LLCs, Family Partnerships and Protection Trusts

Once insurance, exemptions and titling are in place, some people need more: a landlord with several properties, a business owner, a professional in a field with large claims, or a family with significant wealth to pass on. The next layer is legal entities and trusts. They are also the most oversold part of asset protection, sold with promises of being "judgment-proof" that courts regularly reject. This chapter explains what limited liability companies, family limited partnerships, domestic asset protection trusts and offshore trusts actually do, where each has failed in court, and what they cost to keep up, including the federal reporting that comes with anything held abroad.

The LLC: separating risks

A limited liability company does two different jobs, matching the two kinds of creditor from chapter 1.

It contains inside claims. If a tenant is hurt at a rental property owned by an LLC, the claim is generally limited to the LLC's own assets. Your home and personal accounts are not exposed, provided the LLC is run as a real separate business. Courts can "pierce the veil" and hold owners personally liable when an LLC is undercapitalised, mixes its money with the owner's, or ignores its own formalities. Separate bank accounts, separate contracts in the LLC's name and adequate insurance are what keep the shield intact. Many landlords hold each property, or a few properties, in separate LLCs so one claim cannot reach the others.

It can limit outside claims. If you are sued personally, a creditor generally cannot seize the LLC's assets or take over your role in it. In many states the creditor's main remedy is a charging order: a right to receive any distributions the LLC pays you, without any vote or control. Since the managers can decide not to distribute, a charging order is often an unattractive prize, which encourages settlement.

How strong that second protection is depends on the state and on the number of members. Several states make the charging order the exclusive remedy. Others let a creditor foreclose on the interest. Single-member LLCs are the weak spot: after Olmstead v. FTC (2010), Florida changed its law so a creditor can foreclose on a single-member LLC interest when a charging order will not pay the debt, and courts elsewhere have reached similar results. An LLC formed in a state with strong charging order law does not necessarily protect you if you live and are sued somewhere else.

Tax is usually neutral. A single-member LLC is disregarded for income tax and a multi-member LLC is taxed as a partnership by default, so the structure adds paperwork more than tax. Annual state fees and filing requirements vary widely by state.

Family limited partnerships

A family limited partnership, or an LLC used the same way, holds family investments. Parents typically control it as general partners or managers, while children receive limited interests over time. The appeal is threefold: central management of family assets, the charging order protection described above, and gift and estate tax valuation discounts, because a minority interest with no control and no market is worth less than its share of the underlying assets.

The IRS challenges these structures often, and has won when the parents kept using the assets as their own, put in nearly everything they owned, or could show no purpose beyond saving tax. Under section 2036 of the tax code, a court can pull the assets back into the parent's estate at full value. With the federal estate tax exclusion at $15,000,000 per person in 2026, few families need the discount for federal tax at all; the main uses now are management, protection and state estate taxes. Chapter 8 returns to this.

Domestic asset protection trusts

Traditionally, a trust you set up for your own benefit gave no protection from your own creditors. Since Alaska and Delaware changed that in 1997, roughly twenty states have allowed a domestic asset protection trust: an irrevocable trust, with an independent trustee in that state, under which you can be a discretionary beneficiary while your future creditors are blocked.

Their limits matter more than the brochures admit:

• Timing still rules. Transfers can be challenged as voidable for a period set by the trust state, and in federal bankruptcy a trustee can undo transfers to a self-settled trust made within ten years if they were made to hinder creditors.
• Living elsewhere weakens them. Courts in states that do not allow these trusts have applied their own law to residents who set one up in another state. In In re Huber (2013), a bankruptcy court disregarded a trust set up in Alaska by a Washington resident; in Toni 1 Trust v. Wacker (2018), Alaska's own Supreme Court held it could not stop other states' courts from ruling on transfers into Alaska trusts.
• Some creditors get through. Many trust states make exceptions for child support, alimony and certain earlier creditors.
• You give up control. The trust is irrevocable and an independent trustee decides distributions.

Offshore trusts and companies

Some planners recommend trusts in jurisdictions such as the Cook Islands or Nevis, or Nevis LLCs, because those courts do not enforce US judgments, set short deadlines for creditors and may require a creditor to post a bond and retry the case locally. They can make collection very hard. They also carry serious costs and risks:

• Contempt. A US court cannot seize assets held abroad, but it can order you to bring them back and jail you for contempt if you claim you cannot. In FTC v. Affordable Media (1999), a federal appeals court upheld contempt against a couple who said their offshore trustee would not return funds.
• No tax benefit. A foreign trust you fund for yourself is generally a grantor trust: you pay US tax on its income as if you held the assets directly.
• Heavy reporting. Foreign trusts require IRS Forms 3520 and 3520-A, with large penalties for missing them. Foreign accounts above a combined $10,000 at any point in the year must be reported to the Treasury on an FBAR, and foreign financial assets above set thresholds go on Form 8938 with your tax return. For an unmarried person living in the United States that threshold is more than $50,000 at year end or $75,000 at any time during the year; for a married couple filing jointly it is $100,000 or $150,000. The two reports are separate obligations.
• Cost. Setup and annual trustee fees are high enough that these structures are rarely sensible except for large, liquid wealth.

The FBAR and Form 8938 threshold checker shows whether your foreign accounts must be reported.

Trusts that protect what you leave others

The strongest and least controversial trust protection is the one you give your heirs. A trust you set up for children or others, not for yourself, can include a spendthrift clause that stops a beneficiary from pledging their interest and blocks most of their creditors, including in many states a divorcing spouse. Leaving an inheritance in such a trust, instead of outright, is often the most useful protection step a family can take, and it raises none of the timing problems of self-settled trusts. Chapter 8 covers the estate tax uses of irrevocable trusts.