Preserving the Protection of The Corporation

Strategies To Protect The Assets of The Corporate Principals

Strategies To Protect The Assets In Your Corporation

The oldest and best known form of legal entity for asset protection is a corporation. However, it's not suitable for the ownership of passive investments or personal property. For tax reasons, personal assets such as a home, automobiles, art or jewelry should be held personally or in a trust. Investments should either be held in a trust, a partnership or LLC. The assets of a business should be held in a limited partnership, LLC or corporation. 

Partnerships, LLCs and corporations are generally presumed to exist to make a profit. When non income producing assets like a home or personal art are the primary assets of a partnership or corporation, it causes a lot of tax problems. And the tax law has a number of rules that are designed to strongly discourage the use of a corporation to own investment assets like stocks and bonds. Thus, there are very few cases where a corporation is a useful way to own assets other than the assets of an operating business.

First, anyone who sues a small corporation is likely to also sue the responsible officer/director of the corporation. Second, if the major shareholder of a corporation guarantees any obligations of the corporation, the shareholder is personally liable for those debts. If the corporation loses it's assets in a lawsuit, those assets aren't available to pay the creditors with guarantees. So, indirectly, the shareholder is still at risk for the lawsuit. Third, where a plaintiff can show that the corporation is merely an alter ego for the primary or sole shareholder, the courts will often ignore the legal protection provided by the corporation. 

Finally, the corporation does not shield any owner/employee from liability for his or her own acts. The most common examples are errors and omissions (malpractice) by professionals such as accountants, lawyers, doctors and engineers. This also applies to any alleged damages caused by the acts of an employee. Thus, if you are that employee, you are personally liable. In many cases, you are also liable for any acts by employees or sub-contractors

"If a corporation has no significant assets, the plaintiff will attempt to convince the court that the corporate entity should not be respected and that the principals of the company should be personally liable." ("Lawsuit Proof" by Mintz and Rubens, page 101) 

Whether a creditor can succeed in getting past the corporation to make the principal owners liable, usually depends on whether the principal owners maintain the legal formalities that are required for a corporation. These formalities include:

1. Having a set of corporate by-laws and having regular meetings of the shareholders and board of directors.
2. Keeping a corporate minute book to record the actions of the shareholders and directors of the corporation, such as corporate loans, major purchases, adopting or changing employee benefit plans and the amount of the compensation for the officers and directors.
3. Having and keeping a corporate stock ledger book that shows the current names, addresses and number of shares owned by each shareholder.
4. Using the corporate name and showing that the business is a corporation on all correspondence, sales materials, invoices, purchase orders, contracts, etc.
5. Having separate bank accounts for the corporation and keeping the corporate books and transactions separate from any personal transactions. This includes being sure that any money paid to an owner is treated as taxable compensation or as an interest bearing loan, with a clear repayment arrangement.

1. Don't have family members involved as officers or directors unless they actually work in the business.
2. Put your other financial assets into a family limited partnership, offshore trust, charitable trust or other legal entity to insulate those assets for you.
3. Make maximum use of available bankruptcy exemptions such as the homestead exemption, the pension exemption, exemptions for life insurance and annuities.
4. Segregate the ownership of property between yourself, your spouse, children or parents. Avoid joint ownership of assets. Use joint tenancy in the entireties for real estate where state law provides that benefit.
5. Make early gifts of property that is intended for family members, such as college expenses. Use a family limited partnership or an irrevocable trust.
6. If your marriage is very strong and you are not concerned about a divorce, transfer assets to your spouse if your spouse has minimal liability exposure.
7. If a plaintiff "pierces your corporate veil" and gets a judge to grant a judgment against you, the plaintiff can take your stock and can then proceed to dissolve your corporation and liquidate it's assets. The only sure way to prevent that is to spread the ownership of the corporation among your family so that you won't personally own over 49% of the corporate stock.

Don't use your corporation as a savings account with large amounts of accumulated cash. Pay the money out as salaries, put it into a pension plan, or invest it in a limited partnership (where other family members are also partners) or move the cash into an offshore trust if there's a lot of it. In some cases, excess cash can be invested in real estate ventures or other limited partnerships. However, the corporation does need enough assets to avoid being ignored (by the courts) because of inadequate capital. 

You can protect your accounts receivable and your corporate inventory by pledging these assets as collateral for loans from a family trust or a family partnership or another corporation. The cash that is received can be used as described above. 

The best way to protect the physical assets in your corporation (like equipment and real estate) is to have the assets owned by some other legal entity that is owned by yourself or a family member, and to then lease those assets to your corporation for a fair rent. 

Even though there are no tax advantages in doing business in the form of multiple corporations, using multiple corporations can be an effective way to protect the assets of your business. You can use different corporations for different business locations, for different product lines or services or even to provide separate corporate functions like your marketing, your accounting, your computer operations, etc. To get the maximum protection, each corporation should be owned by multiple family members or entities so that no one owns 50% or more or any corporation. 

When using multiple corporations, put the most valued assets (such as cash) in the corporation with the least liability exposure.

Further details about protecting your assets from future lawsuits  are available in our subscriber's web site. Changes in the tax laws and various federal and state laws affecting various asset protection devices are provided in our monthly newsletter on Asset Protection Strategies.

NOTICE: This Information is intended only for educational purposes and may be regarded as controversial by some legal experts. Readers should consult with a qualified  professional who is familiar with their specific financial and tax circumstances before adopting any ideas that are discussed in this article.

About the author:

Vernon Jacobs is a CPA/CLU who works as a tax author and consultant. He  sponsors and moderates a free discussion group on asset protection and offshore topics.  His email address is vkj@rpifs.com.  He can be reached by phone or fax at (913) 362-9667.

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