The Number One Reason not to Hold Assets in a C or S Corporation

Here’s the final word on why corporations aren’t good asset-protection. We’ve told you about the issue with taxes and capital gains. We’ve told you about the problems with removing assets from a C or S Corporation for your use. But there’s still one more, big reason to avoid this business strategy, and that is a lack of legal protection.

If you hold appreciated assets in an LLC or an LP, you have access to a creditor remedy called a “charging order” to protect your assets. LLCs and LPs were designed as asset protection entities, and the laws in most states don’t allow your personal creditors to reach inside your LLC or LP and seize assets. Instead, creditors are limited to placing a charging order (which acts like a lien or garnishing order) over your ownership. All of the profits that would normally flow through to you are instead paid to your judgment creditor until the debt has been paid off. And, in most cases, there is language in an LLC or LP’s corporate documents that specifically states that the business will automatically buy out an owner who gets into trouble, therefore making sure no charging order would be granted in the first place. This works to protect the other owners in the business, and the business itself.

But you can’t protect shares in a C or S Corporation in the same way. That’s because there is no charging order provision relating to a corporation’s shares – they’re fair game for creditors. If you were sued, and the biggest asset you owned was your corporation, all a creditor would need to do in this instance would be to get a court order transferring your shares into that creditor’s name, and the creditor would then be free to sell your shares, especially if you were in a large or public corporation.
Even if you just had a small corporation where you were the only shareholder, or there were just a few shareholders, your creditor could still call for a vote to liquidate the corporation’s assets to pay off its judgment. Now, if there are enough other shareholders willing to vote against the proposal and together they outvote your creditor, they may be able to save the corporation’s assets. But, on the other hand, if you are a corporation of one, or if you have majority control and can’t be outvoted, your creditor can and will use this method to gain control of the assets.

If you have a business that is very successful and full of valuable assets, there are things you can do. You can move expensive equipment into a safer business structure like an LLC, and lease the equipment back to your corporation to carry out its business. If you have a C Corporation, you can transfer ownership of your shares in an LLC or LP, rather than in your name personally. Now if someone were to sue you they would not be able to go through the LLC or LP to get at the corporation’s shares, because you don’t directly own them anymore. This strategy may work with an S Corporation, but only if you use a solely-owned LLC that has elected disregarded taxation. However, it won’t work with a revocable trust. Most revocable, or living trusts don’t give you any asset protection.

The table on the next page summarizes all of the terms we’ve discussed so far into a quick reference guide for you. This may all seem confusing, but remember that a corporation needs to be flexible—it can be a simple, one-person operation, have a few people involved, or it can have thousands of people running it.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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