| Recently I've run across some significant issues with | | | | charging order to protect the single member LLC is |
| the single member LLC's with courts handing down | | | | dynamic and evolving. There's no legal reasoning for a |
| noteworthy judgment decisions in favor of creditors | | | | charging order protection for single member, even |
| using the theory of "fraudulent transfers" and "civil | | | | though most state statutes call for such protection. |
| conspiracy." I ran across two such individuals that have | | | | The charging order protection cannot create a |
| made me more caution on client advice regarding | | | | "personal legal liability" out of a legal business entity for |
| single member LLC's. | | | | "the acts" of the LLC. |
| SINGLE MEMBER LLC - LIMITED LIABILITY | | | | There are several litigation issues unique to the LLC |
| COMPANY PASS-THROUGH LEGAL ENTITY | | | | that are beginning to emerge in trial forums. State LLC |
| The LLC is a TAX HYBRID "pass-through" legal entity | | | | laws, when written, were primarily tax driven, and |
| similar to a partnership but with the limited liability of a | | | | accordingly, they defined key terms and concepts in |
| corporation. The LLC is tax-driven and was classified | | | | accounting and tax terms, and not with thought of |
| legally by the IRS on January 1, 1997 when the IRS | | | | contract tort law issues. When the LLC is in financial |
| threw out its old, and unnecessarily complicated, | | | | distress, litigation will usually focus on: |
| business entity tax classification regulations and agreed | | | | A. Dissolution issues, |
| that LLCs should be taxed as partnerships (or sole | | | | B. Capitalization issues, |
| proprietorships if they have one owner) without | | | | C. Failure to comply with state statutory and regulatory |
| jumping through a number of technical hoops. | | | | requirements, and |
| Moreover, the IRS now lets an LLC elect to pay taxes | | | | D. Violation of one or more provisions of the entity's |
| as a sole proprietorship, as a partnership, or as a | | | | documents. |
| corporation by filing IRS Form 8832. | | | | FRAUDULENT CONVEYANCE, CIVIL CONSPIRACY |
| For "Income Tax purposes" income and expenses of | | | | WITH SINGLE MEMBER LLC |
| the LLC "pass-through" directly to your income tax | | | | The central issue to single member LLCs (one owner) |
| return proportionate to your percentage of ownership, | | | | is "FRAUDULENT CONVEYANCE" which, if not |
| or if there is more than one member, whatever | | | | handled properly may become part of a "civil |
| percentage you decide, for example, 50/50 or 75/25. | | | | conspiracy" to fraudulently act against creditor claims. |
| Irrespective of your equity ownership percentage, this | | | | In some cases the financial planner, lawyer, or |
| is a significant advantage over other forms of | | | | accountant becomes part of the conspiracy and in |
| business entities, and the LLC also has another | | | | some cases such advisors have been reprimanded. |
| significant advantage; members decide how they want | | | | Single shareholder corporation, single shareholder of |
| to be taxed or, in other words, as sole proprietor, | | | | Sub "S", and single member LLCs can provide the |
| partnership, or corporation. The LLC will obtain it's own | | | | owner with protection against liabilities arising from "the |
| Federal Identification Number (similar to a social | | | | conduct of the LLC" but not the owner of the LLC |
| security number), operate as a business, and maintain | | | | membership shares. In other words, "if" the LLC does |
| it's own bank account. | | | | something wrong, the owner is not necessarily |
| SINGLE MEMBER LLC MAY NOT BE PROTECTED | | | | responsible. To reach the owner's personal assets, a |
| FROM CREDITORS | | | | plaintiff would have to "pierce the veil" of the entity |
| Ninety percent of financial advisors give the wrong | | | | showing that: |
| advice regarding single member LLC formations. Single | | | | A. The LLC, the corporation, or the Sub "S" was under |
| member LLC are mistakenly assumed to protect the | | | | capitalized for it's intended business purpose, |
| member from the creditor. Most financial LLC advisors | | | | B. Formalities were not followed, |
| state that a Limited Liability Company (LLC) protects | | | | C. The owner used the LLC, Corporation or Sub "S" |
| the owner (i.e. single member LLC) against present, | | | | mostly for personal purposes, |
| past, and future creditors because the creditor may | | | | D. It did not serve a "bona fide" commercial purpose, |
| not step into the shoes of the LLC and has to look at | | | | E. It lacked in economic substance and was merely an |
| the LLC member for collection. | | | | alter ego of the owner whose sole intention is to |
| The advisors point to an IRS Revenue Ruling (77-137), | | | | frustrate the creditor(s), etc. |
| where the creditor holding the "Charging Order" will | | | | A single member LLC (one owner), Corporation, or |
| receive the "K-1." They further explain, the creditor | | | | Sub "S" will not protect the owner, because the |
| must pay the taxes on the income generated by the | | | | charging order protection that is much touted, is based |
| LLC, even though the creditor never receives any | | | | on protecting the "innocent" non-debtor. |
| actual cash from the business. The creditor saddled by | | | | Under the Uniform Fraudulent Transfer Act you would |
| the charging order is treated as a "substituted limited | | | | be committing a crime, see Section 19.40.041: |
| partner for tax purposes" and will suffer the tax | | | | "...(a) a transfer made or obligation incurred by a debtor |
| consequences without capacity to force payment, | | | | is fraudulent as to a creditor whether the creditor's |
| dissolution, or distribution of the LLC. | | | | claim arose before or after the transfer was made or |
| CHARGING ORDER DEFINES CREDITOR AS | | | | the obligation was incurred, if the debtor made the |
| SUBSTITUTED LIMITED PARTNER FOR TAX | | | | transfer or incurred the obligation: (1) with actual intent |
| PURPOSES TO PROTECT SINGLE MEMBER LLC | | | | to hinder, delay, or defraud any creditor of the debtor... |
| The area of the laws surrounding the issues of the | | | | |