PROTECTING ASSETS THROUGH BUSINESS REORGANIZATION
with a LIMITED LIABILITY COMPANY
For many business owners, their business is their most valuable asset. It also represents the legacy they have built for their families, the hard work that they have invested over the years and the fulfillment of their professional goals. When a business owner decides to scale back and spend more time on leisure activities, he will often seek out a successor who can purchase the business, in turn providing the owner and his family with a stream of income that will support them during retirement.
Given the importance of the business, how do we protect its value from claims made against the owner? Our clients tend to have good plans in place for the professional risks and liabilities that they face. They will have property and casualty insurance and errors and omissions policies to cover specified business activities. We are often surprised, however, to find that they have not taken additional steps to insulate their businesses from personal risks and liabilities.
Many business owners are unaware that creditors who have successfully asserted personal claims against them may be able to attach their ownership interests in their businesses. The protection provided by corporate ownership protects owners from personal liability for claims against the business; it does not protect them from personal liability for their business activities or other personal claims asserted against them. Business owners are usually unaware of the available solutions, which is the focus of this article.
Risk from personal claims can arise from many events. It could be from a divorce, a bad driving decision, a bad business decision or catastrophic health costs for the owner or family members. As noted above, a business owner who is personally liable for a business activity is not protected from having to satisfy that claim.
Things happen and when they do, there may be unpleasant consequences. Shares of stock in a corporation can be attached by a creditor and the business owner loses control of his corporation. The creditor controls the stock and can then reach the assets of the corporation.
How can we successfully avoid this result? Fortunately, Ohio now provides an answer; conversion of ownership from a corporation (whether a C or S corporation) to a limited liability company (LLC). A creditor of the owner of interests in an LLC (called Units, which are like shares of stock) cannot become a Member of the LLC. Its rights are described as those of an assignee, which does not give it any ability to vote the Units of the LLC or participate in management. In short, it is a very undesirable way to have ownership of a business.
This occurs because the Ohio Legislature recently passed legislation that seeks to attract new businesses and keep existing businesses in the State of Ohio. One way that Ohio attempts to achieve this goal is by increasing additional protections against creditors of the owner of an LLC who seek to attach that person’s interest in the LLC. The new law applies to businesses regardless of whether there is one or multiple owners. With the most recent changes in the law, Ohio stands as one of the more business-friendly and creditor-hostile LLC jurisdictions in the United States.
With the appropriate assistance of counsel, conversion from a corporation to an LLC is not difficult and is specifically provided for in Ohio law. Conversion requires specific filing of documents with the Ohio Secretary of State and the creation of an LLC company record book, which replaces the corporate record book. The principal document in the company record book is the Operating Agreement, which contains the rules for the management of the company. It can (and will for Cavitch clients) include provisions that further enhance the asset protection planning benefits of having an LLC.
Furthermore, as long as the legal requirements detailed below are followed, conversion is a tax neutral event and will not result in the imposition of any federal or state taxes:
- Complete conversion of all business assets. All of the shares of the old corporation must be exchanged for all of the Units of the converted LLC.
- No change in ownership. The owners of the shares of the old corporation must own Units of the converted LLC among themselves in the same proportions.
- No change of the business assets. Prior to and after the conversion, the business must hold the same assets and the same liabilities.1
- Continuity of tax status. Form 8832, Entity Classification Election, will need to be filed with the IRS stating that the converted LLC will continue to be taxed as a corporation.
Business owners can significantly limit their liability exposure by converting their corporations to LLCs. With appropriate legal guidance, the conversion will not result in any tax liability, change the way that the business is taxed, nor will it change the day-to day operations of the business. In fact, the business will even continue to operate under the same taxpayer identification number.
Further, conversion to an LLC will simplify management of the business. As an example, LLCs, unlike corporations, do not require annual meetings and the preparation of minutes.
A final thought: Asset protection planning needs to be done before there is a problem. Application of strategies, such as conversion to an LLC after the fact, is probably not helpful and may make things worse. The best time to put a comprehensive, well thought out strategy in place is when times are good.
Please feel free to contact us for more information as to this opportunity as well as to discuss other asset protection and tax planning strategies that we have.
CAVITCH, FAMILO & DURKIN CO., L.P.A.