Keeping Your Liability Limited: Rules for Corporations and LLCs

December 10, 2013

Limited Liability Companies (LLC) and corporations have become indispensable business entities in our society. They allow business owners the opportunity to take business risks without worrying about losing everything they own in the process. This type of protection benefits all of us by allowing enterprising entrepreneurs to offer new products and services by removing their fear of losing every penny they own if the venture fails. For small business and real estate owners, this limited liability protection provides the vital peace of mind that an owner needs to operate their business on a daily basis.

Liability protection does come with certain requirements, however. In order to achieve the asset protection benefits described in my previous article on real estate and LLCs, it is vital that the owner treat the entity separately from his personal or other corporate assets. Additionally, a host of legal formalities should be observed. The failure to do so can make it easier for a creditor to “pierce the corporate veil” and collect against the owner individually or against his other business interests. What follows is a short list of general safeguards which need to be observed in order to reap the rich benefits of limited liability. As always, all individual situations should be discussed with a competent New York attorney.

The first step one takes is preparing and filing the appropriate incorporate/organization documents with the New York Department of State. LLCs, unlike corporations, have a publication requirement which is essentially a gift to the newspaper lobby at the expense of business owners. The law requires LLCs to publish a notice once a week for six straight weeks in two newspapers in the county in which the office of the LLC is located. One newspaper must be printed daily and the other must be printed weekly. LLCs also need to have operating agreements which dictate everything from day to day operations to how the death of an owner affects the LLC. This is especially important for LLCs with multiple members as they prevent one member from selling or gifting his share without the other members’ consents. Operating agreements also discuss the mechanism of how one member can buy out the other members. A corporation needs to have corporate bylaws, which dictate how the corporation is run. Shares of stock need to be issued to all owners, and the corporation needs to have an initial shareholder meeting to vote on directors. Corporations also need to conduct annual shareholder meetings and keep minutes of those meetings.

The corporate entity (other than certain single member LLCs) needs to obtain an EIN number from the IRS and open a separate bank account to transact out of. Corporate bank accounts should not be comingled with personal accounts, and corporate assets should not be used to pay personal debts or debts of other corporate entities. The business should be properly capitalized, and business funds should not be depleted to unreasonable levels. In order to make it clear to the outside world that an owner is acting in his capacity as a member or officer, the official corporate name should be used on all documents followed by the appropriate corporate suffix (Inc, Corp, LLC). All stationary should have the business name and corporate suffix or risk losing limited liability protection. An individual should be careful about not to personally sign on a contract or a lease. Rather, he should sign as an officer or member of the LLC or corporation to avoid personal liability. Although creditors often ask for a personal guaranty, especially when dealing with newer or smaller entities, an attorney should be consulted prior to giving one. I have successfully negotiated away the necessity of such a provision for my clients.

If a business entity is properly formed, segregated, managed, and capitalized, it can provide a tremendous benefit to its owners. The biggest mistake owners can make is managing their corporation or LLC as an alter-ego of themselves. Remember: if you take care of your company, your company will take care of you for years to come.

Asset Protection for NY Real Estate Investors: Protecting Yourself With LLCs

November 4, 2013

As both a Queens real estate lawyer and an estate planning attorney, I am asked by clients with real estate what they should do to protect their assets. They want to shelter their other investments and personal assets from potential creditors of their investment properties. Lawsuits based on slip and falls, environmental contamination, contract disputes, and landlord tenant issues are all potential perils for the real estate investor. Investor usually purchase insurance on their properties but feel that they need more peace of mind. After all, a claim by a severely injured party could exceed their insurance coverage, or their insurer may not cover the claim because of some quirk in the policy. Before discussing more exotic structures like foreign or domestic asset protection trusts (DAPTs), I ask how their property is owned. Many times, the investor unwittingly owns real property in his personal name which, as will be discussed in this article, opens up the individual’s other assets to avoidable claims. The first step to reaching their goal of asset protection is the creation of a Limited Liability Company (LLC) to act as the legal owner of the investment property. If structured and managed properly, this legal entity can provide excellent asset protection through the form of limited liability, while providing important tax advantages.

While sole proprietorships (owning assets in your name) are the most common and simplest form of property ownership, they provide no asset protection for owners. When a person who owns property in his personal name gets sued, all of his assets, even those unrelated to the property, can be used to satisfy a judgment. An example can help illustrate this: Let’s consider Joe, who is single and owns two houses; one in which he lives and one that he rents out. His personal home is worth $300,000 with no mortgage. The rental home is worth $250,000 but has a mortgage of $225,000. Joe signs a deal with Mark, a contractor, to perform major renovation work on his rental home for $50,000, which is not performed to Joe’s satisfaction. Joe does not pay Mark the money because he claims Mark violated the contract. Mark sues Joe for $50,000 and wins. Not only is Mark able to collect against the $25,000 of equity from the rental home, but he is also able to collect the balance against Joe’s personal residence or any of Joe’s other personal or business assets. Had Joe held his rental home in an LLC, Mark would only be able to collect against the value of the property held in the LLC, and not of any other assets outside of it.

A similar mistake investors make is owning multiple investment properties in one LLC. When an LLC is sued, all of that entity’s assets become available to creditors. However, by placing each property in separate LLCs, an investor can protect his other properties from being subject to the judgment related to only one of the properties. This way, if Joe owns two rental houses in separate LLCs and one property is subject to a judgment for an amount greater than his insurance policy and home equity can satisfy, his creditor can’t collect from the other LLC. While there are additional fees to set up and manage two LLCs, they are well worth the protection that they provide.

From a tax perspective, an LLC is a “pass-through” entity, which means that income is passed to its owners, also known as members, and reported on the owners’ individual tax returns. This feature of LLCs avoids double taxation and is similar to that of an S Corporation. LLCs with multiple members are taxed as partnerships and the members have to file a Schedule K-1. Single member LLCs are taxed as sole proprietorships and members report the income on their personal 1040.

The benefits for real estate investors is tremendous; if the proper legal distinctions are observed, a creditor can not enforce a judgment against the investor individually or against any other properties he may own. Consequently, properly safeguarding your LLC is critical and will be discussed in a subsequent article. As with all complex legal issues involving real estate and business law, a competent real estate attorney should be consulted.

Contact our law offices at 347-766-2685 to discuss your individual situation with an estate planning/real estate attorney.