a divorce. The trust could continue on until the statutory end or it could end when a child reaches a certain age. All the while, the assets are safe from the creditors of the children.
In Pennsylvania, as in all states, A sole proprietorship is not the way to go. An LLC alone can help with asset protection somewhat, but one of the best asset protection strategies to hold a business in Pennsylvania is to combine an LLC with an irrevocable trust. Not only will the protection increase 10 fold, but one gets the added bonus of skipping estate tax when passing the asset to heirs. If one wants to keep their business firmly rooted in the keystone state, an irrevocable trust with and independent trustee is a great choice for any sized business.