Recently my clothes dryer was not drying because a bird built a nest in the vent. This illustrates the rule that everything we use should be tuned from time to time. This applies to single-member limited liability companies (LLCs).
The LLC is widely used because it provides the simplicity and flexibility of a partnership with the protection from creditors of a corporation. The LLC is easy to create and operate. An LLC may elect to be taxed as a Subchapter C corporation, a Subchapter S corporation, or a partnership. If it is a single-member LLC, it may be treated as a disregarded entity, which is to say for federal income tax purposes it does not exist.
One of the major benefits of an LLC is that if you own an interest in an LLC, and a creditor secures a judgment against you, he cannot seize the LLC, except as we note below. All the creditor can do is obtain a "charging order" against the LLC. This means that anything that comes out of the LLC for your benefit must first go to pay off the judgment.
The charging order, until recently, was the only remedy the creditor had. If the members of the LLC decided not to pay out any of the profits, the creditor got nothing under the charging order, but he would be liable for tax on his share of the LLC's undistributed profits. This tax on the "phantom income" made for a Pyrrhic victory, indeed - the creditor had won something that was a burden, so probably he would settle the claim for pennies on the dollar.
In Olmstead v F.T.C. the Florida Supreme Court held that a creditor could seize a single-member LLC. I think the rationale for the decision is that limiting the creditor's remedy to the charging order protects the non-debtor members of a multi-member LLC from having the creditor join them in the business. In the case of the single-member LLC, no other people are harmed if the creditor takes over the LLC.
The Olmstead rule makes some sense. In today's legal climate, you may wish to talk with us about converting single-member LLCs to multi-member LLCs.
