Integrated Risk Planning

Preventing Disaster: Planning Across Lines of Business, Personal and Estates Russ Pike Sherman, Sherman, Johnnie & Hoyt, LLP russ@shermlaw.com or 503-364-2281

Overview
Risk Planning Concepts
Different Types of Trusts and Their Uses
Different Types of Entities and Their Uses
Integrating Trusts, Entities, and Insurance
Achieving Risk Reduction – Putting it All Together

Why Risk Planning?
Victim oriented society
Deep pockets
Substantial insurance
Significant personal assets
Increased social media and awareness- nothing is private
Publicity of judgments against high net worth individuals

Risk Planning Basics
Risk Planning is:
A structure that makes assets difficult or impossible to reach
Places a portion of your net worth behind some obstacles
Planning for future liabilities
Risk Planning is Not:
Fraud
Tax Avoidance
Transferring control of all your assets
Reliance on Stealth Alone

Risk Planning Concepts
Judgment creditors can only take what you own.
Without your permission, no one can take what you own without winning a lawsuit.
Timing is of the essence. Risk Planning must be done while the seas are calm.
Risk protection is a cost-benefit analysis from your standpoint and the predators.
Never mix liability generating assets (Dangerous Assets) in the same entity with other Dangerous Assets or Safe Assets.
Insurance is the first line of defense for business and personal protection.
Every asset you value must be protected and titled properly.

Planning Limitations
Fraudulent Conveyance Statute
Timing the transfer- 4 years look back; one year of discovery
Not receive “reasonably equivalent value”
Insolvency test for Oregon
Debts greater than assets
Not paying debts when due
Cannot protect against already incurred debt
Timing before Bankruptcy
Present and Future Creditors- hinder, delay, defraud

Planning Limitations, Cont’d
Bankruptcy
Preferential transfers
Nondischargeable debts
Lien stripping
Ten year claw back on
Homestead exemption limitation
Criminal Violations
RICO Statute
Bankruptcy Crimes
Money Laundering
Conspiracy to Defraud
Mail and Wire Fraud
Criminal Fraud
Defenses
Legitimate business purpose
Valid estate planning motivation
All of the facts/credibility of debtor will be considered by court

Reducing Risk: Insurance
Business Insurance Coverage
Compare premiums/coverage before purchasing
Retain insurance policies indefinitely
Give prompt verbal and written notice to the right person
Enforce the duty to defend
Rely on another party’s insurance
Require another party to indemnify
Factor liability insurance into the insolvency test
Obtain umbrella coverage

Reducing Risk: Trusts
Types of Trusts
Irrevocable Life Insurance Trust (ILIT)
Self-Settled and Spendthrift Trust
Domestic Asset Protection Trust
Foreign Asset Protection Trust

Irrevocable Life Insurance Trust
Protects value from creditors of insured and trust beneficiaries
Excludes death proceeds from taxation in insured’s estate
Under certain conditions, may have access to cash values
Requires annual maintenance to pay premiums
Requires an independent trustee

Self Settled Trust
Creates trust for your benefit, contains provision that prevents creditors from reaching your interest in trust assets
Usually ineffective to reduce risk except in certain jurisdictions
Creditors can reach interest of trust maker
Spendthrift protection does not work when trustor and beneficiary are the same person
Bankruptcy Code – Bankruptcy trustee can avoid transfer made within 10 years of filing bankruptcy.

Domestic Asset Protection Trusts
Selected jurisdictions’ statutes allow a DAPT Irrevocable Trust (11 states)
Incorporates the respective State’s law
Discretionary benefits, not in trust maker's estate at death
Done properly, can create some protection, but this vehicle is not yet well tested in court
Works best if you reside in a state that allows it by statute and assets can be domiciled in state
Limited use if bankruptcy is filed within 10 years and there exists actual intent to hinder, delay or defraud
Some states have better protections than others

Other Considerations for a DAPT
Bankruptcy claw-back
Irrevocability
Discretionary distributions
Estate tax and income tax
Risk of validity challenge
Fees of creation and maintenance
Full faith and credit attacks
Supremacy clause argument – risk from federal courts
Contract clause concerns
State of domicile versus state of trust jurisdiction
Limited existing case law on constitutional issues

Why a Delaware Trust?
Specific Benefits
Carry out wishes of trustor (Maker)
Protect trustees from liability
Delaware income tax benefit
Effective enforcement of trust agreement
No change in current trust current advisors
Procedure to change situs of irrevocable trust

Foreign Asset Protection Trust
How it works
Independent Foreign Trustee more protection
Independent Trust Protector with certain powers
APT holds overseas money
99% LP Ownership
LP holds US money
LLC 1% GP of LP
Move only liquid assets
Less than 50% of net worth
Reserve assets to pay government or large corporate creditors
Creditor Attack is Less Likely Because
Flight (Remove US Assets)
Flight (Resign as US Trustee)
Experienced Foreign Trustee, Trust Protector, Counsel
Practical difficulties to enforce judgment are greater offshore

Key Features of FAPT
Arms Length Transaction
Irrevocable
Letter of Wishes- non-binding control
Supervised by Trust Protector
Cannot be fraudulent conveyance
Action usually limited to actual creditors who have the burden of proof
Short statute of limitations
Does not recognize U.S. judgment
Legal proceedings brought in foreign jurisdiction
Difficult to establish jurisdiction if not physically within jurisdiction

Key Features of FAPT (Cont.)
Foreign plaintiff often has to post bond or cash to sue
No disclosure laws for trusts
Usually enough of a barrier to lead to settlement
Options to move trust situs
Limited to amount of creditor claim
General Rule: Minimum $1,000,000 liquid assets
Contempt Decisions- Anderson, Lawrence, Brennan

Disadvantages of FAPT
Complexity
Cost (Legal, Appraisals, Maintenance)
IRS Reporting Obligations
Ownership Transfer is Irrevocable
Contempt Cases for not returning assets
Security of foreign jurisdiction

Limited Use of Asset Protection Trusts for Risk Reduction
Valid uses of trusts, but limited for risk reduction
Bankruptcy 10 year claw back- severe limit in bankruptcy context
Anderson, Lawrence and Brennan decisions provide risk for both Domestic and Offshore Trusts
All bets are off if the creditor is the US Government
Most bets are off if the creditor is a powerful corporation
In these cases, creditor did not get complete recovery
Bad facts make bad law
Six contempt citation cases for ignoring a repatriation order
No cases of recovery other than voluntary settlement
Will have to have strong non-protection reasons for the trust
Prepare an affidavit of solvency before setting up FAPT or DAPT
Must balance risks with the benefit- probablity of limited value for most high net worth individuals
Goal : Deter Litigation, Incentive for Early Settlement, Enhance Bargaining Position, Level the Playing Field, Provide Options in Litigation

Choice of Business Entity
Factors Driving the Choice
Management Control & Duties
Tax Considerations
Risk Reduction
Flexibility
Cost to Form and Operate
Restrictions on Structure and Capital
Integration with Estate Plan

Key Terms
Inside Liability
Risk from operation of the business or property itself
Outside Liability
Risk from matter not related to the business which exposes the business to liability
Dangerous Assets
Assets that have a high potential of creating liability
Safe Assets
Assets with a low probability of creating lawsuit liability

Corporations
Pros
Inside out risk reduction
Graduated tax rates
Dividends taxed at lower rates
Medical reimbursement plans
Cons
No outside-in risk reduction
Double tax on sales
Year end tax planning to zero out earnings
Unreasonable compensation
Accumulated tax earnings
Strict corporate formalities
Double tax on operating income
Piercing the Corporate Veil

General Partnership
Pros
Easy to form
Low cost to form and operate
Cons
Unlimited liability for acts of partnership and other partners
Loss of protection if participate in management

Limited Partnership
Purpose
Holding company--Hold safe assets
Hold interest in other entities
Estate planning technique
Not Used For
Dangerous assets
Operations
Personal residence

Limited Partnership
Pros
Risk reduction
Pass thru taxation
Maintain control even if ownership gifted or vested in another person or entity
Step up basis at death of partner (IRC 754)
Inexpensive to operate
Flexible management and economic structures
Use as a holding company in other entities
Estate Planning transfer of assets out of estate; discounting; freeze appreciation
Cons
Expense of formation
Charging Order
Foreclosure of Interest

Limited Liability Company
Pros
Use for rental property
Insulate dangerous assets
Operating businesses
Financial privacy
Protection for inside liability
Flexibility-reduced formalities
Ownership-Trust; Special Purpose Vehicles
Tax options-pass through
Estate planning
Can be set up offshore
Cons
Must carefully draft operating agreement
Business mergers, divisions and reorganizations are more difficult
Not valuable for single member LLC
Oregon allows charging order

S Corporation
Pros
Pass thru taxation
SE tax minimization planning
Inside-out risk reduction
Eligible for qualified plans
Easy for mergers and reorganizations
Cons
Restrictions on ownership
No outside-in risk reduction
Strict corporate formalities

Risk Reduction
Outside Creditors
Claims outside purview of business entity asserted against owner personally
Inside Creditors
Claim against business operation or real estate operated and owned inside a business entity
Risk Reduction Inside Claims
C or S Corporation
LLC
Protection of Real Estate
LLC or FLP
Insurance
Not held as individual or General Partnership

Use of Multiple Entities
Segregate Business Assets
Dangerous Assets versus Safe Assets
Real estate in LLC and leased to operating business
Equipment in LLC and leased to business
Separate liability entity for different business functions and operations
Separate entity for trademarks, patents and copyrights

Funding the Entities
Owner owns and leases exempt assets to operating entity
Combination of debt and equity financing
Encumbering operating entities assets with liens in favor of owner or holding company
Regular withdrawals of funds generated
Do not put dangerous and safe assets in same entity

Buy-Sell Agreements
Structure: Owner Purchase
Agreement among business owners to purchase each other’s share –mandatory or optional
Triggering Events
Owner’s death
Retirement
Disability
Gift or sell interest
Bankruptcy
Divorce
Leave employment
Advice
Avoid making business decisions with partner’s spouse
Make sure your spouse and family gets your share of value from your business so they can pay the bills

Funding the Buy-Sell Agreement
Installment Notes
Security
Personal guarantees
Time needed to accumulate capital-useful for retirement
Life Insurance
Regular Review- type of policy; value of corporation; guaranteed insurability option
No deduction for premiums
Lack of insurability
Transfer for value rule applies absent exception
Charitable Remainder Trust
Asset value low
Owner receives income for life; remainder to charity
Trust does not pay capital gains tax

Stock Redemption
Structure: Sale to Entity
Corporation redeems the shares of a deceased shareholder at death/disability
Advantages
Simplicity of one life insurance policy per shareholder
Premium costs are allocated to the shareholders according to their percentage ownership
Policy protected from shareholders’ creditors

Stock Redemption
Disadvantages
Loss of step up basis surviving shareholders
Insurance polices subject to attachment by business creditors
C Corp death proceeds may be subject to AMT
If policies overfunded to provide non-qualified retirement benefits, benefits are taxable
Proceeds increase earnings, redemption decrease in earnings for dividends
Estate tax issues if deceased shareholder has control-ownership interest results in inclusion in estate

Cross Purchase
Structure: Purchase from Decedent’s Estate
Surviving owners purchase deceased member shares from estate
Advantages
Individuals own policies, receive death benefit, family of deceased has stepped up basis by buying the stock directly
Life Insurance proceeds to surviving owners not subject to income tax; tax basis is purchase price
Estate tax—life insurance proceeds not included in estate of deceased shareholder
Wait and see approach allows decision on source of funds to buy stock
Policies protected from corporate creditors
Proceeds of policy not subject to AMT

Cross Purchases
Disadvantages
Difficult to administer if numerous shareholders buying a plan for each other
Number of policies expand if disability insurance is purchased
Age or insurability creates disparity in premiums
Subject to attachment by shareholders’ creditors
Shareholder may fail to pay premiums
May fail to pay benefits pursuant to buy sell agreement

Valuation
Book Value
Recorded in accounting records
Snapshot of assets/liabilities
No appraisal
Fair Market Value
Willing buyer-willing seller
Requires appraisal
Parties can agree on value if provided in agreement
Formula Approach
Book value plus percentage
Capitalization of future earnings
Method can be different for different triggers

Insurance Trust Agreement
Structure: Purchase Policies with Trust
Policies owned by an irrevocable trust
Advantages
Simplicity of one policy
Premiums based on ownership interest
Assures compliance with buy-sell
Not included in estate of deceased shareholder
Disadvantages
Potential for income tax under transfer for value rules

Issues When Withdrawing Funds: Fraud Potential
Fraud Restrictions
Covers all transactions of business with owners
Must have intent to defraud creditors
Motive
Timing
Insolvency at time
Adequate consideration
Substantially all the debtor’s assets
Concealment
Transfer to lien holder for insider
Constructive Fraud Restrictions
Receives less than full value
Transferor is insolvent –cash flow or balance sheet test
Transfer to owner for return value-avoids constructive fraud
Statutory Fraud Limits
Less than full value
Restrictive Balance Sheet test
Cash Flow Test

Issues When Withdrawing Funds: Withdrawl Methods
Dividends
Statutory Test
Earned Surplus
Delaware less restrictive test
Salary
Reasonable compensation
Regular and in Writing
All subject to self employment tax
Not paid because of ownership interest
Loans and Leases
Business owner secured creditor
Courts held legitimate business expenses
Exempt self employment taxes if multi-owner
Contractual Obligation of Guaranteed Payments
Does not reduce tax basis in LLC
Make to owners without reference to ownership interest
Sales of Accounts Receivables
Sell to holding company
Operating entity withdraws for salary, leases, loans and operating expenses

Transferring Business Interest to the Family
LLC Interest
Voting and Non-Voting Interest
Transfer Value without Transferring Control
Discounted Value
Lack of Control
Lack of Marketability
Appraisal
Tax Free Gifts
Annual Gifting
Gift Splitting for Married Couples
Lifetime Exemption
Issues for the Business Owner
Planning methods under IRS scrutiny
Children receive share on liquidation
Still must plan for transfer of control
Must be a capital income producing business, not service of parent or taxed to parent
Only appropriate to family owned business

Risk Reduction: What Probably Won’t Work
Revocable Living Trusts
Nevada Corporation alone
Leaving no equity anywhere
Giving it away (but not really)
Lying
Some types of Trusts
Transferring assets after claim

Risk Reduction: What Might Work
Limited liability companies
Limited partnerships
Multiple entities
Buy-sell agreements
Statutory exemptions
Life insurance/ Life insurance trusts
Personal residence trusts
Domestic Asset Protection Trust (Limited-Non Oregon)
Offshore Asset Protection Trusts (Limited)
Divide and conquer- properly title assets
Maintain adequate insurance
Avoid general partnerships
Planning when the seas are calm
Planning done for non-asset protection reasons
Don’t use a Ferrari to cut the lawn

Questions?
Let me be a resource to you and your clients.
Russ Pike
[email_address]
503-364-2281
www.shermlaw.com
Also find us on LinkedIn or facebook

Integrated Risk Planning

by Russ Pike on Jul 13, 2011

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Integrated Risk Planning — Presentation Transcript