Bubbles & Boxes Business Planning

This week I’m sharing a blog on Medicaid from Dave Zumpano, who focuses in Medicaid planning. I’ll be sharing Medicaid blogs from Dave Zumpano monthly in this space.

Now, here’s Dave’s blog:

Blog Author: David J. Zumpano, Esq, CPA, Co-founder Lawyers With Purpose, Founder and Senior Partner of Estate Planning Law Center

Over the last 25 years of dealing with the buying and selling of small businesses, I have become accustomed to lawyers and clients believing that creating an LLC or a corporation is the best way to protect their assets. While this is an effective start, creating an LLC or a corporation is far from effective in protecting your assets.

I always use the example of John’s Backhoe Service. John is a small contractor who bought a backhoe to install plumbing and other underground improvements. John starts small and, little by little, his business grows. The advice he is quick to receive from his lawyer and anyone else with an opinion is, “John, you’d better incorporate or do an LLC.” They assure John that creating an LLC or corporation will protect him from the liability of that business. If John owns the business himself, and is using the backhoe and hurts a little boy who is standing nearby watching him, John will be personally liable and all of his assets will be at risk to any lawsuit that comes from his actions in the business.

Creating an LLC or a corporation ensures that the liability for John’s actions will be limited to the assets of the LLC or corporation. [I] call LLCs and corporations a bubble; so if John’s backhoe suddenly becomes John’s Backhoe Service, LLC or Inc., then the only thing at risk of being lost if John were to hurt someone with the backhoe would be those things that are owned “inside the bubble.” Assets owned inside the LLC typically would consist of the backhoe and any cash accounts or other business assets. Unfortunately, that is not complete protection; it is only protection from the inside out!

Having an LLC or corporation protects John’s personal assets from all liabilities created by his business – and that’s where most people end, which is a mistake. Although an LLC or corporation protects John’s personal assets from the liabilities of his business, John’s business itself and his other assets are not protected from John’s personal liability. [I] say John’s assets, while protected from the inside out, are not protected from the outside in! If John buys his 16‑year-old child a new car and they go out and kill someone with it, John can be sued. Since John owns an LLC or the corporation, it can be taken from him as a general asset. Although some states provide protections from creditors getting inside the assets of an LLC, it is not always so. Many states require that there be more than one owner of the LLC for it to be protected. Others, while not allowing access even as a single-member LLC to the company assets, consider John’s interest in the company itself to be an asset that is subject to risk from third-party creditors and predators.

Perhaps the greatest creditor and predator to John is in fact not a lawsuit at all, but rather a nursing home or other long-term care costs. If John were to enter a nursing home, the full value of his business and all of the income it produces would be considered available in determining his eligibility for Medicaid or other needs-based benefits. This could be catastrophic, since small businesses rarely produce enough income to support the monthly cost of a nursing home stay. That’s why it’s absolutely essential: If John wants to protect his assets from the inside out and outside in, he needs to utilize an [irrevocable] trust.

[Irrevocable] trusts [can] ensure not only that John’s assets are protected from the inside out – that is, his personal assets will be protected from the liabilities of the business – but also that his assets will be protected from the outside in – John’s business and other assets will not be within reach of general creditors and predators (i.e. the kid’s car accident or a nursing home pay out).

So get really clear on how to protect people.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (800) 846-1555
www.aaepa.com