14 03-20 LLCs - Beyond The Basics

LLCs: Beyond The Basics

Owen Kaye, Esq.

March 20, 2014

1

Givner & Kaye, A Professional Corporation

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March 20, 2014 Owen Kaye, Esq. 2


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You need a good operating agreement among the members. March 20, 2014 Owen Kaye, Esq. 6


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The operating agreement’s importance and Complexity increases as the number of members increases. March 20, 2014 Owen Kaye, Esq. 7


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The operating agreement is the way to establish a dispute resolution mechanism in advance of having a dispute. March 20, 2014 Owen Kaye, Esq. 9


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Otherwise your disputes are going to end up in court where the only one who makes money is the litigator. March 20, 2014 Owen Kaye, Esq. 10


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Let’s discuss the impact of the IRS. March 20, 2014 Owen Kaye, Esq. 11


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A tax return may not even be technically necessary in some situations when there is only one member or when the only other member is a disregarded (grantor) trust for the benefit of the children. However, it’s still a good idea to have one prepared since we don’t want to confuse some state court judge about it being a “disregarded” entity. Also, the K-1s make it easy to keep track of membership interests. March 20, 2014 Owen Kaye, Esq. 12


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What about the impact of the State of California? March 20, 2014 Owen Kaye, Esq. 13 Givner & Kaye,

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The state publishes some helpful information on the applicable tax rules. Don’t forget California’s gross receipts tax. People play all sorts of games to try to avoid it, e.g., owning an apartment building through a Nevada LLC and claiming it is not engaging in a business so that it need not pay the gross receipts tax or even register to do business. March 20, 2014 Owen Kaye, Esq. 14


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Are the benefits to using a non-California LLC? March 20, 2014 Owen Kaye, Esq. 15


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Why not Delaware? It’s the most important state in the Country. March 20, 2014 Owen Kaye, Esq. 16


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LLCs: Beyond The Basics Why Delaware?

1. As the headquarters of most public companies, its law is thorough and favors insiders. The thorough law helps companies plan carefully, e.g., to avoid lawsuits. Delaware corporate attorneys complain that they have worked themselves out of a job because there is virtually no litigation. 2. Its Chancery Court is a special court that makes decisions upon business matters. Chancery Court decisions are studied by law students and business lawyers in every state, and has a reputation as one of the finest courts in the country. Decisions are made without juries. Judges are appointed on merit, not elected. 3. The Delaware Division of Corporations generates a great deal of revenue for the State. So it has state-of-the art imaging equipment, and processes new filings very quickly. The initial charge for incorporating can be as low as $89. The annual franchise tax can be as low as $75, $250 for LLCs. 4. Some Delaware registered agents have a direct connection to the Division of Corporations electronic database, and can file formation documents electronically. March 20, 2014 Owen Kaye, Esq. 17


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LLCs: Beyond The Basics Why It Probably Doesn’t Matter.

1. Assume a California plaintiff sues a California defendant in a California court and wins a judgment. Assume that the only asset is the judgment debtor’s interest as a member in a Nevada LLC that owns a California apartment building. The California debtor’s hope is that the California judge will apply Nevada’s superior creditor law to stop the California judgment creditor from foreclosing on his membership interest. Ain’t gonna’ happen. The California judge is not going to apply Nevada law on these facts. Nevada’s law is useful for its “internal affairs,” meaning for issues among the members. But when dealing with the outside world, the law of the state of the forum will prevail. 2. There are, as of yet, no cases in which judgment debtor using an LLC or even an asset protection trust from another state has been able to invoke that other state’s superior law to protect the judgment debtor. 3. There are, as of yet, not a landslide of cases striking down the judgment debtor trying to use out-of-state LLCs and trusts. So, until that is clear beyond the shadow of a doubt, unsophisticated plaintiffs may still be scared into giving a somewhat better negotiated settlement if the debtor uses a trust or LLC in a state with superior law. March 20, 2014 Owen Kaye, Esq. 18


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Parents naturally want to pass assets to their children in a protected fashion and, in meeting that goal, LLCs can be extremely useful in conjunction with irrevocable trusts. March 20, 2014 Owen Kaye, Esq. 19


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On the other hand, parents naturally want to be protected from the idiotic things done by their adult children and, in that respect, LLCs can be helpful if used artfully. March 20, 2014 Owen Kaye, Esq. 20


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Nobody wants to believe that he or she could become the next George Russell Weller (July 16, 2003, age 86, driving westbound on Arizona Avenue towards the Third Street Promenade, killing 10 people and injuring 63). March 20, 2014 Owen Kaye, Esq. 21 Givner & Kaye,


http://www.google.com/url?sa=i&rct=j&q=&esrc=s&frm=1&source=images&cd=&cad=rja&uact=8&docid=0JFAHqkTXYNlHM&tbnid=iTdpiWmdFoyerM:&ved=0CAYQjRw&url=http%3A%2F%2Flatimesblogs.latimes.com%2Flanow%2F2009%2F09%2Fsupreme-court-refuses-to-examine-conviction-in-santa-monica-farmers-market-crash.html&ei=F9AfU7nGI4XaqgH6hICYAw&bvm=bv.62788935,d.aWM&psig=AFQjCNGQF9DwdPsk1E7bfOo7VtUL8cd-XQ&ust=1394680172221323�


What about the liability that comes from owning real property? March 20, 2014 Owen Kaye, Esq. 22 Givner & Kaye,



The families of the decedents will sue you. March 20, 2014 Owen Kaye, Esq. 23 Givner & Kaye,



More frightening than the lawsuits from those you have killed are the lawsuits from those you have injured. March 20, 2014 Owen Kaye, Esq. 24


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LLCs: Beyond The Basics The Basic Estate Tax Planning Joke:

“QPRT. QTIP. QDOT. T-CLAT. CRT. FLP. LLC” “All of these acronyms come to us from some SOB in D.C.”



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LLCs: Beyond The Basics Another Estate Tax Planning Joke:

“Do not leave your children liquid assets.” “If you do, they will drink them.”



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LLCs: Beyond The Basics Problem: Giving To The Children – This is NOT A Joke

We NEVER Give Anything Directly To The Children. We Always Establish An Irrevocable Trust For Their Benefit. 1. Parents have more control in their relationship with the trustee than they will if they give assets directly to the children. That is especially true when there are multiple children. (Of course they can threaten to disinherit a child-trustee.)

2. The children are protected from future ex-spouses (and other types of liability) by the trust.

3. The trust can have a Protector, giving Parents additional control, e.g., the Protector can change allocations among the children, add and remove beneficiaries.

4. The trust can drop assets into an SMLLC, the Parents can be the non- member managers, giving the Parents even more control. March 20, 2014 Owen Kaye, Esq. 27


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Distinguish Three Different Types Of Asset Protection

Up – problem with the asset gets to you and your valuable personal assets


You

Your Entity

Valuable asset #1

Valuable asset #2: someone dies

The decedent’s

family wants to

sue you


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Up – problem with the asset

gets to you


You

Your Entity

Valuable asset #1


But is blocked by your entity

(which should be

“adequately capitalized”) from doing

so


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Down – problem with you; can they get to the valuable assets owned by your entity?


You get into a car crash which is your fault and

someone gets seriously injured

Your Entity

Valuable asset #1

Valuable asset #2

The judgment creditor wants to get your assets


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Down – problem with you get to the asset


You

Your Entity

Valuable asset #1

Valuable asset #2

But the judgment creditor is blocked by your (“adequately

capitalized”) entity


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Collateral – problem with one asset get to the other


You

Your Entity


Valuable asset #2

The decedent’s family wants to get your equity in ➜


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Collateral – problem with one asset; can they get to the other?


You

Your Entity

LLC For Valuable Asset #1

LLC For Valuable Asset #2

But they are blocked because each is in a

separate LLC


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Why An LLC?

1. Protects members’ other assets (Corp. Code. §17101(a)) like a corporation or a limited partnership.

2. Protects the LLC’s assets and other members from the creditor of another member.

3. Flow-through taxation (like an “S” corporation and a partnership).

4. No restriction on the number of owners (unlike an “S” corporation).

5. If the LLC cannot file its Form 568 by the due date, the LLC is granted an automatic 6 month extension. However, that does not extend the time to pay the LLC fee.

6, Better discounts than a tenancy in common. See the 17.2% partition discount allowed in Ludwick, T.C. Memo 2010-104 (5/10/10), for 50% interests in Hawaiian vacation home transferred by spouses to separate QPRTs.

March 20, 2014 Owen Kaye, Esq. 34 Givner & Kaye,



Why An LLC?

Can the K-1 for every member be checked as being a limited partner or other LLC member? In other words, can there be a situation in which no K-1 is checked as being a general partner or LLC member-manager? (Trying to avoid self-employment tax?)

Yes. For instance, suppose there is an LLC where no member is a manager or a member-manager. That is, suppose there is an LLC where the manager is not a member. (Or, if there's more than one manager, all the managers are not members.) That's permitted under California LLC law. (It's unusual, but permissible.)



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Problems With LLCs 1. Single member LLCs: In re Ashley Albright, 291 B.R. 538 (Bankr. D. Color. 2003), allowing a Chapter 7 bankruptcy trustee to reach the assets in the debtor’s SMLLC. 2. Gross receipts tax (“S” corporation and partnership are not subject) based on California source, not Worldwide, total income. 3. No series LLCs in California: FTB Form 568 instructions, page 4, item F. 4. No restriction on the number of owners (unlike an “S” corporation). 5. The California LLC Tax Booklet for 2012 is 60 pages long, of which only 12 pages is the Form 568 itself!! (8 pages are intentionally left blank.) 6. 10% penalty due if estimated gross receipts fee for year – due 15th day of 6th month (May 15) – is less than LLC fee owed for the year. 7. LLCs may not render professional service for which a license, certification or registration is required except insurance agents and brokers. March 20, 2014 Owen Kaye, Esq. 36 Givner & Kaye,



Problems With LLCs [continued] 8. LLC that is a member of an LLC doing business in California or a GP of a limited partnership doing business in California is itself doing business in California. 9. An LLC is doing business in California if any of its members, managers or agents are conducting business in California on its behalf. 10. Foreign LLCs not doing business in California but deriving California income do not file a 568. 11. Failure to timely file the return: $10 multiplied by the total number of members up to a maximum of 5 months. Starts from the extension date. 12. Failure to file also is 5% of the unpaid tax per month not to exceed 25%. 13. Failure to pay also is 5% for the first month increasing by 0.5%, continuing for 40 months, topping out at 25%. The total of this plus failure to file cannot exceed 25%. 14. LLC (like a corporation) cannot represent itself in a lawsuit. March 20, 2014 Owen Kaye, Esq. 37 Givner & Kaye,



2013 Gross Receipts Tax If total California annual income from Form 568, Side 1, Line 1 is: The fee is: Equal to or over – but not over - $ 250,000 $ 499,999 $ 900 $ 500,000 $ 999,999 $ 2,500 $1,000,000 $4,999,999 $ 6,000 $5,000,000 and over $11,790 If the FTB determines multiple LLCs were formed for the primary purpose of reducing fees, the LLC’s total income from all sources that are reportable to California could include the aggregate total income of all commonly controlled LLC members. “Commonly controlled” means control of more than 50% of the capital interests or profit interests of the taxpayer and any other LLC or partnership by the same persons. March 20, 2014 Owen Kaye, Esq. 38


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2013 Gross Receipts Tax [continued] Revenue & Taxation Code Section 24271 applies to California source income, which solved the Constitutional problem present in the prior version. This statute refers to Internal Revenue Code Section 61, which refers to “gains derived from dealings in property.” As a result, in the sale of appreciated property, only the gain is included in California source income. Section 61 refers to “gross income derived from business.” Therefore, the entire costs of goods sold (inventory) is included as California source income. (Real estate is never inventory.) March 20, 2014 Owen Kaye, Esq. 39


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Series LLCs In California “If the laws of the state where the LLC is formed provide for the designation of series of interests (for example, a Delaware Series LLC) and: (1) the holders of the interests in each series are limited to the assets of that series upon redemption, liquidation, or termination, and may share in the income only of that series, and (2) under home state law, the payment of the expenses, charges, and liabilities of each series is limited to the assets of that series, then each series in a series LLC is considered a separate LLC and must file its own Form 568 and pay its own separate LLC annual tax and fee, if it is registered or doing business in California.” March 20, 2014 Owen Kaye, Esq. 40 Givner & Kaye,



Best States For LLCs About 15 states provide that a charging order is the sole and exclusive remedy available to a creditor. This is the type of language that such a statute would contain: “On application to a court of competent jurisdiction by any judgment creditor of a member or assignee, the court may charge the interest of the member or assignee with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of financial rights. This section shall be the sole and exclusive remedy of a judgment creditor with respect to the

judgment debtor's membership interest.”



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Best States For LLCs

Simplistically we think of the “best law” as being one that limits a creditor’s remedy to a “charging order.” However, there are states whose laws go above and beyond that type of protection. There are at least two basic variations that go “above and beyond.” Alaska Prototype. The creditor may not get financial information. The charging order can not require the entity to get court approval to make a loan to a member, to make capital acquisitions and to sell a partnership interest. Delaware Prototype. In addition to protecting the management of the entity, the Delaware statute protects against legal or equitable remedies. That may prevent the attacks still available against those statutes following the Alaska prototype, e.g., reverse veil piercing, constructive trust, resulting trust, sole purpose and alter ego theories. Also, is an “accounting” a “legal” remedy or an “equitable” remedy? March 20, 2014 Owen Kaye, Esq. 42 Givner & Kaye,



Arguably The Best: Wyoming LLCs “[The Charging Order] is the exclusive remedy by which a person seeking to enforce a judgment against a judgment debtor, including any judgment debtor who may be the sole member, dissociated member or transferee, may, in the capacity of the judgment creditor, satisfy the judgment from the judgment debtor’s transferable interest or from the assets of the limited liability company.” W.S. 17-29-503. “Other remedies, including foreclosure on the judgment debtor’s limited liability interest and a court order for directions, accounts and inquiries that the judgment debtor might have made are not available to the judgment creditor attempting to satisfy a judgment out of the judgment debtor’s interest in the limited liability company and may not be ordered by the court.” March 20, 2014 Owen Kaye, Esq. 43 Givner & Kaye,



Pre-January 1, 2014 Old California Corporations Code Section 17302.

Charging assignable membership interest of judgment debtor to satisfy judgment; appointment of creditor; charging order as lien; foreclosure; redemption; exclusivity of remedy (a) On application by a judgment creditor of a member or of a member's assignee, a court having jurisdiction may charge the assignable membership interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect to the LLC and may make all other orders, directions, accounts, and inquiries that the judgment debtor might have made or that the circumstances of the case may require. (b) A charging order constitutes a lien on the judgment debtor's assignable membership interest. The court may order a foreclosure on the membership interest subject to the charging order at any time. The buyer at the foreclosure sale has the rights of an assignee.



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LLCs: Beyond The Basics Old California Corporations Code Section 17302. [continued]

(c) At any time before foreclosure, a membership interest charged may be redeemed in any of the following manners: (1) By the judgment debtor. (2) With property other than property of the LLC by one or more of the other members. (3) With property of the LLC by one or more of the other members with the consent of all of the members whose membership interests are not so charged. (d) This section does not deprive any member or assignee of a membership interest of the benefit of any exemption laws applicable to the membership interest in the LLC. (e) This section provides the exclusive remedy by which a judgment creditor of a member or of a member's assignee may satisfy a judgment out of the judgment debtor's membership interest in the LLC. March 20, 2014 Owen Kaye, Esq. 45 Givner & Kaye,



New California Corporations Code Section 17705.03(d)

(d) At any time before foreclosure under paragraph (3) of subdivision (b), a limited liability company or one or more members whose transferable interests are not subject to the charging order may pay to the judgment creditor the full amount due under the judgment and thereby succeed to the rights of the judgment creditor, including the charging order. March 20, 2014 Owen Kaye, Esq. 46 Givner & Kaye,



New California Corporations Code Section 17705.03(d)

(d) At any time before foreclosure under paragraph (3) of subdivision (b), a limited liability company or one or more members whose transferable interests are not subject to the charging order may pay to the judgment creditor the full amount due under the judgment and thereby succeed to the rights of the judgment creditor, including the charging order. By contrast, Limited Partnerships still have the old “poison pill” language!!!!!! Corporations Code Section 15907.03(c)(2). March 20, 2014 Owen Kaye, Esq. 47


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The Best Structure


Self-Settled Spendthrift Trust Client

Single Member LLC

#1: establishes

#3: Non-member manager

(at least until there is a problem)

#2: Contributes

Assets


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The Best Structure [continued]


Nevada SSST: has nothing

but the membership interest

Client

Single Member LLC: has the assets

Client as beneficiary

Non-member manager


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The Rollout LLC: The Problem

We know that buyers like to buy assets, not the stock, of a closely held corporation and, If that happens, there will be a “double” tax for the owner to get the proceeds out.


Client

Highly Appreciated

Assets

Owns 100% of “C” Corporation


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The Rollout LLC: The Solution


First Tier LLC

Highly Appreciated

Assets

Contributes assets

“C” Corporation

Children’s Trust

Contributes cash

99% 1%


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The Rollout LLC: The Solution [continued]


Second Tier LLC

Highly Appreciated

Assets

Contributes assets

Grandchildren’s Trust

Contributes cash

99% 1%

First Tier LLC


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The Rollout LLC: The Result

Assets with a FMV of $1,000,000 and a basis of zero in the “C” Corporation. 99% interest in the Tier 1 LLC: 99% X $1,000,000 X 75% (to allow for a lack of control and lack of marketability discount) = $742,500. 99% interest in the Tier 2 LLC: 99% X $742,500 X 75% = $551,306. 99% interest in the Tier 3 LLC (not shown): 99% X $551,306 = $409,345. The “C” corporation elects “S” status and the sale takes place later. The B.I.G. (IRC §1374 built-in gain) is limited to the first $409,345. March 20, 2014 Owen Kaye, Esq. 53


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The FLP Using LLCs

54

Givner Enterprises, L.P. 2% GP

96% LP

Givner Properties,

Inc.

Givner Heirs’ Trust

#2

Heirs’ Trust #1 owns 100% of Corporate GP

Non-(immediate) family member, e.g., a charity

(could be a family foundation)

1%+ LP

1% LP

Givner Family Trust

Givner Heirs’ Trust #1

LLC Bldg. #1

LLC Bldg. #2


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The FLP Using LLCs [alternate using LLC as GP]

55

Givner Enterprises, L.P. 2% GP

96% LP


#2

Heirs’ Trust #1 owns 100% of Corporate GP

Non-(immediate) family member, e.g., a charity

(could be a family foundation)

1%+ LP

1% LP

Givner Family Trust

Givner Heirs’ Trust #1

LLC Bldg. #1

LLC Bldg. #2

Givner Properties, LLC


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LLCs: Beyond The Basics The FLP Using LLCs: Strengthening The LLCs

The LLCs are no longer “ignored” so they must start filing tax returns


Givner Enterprises, L.P.

96% LP


#2 1% LP

Givner Family Trust

LLC Bldg. #1

LLC Bldg. #2

1% LP


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LLCs: Beyond The Basics LLCs As Members Of LLCs


Givner Enterprises, LLC

50%

Sam’s LLC

50%

Joe’s LLC

Building


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LLCs: Beyond The Basics Limited Partnerships Instead Of LLCs

No self-employment tax for Joe and Sam. No gross receipts tax for the business.


Givner Enterprises, L.P., an operating business

2%

Sam

49%

LLC As the General Partner

Joe

49%


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LLCs: Beyond The Basics LLCs For Tax Exempt Entities


Smith Family Foundation Trustee

Joe Smith

Building


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Smith Family Foundation

Trustee

Holding LLC

Joe Smith

Building


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Joe, Inc. Pension Plan and Trust sponsors

Building

Joe, Inc.


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Joe, Inc. Pension Plan and Trust

Sponsors Holding LLC

Building

Joe, Inc.


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LLCs: Beyond The Basics QPRT: Assigning The Retained Term


Mom (60) and Dad

(65)

Qualified Pers ona l

Res idence Trus t

Trusted Best Friend

Trustee

House: Fair Market Value $1,000,000,

no debt

Trans fe r hous e

Right To Live Rent Free for

20 years

Nevada LLC

The Retained Term: 20 years rent free


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Rules For Introducing And Operating LLCs

1. What assets does the client have that are already protected by some state or Federal law? e.g.: private retirement plans; homestead.

2. What assets are not protected and are, therefore, subject to seizure, e.g., excess equity in the home above the homestead; investment real estate; liquid assets.

3. Ask the client: “can you survive comfortably with the assets that are already protected?” If, as is likely, the answer is “no,” then proceed to the general asset protection planning discussion.

4. If a creditor obtains a Charging Order, the income stream from the LLC will not be protected. However, since no one can force the manager to make distributions, the member has great leverage against the creditor. March 20, 2014 Owen Kaye, Esq. 64 Givner & Kaye,



Rules For Introducing And Operating LLCs [continued]

5. The LLC manager may suspend income distributions, giving the judgment creditor nothing to take. Of course, that leaves the LLC owner with nothing.

6. That is why the LLC owner first establishes a self-settled spendthrift trust (“SSST”) in an appropriate jurisdiction (Nevada, Delaware, Wyoming) to own the SMLLC. With the SSST owning the LLC units, the LLC’s income is distributed to the SSST instead of to the judgment creditor who has the charging order.

7. Use a state-of-the-art operating agreement designed to address all of the asset protection and discounting rules.

8. The LLC must act like a business. Do not treat it as a checking account. March 20, 2014 Owen Kaye, Esq. 65


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LLCs: Beyond The Basics Still Another Estate Tax Planning Joke:

Joe, an unmarried 94 year old worth $20,000,000, walks into our office. He tells me:

“Bruce, I’ve been doing a lot of reading about estate tax planning, and I understand the unlimited marital deduction. So I’ve decided to marry my 25 year old secretary. This way, when I die, everything will pass to her free of estate tax.”

I think about this for a moment, trying to figure out how to put this delicately. However, coming up with nothing, and knowing Joe’s forthright manner, I decide to “go for it”. I tell him:

“Joe, you realize, that at your age, having sex could be fatal.

Joe replies: “If she dies, she dies.” March 20, 2014 Owen Kaye, Esq. 66


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LLCs: Beyond The Basics The Final Tax Planning Joke:

Two people are flying cross country in a hot air balloon. The sky is so thick with clouds that they can’t tell whether they are in Iowa or Idaho. So they decide to let some air out of the balloon, coast down through the cloud cover, and ask someone on the ground where they are.

As they approach the ground they see a man walking along the street in a suit carrying a briefcase. One man leans over the edge of the hot air balloon basket and asks the man on the ground: “Can you tell us where we are???”

The man on the ground yells up to them: “You’re in a hot air balloon!!”

The one man in the balloon turns to the other and says: “That guy is a tax lawyer.”

The other asks: “How can you tell?”

The first guy replies: “Because what he told us was absolutely correct and utterly worthless.”



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Questions and Answers March 20, 2014 Owen Kaye, Esq.

68 Givner & Kaye,


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14 03-20 LLCs - Beyond The Basics

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