Just what is an LLC and what does it do?

I’m an estate planning attorney, not a business attorney. Sure, some of my clients own businesses, but my focus is on how they transfer that business smoothly to their heirs on death, not about what kind of business entity they should use for other purposes.

But once in a while I go a little bit beyond that, and talk to clients about LLCs.

What is an LLC? It stands for “limited liability company”. Please note that it is not “limited liability corporation,” although people often refer to them that way. A corporation is a different kind of animal.

An LLC is a type of business entity, much like a corporation, or a sole proprietorship, or a partnership. If you form an LLC, you then put your business into the LLC. A lot of my clients own rental properties. If they form an LLC, they will then need to deed the property into the LLC. Now the LLC owns the property, not my client. But my client still controls the property, and gets the profits from it, because my client owns the LLC.

So why would somebody go to the trouble of setting up this LLC, if they already own the property? The usual reason is for liability protection.

Let us say that I own a four-plex. I fail to notice that there is a nail coming loose on one of the upper stairs. One day a young lady trips on the nail, tumbles down the stairs, and suffers a catastrophic injury. A sympathetic jury awards her a verdict of $8 million.

But I don’t have $8 million in assets. I do have $2 million in liability insurance coverage on the four-plex, so the insurance company pays that to the plaintiff. Are the plaintiff’s attorneys going to accept that? Of course not. They want the whole thing; after all they’re getting paid a percentage of what they actually collect.

So they go after the rest of my assets. Let us say that in addition to the four-plex, which is worth $500,000, I have $4 million in other assets. If I own the four-plex in my own name, the plaintiff’s attorneys can start selling my assets to pay the judgment. I could easily be left penniless.

But with the LLC in place, all they can get is the property that is in the LLC. They cannot get the rest of my assets. Because of that little bit of extra planning for liability protection, I am only out $500,000, and I still have the rest of my assets for my retirement.

Notice that the LLC does not protect the assets that are in the LLC. In this example, my four-plex is going to be forfeited. The LLC protects everything outside the LLC. It is like those canisters the bomb squad has; everything inside the canister is going to be obliterated, but it protects everything outside the canister.

I am using the example of a rental property because that is what a lot of my clients need an LLC for. However, I also have clients who have a variety of other types of businesses. Many of them sell those businesses when they retire, but many retirees hold on to their rental properties as a continuing source of income. For many of them, the difference between having an LLC and not having one could be the difference between living a comfortable retirement or having to scrape by on Social Security alone. I don’t know about you, but when I retire, I want to be able to visit my grandkids, sit on a beach, and go out to dinner once in a while.

A few caveats: You should still have liability insurance. In that example I gave, the plaintiff’s attorneys are going to try to find some way to have the judge invalidate the LLC. Not having any liability insurance, which means the plaintiff only gets $500,000 and nothing more, is like waving a red flag in front of a bull when that case gets to court; a judge can almost always find a way to get past the LLC if she really, really wants to. Also, you have to do all of this right. I see a lot of people form their own LLCs, but get sloppy about how they handle them, with the result that if the LLC has to earn its money, it will have become useless.

Wills are useful if you have to go to probate. Trusts are useful for avoiding probate and smoothing the transition on death. Neither of those does anything for liability protection. Corporations do, but they are complicated. For a lot of folks, an LLC is the right answer.

Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. If you’re going to do it, do it right.

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