In the 2010 case of Olmstead vs. Federal Trade Commission, the Florida Supreme Court ruled that the “charging order” was not the sole and exclusive remedy for a judgment creditor of a single-member limited liability company (“LLC”) (we discussed the Olmstead case in an earlier post). The dissenting justices in that case raised the concern that the Supreme Court’s ruling was sufficiently broad that it might apply to multi-member LLCs.
In the 2011 legislative session, the Florida Legislature, responded with a resounding, emphatic, and absolutely clear message that multi-member LLCs continue to provide the owners of the LLC with the protection of the charging order with respect to the rights of a judgment creditor against the LLC member’s ownership interest in the LLC. This protection is clearly delineated in the rewrite of Florida Statutes, §608.433. The amendment keeps Florida among the small handfull of states (6 others besides Florida) who provide that the charging order is the sole and exclusive remedy for a judgment creditor seeking to recover a judgment against the ownership interest of an LLC owned by the judgment debtor.
Superior Asset Protection
The legislation removes all dobut, if any existed, that a limited liability company provides far superior asset protection compared to a corporation. In fact, I will go so far as to say that any attorney, certified public accountant, or any other business advisor, who forms a corporation, or recommends a corporation, as their client’s business operating entity, is committing malpractice at a minimum, and is doing a significant disservice to their client. The only exceptions to that statement are when a corporate form of organization is needed for some regulatory or statutory reason, or the company intends to go public within the near future.
The reason for such a strong and specific statement is simply this: If one of the individual owners of a multi-owner business entity has a judgment entered against him or her, the judgment creditor can seize the ownership of the stock of the corporation if that is the form of the business entity; but, if the business entity is a limited liability company, the judgment creditor cannot seize the ownership interest of the business entity to satisfy the judgment – even if the individual is in bankruptcy court. That’s powerful asset protection!
No Income Tax Reason for a Corporation
There is absolutely no income tax reason – or advantage – to having a corporation as the form of business entity. Pursuant to the “check the box” provisions of the Internal Revenue Code and regulations, the owners of an LLC have the option to choose how the LLC is going to be taxed. If there are multiple members of the LLC the “default” form of taxation is as a partnership. However, upon filing the proper “check the box” form (a Form 8832) with the IRS, the owners can choose to be taxed as a “C” corporation, or as an “S” corporation. There simply is no reason to ever use a corporation as the form of business entity for a small business, or any other private business that has no intention of “going public.”
Converting a Corporation to a Limited Liability Company is a Tax Free Event
So what if you already have a corporation that has been operating for many years, but you want the asset protection value of a limited liability company? Florida Statutes allow for the straight forward conversion from a corporation to a limited liability company. Such a conversion is retroactive to the initial formation of the corporation. The net result is that after the conversion, the former corporation is treated, under Florida law, as if it has been a limited liability company since its inception.
The IRS has issued revenue rulings and Private Letter Rulings that allow such a conversion to be a tax-free reorganization. If the “equitable ownership” before and after the conversion are the same (same owners and same proportionate ownership interests), and immediately after the conversion all of the owners elect for the LLC to be taxed in the same manner as the corporation was taxed, there are absolutely no federal income tax consequences of the conversion, and no change in the manner of taxation by the State of Florida.
No One Should Ever Again Use a Corporation for a Small Business
When establishing the limited liability company, the most important issue, for asset protection purposes, is to ensure that the LLC’s “operating agreement” has appropriate provisions to maximize the asset protection value of the charging order remedy. The “operating agreement” is the document that controls the management and operation of the LLC – similar to the corporation’s by-laws. With the proper provisions included in the operating agreement, the owners of the small business can create such negative consequences for a judgment creditor who obtains a “charging order” that virtually no creditor will ever want to even think about asking the court to issue a charging order. That means you have essentially “creditor proofed” your business ownership interest.
With this emphatic “clarification” of the exclusvie nature of the charging order remedy for owners of a multi-member LLC, the Florida legislature has maintained a significant safety net for business owners and their ownership interests in their businesses. No one should ever again use a corporation as the chosen entity for their small business operations, and all successful business owners should convert their corporations to multi-member LLCs, without exception.
Estate PLanning Advantages of LLCs
In addition to the invaluable asset protection features provided by LLCs, such entities also provide, based on current law, some very substantial estate planning objectives that are not available with corporations. It is easier to gift partial interests in LLCs to other family members for business succession purposes, without giving up control of the business operations until the owner decides he or she wants to also give up control. There are potentially substantial valuation discounts available for gift tax and estate tax purposes for a properly structured LLC. Utilizing the current $5 million lifetime exemption from gift and estate taxes that is available through the end of 2012, a successful business owner can transfer a huge amount of assets to the next generation, without giving up control of the business, and avoid potentially millions of dollars of estate taxes in the future.
There is no reason for any prospective small business owner to ever again establish a corporation as the form of business entity for his or her business operations. In fact, any current business owners who have their business operations owned by a corporation should immediately consider converting the corporation to a limited liability company. There is no reason not too, and lots of reasons to do so.
Copyright 2008-2014 – The Coleman Law Firm, PLLC