Asset Protection


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Asset Protection

  1. 1. Sentinel Solutions530 Fifth Avenue11th FloorNew York, NY 10036212-536-6150cschneider@sentinelsolutions.comwww.sentinelsolutions.comAsset Protection December 03, 2012 Page 1 of 10, see disclaimer on final page
  2. 2. Asset Protection Introduction • Business creditors, including employees and former employees, governmental If you havent done any asset protection agencies, suppliers, customers, partners, planning, your wealth is vulnerable to potential shareholders, and the general public future creditors and, should the worst happen, • Creditors of other individuals, where you you could lose everything. have cosigned or guaranteed obligations for those individuals Lawsuits, taxes, accidents, and other financial • Marital or other live-in partners risks are facts of everyday life. And though youd like to believe that youre safe,If you havent done any misfortune can befall even the most careful Asset Protection Techniquesasset protection planning, person. What can you do? First, identify youryour wealth is vulnerable to potential loss exposure, then implement There are three basic asset protectionpotential future creditors strategies that are designed to help reduce techniques: insurance, statutory protection,and, should the worst and asset placement. None of thesehappen, you could lose that exposure without compromising your other estate and financial planning objectives. techniques is a complete solution by itself, buteverything. may make sense as one limited component of an asset protection plan. First, a word about fraudulent transfers Insurance Part of your overall asset protection plan might The simplest way to cope with risk is to shift include repositioning assets to make it legally the risk to an insurance company. This should difficult for potential future creditors to reach be your first line of defense. Before you do them. This does not, however, extend to anything else, review your existing coverage. actions that hide assets or defraud creditors. If Then consider purchasing or increasing a court finds that your asset protection plans coverage on your insurance policies as were made with the intent to defraud, it will appropriate. You should be adequately disregard those plans and make the assets insured against: available to creditors. How can you avoid running afoul of the fraudulent transfer laws? • Death and disabilityThe simplest way to cope • Medical risk, including long-term carewith risk is to shift the risk • Make sure your plans are made forto an insurance company. legitimate business purposes or to • Liability and property loss (both personalThis should be your first accomplish legitimate estate planning and business)line of defense. objectives • Other business losses • Carefully document the legitimate business and estate planning purposes of any Statutory protection arrangements you make • Put your plans into effect before you have Creditors cant enforce a lien or judgment any problems with creditors against property that is exempt under federal • Do not implement a plan at a time when a or state law. While exemption planning cant lawsuit is imminent or pending or at a time offer total protection, it can offer some shelter when you have an outstanding debt that for certain assets. you believe you may be unable to pay Both federal and state laws govern whether property is exempt or nonexempt in Where the dangers lie nonbankruptcy proceedings (separate federal and state laws govern whether property is Unexpected liability can come from just about exempt or nonexempt in bankruptcy anywhere: proceedings). Generally, you can choose whether the federal exemption or the state • The IRS and other tax authorities exemption applies. When looking at • Accident victims, including victims whose exemption laws, be sure to find out how much injuries were caused by the actions of of an exemption is allowed for a particular type minor children or employees of property--it may be completely exempt, or • Doctors, hospitals, nursing homes, and exempt only up to a certain amount or other health-care providers restricted in some way. Types of property often receiving an exemption include: • Credit card companies Page 2 of 10, see disclaimer on final page
  3. 3. • Homestead (principal residence) (e.g., organizational meetings), has its assets• Personal property drained (e.g., unreasonably high salaries paid to shareholder-employees), is inadequately• Motor vehicle funded, or has its funds commingled with• IRAs, pension plans, and Keogh plans shareholders funds.• Prepaid college tuition plans Caution: A number of issues should be• Life insurance benefits and cash value considered when selecting a form of business• Proceeds of life insurance entity, including tax considerations. Consult an• Proceeds of annuities attorney and tax professional.• Wages Limited liability companies (LLCs) andTip: In those jurisdictions that recognize partnerships (LLPs and FLPs)ownership by tenancy by the entirety (TBE),creditors of the husband or creditors of the An LLC is a hybrid of a general partnershipwife cannot reach TBE assets. and a C corporation. Like a partnership, income and tax liabilities pass through to theAsset placement members, and the LLC is not double-taxed as a separate entity. And, like a C corporation, anAsset placement refers to transferring legal LLC is considered a separate legal entity thatownership of assets to other persons or can be used to own business assets and incurentities, such as corporations, limited debt, protecting your personal assets frompartnerships, and trusts. The basis for this other nontax claims against the LLC.technique is simple--creditors cant reachproperty that you do not own or control. Professionals (e.g., doctors, lawyers, and accountants) face liability for damages thatShifting assets to the spouse who is less result from the performance of theirexposed to claims professional duties. While no business structure will protect you from personal liabilityIf you have high exposure to potential liability for your professional activities, an LLP willbecause of your occupation or business, it protect you from the professional mistakes ofmay be advisable for you to shift assets to your partners. That is, if one of your partnersyour spouse. Your spouse would retain the is sued, and the LLP is also named in theassets that are subject to the exposure as his lawsuit, any malpractice judgment is theor her separate property, and you would retain personal liability of the partner whos beenassets that enjoy statutory protection, such as sued, but a business liability for you and thethe homestead, life insurance, and annuities, other partners. Your personal assets arent atas separate property. Furthermore, the shifting stake if your partner commits malpractice,of assets to a spouse or children may help although your investment in the business mayaccomplish other estate planning goals. still be at risk.Caution: To avoid complications in the event An FLP is a limited liability partnership formedthat your marriage ends in divorce, both you by family members only. At least one familyand your spouse should agree to the division member is a general partner; the others areof assets in writing. This is especially limited partners. A creditor cant obtain aimportant in community property states. judgment against the FLP--it can only obtain a charging order. The charging order only allowsC corporations the creditor to receive any income distributed by the general partner. It does not allow theIf you own a business and arent already a C creditor access to the assets of the FLP. Thus,corporation, changing your business structure a charging order is not an attractive remedy toto a C corporation will make it a separate legal most creditors. As a result, the limitation toentity in the eyes of the law. As such, a C seeking a charging order can often convince acorporation owns the business assets and is creditor to settle on more reasonable termsresponsible for all business debts. Thus, than might otherwise be possible.incorporating your business separates yourbusiness assets from your personal assets, so Protective trusts in generalyour personal assets will generally not be atrisk for the acts of the business. A protective trust can protect both business and personal assets from most creditorsCaution: The limited liability feature may be claims. A trust works because it splitslost if, for example, the corporation acts in bad ownership of trust assets; the trustee hasfaith, fails to observe corporate formalities equity ownership and the beneficiaries have Page 3 of 10, see disclaimer on final page
  4. 4. beneficial ownership. Essentially, a protective be able to reach assets held in a trust, a court trust works like this: must have jurisdiction over the trustee or the trust assets. Where the trust is properly Example: Harry would like to leave property established in a foreign country, obtaining to Wendy. However, Harry is afraid that his jurisdiction over the trustee in a U.S. court creditors might claim the property before he action will not be possible. Thus, a U.S. court dies and that Wendy will receive none of it. will be unable to exert any of its powers over Harry establishes a trust with both himself and the offshore trustee. Wendy as the beneficiaries. The trustee is instructed to allow Harry to receive income So, the creditor must commence the suit in the from the trust until Harry dies and then to offshore jurisdiction. The creditor cant use its distribute the remaining assets to Wendy. The U.S. attorney; it must use a local attorney. trust assets are then safe from being claimed Typically, a local attorney will not take theA protective trust can by Harrys creditors, so long as the debt was case on a contingency fee basis. Therefore, ifprotect both business and entered into after the trusts creation. a creditor wants to pursue litigation in thepersonal assets from most offshore jurisdiction, it must be prepared tocreditors claims. A trust Under these circumstances, any of Harrys pay the foreign attorney up front. To makeworks because it splitsownership of trust assets; creditors would be able to reach assets in the matters even less convenient, manythe trustee has equity trust only to the extent of Harrys beneficial jurisdictions require the creditor to post a bondownership and the interest in the trust. Say that Harrys interest in or other surety to guarantee the payment ofbeneficiaries have beneficial the trust is a fixed income distribution each any costs that the court may impose againstownership. month in the amount of $1,000. Assuming the creditor if it is unsuccessful. Taken as a Harrys creditors obtained a judgment, they whole, these obstacles have the general effect would only be entitled to the $1,000 per of deterring creditors from pursuing action. month. Domestic self-settled trusts Irrevocable trusts The laws in Alaska, Delaware, Nevada, and a As the name implies, an irrevocable trust is a few other states enable you to set up a trust that you cant revoke or change. Once self-settled trust. Alaska was the first state to you have established the trust, you cant enact such an anti-creditor trust act, and dissolve the trust, change the beneficiaries, Delaware quickly followed. Hence, this type of remove assets from the trust, or change its trust is often called an Alaska/Delaware trust terms. In short, you lose control of the assets (sometimes also referred to as a domestic once they become part of the trust. But, asset protection trust, or DAPT). A self-settled because the assets are out of your control, trust is a trust in which the person who creates theyre generally beyond the reach of creditors the trust (the grantor) can name himself or too. You may further protect those assets from herself primary, or even sole, beneficiary. your beneficiaries creditors by using special These trusts give the trustee wide latitude to language (known as a spendthrift clause) in pay as much or as little of the trust assets to the trust. any or all of the eligible beneficiaries as the trustee deems appropriate. The key to this Caution: Unlike an irrevocable trust, a type of protective trust is that the trustee has revocable trust provides the assets in the trust the discretion to distribute or not distribute the with absolutely no legal protection from your trust property. Creditors can only reach creditors. property that the beneficiary has the legal right to receive. Therefore, the trust property will Offshore (foreign) trusts not be considered the beneficiarys property, and any creditors of the beneficiary will be Its possible to transfer assets to trusts that are unable to reach it. formed in foreign countries (certain countries are preferred). While the laws of each country Caution: Domestic self-settled trusts may not are different, they share one similarity--they be as effective as a foreign trust, because a make it more difficult for creditors to reach judgment from an individual state must be trust assets. honored by another state under the United States Constitution. Heres how it works: In order for a creditor to Page 4 of 10, see disclaimer on final page
  5. 5. State Homestead LawsThe origin of state homestead Generally, the property you homestead must be property that you own and occupy as yourlaws primary residence. In most states, property eligible for homestead law protection includesThe federal Homestead Act, which was a single-family or multifamily home (and itsenacted in 1862, offered free 160-acre parcels lot), a condominium unit, or a mobile home.of land to anyone willing to settle on them.After five years, these "homesteaders" wouldbecome the owners of the land, as long as Protection limitscertain conditions were met (such as buildinga house and living on the property). Though Homestead laws exempt from attachment athis act was repealed in 1976, many states certain amount of the equity value in thehave enacted their own homestead laws. If homestead property. A few states offeryour state has one, it may protect some or all unlimited protection; in Florida, for example,of the equity in your home against certain the homestead law completely exempts acreditor claims. multimillion-dollar mansions total value from attachment by certain unsecured creditors.Caution: A homestead filing will protect your Most states, however, assign a limit to thehome from most debts (including judgments) amount of protection offered by theirthat arise after the homestead becomes homestead laws. These limits vary widely. Foreffective. It generally will not protect a home instance, an individual homeowner infrom debts incurred before the homestead California may be eligible for only $75,000 instatus attaches. exemption protection, while the same homeowner in Massachusetts would receiveCaution: While the homestead laws in some $500,000 in protection.states may substantially protect yourresidence from unsecured creditor claims, Example: You are a single individual, youreven through a bankruptcy filing, this is not home is valued at $450,000, and it carries aalways the case. You should consult an mortgage lien of $200,000 against it. Yourattorney about the protection offered by your equity is then $250,000 ($450,000 -states homestead laws and other asset $200,000). If you live in California, you mayprotection strategies. use the homestead law there to protect $75,000 of that equity, leaving $175,000 unprotected. However, if you live inWhat homestead laws do Massachusetts, your states homestead declaration exempts all $250,000 of yourState homestead laws vary widely from state equity from unsecured creditor state. Some offer property tax relief or otherspecific tax considerations to real estate Homestead laws do not automatically preventowners. Generally speaking, however, most a forced sale of your primary residence tostate homestead laws allow you to exempt a satisfy a creditor claim. In the example above,specified amount of the equity in your if you live in California, the sale of your homehomestead property from attachment and could be forced to satisfy such a claim, sinceseizure efforts by certain unsecured creditors. the creditor could be paid from the salesThe intent of these laws is to ensure that you equity proceeds over and above the amountwont be forced to sell your home if youre the homestead law exempts from attachment.otherwise unable to pay certain debts. If you live in Massachusetts, however, the homestead law would exempt up to $500,000How to obtain protection of a sales equity proceeds from attachment; in this case, there would be no point in a creditorThe process of acquiring homestead law forcing a sale of the property to satisfy a varies from state to state. Somestates require you to live in the state for a Caution: If the equity value of your propertycertain length of time before you become increases over time (as your mortgageeligible for homestead law protection. In a few balance decreases and/or property valuesstates, coverage is automatic. In most states, rise), it may exceed the exemption protectionhowever, someone who is named on the deed allowed by your states homestead law. In thatto the property and who lives there must file a event, should a forced sale occur to satisfy anotarized declaration of homestead form with creditor claim, the homestead law woulda local government office, such as a registry of protect some, but not all, of the equity in yourdeeds. home. Page 5 of 10, see disclaimer on final page
  6. 6. Some creditors are not subject your home, particularly if you have substantial equity in it. to homestead law protections Example: Jimmy, a single individual, lives in Homestead laws do not protect your home Georgia, where he owns a modest home from all creditors. Generally, these laws valued at $100,000. When he files for Chapter exempt a portion of the equity in your principal 7 bankruptcy against $97,000 in unsecured residence from attachment by creditors to debt, he is required to do so under the whom you owe unsecured debts (e.g., medical Georgia exemption laws, which allow him to bills, credit card balances, and personal keep a homestead worth only $5,000. Since loans), even if the creditor has obtained a the value of his home exceeds that amount, court judgment against you. he must sell his home, keep $5,000 of the sale proceeds as allowed by the state exemptionA Note of Caution Other debts are simply not subject to the laws, and distribute the remainder to the exemption protection homestead laws offer. creditors named in his bankruptcy petition toFor bankruptcy filings made onor after October 17, 2005, These include: partially satisfy their claims.there is a two-year residencyrequirement for using state • Mortgages, second mortgages, home Meanwhile, George, a single individual, liveshomestead exemptions. equity loans or lines of credit secured by in Texas, where he owns a ranch valued atSpecifically, to use a states the property $750,000. When he files for Chapter 7exemption, you must have • Mechanics liens for labor and/or materialsresided there for 730 days bankruptcy against $325,000 in unsecured(about 2 years) prior to filing provided to construct, alter, improve, or debt, he is allowed to elect either the federalbankruptcy. If you resided in repair the property or the state exemption laws. Since Texasmore than one state during this • Federal, state, or local income taxes; homestead law exempts a residence of730-day period, the governing property taxes; or other assessments unlimited value, George chooses to file underexemption law will be the state the state exemption laws. He is not required toin which you resided for the • Debts owed to government agencies, such sell his ranch to raise money to satisfy themajority of the 180-day period as federal student loans or state Medicaid creditors named in his bankruptcy petition.(about 6 months) preceding the liens730-day period. • Court-ordered support of a spouse or minor For bankruptcy filings made on or after April children 20, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 Homestead laws and imposes certain restrictions on state bankruptcy homestead exemptions. State homestead laws can profoundly affect • Even if your state allows for a larger whether or not you may keep your home in exemption, you may only exempt up to bankruptcy. In bankruptcy, you are not $146,450 (as of April 1, 2010) if you required to surrender exempt property to acquired your home within the 1,215-day satisfy the claims of creditors. The federal period (about 3 years, 4 months) prior to government allows individuals an $21,625 (as filing bankruptcy. This limit does not apply of April 1, 2010) exemption in bankruptcy for to equity you rolled over from one home to real estate used as a primary residence. This another within the same state during this federal exemption can vary significantly from period. what you may be allowed to keep under your • If you made an addition to your home in the states exemption laws. 10-year period prior to filing with the intent to hinder, delay, or defraud creditors, your Some states require you to follow their allowable exemption is reduced by the exemption laws when filing for bankruptcy. In value of the addition. such cases, youll have no choice about the • An absolute cap of $146,450 applies if you amount of your home exemption; youll be (a) have been convicted of a felony that able to keep what your states homestead law demonstrates that the bankruptcy is allows. Other states allow you to choose "abusive," or (b) owe a debt arising from between the federal and state exemption laws. violations of securities laws, fiduciary fraud, In states where you have a choice, your racketeering, or crimes or intentional torts decision about how to file for bankruptcy may that caused death or serious bodily injury in turn in part on which set of rules allows you to the preceding five years. This provision, keep the greatest amount of your homes however, will not apply if the homestead is value. In such cases, if your state homestead reasonably necessary for your support and law allows a more liberal home exemption the support of your dependents. than the one allowed by the federal law, filing for bankruptcy under the state exemption laws may increase the probability that youll keep Page 6 of 10, see disclaimer on final page
  7. 7. How Insurance Preserves AssetsType of Insurance How Does It Work?Life insurance Provides the beneficiaries of your life insurance policy with funds upon your death so that your assets will not need to be used to pay final expenses and estate taxes.Disability income insurance Pays benefits to replace part of your earned income while you cant work due to illness or injury so that you continue to meet your financial obligations (e.g., mortgage).Health insurance Pays medical expenses incurred as a result of an illness or injury, so that you do not need to use your assets to pay for them.Long-term care insurance Pays for certain in-home and nursing home care expenses, preserving your assets for your heirs.Homeowners insurance Pays for certain property damage and losses so that the property can be repaired or replaced without you having to use other assets to do so. Also covers certain liability claims.Automobile insurance Pays for damage to your automobile so that you can fix or replace it (collision/other-than-collision coverage). Also covers certain liability claims (liability coverage).Umbrella liability insurance Provides liability protection above and beyond basic coverage provided by homeowners and automobile policies.Business or professional insurance Pays for certain business losses (e.g., property damage, business interruptions, liability claims). Page 7 of 10, see disclaimer on final page
  8. 8. How C Corporations, Limited Liability Companies,and Limited Liability Partnerships ProtectPersonal AssetsHow an Irrevocable Trust Protects Assets Page 8 of 10, see disclaimer on final page
  9. 9. How a Domestic Self-Settled Trust Protects AssetsHow an Offshore (Foreign) Trust Protects Assets Page 9 of 10, see disclaimer on final page
  10. 10. Disclosure Information -- Important -- Please ReviewSecurities, Investment Advisory Services and Financial Planning Services through qualified RegisteredRepresentatives ofMML Investors Services, LLC., Member SIPC. Supervisory Office: 530 Fifth Ave., 14th Fl. ? New York, NY10036 ? 212.536.6000Sentinel Solutions, Inc. is not an affiliate or subsidiary of MML Investors Services, LLC or its affiliatedcompanies. Sentinel Solutions 530 Fifth Avenue 11th FloorBroadridge Investor Communication Solutions, Inc. does not provide investment, tax, or legal advice. The New York, NY 10036information presented here is not specific to any individuals personal circumstances. 212-536-6150To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot beused, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer shouldseek 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 publiclyavailable information from sources believed to be reliable—we cannot assure the accuracy or completenessof these materials. The information in these materials may change at any time and without notice. Page 10 of 10 December 03, 2012 Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2012