What Are The Best Strategies For Asset Protection?
Introduction
If you haven't done any asset protection
planning, your wealth is vulnerable to potential future creditors and, should
the worst happen, you could lose everything.
Lawsuits, taxes, accidents, and other
financial risks are facts of everyday life. And though you'd like to believe
that you're safe, misfortune can befall even the most careful person. What can
you do? First, identify your potential loss exposure, then implement strategies
that are designed to help reduce that exposure without compromising your other
estate and financial planning objectives.
First, a word about fraudulent
transfers
Part of your overall asset protection plan
might include repositioning assets to make it legally difficult for potential
future creditors to reach them. This does not, however, extend to actions that
hide assets or defraud creditors. If a court finds that your asset protection
plans were made with the intent to defraud, it will disregard those plans and
make the assets available to creditors.
How can you avoid running afoul of the
fraudulent transfer laws?
•
Make
sure your plans are made for legitimate business purposes or to accomplish
legitimate estate planning objectives
•
Carefully
document the legitimate business and estate planning purposes of any
arrangements you make
•
Put
your plans into effect before you have any problems with creditors
•
Do not
implement a plan at a time when a lawsuit is imminent or pending or at a time
when you have an outstanding debt that you believe you may be unable to pay
Where the dangers lie
Unexpected liability can come from just about
anywhere:
•
The
IRS and other tax authorities
•
Accident
victims, including victims whose injuries were caused by the actions of minor
children or employees
•
Doctors,
hospitals, nursing homes, and other health-care providers
•
Credit
card companies
•
Business
creditors, including employees and former employees, governmental agencies,
suppliers, customers, partners, shareholders, and the general public
•
Creditors
of other individuals, where you have cosigned or guaranteed obligations for
those individuals
•
Marital
or other live-in partners
Asset protection techniques
There are three basic asset protection
techniques: insurance, statutory protection, and asset placement. None of these
techniques is a complete solution by itself, but may make sense as one limited
component of an asset protection plan.
Insurance
The simplest way to cope with risk is to
shift the risk to an insurance company. This should be your first line of
defense. Before you do anything else, review your existing coverage. Then
consider purchasing or increasing coverage on your insurance policies as
appropriate.
You should be adequately insured against:
•
Death
and disability
•
Medical
risk, including long-term care
•
Liability
and property loss (both personal and business)
•
Other
business losses
Statutory protection
Creditors can't enforce a lien or judgment
against property that is exempt under federal or state law. While exemption
planning can't offer total protection, it can offer some shelter for certain
assets.
Both federal and state laws govern whether
property is exempt or nonexempt in nonbankruptcy proceedings (separate federal
and state laws govern whether property is exempt or nonexempt in bankruptcy
proceedings). Generally, you can choose whether the federal exemption or the
state exemption applies. When looking at exemption laws, be sure to find out
how much of an exemption is allowed for a particular type of property--it may
be completely exempt, or exempt only up to a certain amount or restricted in
some way.
Types of property often receiving an exemption include:
•
Homestead
(principal residence)
•
Personal
property
•
Motor
vehicle
•
IRAs,
pension plans, and Keogh plans
•
Prepaid
college tuition plans
•
Life
insurance benefits and cash value
•
Proceeds
of life insurance
•
Proceeds
of annuities
•
Wages
Tip: In those jurisdictions that
recognize ownership by tenancy by the entirety (TBE), creditors of the husband
or creditors of the wife cannot reach TBE assets.
Asset placement
Asset placement refers to transferring legal
ownership of assets to other persons or entities, such as corporations, limited
partnerships, and trusts. The basis for this technique is simple--creditors
can't reach property that you do not own or control.
Shifting
assets to the spouse who is less exposed to claims
If you have high exposure to potential
liability because of your occupation or business, it may be advisable for you
to shift assets to your spouse. Your spouse would retain the assets that are
subject to the exposure as his or her separate property, and you would retain
assets that enjoy statutory protection, such as the homestead, life insurance,
and annuities, as separate property. Furthermore, the shifting of assets to a
spouse or children may help accomplish other estate planning goals.
Caution: To avoid complications in the
event that your marriage ends in divorce, both you and your spouse should agree
to the division of assets in writing. This is especially important in community
property states.
C
corporations
If you own a business and aren't already a C
corporation, changing your business structure to a C corporation will make it a
separate legal entity in the eyes of the law. As such, a C corporation owns the
business assets and is responsible for all business debts. Thus, incorporating
your business separates your business assets from your personal assets, so your
personal assets will generally not be at risk for the acts of the business.
Caution: The limited liability feature
may be lost if, for example, the corporation acts in bad faith, fails to
observe corporate formalities (e.g., organizational meetings), has its assets
drained (e.g., unreasonably high salaries paid to shareholder-employees), is
inadequately funded, or has its funds commingled with shareholders' funds.
Caution: A number of issues should be
considered when selecting a form of business entity, including tax
considerations. Consult an attorney and tax professional.
Limited
liability companies (LLCs) and partnerships (LLPs and FLPs)
An LLC is a hybrid of a general partnership
and a C corporation. Like a partnership, income and tax liabilities pass
through to the members, and the LLC is not double-taxed as a separate entity.
And, like a C corporation, an LLC is considered a separate legal entity that
can be used to own business assets and incur debt, protecting your personal
assets from other nontax claims against the LLC.
Professionals (e.g., doctors, lawyers, and
accountants) face liability for damages that result from the performance of
their professional duties. While no business structure will protect you from
personal liability for your professional activities, an LLP will protect you
from the professional mistakes of your partners. That is, if one of your
partners is sued, and the LLP is also named in the lawsuit, any malpractice
judgment is the personal liability of the partner who's been sued, but a
business liability for you and the other partners. Your personal assets aren't
at stake if your partner commits malpractice, although your investment in the
business may still be at risk.
An FLP is a limited liability partnership
formed by family members only. At least one family member is a general partner;
the others are limited partners. A creditor can't obtain a judgment against the
FLP--it can only obtain a charging order. The charging order only allows the
creditor to receive any income distributed by the general partner. It does not
allow the creditor access to the assets of the FLP. Thus, a charging order is
not an attractive remedy to most creditors. As a result, the limitation to
seeking a charging order can often convince a creditor to settle on more
reasonable terms than might otherwise be possible.
Protective
trusts in general
A protective trust can protect both business
and personal assets from most creditors' claims. A trust works because it
splits ownership of trust assets; the trustee has equity ownership and the
beneficiaries have beneficial ownership. Essentially, a protective trust works
like this:
Example(s): Harry would like to leave
property to Wendy. However, Harry is afraid that his creditors might claim the
property before he dies and that Wendy will receive none of it. Harry
establishes a trust with both himself and Wendy as the beneficiaries. The
trustee is instructed to allow Harry to receive income from the trust until
Harry dies and then to distribute the remaining assets to Wendy. The trust
assets are then safe from being claimed by Harry's creditors, so long as the
debt was entered into after the trust's creation.
Under these circumstances, any of Harry's
creditors would be able to reach assets in the trust only to the extent of
Harry's beneficial interest in the trust. Say that Harry's interest in the
trust is a fixed income distribution each month in the amount of $1,000.
Assuming Harry's creditors obtained a judgment, they would only be entitled to
the $1,000 per month.
Irrevocable
trusts
As the name implies, an irrevocable trust is
a trust that you can't revoke or change. Once you have established the trust,
you can't dissolve the trust, change the beneficiaries, remove assets from the
trust, or change its terms. In short, you lose control of the assets once they
become part of the trust. But, because the assets are out of your control,
they're generally beyond the reach of creditors too. You may further protect
those assets from your beneficiaries' creditors by using special language
(known as a spendthrift clause) in the trust.
Caution: Unlike an irrevocable trust, a
revocable trust provides the assets in the trust with absolutely no legal
protection from your creditors.
Offshore
(foreign) trusts
It's possible to transfer assets to trusts
that are formed in foreign countries (certain countries are preferred). While
the laws of each country are different, they share one similarity--they make it
more difficult for creditors to reach trust assets.
Here's how it works: In order for a creditor
to be able to reach assets held in a trust, a court must have jurisdiction over
the trustee or the trust assets. Where the trust is properly established in a
foreign country, obtaining jurisdiction over the trustee in a U.S. court action
will not be possible. Thus, a U.S. court will be unable to exert any of its powers
over the offshore trustee.
So, the creditor must commence the suit in
the offshore jurisdiction. The creditor can't use its U.S. attorney; it must
use a local attorney. Typically, a local attorney will not take the case on a
contingency fee basis. Therefore, if a creditor wants to pursue litigation in
the offshore jurisdiction, it must be prepared to pay the foreign attorney up
front. To make matters even less convenient, many jurisdictions require the
creditor to post a bond or other surety to guarantee the payment of any costs
that the court may impose against the creditor if it is unsuccessful. Taken as
a whole, these obstacles have the general effect of deterring creditors from
pursuing action.
Domestic
self-settled trusts
The laws in Alaska, Delaware, Nevada, and a
few other states enable you to set up a self-settled trust. Alaska was the
first state to enact such an anti-creditor trust act, and Delaware quickly
followed. Hence, this type of trust is often called an Alaska/Delaware trust
(sometimes also referred to as a domestic asset protection trust, or DAPT). A
self-settled trust is a trust in which the person who creates the trust (the
grantor) can name himself or herself as the primary, or even sole, beneficiary.
These trusts give the trustee wide latitude to pay as much or as little of the
trust assets to any or all of the eligible beneficiaries as the trustee deems
appropriate. The key to this type of protective trust is that the trustee has
the discretion to distribute or not distribute the trust property. Creditors
can only reach property that the beneficiary has the legal right to receive.
Therefore, the trust property will not be considered the beneficiary's
property, and any creditors of the beneficiary will be unable to reach it.
Caution: Domestic self-settled trusts may
not be as effective as a foreign trust, because a judgment from an individual
state must be honored by another state under the United States Constitution.
CornerStone Financial
Whether your
nest-egg is worth millions or thousands,
You and your
family deserve it more than the government....
We are here to help you with all of your
financial and insurance needs. Our skilled professionals are licensed
with over 100 top name companies and can help you gain a better understanding
of the concepts behind insurance including investing, retirement and estate
planning. There are literally thousands of products to choose from,
but we can help pinpoint what is best for you and your situation. Please
do not hesitate to contact us if you have questions.
Contact:
Eric Tuttobene
President/CEO
CornerStone
Financial
(615) 427-8780
IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
in these materials may change at any time and without notice.
