Is Your Legal Structure Being Maintained Properly?

It’s not uncommon for an astute businessperson to set up a number of entities: corporations, limited liability companies (LLCs), trusts, family partnerships and maybe even a family foundation. These can all be great ways to accomplish a number of objectives: asset management; centralization and preservation of wealth; maintenance of peace and harmony in the workplace and the family; tax minimization; asset protection; and so on.

However, even though these vehicles can be terrific, they must also be properly maintained. Imagine buying a brand new backhoe loader, and then neglecting to change the oil on schedule. It would be like pouring money into a hole you dug yourself.

The same thing can happen with legal entities you’ve set up. It’s important to keep them maintained or else they’ll stop working properly. From time to time, you hear sad stories about folks who have paid a lot of money to set up an elaborate corporation structure, and then it all backfires on them. Often, this is because of lack of maintenance. And it’s not their fault—perhaps they were never told there was a service schedule!

Here are some things that you can do to make sure your legal structure is being properly maintained:

• Minutes. Make sure your corporation has an annual meeting of the Board of Directors and Stockholders, and that written minutes are prepared to document that meeting. An LLC may also need to have an annual meeting of the members, depending on how the LLC was set up and what its purpose is.
  
• Buy/Sell and Business Continuation Agreements. A famous tax expert once said something like this: “A corporation, like a lobster pot, is easy to get into, difficult to live in, and almost impossible to get out of.” It’s important to have a plan in place for the continuation of a business in the event a key person dies or becomes disabled. In the case of a multiple-owner company, it’s essential to have a plan that addresses what happens if one of the owners dies. Should his shares be bought out by the corporation or the remaining shareholders? How will the buy-out be financed? In addition to death, the stockholders might also want to address disability, bankruptcy, risk of losing shares of stock in a divorce, retirement, resignation and involuntary termination.
  
• FLP and FLLC Periodic Inspection. If you have formed a family limited partnership or family LLC, are all of the documents up to date with recent case law? A number of cases are decided each year by the Tax Court and Courts of Appeals. Some are favorable to the taxpayer; others are adverse. Sometimes, the emerging case law warrants an amendment to your legal documents, or a change in how the FLP or FLLC is being funded or gifted to your loved ones. It’s important to have all this reviewed annually to make sure you are in compliance with the current state of the law, which is constantly unfolding. If the FLP or FLLC is not maintained, the result can be costly estate and gift taxes.
  
• Family Foundations. The Senate Finance Committee had been working on a major overhaul of the area of law dealing with tax exempt organizations, including private foundations and supporting organizations. The efforts of this committee were stalled due to the refocus of energies in the aftermath of Hurricane Katrina. However, it won’t be long before this Committee gets back to work, whether it directs its efforts toward sweeping legislative reform or just some ad hoc measures intended to curtail perceived abuses.
  
• Insurance Trust Yearly Maintenance. If you have an insurance trust, an annual inspection should be done to make sure you are in compliance with the rules that allow you to reap the huge tax benefits from it. For example, does the trust do the following:
  
  
• Is cash being gifted to the trust?
• Is the trustee paying the premiums? (If you are paying them directly, then the policy proceeds will be subject to estate tax.)
• Are “Crummey” notices being provided to the beneficiaries to ensure that the gifts qualify for the $12,000 gift tax exclusion per beneficiary?
• Are copies of the “Crummey” notices being kept permanently?
• Are copies of canceled checks being kept to prove your gifts to the trust and the trust’s payment of the premiums?
• Is the trust maintaining checking account records, showing gift deposits and premium disbursements?
• Have you, the grantor, avoided incidents of ownership that could arise from retaining prohibited powers to: change or add a beneficiary; surrender or cancel the policy; assign the policy; revoke an assignment; borrow against the policy; use policy loans to pay premiums; pledge the policy to secure a loan?

All of the above vehicles are valuable and useful for helping you accomplish your goals. However, it is important to ensure they comply with the current state of the law. Otherwise, neglect, however inadvertent, will cause them ultimately to backfire.