The asset-protection analysis here misses a key difference between corporations and partnerships.
Control of a corporation is through the voting of shares (for members of the Board), and shares are personal property. Because shares are personal property, they can be attached and taken when a judgment is executed. Whomever controls the right fraction of shares can control a corporation, and shares can be taken like a third car or a third home – they have no special protection. If a corporation is sued, generally the persons who own the corporation are not personally liable for the contracts and torts of the corporation (unless they would be individually liable, e.g., they were personally driving the car that hit the pedestrian in the above example, and the corporation was sued because it was a company car and the trip was company business). Corporations thus can be viewed as offering 1-way asset protection: protection for personal assets if the corporation is sued. A corporation who’s owners loot the company’s assets, comingle corporate and personal assets, disregard the corporation’s separeteness in their business dealings, and the like are like to to find that this 1-way asset protection will fall to an attenpt to “pierce the corporate veil” and reach the owner’s assets for liabilities of the corporation.
Control of a partnership is through partnership in the partnership. That is, it is a personal repationship between the partners. If a partner is sued in a personal capacity only, the assets of the partnership are not directly available to creditors any more than the assets of a corporation, but another advantage appears: the control of the partnership does not depend on the ownership of personal property such as shares. Because a partnership traditionally was not a creature created by statute but a common-law creature developed to describe the rights of people who entered business together without an entity, many of the rules on partnerships must be gleaned from the cases which describe how they work. Yes, much of this has been codified. What is not obvious is that since changing the identity of one of the partners – swapping him for one of his creditors, for example – would necessarily fundamentally change the partnership, this is not a permitted way to recover assets from people whose wealth is tied up in a partership. The way you must approach getting at these assets is to attach the income received by the particular partner who must satisfy the judgment. Thus, the partnership does business as usual, but the partner has trouble getting his paychecks. The partner might not have trouble driving a company car, though, or staying in a company residence provided for the supervision of adjacent property … a number of benefits which also benefit the partnership could be quite available. Also, the partnership may stop distributing anything. This makes attachment of the stream of distributions a problem – there aren’t any. Of course, the IRS still expects the partnership to file a K-1 naming the person(s) responsible for the tax on the money made by the partnership, even if the partnership doesn’t actually distribute any profit but keeps it for future development. And the person entitled to the distributions must pay the tax, or face the IRS. Thus, a creditor can find itself in the unfortunate position of paying your partnership share’s taxes while receiving no income. Very unhappy creditor … Thus, tradtional partnership could be viewed as 1-way asset protection, but in the other direction.
LLPs are statutory creatures which are like partnerships but provide partners protection from the acts of other partners, and the partnership itself. (In a traditional partnership, every partner is completely liable without limitation for every debt or obligation of the partnership, even a tort such as an auto accident or fraud committed by a different partner. Avoid being in ordinary partnerships if you have asset protection concerns!) LPs might be described as partnerships that can issue “shares” to investors who are not necessarily also full partners. LLLPs are a hybrid of LPs and LLPs, with the general partner(s) having limited personal liability as in the LLP. The LLP, created by statute in Texas, was the first entity in the US to offer 2-way asset protection.
So, what is an LLC? Developed in Wyoming, the LLC by statute has all the powers of a corporation and of a limited partnership. (The Texas LLC Act is available from the Texas web site. You can compare statutory filing requirements between corporations and LLCs and form your own opinion of which is trickier to get right.) The LLC’s forming documents can specify whether ownership is by control of personal property such as shares or is by membership in the LLC and a personal relationship not subject to attachment. The IRS currently allows LLCs to elect whether they are to be taxed as corporations or are “disregarded” for tax reasons like partnerships. The limitations of the corporations act governing voting, meetings, and the like do not limit the LLC, so if properly drafted it is easier to run without violating the statutes and opening an opportunity for piercing the corporate veil (letting those who sue it disregard it and seek assets of owners). LLCs are extremely flexible in their organization and can be found all over the country now. Because they are so flexible, it is certain that you want on drafted to fit your needs rather than a boilerplate kit, or you could do as well with an LLP. You can have a simgle-member LLC and you don’t have many filing requirements in Texas, so it’s easy not to botch the corporate formalities that sink so many small corporations when viel-piercing is attempted.
The point that the entities are subject to different state taxes is valid. LLCs pay franchise taxes just like corporations, based on either assets or gross receipts (look at the Texas Secretary of State’s website). LLPs pay a per-partner fee annually. These tax comments will no doubt be completely incorrect for any jurisdiction other than Texas.
The thing that people often screw up in their arrangement of entities for asset protection is failure to respect the separateness of the entities. Mixing funds in a common account, answering the debts of one with the assets of the other, writing personal expense checks from an entity’s account – all these support veil-piercing and limit the utility of the entities you’ve created.
While I am an attorney, I do not offer the above as legal advice for any specific person or for any specific application. This is an off-the-cuff informational note intended to provide some overview of the difference between partnership and corporate behavior in the face of a creditor’s attempt to execute a judgment. Please seek legal advice before acting. Advice which is informed by your actual needs and tailored to your situation will better serve you.
Find an attorney who knows and likes entities. Some have reasonable fees
Very best regards,
Christopher Lewis
Houston