Should You Use a Trust or LLC for Asset Protection?

Asset protection involves structuring ownership of assets to shield them from future claims by creditors or in lawsuits. The two most common legal tools for this are the Limited Liability Company (LLC) and the Trust. The choice between them, or the decision to use them in combination, depends on the types of assets involved, the nature of potential risks, and an individual’s financial goals. This article explores how each structure functions to safeguard wealth.

Asset Protection with a Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a business structure that creates a legal barrier between business and personal finances, known as the “corporate veil.” If the business incurs debts or is sued, the owner’s personal assets, like their home and bank accounts, are protected from being used to satisfy those obligations. This protection can be lost if business and personal finances are mixed or if the LLC is not maintained properly.

The main asset protection feature of an LLC against an owner’s personal creditors is “charging order” protection. If an LLC member is sued for a personal matter, a creditor cannot seize assets owned by the LLC. Instead, the creditor’s remedy is to obtain a charging order from a court, which acts as a lien. This order gives the creditor the right to receive any profit distributions made from the LLC to that member.

A charging order is a deterrent because the creditor cannot participate in managing the LLC, force the sale of its assets, or demand a distribution. If a multi-member LLC decides not to make any distributions, the creditor receives nothing. This gives the debtor a stronger negotiating position.

The strength of charging order protection depends on whether the LLC is a single-member or multi-member entity. Multi-member LLCs offer more protection because any action against one member could impact the others. In contrast, protection for single-member LLCs can vary by state, with some jurisdictions allowing a creditor to foreclose on the member’s interest and take control. For this reason, LLCs are used to hold high-risk assets, like rental properties, to isolate that liability from other holdings.

Asset Protection with a Trust

A trust is a legal arrangement where a grantor transfers assets to a trustee, who manages them for beneficiaries. The level of asset protection a trust offers depends on its structure, specifically whether it is revocable or irrevocable.

A revocable trust, or living trust, offers no asset protection from the grantor’s creditors. Since the grantor retains the right to cancel or change the trust, the law views the assets as still belonging to the grantor. Therefore, creditors can pursue assets held in a revocable trust.

For asset protection, an irrevocable trust is required. When a grantor transfers assets into an irrevocable trust, they give up ownership and control. The assets are then legally owned by the trust and managed by the trustee. Because the grantor no longer owns the assets, they are shielded from the grantor’s future creditors.

A Domestic Asset Protection Trust (DAPT) is a type of irrevocable trust available in some states that allows the grantor to also be a beneficiary while receiving creditor protection. Transferring assets into an irrevocable trust to defraud known creditors is illegal. This is considered a fraudulent conveyance, and courts can undo such transfers, making the assets available to creditors.

Key Tax Distinctions

The tax treatment for LLCs and trusts is a major consideration. LLCs offer tax flexibility, allowing owners to choose how the entity is treated by the IRS, which avoids the “double taxation” of C corporations. An LLC can be taxed in four primary ways:

• As a “disregarded entity” (the default for single-member LLCs), with income reported on the owner’s personal tax return via Schedule C.
• As a partnership (the default for multi-member LLCs), filing Form 1065, with profits passed through to the members.
• As an S Corporation by filing Form 2553, allowing owners a salary and profit distributions.
• As a C Corporation by filing Form 8832, where the business pays income tax at the corporate level.

Trusts have two tax classifications: grantor and non-grantor. A grantor trust is a pass-through entity for tax purposes, where the grantor retains certain controls. All income and deductions are reported on the grantor’s personal income tax return.

A non-grantor trust is a separate taxpayer and must file its own tax return, Form 1041. If the trust distributes income, the beneficiaries pay tax on it; if the trust retains income, the trust itself pays the tax. Non-grantor trusts have highly compressed tax brackets. For the 2025 tax year, a trust reaches the top federal tax rate on taxable income over $15,650, a much lower threshold than for individuals.

Formation and Ongoing Compliance

Creating an LLC involves formal steps with the state, beginning with filing Articles of Organization with the secretary of state. This document includes the LLC’s name, address, and its registered agent. State filing fees are required for formation.

After formation, LLCs create an Operating Agreement, an internal document outlining ownership and operational rules. To maintain the liability shield, an LLC must keep business finances separate from personal funds. Filing annual reports and paying yearly fees to the state are also required.

Establishing a trust requires creating a formal trust agreement, a private legal document drafted by an attorney. This agreement names the trustee and beneficiaries and outlines the rules for managing and distributing the trust’s assets. Unlike an LLC, it is not filed with a state agency.

After creating the agreement, the trust must be “funded” by legally transferring ownership of assets into it. For real estate, this requires recording a new deed, while financial accounts must be retitled in the trust’s name. Ongoing compliance for a trust rests on the trustee’s duties, including managing assets and filing tax returns for non-grantor trusts.

Integrating LLCs and Trusts for Enhanced Protection

Choosing between an LLC and a trust is not always an either/or decision, as integrating both structures can offer enhanced protection. This approach creates multiple layers of defense against different types of potential creditors. Combining the features of each allows for a more comprehensive strategy.

A common strategy is to create an irrevocable asset protection trust and make it the owner of an LLC. The LLC then holds high-risk assets, such as a rental property portfolio or a business. This structure segregates the assets and insulates the original owner from related liabilities.

This structure provides dual protection. The LLC’s corporate veil and charging order protection act as the first line of defense, containing any liability from the asset within the LLC. At the same time, because the irrevocable trust owns the LLC, the membership interest itself is shielded from the individual’s personal creditors. A creditor cannot seize the LLC because the trust, not the individual, is the owner.

This integrated strategy separates asset ownership from control. The individual can serve as the manager of the LLC, retaining operational control, while the ownership interest is held by the trust. Although more complex to establish and maintain, this layered approach provides a high degree of asset protection.