Part 3 Asset Protection General limited Partnership Corp Chapter c chapter s Llc TrustsPART 3: ASSET PROTECTION: GENERAL/LIMITED PARTNERSHIP, CORP CHAPTER "C"/CHAPTER "S", LLC, TRUSTS
CORPORATIONS (Standard Corporation under Chapter "C")
The corporation is a legal entity created under the different state laws and internationally recognized as the most common way of doing business or holding business assets. A standard corporation is also referred to as a "C" Corporation formed under state laws. Shareholders enjoy a limited liability on business assets and cannot be held responsible for corporate debts. However, clever lawyers and their persistent clients, with the help of the courts, have figured out how to pierce the corporate veil of limited liability and have been able to hold responsible corporate shareholders, corporate officers, and employees personally liable for negligence reaching far outside the corporate structure.
Shareholders of "C" standard corporations may feel the double pinching of taxation. The corporation is primarily liable for taxes on corporate profits then shareholders are also taxed on the distributions from the same profits, except for common shared controlled corporations.
The Limited Liability Company has essentially replaced the "C" corporation by electing to be taxed as a corporation, but with stronger asset protection as an LLC.
Corporations similar to the LLC have the following advantages:
1. Shareholders are not personally responsible for LLC debts.
2. Unlimited number of membership units (similar to Corporation stock-holders).
3. Ease of transfer of LLC membership interest. Have you noticed that some publicly traded shares are LLC membership units?
4. Ease of raising capital by issuing additional membership units.
CORPORATION UNDER SUBCHAPTER "S"
A Subchapter "S" Corporation is a corporation formed under state law, which files a special IRS tax election to have corporate profits pass through the business and be taxed only at the shareholder level (similar to the tax treatment of LLCs), but less flexible because of IRS limitations specifically on the sub "S."
Like LLCs, Subchapter "S" Corporations also provide limited liability protection to all owners, however a number of litigation cases demonstrate a substantial erosion of this concept. The "S" corporation tax election comes at a fairly heavy price: "S" corporations must limit the number and types of shareholders. They are restricted as to how they allocate profits and losses among owners, the types of losses they can pass along to owners to ease their income tax burden, and the kinds of stock they can issue to investors.
All business entities require a certain amount of attention but Subchapter "S" Corporations requires more formalities. Subchapter "S" Corporations typically need regular and special meetings of directors and shareholders recordings needed to transact important corporate business or decide key legal or tax formalities. And although profits and losses of an "S" corporation are passed along to its shareholders similar to the LLC, the "S" tax return is much more cumbersome.
The primary difference between Subchapter "S" Corporations and LLCs has to do with the requirements for electing Subchapter "S" Corporation tax treatment and some of the unique tax effects that result from this election. "S" corporations are very, very rigid and inflexible with substantial operating limitations. To be eligible to make an "S" corporation tax election with the IRS, the corporation and its shareholders must meet a number of special requirements.
Here are a few of the "S" corporation tax requirements that can present a problem:
1. Individual shareholders of a Subchapter "S" corporation must be U.S. citizens or have U.S. residency status. If shares are sold, passed to (by will, divorce or other means), or otherwise fall into the hands of a foreign national, the corporation loses its "S" corporation tax status.
2. Shareholders must be individuals or certain types of qualified trusts or estates. "S" corporations can't have partnerships or other corporations as shareholders.
Under typical state statutes, LLCs may have both natural (individual) and artificial (corporate, partnership, trust and estate) members. Moreover, the LLC may be the general partner of a partnership or be owner of the "S" stock.
3. There can be no more than 75 shareholders in an S corporation, unlike an LLC which may have an unlimited number of shareholders.
4. "S" corporations must have only one class of stock. Different voting rights are permitted, meaning that "S" corporations may have different classes of shares, but it's just too inflexible.
IT'S SAFE TO SAY THAT THE "S" CORPORATION HAS BECOME A WHITE ELEPHANT. The "S" status tax benefits are quickly dissipated due to its very rigid and inflexible operating requirements. Taxpayers electing the "S" status find out the hard way that they spend an inordinate amount of time and ingenuity in trying to make the "S" emulate the "C" corporation or the LLC. These unwanted results could be avoided with the LLC.
REVOCABLE TRUST OR REVOCABLE LIVING TRUST
A Trust is nothing more than a Contract between the "Grantor" or the original owner, the "Trustee" who will hold and manage the assets for the benefit of "Beneficiaries" which may include the original owner, his spouse, children, grandchildren, or anyone the Grantor(s) wishes.
The word "Revocable" means that the Grantor(s) left too many strings attached to the contract to "revoke" the contract. For purposes of income taxes, the Grantor of a Revocable Trust or a Revocable Living Trust is the deemed owner of the underlying assets and is primarily responsible for the taxes imposed on the Revocable Trust. Because of the Grantor's ability to "revoke" the Trust Agreement, there's absolutely NO asset protection of any kind. In addition, assets of a Revocable Trust will avoid the Probate process but it will NOT avoid the Estate Tax. Only an Irrevocable Trust will avoid the Estate Tax.
The opposite of revocable is "irrevocable." In other words, no strings are attached by the Grantor. Once assets are transferred from the Grantor(s) to the Trust, there's no more control. It's this precise lack of control that makes this Trust very powerful asset protection device. You can't be sued for assets you no longer own or control.
The fiduciary duty of an independent trustee of an irrevocable trust is onerous. The Trustee may never deal himself a new hand and must preserve the assets entrusted to him at any cost. Courts take a very unpleasant view on the Trustee who has abused his fiduciary duty. Breach of fiduciary duties by a Trustee could be considered and intentional tort subject to punitive damages.
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