If you own multiple properties and want those assets protected, consider establishing an irrevocable trust and forming an LLC. There are advantages and disadvantages to both options.
A fundamental tenet of effective estate planning is protecting valued assets from potential creditors, excessive taxation, probate and other perils. A common example is someone who owns multiple properties, such as a rental home, a lake cottage or land that may, or may not, be used for a small farming operation.
These are important assets that you should be able to efficiently pass on to your loved ones without worrying about a court judgment, tax lien, etc. There are an array of different estate planning techniques and strategies that can be utilized to protect your assets, including the formation of a limited liability company (LLC) or the formation of an irrevocable trust. You may be asking, “Which option is best for asset protection?” Let's explore each in more depth.
What are differences between irrevocable trusts and LLCs?
Irrevocable trusts and LLCs have distinct characteristics and can used in different ways when planning your estate. The formation of an irrevocable trust enables you to place assets in the trust and bestow an individual or entity (e.g., financial institution) with the authority to oversee and manage the trust based upon your terms and specifications. However, it is important to note that the terms of managing an irrevocable trust generally cannot be modified, amended or terminated without the express permission of the grantor's named beneficiary or beneficiaries, according to Investopedia. In addition, when you transfer the asset into the trust, you are relinquishing ownership of the assets. Basically, the trust will own the asset.
In contrast, an LLC is a business structure that enables you to manage your assets through the LLC entity while shielding yourself from different forms of liability.
How does an irrevocable trust protect assets?
An irrevocable trust is established pursuant to applicable state law. Once established, the trust allows you to place your assets under the control of a trustee and that trustee will eventually distribute the assets to a beneficiary, or beneficiaries.
Assets you are allowed to place into an irrevocable trust include:
- Cash
- Real estate
- Personal property
- Heirlooms
- Intangible assets such as intellectual property rights
An irrevocable trust is viewed as an independent entity under the law. As mentioned earlier, when you transfer assets into the trust, you no longer personally own the assets. The ownership interest transfers to the trust. As a result, an irrevocable trust is a great shield against creditors since an irrevocable trust normally cannot be accessed to satisfy any personal debts. In addition, creditors are unable to reach these assets even when they are distributed to your beneficiaries. The only exception is if your beneficiary owes a debt or is held liable in some form or fashion. It is also important to note that a court has the authority to pierce the shield of a trust and empower creditors to satisfy debts from trust assets if the asset transfer was completed specifically to evade pre-existing creditors. This is referred to as a “fraudulent transfer” of assets. For example, if you hit and seriously injure a pedestrian in an automobile accident and a $750,000 jury verdict is entered against you, the transfer of assets after the verdict is entered could be viewed as a “fraudulent transfer.”
Creating an irrevocable trust entails drafting and signing specific trust documents. The trust document names the trustee and one or more beneficiaries. The trust document also advises the trustee on how to manage the assets contained within the trust.
How does an LLC protect assets?
An LLC is formed pursuant to state law. You must file articles of organization with the Office of the Secretary of State and pay filing fees in the state in which the LLC is formed. Although an LLC is similar to a corporation, it involves much less oversight and legal formality. For example, an LLC does not need to have a board of directors. In many states, a single individual has the ability to form an LLC and gift or sell assets to the business entity, according to Zacks Finance.
Like an irrevocable trust, an LLC is viewed as an independent entity under the law. This means when you sell or gift assets to an LLC (e.g. a rental property), the ownership interest in the asset transfers to the LLC. As with an irrevocable trust, personal creditors generally cannot access assets owned by an LLC in order to satisfy debts. Though, just like with an irrevocable trust, a court is empowered to pierce the LLC and allow creditors to reach the LLC assets if they were gifted to the LLC via a fraudulent transfer.
How assets are protected
| Asset is Protected from Personal Creditors | Ownership of Asset is Transferred to Enity | Can Be Used to Protect Rental Homes, Vacation Homes and Other Properties | |
| Irrevocable Trust |  |
|
|
| LLC | |
|
|
Forming an LLC
You can form an LLC by filing articles of organization with the Office of the Secretary of State in the state where your LLC will “conduct business.” You will also need to pay a filing fee.
Which is better: irrevocable trust or LLC
There are advantages and disadvantages inherent in both irrevocable trusts and LLCs for protecting assets. The determination of which is better depends on your unique circumstances and the assets you are seeking to protect. For example, if you own a family farm or other family business, it probably makes more sense to form an LLC. Why? Because forming an LLC still enables you to exert a level of control over the operations of the family business and maintain the cash flow from the business. If you were to place the family farm into an irrevocable trust, you risk losing control over the business since the trust would officially have ownership over the business.
In contrast, if you are looking to protect an asset like a family vacation home, establishing an irrevocable trust may make more sense to help ensure the home remains in the family for future generations. Once the vacation property is placed in the trust, you can stipulate that the home cannot be sold for a specific period of time or not sold at all. There is also the option of establishing a qualified personal residence trust. This type of trust enables a parent to transfer a vacation property to this trust but continue to use the property for a specific number of years. This irrevocable trust has the benefit of reducing the parents' taxable estate and lower the gift tax value of the vacation home.