Limited liability companies, or LLCs, exist to protect the business owner’s assets from liability. But what does that really mean? Can you hide assets in your business to keep them away from taxes, lawsuits, or divorce? Everyone wants to protect what they’ve earned, but only within the boundaries of the law.
How an LLC Protects Your Assets From a Lawsuit
An LLC limits your personal liability in case of a lawsuit or unpaid debts. However, this comes with an important caveat: it only protects you when the business is sued, or the business fails to pay its debts. Only the assets belonging to the company must be used to pay the suit or debt. Your personal property, such as your house or personal bank account, is safe.
If, however, you are sued for your own mistake, your personal property is fair game. For instance, if you made an irresponsible decision in your business that harmed someone, the lawsuit can be directed against you personally, not your business. Or if you personally guarantee a business debt—which you may have to do, before your business has established its own credit—you will need to pay it with personal funds if the business funds run out.
What if you are personally sued for something unrelated to the business? Is your LLC safe? Not necessarily. If your LLC has several members, your creditors can obtain a charge order against your LLC. This requires the LLC to pay what you owe. When you are the only member, a court can order your LLC dissolved or foreclosed on to pay the debt. Rules vary from state to state. Speaking to a lawyer or financial advisor in your state is a must before attempting to protect your assets this way.
Whatever you do, form the LLC and put business assets in it before you have a lawsuit or unpaid debts. Moving money around after a lawsuit looks suspicious, and may be illegal. And never mix personal and business funds. If you do, a court may decide you and the business are essentially the same entity.
Does an LLC Protect You From Taxes?
The answer here is short: no. For tax purposes, an LLC is a pass-through entity. All profits from the business pass through to you, and you report them on your personal taxes.
You can, of course, write off your normal business expenses and deduct them from your profit. But always make sure to write off only expenses related to your business. That can include business lunches, your home office, and travel costs. But it can’t extend to personal lunches, your entire house, or all your travel.
Can I Keep My LLC Assets From My Ex-Spouse?
If you own an LLC at the time of your divorce, it may or may not be considered marital property. Marital property usually must be divided equitably between the spouses during a divorce. So how can you tell if your LLC qualifies? Relevant factors include:
- When the business was founded. If you founded it alone before the marriage, it may not be marital property.
- Whether your spouse contributed to the business, either with labor or with marital property. If you took out a home equity loan to fund the business, the whole business may be marital property.
- Whether you paid yourself a competitive wage from the business funds. If you refused to take a fair paycheck and kept the money in the business, your spouse may argue they didn’t benefit from the business during the marriage.
If you found a business while married, it pays to get something in writing, either in the LLC founding documents or in a prenup. Most likely, it won’t matter if you stay married. But if not, having a written agreement can reduce the amount of acrimony and legal trouble you both suffer.
After the Divorce
What about after the divorce is over? Do assets in a business still count as yours when it comes to calculating alimony and child support? In general, yes. Since the business is a pass-through entity, you will report your share of company profits on your taxes as self-employment income. That number will be considered your income for the purpose of calculating child support.
While many divorced people try to tinker with the numbers in their business, like writing off too many expenses or accepting money under the table to disclose a lower income. This is a terrible mistake. Money kept undisclosed this way isn’t protected, but only hidden. When it inevitably becomes known, you will end up back in court, and they will not look kindly on you for your deceit. In addition, you may end up committing tax fraud.
Get Sound Financial Advice
As you can see, an LLC protects your assets from the normal liabilities of doing business. But founding one in order to hide assets from legal claims won’t work. Normally, it only makes sense to start an LLC if your business requires liability protection—not to protect your personal assets from personal claims.
As always, seek out individual financial advice for your unique situation. We can connect you with an experienced advisor with a simple phone call.