Asset Protection for Business Owners

In an effort to remain on top of tax matters for our clients, we spent time with Tax Attorney/CPA Marvin Blum of The Blum Firm (www.theblumfirm.com) discussing tax and asset protection issues that impact private business owners. The following excerpt from Marvin’s recent presentation to the Fort Worth Chapter of the Texas Society of Certified Public Accountants explains why it is now advisable to switch from a ‘C’ or ‘S’ Corporation to an LLC or LP for asset protection reasons.

“Often, businesses are owned in the form of a ‘C’ or ‘S’ corporation, especially businesses that have been around for awhile. One disadvantage of a corporation as compared to an LLC or LP is that under Texas law, corporate stock can be seized by the owner’s personal creditors to satisfy a judgment against the owner. If the stock is seized, the creditor steps into the debtor’s shoes and has the power to vote the stock and, if the debtor owns a majority of the stock, control the business. Therefore, a client with a profitable business that is organized as a state-law corporation may be a target for personal creditors of the business owner.

However, under Texas law, creditors who want to satisfy a judgment through a debtor’s LP or LLC interest are limited to obtaining a “charging order” against the interest. A charging order merely gives the creditor the right to receive distributions made to the partner or member, if any are made. The charging order does not give the creditor the right to vote the stock or otherwise compel the LP or LLC to make distributions. Due to provisions the Texas legislature passed in HB 1737, effective September 1, 2007, a creditor’s only remedy with respect to a debtor’s ownership interest in an LP or LLC is a charging order. As a result, if distributions are never made, the creditor will receive nothing from the LP or LLC.

Because LP’s and LLC’s are far superior to corporations from an asset protection point-of-view, business owners should always consider converting a ‘C’ or ‘S’ corporation into an LP or LLC. If structured correctly, such conversions can be accomplished free of income tax. The converted entity would be an LP or LLC for state-law purposes, but would elect to be taxed as a corporation for income tax purposes. If this is done, the tax filing requirements should not change. If a new business is being started, the client should consider forming an LP or LLC to conduct the new business.”