Two months ago in this column, I wrote about the new Corporate Transparency Act. Don’t worry, you don’t need to dig that issue out from the bottom of the birdcage, I’ll summarize it here.
Starting next year, nearly every Limited Liability Company (LLC for short) and corporation, other than the really big ones, will have to periodically file reports with the federal government, showing among other things the ownership of the entity. They exempted the big companies, but not the small ones. If you have, say, a small LLC to hold your rental property, or a one-owner corporation you use for your ‘side hustle’, you have to file electronic reports with FinCEN. And there are very serious criminal penalties and fines for failing to do so.
With that in mind, you might be wondering whether it makes sense to create an LLC in the first place or, for that matter, to continue one that you already have. Should you close it down? Should you keep the business in your own name as a sole proprietorship?
Let’s think this through.
First of all, you should be aware that most of the information the Feds will be collecting, is already required for corporations and LLC’s in Alaska. If you have either of these types of entity, the state of Alaska requires you to file a report, every two years, which includes the identity of the shareholders (with an LLC those are called “members”). Anybody who has a computer can look that up online. Granted the federal requirements will go a little beyond that, but the biggest thing that a lot of people are concerned about keeping private, the ownership of the business, is already public information in Alaska.
Also the federal government promises that they will keep all of this information confidential and only use it for legitimate law enforcement purposes. Of course if you have been around for a while, you can probably remember any number of cases where someone’s confidential information—tax returns for example—was released by some government employee for political purposes.
But you have to balance that against the purpose for which you might need that entity.
Here’s an example of how an LLC works: let us imagine that you have a rental property. It is a duplex in Anchorage, worth about $500,000. On the advice of someone you trust (your attorney, accountant, brother-in-law, or whoever) you create an LLC, and deed the property into the LLC.
Years pass, and then one day a tragedy happens. Your tenant’s teenage daughter trips on a nail that was sticking out at the top of the stairs, and tumbles down. She was a pretty cheerleader with a scholarship to Bryn Mawr in her pocket, and now she is paraplegic. She sues for negligence, and a sympathetic jury gives her a judgment for $10 million.
The problem is, you only have $2 million insurance coverage on the property. The insurance company hands over a check for the “policy limits” and walks away. You hand over the title to the property, which was worth $500,000. And you try to walk away too —but not so fast.
The plaintiff has now collected $2.5 million on a $10 million judgment, and her lawyers would really like to get the other $7.5 million. After all, they are on a contingency fee and they get paid 1/3 of what they collect. So the plaintiff’s lawyers now file motions with the court to allow them to “pierce the corporate veil” as they call it. If they are successful, they can get at the rest of your assets, which would mean you lose your home, investments, cars, other rental properties, and pretty much everything else you own (except IRA’s, which are protected).
But as long as you properly managed the LLC, they won’t be successful. Yes, you will lose the duplex that is in the LLC, but you won’t lose the rest of your life savings. Of course if you have been sloppy with the LLC, that is another story. I have seen a lot of these situations where someone has set up the entity, but then pretty much ignored it after that. They mixed business expenses with personal expenses, didn’t keep proper records, didn’t file biennial reports, and so forth. In those cases the judge will often let the plaintiff’s lawyers get at the personal assets. But not if you’ve been careful.
So what it comes down to, is a balance. If you create an LLC or corporation, you’ll have to file paperwork with the state and federal governments, and there will be a bit more bookkeeping than you would have had otherwise. But if you don’t, and something goes wrong within that business, you could lose everything.
To LLC or not to LLC, that is the question.
Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. I usually include a clever bon mot here to get you to read this last paragraph, but there’s a writer’s strike on.
