What does Asset Protection Mean?
Asset protection is the adoption of advanced planning techniques that place one’s assets beyond the reach of creditors. It does not involve fraudulent transfers nor illegal activity. It is based upon proven sophisticated combinations of business and estate planning techniques. The methods employed include the use of financial products and legal structures domestically and offshore.
What are the objectives of an asset protection plan?
Protect Assets. A properly prepared asset protection plan can shield assets from creditors. This is not done through fraud or concealment. Rather, the plan establishes legal structures to own and manage assets. Those assets will only be vulnerable to attack by the creditor of that entity and not other entities or the client personally.
Discourage Litigation Many components of an asset protection plan may still be subject to some degree of creditor attack. Therefore, another objective of an asset protection plan is to raise the costs for a creditor to pursue a client’s assets. Prior to litigation, an attorney and the plaintiff will want to be sure that there are sufficient assets of the defendant that can be reached if the litigation is successful. If there are not enough assets, or if the costs to getting to them are too high, the would-be plaintiff will likely decline to pursue litigation.
Allow Access to Funds Prior to Trial In many types of litigation, the plaintiff can obtain from the court a restraining order that freezes a defendant’s assets, pending the outcome of a trial. By having access to assets that a creditor cannot attack, a client will be able to continue to survive during the litigation process. Moreover, having access to such funds will often motivate creditors to negotiate and settle on favorable terms.
Access to Funds After Judgment Once a judgment is entered against a client, real estate and bank accounts will effectively be frozen. However, assets which have been properly transferred (into a family limited partnership or an asset protection trust, for example) are still available to the client. Again, the effect of this tactic will be dramatically increase negotiating leverage in reaching a settlement.
Administrability. In providing these benefits, an asset protection plan should also be easily administrable. This refers to the ease of use, continued effective control by the client, and consistency with other aspects of a client’s financial plan (e.g. estate plan, investment objectives, etc.).
Why not just give all my property to my wife?
A gift of property may be effective in removing that property from the husband’s potential creditors. However, if the husband continues to enjoy the use of the property, a court may find that the gift was not really a gift. Such a finding would negate the gift and would allow the creditors of the husband to lay claim to the property.
How does the Family Limited Partnership work?
The Family Limited Partnership is an extremely useful device for accomplishing a variety of asset protection objectives as it allows you to maintain control and management over family assets without having an interest that can be seized by a creditor. Assets that have been transferred to the FLP cannot be reached by a creditor unless he can demonstrate that the transfer was a fraudulent conveyance.
Rather than reaching the assets in the FLP, the creditor is limited to a remedy known as the charging order. This is a court-ordered charge that any distributions to be paid to the debtor partner be paid to the judgment creditor instead. The judgment creditor does not acquire any other rights to profits or management of the partnership. If the partnership does not make any distributions during the term of the charging order, the creditor will not receive any payments. Because the creditor cannot reach the assets of the partnership and must wait for distributions, family assets will be successfully protected. However, with a charging order, the creditor will still be liable for the tax on the profits of the debtor partner, even if the creditor has not received any distributions.
When the Family Limited Partnership is used in conjunction with a domestic or Asset Protection Trust, which holds the limited partnership interests in the FLP an even more significant level of protection is achieved. Limited Partnership interests held by the trust will not be subject to a charging order or foreclosure because these interests are no longer “owned” by the debtor partner.
If I use a Family Limited Partnership, do I still need a living trust?
A Family Limited Partnership can be used in conjunction with a revocable living trust. Although the living trust does not provide any asset protection benefits, it may be useful in accomplishing certain estate planning objectives. A funded living trust will avoid probate on family assets and will provide for the disposition of the property upon the death of a spouse. However, because the assets of the living trust are exposed to a creditor, upon the death of a spouse, most people prefer to use an Asset Protection Trust which will accomplish the same objectives of the living trust, without exposing the assets to the claims of a creditor.
How are Domestic Trusts used for asset protection?
One popular approach is to establish a domestic trust for the purpose of holding the limited partnership interests in the FLP. The trust does not hold any assets directly, other than the limited partnership interests.
Under the usual arrangement the husband and wife may be trustees and the children are named as beneficiaries. The parents cannot be the beneficiaries of the trust because the law of every state allows a creditor to reach the assets of the trust if the parents retain an interest in a trust, which they have created. Also, the trust must be irrevocable. That is, the parents cannot retain any power to alter, amend, or revoke the trust at any time.
To avoid any liability for Federal gift taxes, the transfer to the trust can be structured as an incomplete gift. As such, the gift will not be considered complete for federal tax purposes yet will still be effective for creditor protection purposes. The amount in the trust will be included in the parents’ estate upon their death and will remain subject to estate tax liability. Similarly, for income tax purposes the trust will be treated as a grantor trust. All income of the trust will be reported on the parent’s tax return in the same manner as if the transfer had never occurred.
What is a Foreign Asset Protection Trust and How does it Work?
A popular alternative to the domestic trust is a Foreign Asset Protection Trust (“FAPT”). A FAP trust is one that is established under the laws of a foreign country and provides certain advantages which cannot be achieved with a domestic trust. Certain countries such as the Cook Islands and Nevis have laws that are much more favorable to asset protection than the laws in the United States. By creating a trust under the laws of one of these jurisdictions an individual can obtain greater protection and flexibility than is available for trusts formed under U.S. law.
In using the FAP Trust, the individual does not sacrifice any degree of immediate control and access to his property. All bank accounts and real estate remain in the FLP. Only the interest in the FLP is transferred to the trust. The individual, as general partner of the FLP, retains total authority over his property.
If a creditor attacks this structure, the FLP can distribute its liquid assets and personal property to an offshore account that has been established in the name of the trust. This feature provides the ultimate protection for family assets since this account will not be subject to the jurisdiction of a U.S. Court. Once assets have been safely relocated under the protection of the laws of that country, recovery of the funds by the creditor becomes unlikely.
The tax rules governing these kinds of trusts are identical to those concerning domestic trusts. Properly structured, there are no gift tax consequences to the arrangement, and all income of the trust is reported directly on the return of the settlor.
I carry liability insurance; isn’t that good enough?
No. Insurance policies do not cover a variety of common liabilities. These include punitive damages or intentional wrongdoing. In addition, even if a policy does cover a liability, a claim may be submitted that exceeds your coverage. For high-net-worth individuals, prudent planning requires a combination of asset protection strategies and liability insurance.
Do Living Trusts Provide Asset Protection?
No, the revocable living trust is a useful estate planning tool, which will result in the avoidance of the probate process for the assets transferred to it, and provide some degree of privacy, but it affords virtually no protection from your creditors. If you get sued and lose, a court can order you to revoke the trust and pay the creditor.
Who Should Consider Asset Protection Planning?
Any high income, high net worth individual whose business, investment, or other activities expose him or her to potential litigation. Clearly, doctors, lawyers, accountants, real estate developers, corporate directors, executives, and persons in similar occupations are exposed. A net worth of approximately $ 500,000 is a guideline point where the benefits of sophisticated asset protection planning begin to outweigh the costs. However, many levels of asset protection planning are available, and some strategies are available to almost everyone.
How Does the Equity Management Mortgage® WorkThis is a method of “equity stripping”, meaning that you maintain control and ownership over the property, but have no equity available for creditors? The mortgage is structured like any conventional mortgage, giving the mortgage company has the first position in the property. Debts to the mortgage company would have to be satisfied before the creditor has any claim on the property. Thus, if a property is highly mortgaged, there will be no equity left available to a creditor. McKenzie-Finch’s mortgages, however, can be structured as “friendly mortgages” whereby, although structured as an arms’ length transaction with a neutral third party, they are funded by offshore entities that the client controls. Thus, the client gains additional asset protection and investment advantages.
How does a Limited Partnership work in Asset Planning?
A limited partnership consists of at least one general partner and one limited partner. The general partner (usually you) is in complete control of the partnership and its assets. The limited partner has no voice in the day-to-day operation of the partnership. The limited partner or partners may be other family members. Frequently, the limited partner will be a trust established by you in an appropriate offshore jurisdiction. A judgment creditor of a partner cannot reach the partnership’s assets or foreclose on a partner’s interest to satisfy his claim. If you place your assets in a family limited partnership and a creditor subsequently obtains a judgment against you, that creditor cannot reach your assets inside of the partnership, but will only be entitled to partnership distributions which the general partner might decide to make. The creditor has no right to foreclose on your partnership interest, as he could if you owned an interest in a corporation or other unprotected asset. Moreover, the creditor is liable for the tax on the income of that partnership interest. This tends to significantly strengthen your ability to settle the judgment on a basis favorable to you.
Can’t I just make outright gifts to my spouse or children?
Of course, you can make gifts for anyone. But if you truly give it away, you can no longer exercise control over the asset. If you give it to someone other than your spouse, you will also lose the income from the property and possibly incur gift tax consequences. Moreover, the property will then be exposed to the new owner’s spouse and other creditors. Finally, if you make the gift when a creditor attack is imminent, the transfer can be set aside by a court.
Why would I still go “offshore” in view of the protections afforded by the various domestic strategies?
Although a significant degree of protection is available through the use of domestic structures, one can never predict how a local court or jury will act. Sometimes a “result-oriented” judge or jury will ignore the statute limiting the creditor’s rights and pierce the limited partnership or other entity. Where the trust is subject to the laws of appropriate foreign jurisdiction, the creditor’s U.S. judgment will be worthless. If the creditor has the financial means to attempt to pursue the trust assets offshore, he would have to begin the lawsuit all over again in the foreign country. Moreover, in many offshore jurisdictions, lawyers are not permitted to accept contingency fees, thereby increasing the costs of litigation. These geographical, financial, and procedural impediments to reaching the foreign trust will impact significantly a creditor’s decision to chase assets.
Why not just hide all my assets in a Swiss Account?
While investing funds in a Swiss or other foreign accounts may prove to be a worthwhile investment, any asset protection planning which depends upon hiding assets or secrecy is inappropriate. As a U.S. taxpayer, the law requires you to report your financial interest in, or signature authority over, any foreign bank account, securities account, or other financial accounts. If you comply with this requirement, a creditor can obtain this information in a lawsuit, and if you lose the suit, the court can order you to bring the funds back to the U.S. to satisfy the judgment. Intentional failure to comply with the foreign account reporting rule is a crime and the IRS has the means to discover such unreported assets.
Q:How sure can I be that I am protected with my assets under the “control” of a foreign trustee?
With respect to the assets held in your partnership (all of the protected assets, with the minor exceptions discussed above), you (as the general partner) will have direct and absolute control. You will write the checks; you will make all the decisions. The foreign trust will be the limited partner, and, as such, it will have no voice in the operation of the partnership. With respect to the assets held by the trust (either initially, as discussed above, or, if the partnership is liquidated), you — as the “trust protector” — will have the power to veto any action of the trustee, and to remove and replace the trustee without cause. As the trust protector, you can also dictate that all trust accounts and assets must have both your signature and the trustee’s signature in order for any transfer to take place.
Is this all legal?
Yes. The key to effective asset protection planning is the word “ADVANCE”. As long as this type of planning is undertaken in advance of a creditor appearing on the horizon, it is 100% legal to protect yourself. Unfortunately, many people first seek to protect their assets after they have been sued or otherwise incurred an obligation. In such circumstances, the planning options are significantly narrowed because of laws (in all states) that permit a court to set aside transfers made at the”eleventh hour”, known as “Fraudulent Conveyance” or “Fraudulent Transfer” laws.