Recently, I had a medical doctor call me in frustration when he received notice that he might be sued either professionally or personally for an event over which he had little or no control. He was involved in a business venture that had failed, and the other investors were incensed at the loss of their investment. He was further frustrated by the recent increase in his cost for malpractice insurance, and questioned whether such coverage would be commensurate with the cost. Personally, he had accumulated a reasonable amount of wealth. His partners were doing well, but sometimes they pushed the limits of their practice, and he was concerned not if they would be sued, but when.
How many of us in the professional and business world are faced with the same circumstances? Unfortunately, we are living in a society which holds us accountable for every action we take. Often our actions could result in litigation. Litigation, whether you win or lose, is a very costly process, and assets we have accumulated throughout our lives could be at stake.
In addition to the concern of whether or not our assets will be attacked under the guise of litigation, we are also being confronted with a highly complex and financially encompassing structure in our society: the taxing authorities at local, state and federal levels. Currently, we pay in approximately one-third to one-half of our earned income and wealth to these governmental entities in the form of income tax, ad valorem tax, school tax, excise tax and estate tax. The government has provided for certain tax benefits to reduce the burden of some of these taxes; however, you must use various legal instruments to derive the benefit from them.
This article attempts to explain various legal avenues which address the issues outlined above. My advice to the medical professional was for us to review not only how we could protect him from potential litigation, but also what we could do with his business and his estate. To accomplish complete asset protection for this individual, an analysis was made of how he should be protected, not only today, but also in the future. This included analyzing how the doctor had designed his business life as well as his personal life.
An individual will organize his business as a sole proprietorship, corporation, professional association, or partnership. His personal assets are addressed in his estate. How he has organized his assets is important because of the level of protection, or non-protection, that the individual has in respect to his accumulated wealth. In the doctor's case, the goal was to provide him with a combination of different types of structures that would afford him different levels of protection. Remember, you cannot separate your professional life from your personal life. Each has a great influence on whether the other will survive in a crisis situation.
The doctor's major concern was his partners. They were organized under the guise of a general partnership of professional associations and sole proprietorships. The exposure the doctor had as a general partner exposed him to full liability. The general partnership is a good entity for tax purposes but not for asset protection. I informed him that the State of Texas had recently established several new entities which provided him and his partners greater protection than his current organization.
The new entities now available in the State of Texas for limitation of liability are formally called Limited Liability Companies ("LLCs") and Limited Liability Partnerships ("LLPs"). The essence of these entities is their ability to limit the amount of liability to each of the members and partners, while providing a taxing structure which allows a pass-through of income to each of them. This pass-through feature is significant as the entity is not double-taxed on income earned. Also, any losses incurred by the practice may flow through to the partners or members, depending on the entity.
The most significant aspect of LLCs or LLPs is that a member or partner is not individually liable for debts and obligations of the partnership arising from errors, omissions, negligence, incompetence or malfeasance committed by another member or partner. Only when there is direct involvement in the specific activity in which the errors, omissions, negligence, incompetence or malfeasance were committed by the other partner or representative, or the partners had notice and knowledge of the matter and the time of the occurrence, and then failed to take reasonable steps to prevent or cure the errors, omissions, negligence, incompetence or malfeasance, is there liability to the individual. As to obligations of the partnership, this limitation does not limit liability to each partner or shareholder. However, under an LLC, the shareholder has even more protection as a member. He is not liable for any actions of the company unless the corporate veil is pierced. This affords an individual the ability to develop his practice without significant concerns that he is subject to liability for acts or omissions of his peers.
The selection of an LLC or LLP depends upon a number of items. This selection process will be addressed in the next article in this series.
The other area addressed with the doctor was how his personal assets were being handled. We discussed whether he had a will and what planning he had in place to deal with whether or not he was personally subject to liability. I noted that there are several tools, such as family limited partnerships, irrevocable and revocable living trusts, and a simple or complex will, that afford different levels of protection. The comparison and relevance of these tools will be discussed in detail in a future article. Since each tool has a unique selection process for creating an overall protection structure, one must have a thorough understanding of these processes in order to make an informed decision.
In answer to the question "Are Your Assets Protected?" I find that a majority of individuals are subject to the loss of their assets if faced with a crisis. The doctor did not have adequate planning in his business or personal estate; therefore, a plan was developed whereby the partnership would be liquidated and the assets placed into an LLC. We moved most of the assets of the doctor's personal estate to a Family Limited Partnership ("FLP") and allocated a prorated interest to his wife, his children and himself. We further reconstructed his and his wife's wills with the appropriate testamentary and living trusts. This planning not only provided protection of the doctor's personal assets, but also maximized the tax benefits permitted him under the Internal Revenue Code.
Published in the Greater Houston Edition of M.D. News, February 1997
Are Your Assets Protected? Part II
The information provided in this article is not legal advice to any reader. Neither the transmission nor the receipt of this article creates an attorney-client relationship. The opinions expressed in this article may not be those of the firm.