More importantly, an ownership interest in an LLC is considerably more creditor protected than are shares in an S corporation which can be easily seized by a stockholder’s personal creditors. A member’s interest in an LLC is creditor protected in the same way a partnership interest in a limited partnership is protected. A member’s personal creditor is limited only to a charging order against the LLC interest, which gives the creditor only the right to receive distributed profits due the debtor partners.

There are still a few advantages of an S corporation over an LLC: (1) An S corporation can be more tax advantageously acquired by another business; (2) S corporation owners pay employment taxes only on their salaries, while LLC owners pay employment taxes on all profits; and (3) State taxes may be lower for an S corporation.

Many practitioners prefer to use an FLP instead of an LLC for estate tax reduction. This is because FLPs are ‘tried and true’ and have a plethora of case law to support their efficacy. However, it is possible to structure an LLC like an FLP for the purposes of estate tax reduction. There is no case or statutory law that would prohibit this. At the same time, LLCs have not been as battle-proven in court as has the FLP.

To make certain an LLC is taxed like an FLP, it should be structured like an FLP. Namely, the company should have limited members (a ‘member’ is the LLC’s equivalent to a partner) and managing members, and it should be taxed as a partnership. It should also have all the characteristics of an FLP.

With the more battle-tested track record of the FLP, one might ask: Why would anyone wish to form an LLC instead of an FLP? An LLC has some other benefits that an FLP does not. We can mention three: First, the LLC may exist perpetually (LPs typically may only exist for 30 years). Secondly, the LLC enjoys limited liability for managing members as well as limited members. Remember, the general partner (manager) of an LP has unlimited liability. Thirdly, after the death of the partner, an LLC may elect to be taxed as a C or S corporation. An LP must use partnership taxation without exception.

Corporations are not COPES. As we have previously said, a corporate shareholder comes under creditor attack, that creditor may seize his shares of stock for the amount of the outstanding debt. If the shares seized exceed 50 percent of the company’s voting shares, the creditor could then vote to liquidate the company, and seize his share of the company assets upon liquidation. You can see why the vulnerability of corporate shares to creditor attachment makes the corporation a relatively poor protective vehicle for personal assets. This inability to seize COPE interests is what makes these entities so desirable for creditor protection.

Though we have discussed several benefits of the LP, we have not yet discussed its biggest benefit from an asset protection perspective. This benefit is the charging order. To say the charging order is a benefit is actually a bit of a misnomer, because in actuality the charging order is a remedy available to creditors. However, the remedy is so limited that it is often ineffective. That is why, amongst the over 20,000 entities we have created for clients (most of which were susceptible to a creditor’s charging order), fewer than five clients have been subject to a charging order. Furthermore, if the LP is created and operated correctly, a creditor has no other way to reach LP assets other than the charging order.

So what is the charging order? The charging order is a statutory provision of law under the UPA, ULPA, RULPA, and Revised Uniform Limited Liability Company Act (RULLCA) which provides a creditor of a company’s partner or owner may attach company distributions made to that individual. However, this is generally the only remedy available to the creditor. This is so because it would be unfair to the other partners – or to the partnership itself – if a creditor were able to disrupt partnership business. This would harm the other partners who are not parties to the debt. Consequently, the charging order does not allow the creditor to control the entity, attach the entity’s assets, or become a partner or owner of the entity. Of critical importance is the fact that, since a charging order holder cannot control the entity, they cannot control its profit distributions. In other words, if the entity never makes a distribution to the debtor-partner, then the creditor never receives a distribution. Their charging order then is essentially worthless. But a note of caution here: It is not a good idea to make distributions to all partners except the partner whose interest has been assigned to a creditor via a charging order. A judge might see this as an overt attempt to thwart the creditor from receiving his due. In such an instance, it is conceivable that a judge could view such circumstances as being akin to a fraudulent transfer which might then lead the court to force a distribution from the entity. If someone wishes to have distributions made to the other partners or owners while keeping his distribution out of the hands of his creditors, then before the creditor threat arises, the partner should place his partnership interest in another entity that is also protected by the charging order. The distributions will then be made to the second entity and not to the individual directly.

For many years, the limited partnership has been a staple of asset protection planning. Although in many instances the limited liability company (LLC) is now preferable to the LP, limited partnerships are still popular, and are sometimes still the entity of choice, especially for the reduction of estate taxes.  Limited partnerships are a variation of the general partnership. General partnerships (commonly referred to as ‘partnerships’) have existed for thousands of years. They are typically small businesses wherein each partner may manage, act for, and bind the company. Although a general partnership is technically not a distinct artificial entity, as it is not created by the government, each partner usually contributes property to a general pool of partnership assets as necessary for it to conduct business, and it is often treated as a distinct entity. General partnerships are often very basic and informal in their structure, and are thus easy to form and operate, requiring a minimum of associated paperwork aside from filing partnership tax returns.

As commercial law developed general partnerships gradually began to demonstrate some glaring shortcomings and that brought about the limited partnership. Among these shortcomings is the fact that one partner can make a decision that could financially harm not only the partnership as a whole, but the personal wealth of the other partners. Like a sole proprietorship, general partnerships have no limited liability. Therefore, if one partner obligates the partnership to debts it cannot pay, the personal wealth of all partners is at risk of being forfeited to the partnership’s creditors. The same is true with debts arising from lawsuits: if one partner is dishonest or commits a tort while working for the partnership, then a creditor could obtain a judgment against the wrongdoer, the partnership as a whole, as well as each individual partner.

The limited partnership’s chief difference from the general partnership is that it has two classes of partners: General partners and limited partners. A general partner manages the company. However, the general partner has unlimited personal liability. Consequently, if the company is unable to pay its debts, its creditors can look only to the property of a general partner to satisfy those debts.

Limited partners do not have this same vulnerability. A creditor can only pursue a limited partner’s assets to the extent those assets have been contributed to the partnership. This makes their liability similar to a corporate stockholder. This idea has been codified in the ULPA and its successors. At the same time, a limited partner is forbidden from managing or otherwise running the company. If a limited partner does manage the company then he will likely lose his limited liability.

Because general partners – even in a limited partnership – have unlimited liability, an LLC or corporation is often used as the general partner of an LP. This effectively gives the general partner limited liability. Although the LLC or corporation has unlimited liability for the debts of the LP, those debts do not generally extend to the owners or managers of the LLC or corporation. This arrangement is especially useful if multiple individuals manage the partnership. Instead of each person acting as a general partner where their actions could expose the other general partners to liability, they can each be a manager of a single LLC, a corporate officer, or board member of a single corporation. This would limit their exposure to the wrongful acts of the other managers, and allow everyone to participate in managing the LP.

Besides the distinction between limited and general partners, a limited partnership essentially operates like a general partnership. Consequently, LPs (before LLCs became popular) were often the entity of choice for small businesses. The reasons for this are threefold: Simple management structure, lack of a requirement to follow corporate formalities, and partnership tax (pass-through) treatment.

In sum, the problem with a corporation to protect personal assets is that you literally ‘chase your tail.’ While your assets are no longer exposed, your shares are instead vulnerable. For protection, you must then find ways to protectively title your corporate shares, as they cannot be owned by you personally.