We live in a litigious society, and our government units are among the most vigorous litigators. The need for asset protection planning should be self-evident. One lawsuit, whether meritorious or not, can result in the loss of one's wealth, whether great or small. All too often it is true that even when you win, you lose. Your assets are depleted by the dollars in legal expenses and fees that are incurred even if you win. Thus, asset protection planning is an important element of wealth preservation and cannot be left to chance.
The goal of asset protection planning is to arrange, in advance, one's assets in such a way so as to prevent their loss by reason of future fiscal calamity. Advance planning is important because, under applicable federal and state laws, the transfer of assets once the calamity is present, known or reasonably ascertainable are ineffective or may be undone. Whereas, a transfer of assets in advance is effective as to future unknown claims or creditors.
Another objective of asset protection planning is to deter litigation by reducing the depth of one's pocket. Let us face facts, litigators are in search of and often name what is perceived as the deep pocket. Economics drives the legal system today. Litigators are not out to merely carve another notch in their gun handle. Winning is not everything - collecting is!
When a person suddenly sees the word "Defendant" next to his or her name, a well-devised asset protection plan may afford him or her more strategies and legal maneuvers in dealing with the antagonists. The result can be a brighter outlook for victory or a reasonable settlement.
Asset protection planning may involve several tools and techniques, many of them already well known. Certain trusts and limited partnerships are perfect for most situations. The assets in certain trusts (which contain spendthrift provisions for asset protection) cannot be attacked by creditors. Thus, availing oneself of the use of such trusts in the estate planning context can be helpful in providing asset protection. A limited partnership is an effective tool for providing asset protection as well by reducing the value of the assets on paper and by protecting the assets owned by the limited partnership from attack by creditors.
By definition, the general partner is personally liable for partnership debts, while limited partners are liable only for their capital contributions. Thus, one's creditors cannot get to one's proportionate share of assets owned by a limited partnership in which one has an interest. Through a complicated legal process under each state's laws, a creditor may obtain a "charging order" by which the limited partner's future income from the partnership may be reached, but not the underlying partnership assets.
The ultimate deterrent and negative feature for a judgment creditor is that for income tax purposes, obtaining a charging order results is the creditor paying the income taxes of the person from whom the creditor is trying to collect assets. Because of restrictions and other language intentionally placed in a specially-tailored partnership agreement, the general partner usually has the discretion to distribute or not distribute cash or other partnership assets to the partners. So, a creditor may never receive limited partnership income even though the creditor possessing the charging order must pay income taxes on a pro rata share of the limited partnership's earned (but not distributed) income because the creditor receives the Schedule K-1 that the partner would have received.
For this reason, creditors usually do not attempt to obtain a charging order or otherwise attack a limited partnership interest. This technique is commonly referred to in asset protection planning circles as the KO by the K-1. Thus, the practical result of creating a limited partnership is conversion of desirable assets into one that is unattractive and not desirable at all.
The transfer of assets between spouses is often another way to allocate or minimize risk. For example, if one spouse is in a profession which increases the likelihood of being sued for malpractice, negligence or some other form of tort (the high risk spouse) and the other spouse is merely a wage earner or does not work (the low risk spouse), it makes sense that high risk spouse transfer assets to or in trust for the benefit of the low risk spouse in advance of any future calamity.
Certain assets owned or held for the benefit of the high risk spouse which cannot be transferred, would be difficult to transfer or would have adverse consequences, like income taxes, in the event of transfer, should be examined so as to make certain that they are either protected under applicable federal or state law. Assets which are protected under federal or state law are often referred to as exempt property. For example, assets in an employer-sponsored retirement account are protected from the claims of creditors under federal law (ERISA). Similarly, a residence may be protected from the claims of creditors under state law (Homestead). Consideration must always be given to the ability to convert non-exempt property, which is at risk, into exempt property, which is not at risk to the claims of creditors.
Finally, exotic alternatives like foreign or offshore alternatives may be desirable or necessary when simpler domestic planning cannot accomplish the asset protection goals. The great advantage that offshore trusts or other foreign entities enjoy is the difficulty that a creditor has in enforcing a lien or judgment. Offshore trusts or other foreign entities are attractive if organized and existing in jurisdictions which give little or no recognition to foreign judgments. Among the most popular are jurisdictions like the Cayman Islands, the Cook Islands, the Bahamas and Gibraltar.
The foregoing materials are by no means a complete review of asset protection planning. At best, they constitute the author's summary of a few concepts in a very complicated area of the law. Accordingly, the reader should not rely on these materials in planning any specific transaction, but should seek legal counsel to determine the law and its applicability to each situation.
If you would like to schedule a free consultation to obtain more detailed information regarding asset protection, simply call our office toll free at (866) 907-7600.
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