Asset Protection for Professionals

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Asset protection is best implemented before a creditor — judgment or otherwise — appears, since a transfer made with the intent to hinder, delay or defraud a creditor may be deemed a “fraudulent conveyance” subject to rescission. Asset protection may consist of simply gifting or consuming the asset. However, trips to Paris unfortunately end, and a gift to a child results in the asset becoming subject to child’s creditors or her immaturity, unless the gift is made in trust. Essential in estate planning, trusts also possess formidable asset protection characteristics. For example, insurance policies are frequently transferred to children to avoid estate taxes. By transfering the policy to an irrevocable trust naming the children as beneficiaries, the death benefit will also be protected against claims made by the children’s creditors.

A residence is often a significant family asset. In jurisdictions such as Florida homestead exemptions protect residences from creditor claims. In such jurisdictions, the debtor’s equity in the homestead should be increased to the maximum amount possible. In jurisdictions such as New York which confer less protection to the residence, a qualified personal residence trust (QPRT) may enhance asset protection. A (QPRT) is often used to maximize the settlor’s unified credit for estate planning purposes.  One such trust is the personal residence trust (QPRT). However, an ancillary effect of creating  a QPRT is that the settlor’s interest in the property is changed from a fee interest subject to foreclosure and sale, to a right to continue to live in the residence, which is not. If the settlor’s spouse has a concurrent right to live in the residence, a creditor would probably have no recourse. Even if the settlor had no spouse, a creditor would at most only succeed in converting the QPRT to a grantor retained annuity trust (GRAT), in which the grantor is entitled to a yearly annuity stream. In that case, a creditor could only reach the yearly annuity stream. By converting a fee interest to a annuity interest, GRATs are also useful in asset protection. Annuitites in general, whether or not arising from the creation of a GRAT, provide a high degree of asset protection.

Modern trusts may require the settlor to part with an unacceptable degree of dominion and control over the trust property. “Offshore” trusts may cure this problem, but repatriating the assets may be difficult. Tax benefits, though possible with extremely careful tax planning, may pose more risk than either the settlor or his advisor may be willing to assume. Trusts used in estate planning are less likely to arouse creditor scrutiny than “offshore” trusts and may provide a significant degree of asset protection.

Another approach to ameliorating the problem of lack of dominion and control involves exploring domestic asset protection trusts. Black letter trust law holds that one cannot set up a trust for one’s own benefit and thereby defeat creditor claims. The assets of such a “self-settled spendthrift” would be exposed to creditor claims to the extent of the maximum property interest available to the settlor under the trust. Nonetheless, recent legislative enactments in Delaware and Alaska appear to mitigate the problem associated with self-settled spendthrift trusts, by permitting the settlor to be a discretionary beneficiary of the trust.

The legal form in which property is held profoundly affects its asset protection value. Property held in joint tenancy between husband and wife is accorded significant asset protection, since the creditor of one spouse cannot execute a judgment on jointly owned property. However, such property will lose its asset protection status if the parties divorce or if the surviving spouse is the debtor.

Asset protection also arises in post-mortem estate planning. Disclaimsers may be extremely effect in avoiding creditor claims and are generally not fraudulent transfers. One who validly disclaims property under state may place the asset beyond the reach of his creditors. A disclaimer may be required for federal tax purposes to create a bypass trust. IRC § 2518 which requires, inter alia, the disclaimer be made within 9 months of the date on which the transfer creating the interest in the would-be disclaimer is made. Certain powers of appointment possess asset protection traits. Limited powers are beyond creditors’ claims since the power holder has no beneficial interest in the power. Presently exercisable general powers of appointment, by contrast, are subject to creditors claims since the power holder has the right to appoint the property to himself. EPTL § 10-7.2

Asset protection is an important consideration in choosing the appropriate business entity. A corporation insultates shareholders from claims made against the corporation: A physician’s house would normally be shielded from claims made against his PC. However, if a landscaper trips and falls over an infant’s toy, the physician’s shares in the PC could be reached by a judgment creditor, and its assets liquidated following execution on the shares to satisfy the judgment.

Limited liability companies (LLCs) improve on the asset protection features of the corporation. First, like claims made a corporation, claims made against the LLC cannot normally “migrate” to the member. LLC asset protection is superior to a corporation’s in that a judgment creditor will be severely hindered in attempting to satisfy a personal claim against the debtor for two reasons: First, the a judgment creditor cannot seize the debtor’s membership interest, but can only obtain a “charging order” which is a lien. A charging order would entitle the judgment creditor, as assignee, to receive only LLC distributions actually made. Second, an assignee possessing a charging order will also receive a Form K-1 and will be required to report his distributable share of income — whether or not a distribution was made by the LLC. The possibility of redceiving this “phantom income” may be so distasteful as to cause the judgment creditor to find other assets, or to settle for a lesser amount. These attributes of LLCs make them superior asset protection devices.

Retirement plans enjoy special asset protection status. Under the federal law, funds held by an ERISA plan will generally shield those funds from all commercial creditors of both the plan participant and the beneficiaries. However, assets distributed will be subject to creditor claims. ERISA protection does not extend to plans which over only the owner of a business and his or her spouse. For plans not subject to ERISA, such as IRAs, state law will govern whether the funds are asset-protected. Commercial creditors cannot reach the IRA of a New York resident. Nonqualified plans are preferable for asset protection purposes, since contributions are not limited by the internal revenue code

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