Understanding Privacy of Business Ownership

You may want privacy of your ownership interest in your business. This could be for a number of different reasons, including avoiding baseless lawsuits. Perhaps someone you know that owns a business got sued last month and you believe you can avoid the same fate if people can’t find what you own. There are a number of Internet incorporation services touting certain privacy benefits, such as asset protection, by organizing your business under the laws of a certain state. Nevada and Wyoming (and even New Mexico and a few others) are usually the states being sold as “privacy and asset protection havens.” These states do not require the disclosure of the identities of the shareholders of a corporation, or members of a manager-managed LLC in the required corporate filings (public records). Usually, these “privacy” states only require that the directors (sometimes only 1) and officers of the corporation, or the managers of the LLC, be disclosed on the Articles of Incorporation (or Articles of Organization) and all annual reports.

But, there are a ton of myths out there regarding privacy and asset protection. Many new entrepreneurs get lured into believing what often amounts to false hype. I will try to dispel a few of these myths. The bottom line is that privacy does not protect your assets by itself, it is only beneficial. The single greatest benefit of a state’s privacy protections is that it can help prevent frivolous litigation. Preventing the average Joe from finding out what companies you may own by searching public records is a good thing. This can save a lot of baseless claims. If it takes longer for someone to figure out who the owners are, that is obviously beneficial. The plaintiff will have to spend more money and most lawsuits are a simple game of pure economics. So, privacy can sometimes make it very expensive for a potential plaintiff to find your assets.

Guaranteed asset protection simply through privacy of ownership is basically a myth. Specifically, whether your business should always organize under Nevada or Wyoming laws, or use nominees or even bearer shares are all common questions. The short answer is that Nevada, Wyoming (and a few other states) do offer privacy protections, but that is no guarantee you’ll protect your assets or avoid any type of liability for your conduct.

Myth #1: You can Maintain Complete Privacy by Organizing in Nevada or Wyoming (or elsewhere)

The stated advantages to organizing under Nevada or Wyoming law for privacy purposes include:

  • Privacy for stockholders by not requiring that their names become part of the public corporate records. Nevada or Wyoming do not require shareholders or the members of an LLC to be disclosed in the corporate filings, only the directors, officers and managers of the LLC need to be disclosed-I discuss this later in this article;
  • Permits use of nominee stockholders, directors and officers of corporations and nominee members and managers of LLC’s;
  • Nevada and Wyoming do not share its data with the Internal Revenue Service and is one of a handful of states that do not have a sharing arrangement in place with the IRS (33 states have an “Information Sharing Agreement” in place with the IRS). But, just because Nevada does not share information with the I.R.S. does not mean your information will be kept private. You will need to provide the I.R.S. with the name and social security number of the person responsible for all tax issues involving the company in order to obtain an EIN. Also, the company will be required to prepare a tax return (informational returns for S-Corp’s and most LLC’s), on which the names and social security numbers of the owners will be provided. Thus, the I.R.S. will end up with this information regardless.

But, you can lose this privacy in a variety of ways. Business owners may be required to disclose their identity in the following instances: 1) Registering to do business in your home state; 2) Issuing stock; 3) Obtaining any required business licenses (which the State of Nevada requires for most activities and charges an additional fee to obtain); 4) Opening a bank account; 5) Being an employee or independent contractor to the corporation or LLC; or 6) Entering into other contracts or agreements where you sign individually, such as entering into any loans. Nevada now also requires a tax payer ID number of the company and personal guarantee by you on the state’s business license.Thus, it may not make sense for the average business to organize in Nevada or Wyoming solely to take advantage of privacy for these reasons.

Also, keep in mind, you may have to personally guarantee any debt on behalf of your business and will likely enter into contracts on behalf of your business. This means providing your name and signature on certain documents. You will also need to provide a designated person along with their social security number to the IRS as the responsible party for tax matters when you obtain an FEIN for your business. These are all ways in which you could possibly disclose your identity. The average owner of an Internet business is going to operate his/her own business and really has no way to avoid these things.

Of course, if you don’t take an active role in operating the business or sign any such contracts or guarantees, these concerns may not apply. Also, using nominees (discussed more below) or even shelf corporations will generally allow you to avoid disclosing your identity in public (corporate) records. Some shelf corporations can even be purchased with established bank accounts, credit histories and tax returns filed with the Internal Revenue Service.

Myth #2: Privacy Alone Protects Your Assets

The privacy afforded to those organizing in Nevada, Wyoming or any other state with similar privacy features simply will not protect your interest in a corporation or LLC from your creditors. For example, pursuant to Nevada Civil Code NRS 21.080, all real and personal property of a judgment debtor (not otherwise exempt by law) is liable to execution, including “shares and interests in any corporation or company.” If a creditor obtains a judgment against you, your interest in a Nevada or Wyoming corporation/LLC is subject to attachment in order to satisfy the debt. You can either ignore the court order to testify regarding your assets (or refuse to answer questions after appearing) and face imprisonment for contempt of court, or commit perjury by lying about the extent of your assets. Obviously not appealing choices and why the notion of privacy does not protect your assets by itself. Do not be fooled by websites that tell you otherwise.

Myth #3: Using Nominees Is a Bullet Proof Strategy

Many online services tout the use of nominees as a bullet proof method of privacy and asset protection. Nevada and Wyoming law, for instance, allows for the use of nominee directors and officers and managers of an LLC, and nominee shareholders and members. The theory is that you can use a third party to conceal your identity as an owner and corporate officer or manager. Then, you can maintain control over the entity by using a proxy or some other instrument to control the corporation or LLC over the nominee. You should generally avoid using nominees or at least understand there are holes in this “bullet proof strategy.”

While you will gain some layer of privacy from having a nominee officer, shareholder, director, etc. this privacy will be lost once the nominee is served a subpoena and asked to provide the contact information for the owners of the company. The nominee will then be legally required to provide this information and your privacy is gone. Nevada civil procedure law makes it clear that the failure to obey a subpoena shall be punished for contempt. The law leaves no room for discretion unless the records to be disclosed are privileged. I think you would be hard pressed to find a nominee who is going to want to spend some time in jail for the small fee you pay for the services.

But, some services out there do offer the use of an attorney to act as an intermediary between you and the incorporation service. That attorney can then invoke attorney-client privilege, adding a layer of privacy anytime there is an inquiry about your identity. Dealing directly with the incorporation service creates no such privilege. However, in some instances the attorney may be ordered by the court to divulge your identity in cases of fraud or criminal conduct. This practice does present some measure of privacy.

Myth #4: Using Bearer Shares Provides Asset Protection

There are many asset protection and incorporation websites touting the use of bearer shares in the state of Nevada and elsewhere. Bearer shares are now illegal under the laws of the State of Nevada as of 2007. Regardless, the bearer share strategy does not prevent creditors from recovering your stock if a judgment is obtained against you. There are far too many holes with the use of bearer shares as a way to maintain privacy and protect your assets. This “strategy” creates all kinds of fraudulent transfer issues in the first place, as well as possible income and/or gift tax ramifications. There is really no need to go into any more detail other than to say you should you avoid services/websites touting the use of bearer shares as an asset protection vehicle. Also, for most small businesses, the most negative aspect of bearer shares is the inability to make an S-election due to the limitations on the number and type of shareholders. Not to mention bearer shares are not permitted by most states.

Actually Understanding Privacy

If you feel strongly about privacy, at least on the surface, then you should understand what this really means. Privacy actually lies specifically with any initial corporate filings annual reporting requirements of the state. If you are truly concerned, you can use a state like Nevada or Wyoming that allows no disclosure of members in a manager-managed LLC or shareholders on the initial or annual corporate filings. Nevada’s privacy protection protects members and shareholders from disclosure on corporate filings, but this privacy does not apply to certain officers, directors, and in the case of LLCs, managers. Nevada requires an incorporator or organizer to appoint by name at least one initial director in a corporation’s articles or in the case of an LLC, at least one member or manager in the articles of organization. In both cases, the articles are a public record, and anyone can request copies by paying a small fee.

Nevada, as other states, requires that every corporation and LLC file an “Annual List of Officers and Directors” each year. This requires disclosure of the full names of at least some of the officers and the directors of a corporation, and the managers of an LLC. This information is then posted on the Nevada Secretary of State’s Web site, which is a searchable public database and easy for anyone to figure out who is operating the corporation or LLC. Most states will allow you to designate a manager of your LLC and designate directors of a corporation and only list the information of those persons on the organizational documents.

But, depending on state law, the shareholders or members of an LLC are required to be listed on the annual reports go forward. This is where you may run into an issue with privacy if you are concerned. Regardless of state laws, it is very difficult for a small ongoing business to maintain the privacy of all owners. Also, it can be an administrative and financial burden to establish and maintain a corporation or LLC in another jurisdiction. The fees you pay to the state and these nominee type services will add up in a hurry. But, privacy is still a consideration in avoiding frivolous lawsuits, as I mentioned. Just understand the limitations and myths.