Asset Protection: LLCs vs. Trusts (How to Become “Judgment Proof”)
Asset Protection: LLCs vs. Trusts (How to Become “Judgment Proof”)
EXECUTIVE SUMMARY
- The Threat: In the US, a lawsuit is a lottery ticket. If you own assets in your own name, a single car accident or slip-and-fall can wipe out your life savings. Insurance covers negligence, but not everything.
- The LLC (The Shield): An LLC separates your business assets from your personal assets (“Inside Liability”) and protects your business from your personal creditors (“Outside Liability” via Charging Orders).
- The Trust (The Vault): A Revocable Living Trust avoids probate (saves time/fees) but offers ZERO asset protection. For true protection, you need an Irrevocable Trust (Asset Protection Trust), which removes ownership from your hands entirely.
Wealth creation is offense; Asset Protection is defense. Most people confuse “Probate Avoidance” (Revocable Trust) with “Asset Protection” (LLC/Irrevocable Trust). They are not the same. According to Team BMT Analysis, the goal is to make yourself look “poor on paper” so that predatory lawyers settle for the insurance limits instead of pursuing your personal estate. Source: Nolo Legal Encyclopedia / American Bar Association
Scenario: You are sued personally for $2M. You own a Rental Property inside an LLC.
- Without LLC: The judge orders the property sold to pay the $2M judgment. You lose the asset.
- With LLC (Wyoming/Nevada): The creditor cannot seize the property. Their only remedy is a “Charging Order”โa lien on distributions.
The Trap: You (Manager) decide not to distribute cash. The creditor gets nothing but a tax bill on the “Phantom Income” (K-1).
Result: The creditor settles for pennies because they can’t touch the asset.
Protection Level Comparison
| Legal Structure | Protection Score (0-10) |
|---|---|
| Sole Proprietorship | 0 |
| Revocable Living Trust | 1 |
| Domestic LLC | 7 |
| Cook Islands Trust | 10 |
*Chart Note: A Revocable Trust helps your heirs (Probate), but it does not help you (Lawsuits). For protection, you need entities that separate legal ownership from beneficial enjoyment.
CRITICAL SCENARIO: The “Inside-Out” Attack
Where is the liability coming from?
| Direction | Scenario | Best Defense |
|---|---|---|
| Inside Liability | Tenant falls at your rental property. | LLC (Keeps lawsuit contained to that property). |
| Outside Liability | You crash your car (Personal fault). | Asset Protection Trust (Prevents seizing the business). |
Execution Protocol
Everyone needs this. It acts as the “Will Substitute.” Title your home and brokerage accounts in the name of the trust.
Benefit: Privacy (no public probate record) and easy transfer at death.
Limit: It does not stop a lawsuit.
Put every rental property in its own LLC (or Series LLC). This creates “firewalls.” If one house burns down (lawsuit), the fire doesn’t spread to your other houses or your personal bank account.
Before spending $10k on lawyers, spend $500 on a $2M Personal Umbrella Policy. Insurance is the first line of defense. Lawyers usually stop suing once they hit the policy limit.
Fail Condition: Relying on complex offshore trusts while having zero insurance coverage.
WEALTH STRATEGY DIRECTIVE
- Do This: Check the “Grant deed” of your home. If it’s in your personal name, move it to your Revocable Trust immediately. This avoids probate court.
- Avoid This: Putting your personal residence in an LLC. You will lose the “Section 121” Capital Gains Exclusion ($500k tax-free) and Homestead Exemption rights. Keep the home in a Trust, not an LLC.
Frequently Asked Questions
Do I need a Nevada/Wyoming LLC?
Only if you live there or own property there. For real estate, you generally must register the LLC in the state where the property is located. A Wyoming LLC owning a California property still has to pay California taxes.
What is a DAPT?
Domestic Asset Protection Trust. Available in 17 states (like NV, DE, SD). It allows you to be a beneficiary of your own irrevocable trust while still shielding assets. It is the “Nuclear Option” for US residents.
Does a Trust file a tax return?
Revocable Trusts use your SSN (no extra return). Irrevocable Trusts need a separate Tax ID (EIN) and file Form 1041. LLCs file Form 1065 (Partnership) or Schedule C (Disregarded).