Robert J. Mintz, JD

	An LLC is designed to provide liability protection without the formalities and tax issues that often make corporations difficult and expensive to operate and maintain. An LLC can be a convenient and efficient vehicle for operating a business or holding investment real estate. It protects you from legal liability for any debts or obligations associated with the particular venture or property held by the LLC—if you operate a business in an LLC and the business goes broke, you’re not personally responsible for paying the outstanding bills. The same is true when you put an investment property into an LLC if a tenant gets hurt on the property, you cannot be held personally legally responsible. The risks that arise out of the operation of a business are known as “inside liabilities,” and the law is quite specific that you cannot be sued for any liability of your LLC. You may lose the business or the property in the LLC, but your personal loss is limited to the amount of your investment. Your other assets are not at risk for the debts of the company (unless you personally guarantee the obligation). Physicians cannot shield themselves from malpractice claims by operating as an LLC, but for related business activities, the LLC works very well.

	In addition to protection from inside liabilities, LLCs have been used to shield personal assets from other types of claims (“outside liabilities”) not associated with the particular business activity. For example, let’s say you own an investment property that represents a substantial portion of your savings and you would like to shield it from any future claims against you associated with your other business activities. To accomplish this sensible goal, you could transfer the property to a newly formed LLC, after which you would own a membership interest in the LLC rather than the property itself.

	LLCs are effective asset protection solutions in situations like this because membership interests are protected by a “charging order” in the same manner as partnership interests. The membership interests are protected from foreclosure by a creditor—a judgment creditor is not legally permitted to seize LLC interests as he or she could with shares of stock or other property. Creditors have no right to vote or control the LLC. The most a creditor is permitted to do is wait for any distribution of income or sales proceeds to come out of the LLC.

Olmstead v. FTC and future planning with LLCs

	In June 2010, the Florida Supreme Court ruled that an LLC membership interest is subject to seizure by a creditor in the same manner as corporate stock (http://hcp.lv/dB6sxU). As a result, a creditor of a member of an LLC is permitted to seize a membership interest under Florida law. Although this decision is consistent with recent court cases and the law in California and several other states, the Florida ruling was a surprise to observers in the so-called “asset protection—friendly” states such as Florida, Nevada, Delaware, and New Mexico, where it was believed that the charging order protection in state law formed a solid foundation for asset protection planning.

	The Florida Court’s decision did not impact the usefulness of LLCs as strong protectors against inside liability business risks and claims. If you are operating a business or holding risky assets such as investment property, the LLC will often be the most effective choice of business entity. If you create an LLC to hold assets, the Florida decision, as well as existing law in California and other states, means that your membership interests are vulnerable to seizure by a judgment creditor. This rule applies whether your LLC is a single-member or a multi-member company. Although Florida may now amend its LLC law to counter the impact of Olmstead, owning LLC membership interests in your name is unlikely to provide any significant asset protection for you.

	In order to avoid a potential foreclosure of the LLC interests and an outcome similar to the Olmstead case, many lawyers have been recommending that clients put their membership interests into a protective trust (

). My firm has been using a Family Savings Trust (http://hcp.lv/csD3xg) for this purpose for many years. Your lawyer should be able to help you with choosing the structure that most efficiently accomplishes your asset protection planning.

	Robert J. Mintz, JD, is an attorney and the author of the book Asset Protection for Physicians and High-Risk Business Owners.

	To receive a complimentary copy of the book call 800-223-4291 or visit 

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An LLC is designed to provide liability protection without the formalities and tax issues that often make corporations difficult and expensive to operate and maintain. An LLC can be a convenient and efficient vehicle for operating a business or holding investment real estate. It protects you from legal liability for any debts or obligations associated with the particular venture or property held by the LLC

Covering Your Assets - Florida Case Highlights LLC Dangers

	During the debate about tax cuts and the estate tax, a type of trust known as a “dynasty trust” has received a barrage of criticism from those who claim that the wealthy are not paying their fair share of taxes. A recent op-ed in The New York Times (

) complained that dynasty trusts create a powerful new aristocracy whose wealth is protected and untaxed for generations into the future. Sounds appealing right? A closer look at the available benefits of these trusts can help you determine whether they have a role to play within your overall estate plan.

	Many states have recently adopted legislation abolishing the “rule against perpetuities” (

) that eliminates legal restrictions on the period of years that a trust may last. In these states, a trust is now permitted to exist for whatever term is chosen, even if it reaches far-off generations many years in the future (in Nevada, a dynasty trust is permitted to last for up to 365 years).

	Estate plans often include some type of trust to take care of the needs of minor children upon the death of the parents%u2011%u2011usually lasting until the children reach age 20-25. It makes sense to limit the term to a relatively short period if the trust fund contains only enough money for the child’s basic living needs or for the expenses of college and higher education. If there is not going to be anything left over after covering the child’s basic needs, an extended term trust would not make sense.

	It is a different matter when family wealth consists of substantial accumulated savings, a valuable business, or a large insurance policy. In these cases, the issue of how long a trust should last assumes much greater significance, and specific questions must be addressed. At what age do we want a child to receive a full distribution of substantial trust funds? Should we make large sums of money available to the child when he or she is young, or do we want to control and limit the distributions based on whatever standards we define for need, responsibility, and maturity? These are not easy questions to answer, especially for children who are young when the trust is formed.

	The answer to the question of how long the trust should last is often based on two key considerations: the estate tax consequences of the plan and the possible need for asset protection.

	A dynasty trust can create substantial estate tax savings. Each time wealth is passed to a younger generation, a new estate tax is imposed. At a 50% estate tax rate, a dollar in wealth is reduced to 50 cents when you pass it on to your children. The remaining 50 cents is further taxed so that grandchildren would receive only 25 cents of the original dollar, and so on until there is nothing much left. This is not a problem for people whose total assets are under the estate tax exemption amount (currently scheduled at $1 million for 2011). Those who have accumulated assets in excess of the exemption amount, or who have large insurance policies and wish to maximize and preserve these funds for future generations, can significantly reduce estate taxes with a properly structured dynasty trust.

	The provisions in the tax law that allow these benefits are long standing and well established. Briefly stated, if assets are left to children or any younger generation and the beneficiary’s rights to the property are limited by certain defined standards, the trust property is not subject to estate tax as it passes to a younger generation of beneficiaries. For example, if you leave $1 million in a trust for your child, and he or she has the right to the income from the trust and also a right to principal for “health, education, maintenance and support,” the trust assets will not be included in your child’s estate on death and can then pass to your grandchildren free of estate taxes. The trust can continue, subject to these same provisions, and there will never be an estate tax imposed as it passes from children to grandchildren and so on. Depending on the amount of trust assets and whether income is accumulated or distributed, wealth that is not subject to estate tax can be maintained or even increased over time as succeeding generations of family members become beneficiaries. As with the estate tax itself, the total amount that can be passed through the generations is subject to a generation-skipping tax on amounts in excess of an exemption amount that has yet to be determined by Congress. Stand by for future developments.

Protecting your children from divorce and lawsuit risk

	Whether or not you have a need for estate tax savings, the dynasty trust is a popular strategy to help protect children from the risks of divorce and creditors’ claims that they may face in their personal life and business careers. Possible claims by a child’s current or future spouse is always a paramount concern in every estate-planning discussion. Facing hard facts, a 50% divorce rate means that there is a substantial financial risk of losing assets to a spouse at some point. Dynasty trusts are often designed to specifically address this issue to make sure that amounts intended to be the separate and protected property of a child are not available to a future claim by a divorcing spouse.

	The same logic applies to other potential creditors that may arise during a child’s lifetime. Some common examples of these risks include student loan debt that is almost impossible to discharge, personal guarantees on loans and debts from bad business decisions, or just plain bad luck that can cause lasting financial hardship and burdens. The point of the dynasty trust is to make sure that a nest egg is preserved for the child that is not subject to lawsuit and liability claims, no matter what happens in the future.

	Depending on the outcome of the estate tax legislation proposed in Congress, your estate may be subject to significant estate taxes as it is passed to your children or grandchildren. A dynasty trust may be useful in reducing or eliminating these taxes as well as preserving family assets from future claims and liabilities. These issues are complicated from a legal and tax perspective%u2011%u2011as always, you should discuss your personal situation and the possible benefits and drawbacks of this planning with your professional advisors.

Robert J. Mintz, JD, is an attorney and the author of the book Asset Protection for Physicians and High-Risk Business Owners. To receive a complimentary copy of the book call 800-223-4291 or visit 

Depending on your financial situation, a dynasty trust may be a valuable part of your asset-protection strategy.

Taking the Long View When it Comes to Asset Protection

	Many physicians use S-Corporations (S-Corp) to conduct the business side of their practice. Although an S-Corp cannot shield a physician from medical malpractice claims, it can help limit personal liability from other obligations of the practice. For example, if your practice leases office space or equipment and is organized as an S-Corp, you have no legal responsibility for payment unless you have personally guaranteed the contract (see “Pros and Cons of Professional Corporations” 

	A Limited Liability Company (LLC) would achieve the same result but physicians are generally prohibited from practicing medicine in an LLC, so the choices for how to organize your practice are usually restricted to partnerships, sole proprietorships, and corporations.

	One challenge with corporations is that they have the potential to produce two layers of tax obligations—once at the corporate level and again at the shareholder level. The corporate tax can produce some nasty and surprising tax problems, but fortunately, the law allows shareholders to opt out of the corporate tax by filing an S-Corp election if they meet certain qualifications. Under this treatment, all income from the S-Corp flows through to the shareholder’s personal return and is taxed there, similar to a sole-proprietorship or a partnership.

	S-Corps have a unique hybrid tax status, capable of producing savings not available to other business entities. These benefits are created by grey areas within the tax law that treat certain types of business income more favorably than others. If income can be characterized to take advantage of the lower available rates, substantial savings can be generated. The income generated through an S-Corp and reported on the shareholder’s return can be classified as wages or as a profit distribution based upon a variety of factors. The outcome of that determination matters a great deal, because amounts treated as wages are subject to payroll taxes, whereas profit distributions are not. Depending on the amount involved, the difference in taxes can be substantial. For example, in the years after 2011, the FICA (Social Security) tax is 12.4% of the first $106,800 of salary and the separate Medicare tax is 2.9% of all salary. If an S-Corp has profits of $250,000, taking that full amount as salary, results in combined payroll taxes of roughly $20,000. If the amount of salary was instead lowered to $50,000, with the balance claimed as a profit distribution, tax savings for the year would be about $11,000.

	The issue in most cases turns on what is considered a “reasonable salary” under the circumstances. What amount of corporate income is properly allocable to invested capital and what amount represents income from the shareholder’s services? It’s not an easy question, as illustrated by the case David E. Watson PC v. US (

), in which the key issue had to do with how Watson handled several hundred thousand dollars distributed to his S-Corp over a two-year period by the accounting firm in which he was a partner. Watson claimed only $24,000 in salary in both of those years, claiming the balance of the money as “profit distribution,” resulting in a tax savings of nearly $20,000.In keeping with its position that earnings attributable to corporate capital or assets may be properly classified as a profit distribution, but that payments for shareholder services must be treated as wages, the IRS rejected this treatment and asserted that Watson’s reported salary was unrealistically low in relation to the pay for other accountants with similar experience. Ultimately, the District Court decided that a reasonable salary for Watson should have been about $90,000 per year and full payroll taxes were due on this amount. The balance of the corporate income was treated as profit distribution.

	In a medical professional corporation, it is often true that a large percentage of the income is related to services performed by the physician shareholder, but there are significant exceptions. If profits are generated by the services of non-shareholder employees or from charges for lab work, equipment use, the sale of products or from other investments, then income earned from these activities might not be related to the physician shareholder’s services. In these cases, the allocation between profits and wages is subject to considerable interpretation, and the amounts claimed for each can significantly impact the amount of payroll taxes that may be owed. Although Congress may take steps in the future to clarify these issues, for now, the outcome of disputes on this issue depends on the circumstances involved. You should certainly obtain the assistance of an experienced tax advisor when navigating the rocky landscape of tax strategies.

Robert J. Mintz, JD, is an attorney and the author of the 2011 new and revised edition of the book 

Asset Protection for Physicians and High-Risk Business Owners

. To receive a complimentary copy, visit www.rjmintz.com.

Recent court case highlights risks and opportunities  

Covering Your Assets: S-Corps as Tax Shelters

The biggest obstacle to filing a lawsuit has always been money. Lawsuits cost a lot and most people just can’t afford it. When legal fees are added to the costs of consultants and expert witnesses all but the wealthiest few would be hard pressed to cover the ongoing expenses of even the most routine business dispute or injury case.

Medical malpractice cases, in particular, are often among the most expensive for a plaintiff. Usually one or more medical experts are required for the initial evaluation of liability and then for ongoing advice and testimony in depositions and possibly a trial. At expert rates of $500-$1,000 per hour and up, it is difficult for any plaintiff to mount a credible case without access to significant resources to finance these costs.

As we’ve discussed in previous articles, a partial solution to this affordability issue is the contingent fee agreement that shifts the up-front cost of the litigation from the plaintiff to the lawyer in exchange for a percentage of the recovery. This arrangement often works well for both sides. Many individuals who otherwise cannot afford to hire lawyers are able to achieve some measure of compensation for legitimate injuries.

The contingent fee business model works especially well for attorneys. Because of the inherent advantage of the plaintiff in litigation, the potential profits are limited only by the number of cases, good or bad, that can be effectively financed. Think of the plaintiffs lawyers as the house in a casino game. They have a built-in advantage and like the casino house, all they need to make lots of money is cash for financing and a steady supply of customers.

What happens when attorneys don’t have enough money to cover existing cases or to take on new ones? Within the past few years, lawyers and other profitable business owners have had their bank credit lines tightened or closed, severely restricting funds available to finance an inventory of cases. Without easy access to cash, lawyers have been forced to reduce their case load, limiting the number of cases they can take and leaving lots of potentially profitable cases on the table.

Although the litigation business was once the exclusive province of the lawyers, the potential for large profits is attracting a flock of outside entrepreneurs who have an appetite for risk, surplus cash, and a willingness to supply ample funds in exchange for outsized returns. Historically low interest rates are encouraging individual investors, investment companies, hedge funds and even some specialty banks to enter the business of financing malpractice cases, personal injury claims, business litigation, and even divorce cases. In exchange for supplying the attorney with the funds to fully litigate a case, these investors take a big share of the ultimate settlement or award.

For example, one company, Lawsuit Financial Corp., claims on its website that it is often able to supply funding for a case within an hour of receiving the case material. In addition to providing the cash for the litigation, the company also offers to provide advances to the injured client to relieve financial pressure and enhance “staying power” and settlement leverage. The company invites investor participation in funding specific cases with the prospect of generous returns.

Investors can also participate in cases where contingent fee financing is not practical or permitted. For example, The Model Rules of Professional Conduct 1.5(d) expressly prohibit contingency fees in domestic relations cases where the fee is contingent on the securing of a divorce or obtaining a property settlement. The stated policy behind this rule is that the role of a lawyer in domestic matters should be to encourage reconciliation. As legal commentator Christine Hurt points out (

), if your lawyer only gets paid from a property settlement and the amount of the fee is based on a percentage of the total settlement, the goals of reconciliation and family preservation are even less likely than they are now.

Litigation has always been a profitable business for lawyers. But now outside investors are taking advantage of burgeoning opportunities for profits in the litigation business. While this is certainly great news for the plaintiff class, physicians and other potential “deep pocket” defendants may be facing a newly armed and cash-rich adversary in the courtroom.

, is an attorney and the author of the 2011 new and revised edition of the book 

. To receive a complimentary copy, call 800-223-4291 or visit 

Robert J. Mintz, JD

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