PITFALL 3: Using a limited liability corporation as a substitute for estate planning documents
In an effort to reduce the costs of estate planning, some domestic partners are using an extremely poor substitute to a revocable living trust. In fact, the substitute is actually using a type of business entity called a limited liability company for their estate planning goals.
A limited liability company, or LLC, is a legal business entity where one or more people or companies come together to perform a common business with corporate protection, and the business assets are placed into the LLC. In many ways, this form of company was designed to give the classic business partnership some corporate protection without having to issue stock certificates or have shares openly traded. Two people could decide to open a hardware store together with each being 50-50 partners, and with an LLC they could have the benefits of corporate protection without a lot of the meeting and other legal formalities that go with a corporation. However, this business entity was not designed to handle the estate wishes of domestic partners or anyone else.
On the other hand, a revocable living trust is a personal entity created by one or more people to handle life and estate planning goals. Personal property and business interests (not business assets) are placed into the trust. The people who receive assets after one of the trust owners dies are listed in the governing trust document. For domestic partners, the right revocable living trust is designed to help them combine property as a family unit during life and then distribute assets after one and then the other partner passes on.
Depending on the competence of the attorney, the trust will also list multiple contingencies for who gets the trust assets after the second partner passes on. For example, John and Rob may leave everything to each other if something happens to one of them. After both of them have passed on, they may choose to leave 50% of the trust equally to all of Rob’s nieces and nephews and the other 50% to John’s cousin Melanie. IF something happens to one of Rob’s nephews, they can state that the deceased nephews share will go equally to his children or to the other nieces and nephews. IF something happens to Melanie, then John and Rob can state that the 50% goes to Melanie’s children or to a charity.
The distribution options are endless, and a good revocable living trust will spell all of these matters out. The operating agreement of a limited liability company will only spell out how the business is to be run and who has certain business powers and responsibilities. In a limited liability company, it is awkward to even plan one step ahead to protect the surviving partner, let alone plan for multiple distribution contingencies.
Another difference between LLCs and revocable trusts is that revocable trusts do not provide corporate protection for the assets inside of them because the trust is not a corporate entity transacting business. But for that matter, limited liability companies used for life and estate planning purposes are not going to have corporate protection either. Whenever a corporation is set up and the owner uses corporate assets for personal reasons, or they use personal assets in the conduct of their business, courts will generally allow people to sue the individual and the corporation as if they were one and the same without corporate protection. This is called piercing the corporate veil. In short, courts are not going to give corporate protection to you unless you are actually conducting business.
Finally, there are corporate formalities and fees that need to be considered as well. In setting up a limited liability company, there are always filing fees. North Carolina's filing fee is $125. Limited liability companies also must file an annual report with the secretary of state’s office listing the current names and addresses of the members. While the paperwork is not overly burdensome, you do have to pay a $200 fee with each report to maintain your limited liability company. Whatever cost savings domestic partners might have in the short term by using a limited liability company rather than a revocable living trust for estate planning purposes, those savings will quickly disappear in the form of $200 checks to the North Carolina Secretary of State.
To summarize, there are many drawbacks and no advantages for domestic partners, or anyone else for that matter, in using a limited liability company rather than a revocable living trust for their life and estate planning needs. LLCs are used for business purposes and not personal matters.
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