Commonly Asked Questions About Asset Protection
Volume I, Number 3 – October 1992
COMMONLY ASKED QUESTIONS ABOUT ASSET PROTECTION
What People Want To Know – Part One
During the course of numerous asset protection consultations, we have found that some questions seem to be asked repeatedly. We thought it would prove useful to recount them here, with our responses, for everyone’s benefit:
WHAT DOES ASSET PROTECTION MEAN?
Asset protection is the adoption of advance planning techniques which place one’s assets beyond the reach of future potential creditors. In our practice, it does not involve hiding assets, nor is it based upon secret agreements or fraudulent transfers. It isbased upon proven sophisticated combinations of business and estate planning techniques. The methods employed vary from outright gifts to the sophisticated use of limited partnerships and offshore trusts.
I CARRY SIGNIFICANT LIABILITY INSURANCE COVERAGE – WHY SHOULD I BE INTERESTED IN ASSET PROTECTION?
If you review your insurance policy, you’ll find that it does not cover you for punitive damages or intentional wrongdoing. In addition, with the ongoing crisis in the insurance industry, the financial stability of liability insurance companies is never certain, and the scope of coverage seems to be decreasing all the time. Finally, a claim can always be made which will exceed your coverage. Prudent planning might indicate a combination of asset protection strategies and liability insurance.
I RECENTLY HIRED AN ATTORNEY TO PREPARE A LIVING TRUST. DOESN’T THIS PROTECT MY ASSETS?
Simply put, 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 DO LAWYERS DECIDE WHETHER TO SUE SOMEONE?
When a potential client consults a litigator, the attorney will analyze the merits of the client’s case, and, if the case looks strong, make a determination regarding whether a judgment, if won, can be collected. If the lawyer does not believe he can collect the judgment – the source of his fee – he will not take the case. Sophisticated asset protection planning reduces or eliminates the ability of a creditor to collect a judgment from you, making you an unattractive target for the litigator.
I’VE HEARD ABOUT THE USE OF LIMITED PARTNERSHIPS IN ASSET PROTECTION PLANNING. HOW DOES THIS WORK, AND WHO ARE THE PARTNERS?
A limited partnership consists of at least one general partner and one limited partner. Under the law, and in accordance with the partnership agreement, 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. Under the laws of 49 states, a judgment creditor of a partner in a limited partnership 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. The Internal Revenue Service says that regardless of whether the creditor gets any distributions from the partnership, the creditor must pay tax on the distributions that would otherwise go to you! Several methods are available to enable you to continue to enjoy the income from the partnership assets, even while the creditor is lurking. The creditor will continue to pay tax on your share of partnership income while waiting for a distribution which may never come. This tends to significantly strengthen your ability to settle the judgment on a basis favorable to you.
WHAT ARE THE TAX CONSEQUENCES TO ME IF I SET UP A FAMILY LIMITED PARTNERSHIP?
Structured, setting up a limited partnership can be accomplished on a tax free basis.
I OFTEN BORROW FUNDS FROM MY BANK. WILL THE LIMITED PARTNERSHIP IMPEDE MY ABILITY IN THIS REGARD?
No. The partnership, if requested by the bank, can be a co-borrower with you, or provide collateral for you on any loan. This would expose the partnership assets or specific collateral to that bank, but to no other creditor.
WHY CAN’T I JUST MAKE OUTRIGHT GIFTS TO MY SPOUSE OR CHILDREN?
Of course you can make gifts to anyone. But if you truly give it away, you can no longer enjoy control over the asset, and 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 is nipping at your heals, the transfer can be set aside by a court, unless you (and/or the donee of your gift) commit perjury, which is a crime.