Litigation and Estate Planning gone wrong

Many businesses will set up complicated structures in an attempt to avoid estate tax, (which is called estate planning) or to make the business less appealing in a possible lawsuit. Both of these are great ideas. Some estate planning ideas work great as litigation prevention ideas and vice versa. In both cases the person who owns the assets is trying to divide them up to make them harder to get and make the entire estate less valuable. In reality, a plaintiff and the IRS are both possible creditors to your income and assets.

There are sometimes other reasons for doing this. These reasons include separating the liability from the assets, making it easier to get loans, lowering insurance costs, or maybe to bring family members or valued employees into the business by giving them an equity position.

One of the issues that always pop up is control. It is difficult to effectively split up an asset so a plaintiff’s attorney or the IRS; possible creditors do not look at it as available. Besides changing the name the real issue is whether or not the original owner, the person who is attempting to lower the value of their estate, still has control over the asset.

The Kerrville Daily Times is reporting in Camp Mystic embroiled in lawsuit about a lawsuit where the original owner is attempting to regain control over his assets. Camp Mystic is a Christian summer camp that has been around for more than 50 years. About 10 years ago the camp was split into two entities. One which owned the land and one which ran the camp. Both entities were owned by the original family members and some new family members. Now they are all involved in litigation arguing they owe each other money, have undervalued or ruined the original asset and in general calling each other names.

If it were not sad, the description of what happened and now who is suing who is almost comical.

At the heart of the litigation is lease payments owed by one entity to the other. To make the split legally effective the parties have to not only go through the process of changing the ownership but must also, if necessary contract with each other. In this case the camp signed a lease agreement to rent the land from the entity that owned the land.

These blog is too short and not directed at providing all of the legal answers to dealing with these issues. However we can point out some simple do’s and don’ts so you can have an idea of how to proceed.

The only entity to use for anything in the future is the Limited Liability Company, an LLC. It requires less paperwork to create and run than any other entity. It still requires paperwork to create, both an organizational agreement which is required to be filed with the secretary of state and an operational agreement which most people skip. If you don’t have an operational agreement, you don’t have an LLC according to creditors and they can have the LLC voided and attack you personally.

An LLC can be taxed the way you want it to be taxed, including taxed as a subchapter S. Subchapter S is not a type of corporation or entity. Subchapter S is how the entity is going to be taxed. Most Subchapter S’s were regular corporations in the past. The name Subchapter S came from the chapter of the IRS regulations that created this taxing scheme. Corporations are taxed under Chapter C and Sub-Chapter S is the Subchapter S taxing scheme for used to be solely corporations and now includes LLC’s.

The worst situation to be in is a Partnership. A partnership is created always when two or more people go into business together and do not create an LLC or a corporation. Partnerships have two major flaws, besides hundreds of minor flaws. The first is any partner act holds all partners liable for his or her actions. One partner in an automobile accident doing partnership business can put all of the other partner’s assets, including their homes at risk. The second is getting divorced is usually cheaper and easier than breaking up a partnership.

Splitting up a business into separate entities is a good idea. Keeping the land, the concession or permit, and the operation in different entities is easy, cheap and helps to make sure no lawsuit will bring the business down. These entities also make it easier in some cases to get loans, to bring family members into the business and to possibly cut estate and other taxes. It may also help move income to individuals or entities with lower tax brackets. Finally it allows you to pick in some cases how the income will be taxed by sending the income to the entity with the type of tax entity you need.

You have to make sure though that you have created the proper relationship between the entities. If you are going to use the land, the entity using the land must lease the land with a proper fair market value lease agreement. An entity that owns major operating assets such as boats, vehicles or machinery must have proper lease agreements back to the operating entity. Both of these entities must receive fair market value lease payments from the operating entity.

There are some better entities to use as a Limited Liability Partnerships or Limited Liability Limited Partnerships but there is not enough time here to get into them.

Anytime you look into these types of planning you must involve your CPA. Also important as evident by the Camp Mystic lawsuit, you have to make sure that you understand who is in control of the entities and how they are going to be operated. Proper paperwork is the key to making sure you don’t lose everything you have worked hard to build.