You may understand that it is a significant liability risk to put all of a business's "eggs" into one basket. But what's the solution? For your business, it may be as simple as using multiple baskets. In fact, using multiple entities to run a business is quite common in many types of business. Consider:

  • Most restaurant businesses use different entities if they expand beyond one location.
  • Most real estate developers or investors use multiple entities for different pieces of property.
  • Many owners of taxicabs use one entity to own each taxicab.

Why do these business owners use multiple entities in this way? They do so primarily because they want their businesses to be "fortresses" — shielding different business units or assets from claims against their other businesses or assets.

If one restaurant location performs poorly or there is a lawsuit at one property, the restaurateur does not want the other locations to be held responsible. If one taxicab is in a terrible accident, the owner of the taxicab business does not want the income from the other taxicabs to be exposed to the lawsuit creditor. Any business can use the same tactic for the exact same reason.

How should you use multiple entities to protect your business? The most common way is to separate the business's assets into various entities.

For example, let's examine a business's real estate. There are three asset protection goals of separating the ownership of the real estate (RE) from the operating business:

1. First, the RE is a valuable asset that should be isolated from any liability created by the business. By isolating the business from the real estate, you may have isolated liability created by the business from the valuable RE.

2. Second, the RE itself may cause liability, such as slip-and-fall claims from those coming and going on the premises. If the RE and the business are operated by the same legal entity, all the "eggs" are in the same "basket." This means the claim will be against an entity that has something to lose — all of those valuable assets. By separating the RE from the business, you have also insulated the business from these risks.

3. If there is a claim against the owners personally, an LLC formed in the proper jurisdiction (often Nevada, Wyoming or Delaware) can provide a solid level of protection of the assets in the separate LLC from such claims due to the charging order protections that shield the ownership interests in LLCs that are properly formed and maintained.

Separation involves LLCs and lease-backs

The actual tactic of separating ownership simply involves creating a new limited liability company (LLC) and transferring ownership of the real estate or equipment to the new LLC. Because the RE is no longer owned by the operating business, claimants suing the business have no claim against the LLC that owns the RE. For this arrangement to be respected and to ultimately protect the assets, owners must:

  1. Properly create the LLC, with the right language in its operating agreement and all formalities being followed by the owners.
  2. Respect and observe all entity legal and accounting formalities.
  3. Transfer title of the RE to the LLC.
  4. Create fair market-value lease documentation between the business and the LLC(s) and make actual rental payments.
  5. Ensure proper tax treatment for all parts of the transaction.
  6. Transfer all insurance policies for the RE to, and premiums paid by, the LLC.
  7. Comply with all other formalities that evidence the ownership of the RE by the LLC.

Your financial incentive

Beyond risk management and asset protection, there is also a way the LLC lease-back tactic can be part of a business buy-in and buy-out strategy as well. In other words, the LLC lease-back can actually allow you to create more wealth while also protecting the RE. The lease-back provides a structure through which new partners buy in to the LLC, as well as the operating business, and exiting owners can sell their LLC interests as well as those of the main business as well.

For certain solely-owned businesses, the LLC can be used as part of a gift and estate plan as well. Over time, you can gift ownership interests to children while maintaining 100 percent control of the LLC and the RE the LLC owns. Once the children are over a certain age, their percentage of the LLC income will be taxed at their (likely) lower income tax rates.

If you can take full advantage of this opportunity for tax bracket sharing, you can save tens of thousands of dollars in income taxes each year. Stretched out over a career, the savings (and growth on saved dollars) can reach well into the six figures.