SMLLC, taxed as disregarded entity, and liability

Does taking the default tax election of “disregarded” make the LLC more pierceable for something that happens inside the LLC?


How so?

SMLLC has no charging order protection.

I have heard of, but haven’t read, cases where a form wasn’t set up properly and the SMLLC was treated as a sole prop instead of an LLC

Would “disregarded” make it more vulnerable to be pierced from the inside (i.e. not the charging order)?

As for the wrong form, do you mean doing something wrong on your personal tax return? I would assume that if you wanted to treat it as a pass through on a single tax return you could just have a CPA do your taxes to make sure it’s done right? Thanks.

The fact that an SMLLC is a disregarded tax entity does not make it more likely to be pierced. Nor does it have anything to do with “charging order” protection, which BLL harps on for some reason but is about as big a risk as the due on sale clause foreclosure.

The key factor in whether an LLC will be pierced is whether it was truly a separate entity. If you are buying in the name of the LLC but borrowing in your own name, for example, you are not maintaining the legal separation.

The key factor is that the single member will be the one who generated the liability and will be personally liable for injuries along with the LLC. An $11K judgment is enough to force an involuntary BK where the SMLLC will be liquidated to satisfy the judgment against the debtor. In the multi-member LLC case, the LLC is not automatically liquidated to pay the debt.

Only in the sense that single owner entities tend to be lax in maintaining corporate formalities.

Piercing is not really a threat. The real threat is the single member is the one who caused the injury and becomes personally liable for any judgment. At that point, non-exempt personal assets and LLC assets are available to the creditor. You can’t insulate yourself from your own actions. If you did it, you’re responsible whether you acted on behalf of an LLC or not.

It had something to do with filing some form from the IRS when setting up the LLC. It was done in such a way that the court treated the LLC as a sole prop and held the owner personally liable for business debts. Again, I haven’t read the case and don’t know the details. It’s on my to-do list, but not a priority since I don’t recommend SMLLCs for individuals. I’m more interested in the judge’s reasoning than the implication on LLCs.

Interesting–so the people who buy in their own name to get easier financing and then quit claim to the LLC may be weakening their own entity, if I’m understanding correctly.

Yes, there is a potential piercing issue. However, there’s also a fraudulent transfer argument that can be more persuasive.

OK. Is the fraudlent transfer issue because of moving the property into the entity, or does it have to do with the mortgage?

Mortgage is irrelevant. You are making a transfer at less than fair market value and a creditor could challenge the transfer to the LLC on that basis. It’s best to buy in the name of the LLC directly and avoid the situation.

So how does this effect it.

I set up LLC
Bought home deeded to LLC
Transfered money I personally borrowed to the LLC as opening equity.

Now I have the LLC pay me back with interest for the money I borrowed.

Perhaps it should not all be equity. Should it be a loan I made to the company?

This has nothing to do with any type of piercing or reverse piercing argument. I prefer all equity contribution because it’s easier, but loans are OK if done properly.

How the entity is TAXED should have no impact on any protection the LLC does or does not offer. Taxation is derived from federal tax codes, which congress may change at any time, and have nothing to do with whatever state laws apply to charging order or any other protection. There is no tax code for “LLC.” IRS taxes SMLLC on the 1040 by default simply because there is no other tax code for it to use… unless it overtly elects corporate treatment. (There are only two tax codes: individual and corporate. EVERYTHING has to be made to fit into one of these two)

As an example: Limited Partnerships, which have been around and well tested by the courts, are “taxed” at the partner/owner level.

Having said that, what I see often is that the individual continues to operate an entity as if he and the business are the same. Comingling is a BIG issue, both for tax AND for piercing the veil of protection.