Have You Protected Your Assets? - Steps You Can Take Now
THE COUNSELOR
Volume 11 • Issue 6 • June 2021
The Counselor is a newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue will look at asset protection strategies - from the simple to the complex. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
Millions of lawsuits are filed in the United States every year. This has led to the development of different strategies to place assets beyond the reach of creditors. This is most often accomplished by the compartmentalization of risk and the strategic ownership of assets. These strategies include outright gifts of assets, co-ownership of assets with less “risky” individuals, and transfers of assets to business entities such as limited liability companies (LLCs) and trusts. Asset protection planning is not about hiding or concealing assets. It is about using the existing laws appropriately to obtain the best possible level of protection in the event a lawsuit happens. To be effective, asset protection plans must be properly designed, drafted, and implemented. An asset protection plan is never stronger than its weakest link.
While most of us like to have a high degree of certainty in the outcome of a particular planning strategy, asset protection tends to be more art than science. Asset protection planning tends to be a balancing act between your desire for access to/control over assets and your desire to protect the assets from the claims of others.
When to Plan
In the United States, more than 41,000 lawsuits are filed each day (more than 15 million lawsuits each year). The best and really only time to plan is before the claim arises. Whichever strategy may work best for you, it is important to remember that you should never make a transfer that would constitute a voidable transfer under state or federal law. A voidable transfer is one where a transfer is made or an obligation incurred (1) with actual intent to hinder, delay, or defraud any creditor of the debtor; or (2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they became due.
A transaction is voidable regardless of whether the creditor's claim arose before or after the transfer was made or the obligation was incurred. A recent case made clear that it doesn’t matter what other motives you may have had, if even one of your motives fits within the definition of a voidable transfer, the transaction will be overturned. Therefore, you should always maintain sufficient assets to provide for your support, care, and maintenance. Never render yourself insolvent.
The Seven Levels of Asset Protection
A combination of strategies often works best in asset protection. Also, it is important to crawl before you walk. Therefore, asset protection planning is often done by levels, usually starting at the lowest. Not every level will be appropriate for every person. The following are what we refer to as the seven levels of asset protection.
Level 1: Keep Quiet
The most basic asset protection planning technique we can share is to be discrete. The norm in society is to shout about your wealth. Be discrete! Beware of what you put on Facebook or other social media. Keep quiet! It is harder to take what you don’t know about.
Level 2: Exemptions
Certain assets are automatically protected by state or federal exemptions. State exemptions include personal property, life insurance, annuities, IRAs, homestead, joint tenancy, or tenancy by the entirety. Different states protect assets differently and amounts of the exemptions will vary greatly from state to state. For example, some states, like Florida, have an unlimited homestead exemption while others, like Utah, are very limited. Federal exemptions include ERISA which covers 401(k) and 403(b) plan accounts, pensions, and profit-sharing plans. Creating and funding qualified retirement plans for clients can provide excellent shelters against creditors’ claims.
Level 3: Liability Insurance
Obtain or increase liability insurance and umbrella coverage. It is amazing how few people are carrying relatively inexpensive umbrella policies. Get with your insurance advisor and review your insurance coverage to determine if adequate coverage exists.
Level 4: Titling of Property and Property Agreements
Title is king. If you own an asset that is not covered by an exemption, it could be lost to a creditor. If you are in a high risk profession, consider titling property in the name of a spouse who may not be subject to as much risk. If you are in a community property state, like Idaho or Arizona, consider a property agreement that converts community property into separate property. In making this decision, it is important to take into account the loss of the double step-up in income tax basis that occurs with community property. Also prenuptial agreements can be an important tool in providing asset protection in the event of a divorce, as well as protecting your estate plan at death.
Level 5: Entity Formation
Any entity will be better than a sole proprietorship or general partnership, but choosing the right entity can really make a difference. LLCs can be created to own specialized or valuable equipment and/or real estate and to remove these assets from an operating entity. This allows you to segregate real estate, equipment and even securities accounts from exposure to the liabilities of the operating entity. It is also important to know that the laws of each state vary and there may be a benefit to forming your business in a state other than the state where you reside.
Level 6: Irrevocable Trusts
People are often mistaken in their belief that traditional revocable living trusts (RLTs) provide asset protection. So long as a trust is revocable, it does not provide asset protection. However, an RLT can be drafted to provide asset protection for the surviving spouse or children after the death of the first spouse. Additionally, an irrevocable trust established by a person during their lifetime for the benefit of another person (often a spouse or children) can also provide desired asset protection. Common examples of these include:
Medicaid Asset Protection Trust
Spousal Lifetime Access Trust
Intentionally Defective Irrevocable Trust
Beneficiary Defective Irrevocable Trust
Because these irrevocable trusts are not for the benefit of the person creating them, they have a much higher level of protection. But they can also be drafted in a manner to allow you to continue to benefit indirectly from the assets.
Level 7: Self-Settled Asset Protection Trusts
While irrevocable trusts have always been used to provide creditor protection for third-party beneficiaries, an increasingly popular strategy is to seek asset protection for the individual creating the trust. Self-settled asset protection trusts are irrevocable trusts where the person creating the trust continues to have some access to the assets held by the trust. These come in many forms. Certain states, including Utah, allow a person to establish an irrevocable trust for the benefit of himself or herself. These are referred to as Domestic Asset Protection Trusts (DAPT). To qualify for asset protection, the requirements of the particular state statute where the DAPT will be located must be followed in drafting the DAPT. There are no clear court rulings supporting the use of DAPTs. It is especially unclear that a DAPT will provide protection for assets located in jurisdictions where DAPTs are not authorized by state statute.
Another type of self-settled asset protection trust is the foreign or off-shore asset protection trusts (FAPT). A FAPT is a trust created outside of the United States and assets are also held outside of the United States. Because the assets are outside of the United States, they are also beyond the jurisdiction of judges in the United States. The FAPT is governed by the laws of the jurisdiction where the FAPT is located. Because the asset itself must be located outside of the United States, real property will not benefit from being held in a FAPT. While judges cannot reach the asset, the trend appears to be for the judge to hold the Grantor in contempt and possibly incarcerate the Grantor until the assets are brought back onshore and paid to the creditor.
Conclusion
Asset protection planning is a valuable and important part of estate and business planning. Everyone can benefit from implementing one or more of the seven levels of asset protection planning. As you graduate into the increasingly complex ways of protecting assets, the advice of competent counsel is a necessity. So don’t wait until it’s too late. Protect your assets today.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.