Entity planning for taxation, asset protection, gifting or succession planning is complex and fascinating. CPAs are forced to work with existing and evolving entity structures, court decisions and the tax code. Each situation is unique, and no set model can be established.
CPAs’ experience, breadth of knowledge and attention to detail make us excellent planners in this area. Based on recent cases and legislation, we must continue to plan defensively for our clients.
In 2010, the Florida Supreme Court allowed the Federal Trade Commission (FTC) to seek monetary foreclosure remedy against defendants Olmstead’s and Connell’s single-member LLC (Limited Liability Company) interests for a judgment of restitution in a credit-card scam case. The LLCs in question were single-member limited liability companies (SMLLC) held entirely by either Olmstead or Connell.
The Florida Legislature quickly responded by amending Florida Statute 608.433. The Legislature clarified that, although the courts have power to enforce a charging order with a foreclosure if the judgment cannot otherwise be satisfied in a reasonable time, the courts shall not have any power beyond the charging order to foreclose upon a member’s interest in a multiple-member LLC (MMLLC).
In its decision, the Court appears to align a single-member LLC interest with that of corporate stock, and the Legislature has aligned the MMLLC interest with that of a partnership. Under partnership law, partners are permitted to “pick their partners.” They are not required to accept an “assignee partner,” typically the result of a partner’s judicial proceeding, into the management of the partnership. Corporate stock is deemed fungible, interchangeable and impersonal, so foreclosure long has been an accepted practice.
Do we still prefer LLC over corporate or partnership entities in Florida?
Certainly for multi-member LLCs, business may proceed as originally planned. However, it might be important to consider with whom the membership interest is shared.
Let’s say, for instance that, a husband and wife own several rental-property LLCs and are jointly indicted for tax fraud or similar breach resulting in a judgment and demands for restitution. It is probable that those LLCs could be foreclosed upon to satisfy the judgment in Florida, in light of the Olmstead decision and reasoning. Since the ownership of the assets was held in the same manner as the restitution liability, the Court’s reasoning could apply and allow a distribution, as per Olmstead.
This line of reasoning would be consistent with Florida bankruptcy laws where Tenants by the Entirety (TBE) property is available to pay the debts of the filing spouse if a single joint creditor exists.
For single-member LLCs, the best practice may be to name an unrelated third party as a minority member. Naming a family member or friend simply will subject the LLC to all the litigation that may ensue against family or friends. We have no case law to tell us how close a relationship or control would impair the status of a MMLLC. We also have little guidance for a husband and wife holding the LLC interest as TBE. Could the TBE be severed in a charging order judicial foreclosure or a bankruptcy action? To create the most prudent structure for husband and wife, each spouse should individually hold 1 percent; should jointly hold 98 percent as TBE; and should avoid joint debt.
Albeit far more expensive and complicated, for those who want more protection, an Irrevocable Trust and Florida Limited Liability Limited partnership (LLLP) is worth considering. This single-member structure could be handled by using a Florida LLLP to hold a large interest in the Florida LLC. The owner controls the general-partnership interest through another general-partner LLC, and an Irrevocable Dynasty Trust holds a small percentage of the LLC for the benefit of family with a third-party Trustee (see the diagram at right). This structure is overly complex and an LLLP alone may be a wiser choice.
The LLC flexibility for tax purposes (basis determination, distributions, transfer and liquidation) will allow Floridians to continue their love affair with LLCs, now with more entity complexity (and probably with more tax returns filed).
Under current law, which may change soon pursuant to the Affordable Care Act, one huge disadvantage for closely held LLCs, particularly those set up for operating companies, is the self-employment taxation imposed on all profits. Limited Liability Partnerships (LLPs) and General Partners in Limited Liability Limited Partnerships (LLLP)s suffer the same fate unless the underlying activity is free from self-employment tax, namely rental real-estate holding; investment activities; or oil and gas activities.
LLCs can avoid self-employment tax by electing S corporation status.
We can avoid subjecting the LLC operating company profits to the self-employment tax burden by electing S corporation status for our LLCs on Form 2553 under the “check-the-box” rules. This sometimes is referred to as an LLC envelope. However, with more than 100 owners; any foreign owners; or a complicated distribution and allocation scheme, this election is not available.
Source: Florida Institute of CPAs