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Danger! Watch Out for Changing Entity Types

Author: Chris Boggs

Not long ago my wife and I attended a "training" session with an accountant who specializes in using tax laws/loopholes to help parents pay for college. Since we have a rising junior, we are very interested in anything we can do to save for and lower the cost of college.

The session was geared towards small business owners and my wife owns her own business. We were hoping for some really good insight and ideas.

As I expected, we were really attending a "sales" job. He gave us just enough to whet our appetite, but not enough to do much good. His goal was to get us to pay him big bucks to come to his office to get the useful details.

Surprisingly, or maybe unsurprisingly, I was the only person asking questions. I think I annoyed him a bit; but I wanted more specifics. I learned one thing, this guy could have been in insurance education; his favorite answer was, "It depends."

During the session, the accountant brought up the advantages and disadvantages of the various entity types (though not in any real detail). He briefly introduced some of the advantages of LLCs, vs. S-Corps., vs. C-Corps, vs. LLPs, etc. But he never brought up sole proprietorships, so I asked him if he was against them. He said, "Not necessarily; it depends."

Let me cut to the end. Ultimately the goal is to hide as much money from the government and the college as possible to increase the amount of financial aid available to the student (without having to take student loans). One of the success stories used to reel you in involved a husband who was a lawyer and a wife who was another highly-paid professional (I don't remember what she did) who was able to get their kid into Duke University for around $7,000 per year. The natural reaction of everyone who knows anything about what it costs to go to Duke was, "WOW!!!"

My follow-up question was, "In developing these college-focused plans, what has to be changed after all the kids are finished with college?" My point being, you've directed clients to move money around, set up various legal persons and put money in places where it is not necessarily liquid; what must be undone when you are through?

His partner piped up to help answer the question. I won't bore you with the entire response. Basically she said, you've just got to trust us. Yeah, that's not the warm and fuzzy that motivates me.

But this is not what really bothered me about his suggestions; what really concerned me is that he was oblivious or ambivalent to the insurance issues created when one person is "killed off" and a new person is "hatched" to take its place. He seems to have an incredible need to create one entity then kill it off in favor of another entity when the situation changed. And what's worse, at one point he even said something about setting up multiple entities to hide or move money.

I think he saw my face turn red, but he never said anything. I certainly hope he has a lawyer and an insurance agent providing advice (but I doubt it).

After the meeting, we spent the afternoon on the lake with friends who own a lake house, so I had time to calm down. Later that evening I tried to explain to my wife the insurance problems created when one entity ceases to exist and another entity magically appears in its place; or when multiple entities are created. She feigned interest, but she really just wanted to discuss whether we should pay the account's fees to have him advise us on how to send our daughters to school without going into incredible debt.

Why do I tell this story? Because this is what agents fight against daily. Accountants and maybe even lawyers who don't know anything about insurance, recommending your clients make changes or additions to their business entities.

Don't misunderstand, it's not that these issues cannot be adequately addressed (to some extent), the problem is that you have to know about the issues to do something about them. A few simple questions may keep your client, and you, out of the trouble:

  1. Is this still the correct entity name?
  2. Did the entity type change?
  3. Have any new business entities been created?
  4. Have any entities ceased to exist? 

These are just a few examples of the questions you need to ask at renewal to make sure your business clients have not made changes you know nothing about, but which could have major coverage implications. When you discover something has changed, you need to get all the necessary information. You can't assume everything is as it was. Oh, and this doesn't apply only when kids are getting ready to head off to college. Accounts and lawyers recommend these changes every day (without a thought to the consequences). Ask the questions.

Whether or not we are going to enrich this account any further is still in question. Regardless, I'm definitely going to do my best to make sure anyone who takes this type of advice doesn't suffer an uncovered claim simply because they made seemingly innocuous changes that adversely affected their insurance protection.

We can't have people who know nothing about insurance creating problems for our clients. Agents, keep up the good fight!!

Last Updated: July 7, 2017

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