Jay then discussed what could happen with an LLC formed in a weak protection state like California or New York. In those states the claimant could reach inside the LLC and sell all the assets. When Alana again said, “That is not asset protection,” Jay agreed. If you were going to form an LLC the choice of state of formation made a big difference.
Jay then discussed how Attack #2 would be handled in an S (or C) corporation. In that scenario the judgment creditor could reach and control the shares of the corporation. If Sherri were sued and the judgment creditor got control of her shares equaling 50% of the company all sorts of problems could ensue. First of all, Alana would suddenly have a new and, in almost all cases, uncooperative partner, a partner who wants to sell the company and get their money as soon as possible. Secondly, with a 50/50 split between Alana and the judgment creditor they would be in a deadlock situation where nothing would ever be resolved. Both Alana and Sherri clearly saw that a corporation was not the ideal choice and asked what could be done.
Jay noted that Nevada was the only state to allow charging order protection for corporate shares. The remaining 49 states did not protect corporate shares. But he had a plan, which he explained to the sisters. Jay noted they wanted asset protection and payroll tax minimization. An LLC formed in a strong state offered the best asset protection and S corporation taxation offered the best way to deal with payroll taxes. What if they could combine the two?
Alana and Sherri were puzzled. “How can you do that?” Sherri asked.
Jay explained that with an LLC you could file a Form 8832 with the IRS and elect to be taxed as a corporation. Then you filed a Form 2553 to be taxed as an S corporation. You could have your cake and eat it too.
Alana and Sherri thought about it for a minute and found that they liked the idea. A Nevada LLC for asset protection taxed as an S corporation for payroll tax minimization.
Jay also talked to them about the name they would use for the new business. Sherri said they liked the name SalonAlana because it rolled off the tongue. Jay also liked the name and asked if they had done a trademark search. Alana said they couldn’t afford $1500 for a full name search. They had checked the U.S. Trademark office website at uspto.gov and had not found a conflict. They were able to get the domain name salonalana.com, and felt that that was a good sign.
Jay said that an official government website search was a good indicator but not a definitive one. The girls understood. They would take that risk and go ahead with the name SalonAlana. Jay then asked them if they were certain of this, and they were. With that, Sherri and Alana instructed Jay to begin the LLC formation process and left happy that they were acting on their dreams.
When Sherri got home her husband Clint asked what they decided to do. When she mentioned they were forming an LLC taxed as an S corporation he immediately scowled. His lawyer buddy Wilson down at the lodge had said they should set up as a C corporation. Clint said that would be the best way to pay for their health insurance.
Sherri defended Jay’s decision as Clint became more obstinate that he was right. Finally, she told Clint to call Jay and hear what his thoughts were. Clint said he didn’t want to speak to no lawyer. Sherri patiently said that he had already talked to Wilson about it, why not also speak to Jay. She noted that while Wilson was a personal injury attorney Jay focused on business matters. Clint’s response was to proclaim that all this didn’t matter in the long run because they weren’t going to succeed anyway. He left in a huff. Sherri was left to ask herself, “Why is he acting this way?”
The next day Sherri was running errands and still asking herself why her husband was so against her starting a business. At the grocery store Sherri ran into a girl friend who had successfully become an entrepreneur. Sherri asked how she dealt with people who didn’t like the idea of a start-up. Her girlfriend said that was one of the hardest things she faced. Many friends and family members didn’t want you to succeed because your success would only highlight their own lack of advancement. These people would discourage you and keep you down at their level because they were too afraid or lazy or whatever to rise above where they were. If they were to wallow so would you.
Sherri then asked the entrepreneur friend how the issue was resolved. Her reply was blunt: “I had to find new friends.”
Sherri didn’t like the sound of that.
Tom and Nancy
After their horrendous experience with Steve and the Righteous Rock Quarry case, Tom and Nancy Green were ready to move forward. The attorney who helped them through the engineering malpractice case mentioned an associate in the firm named Katherine could help them set up the right entity.
So Tom and Nancy met with Katherine in her office. They had brought Dooger and left him on a leash tied to a pine tree in front of the law office. All the secretaries and paralegals went outside to pet the loveable Great Dane. Everyone around town was fond of Dooger.
Tom, Nancy and Katherine reviewed the pros and cons of the various entities and the three of them kept coming back to a unique one of them – the professional corporation.
A PC, as they were known, was available to licensed professionals such as doctors and lawyers. Each state had their subtle variations but typically shareholders could only be professionals licensed to do business in one or more states by a state licensing agency. In some states the only way to do business through an entity was with a PC. Since Tom and Nancy were both licensed engineers they would both qualify to be shareholders of a PC.
Katherine discussed using a Professional LLC (or PLLC) for their consulting business. She said the law surrounding professional limited liability companies for professional activities was unsettled. California had just started to allow them and other states still did not permit their use. If they would ever engage in a long-term consulting business in another state (over 30 days, generally) they would have to qualify to do business in that state. Because every state allowed PCs and not every state allowed PLLCs it made sense to use a professional corporation. (In some states PCs are known as a Professional Association [PA] or a Service Corporation [SC]).
Katherine noted that forming a PC was very much like forming a regular corporation. The one additional step involved obtaining and filing a certificate of good standing from the state licensing division. She indicated that the specific division for engineer licensing was usually very cooperative with this.
Katherine then explained an important feature of the PC (which also applied to a PLLC). The entity did not provide protection from a claim of professional negligence. If a client like Steve at the quarry sued again on a malpractice claim they would have to rely on insurance. She suggested that Tom and Nancy have a $5 million E & O (errors and omissions) policy to cover any future claims. She also suggested putting all of their other personal assets in other protected entities in the event a claimant wanted more than the insurance coverage, or in the event their insurance company found a reason not to cover them.
Tom mentioned that they owned a fourplex in their individual names. Katherine explained that this asset needed to be protected for two reasons. First, if they left the property in their individual names and were ever sued by a tenant, the tenant could reach not only the fourplex but all of their other assets. Conversely, in a case like the Righteous Rock matter, if the claimant ever obtained a judgment against them, assets in their individual names could be easily reached. They should put the fourplex into a separate LLC formed in their home state, and then have the home state LLC owned by a Wyoming LLC for maximum asset protection. (This strategy is discussed in Chapter