The Basics of Asset Protection Planning By Michael J. Howell
Asset protection planning is the process of arranging one's financial affairs both to preserve and protect assets in the event that creditor problems are incurred due to lawsuits, divorces, and high risk activities. Asset protection planning also involves preserving assets by avoiding or reducing income, estate, gift, and generation skipping transfer taxes.
Sometimes the creditor is someone who obtains a judgment, maybe because of a lawsuit or a foreclosure with a deficiency judgment, and sometimes it is just the Internal Revenue Service looking for tax dollars. At other times, it may be a spouse in a divorce proceeding.
Asset protection planning is not new and there is nothing unusual or dishonest about it. It is part of good financial and estate planning for protecting you and your family.
For years, estate planning attorneys have incorporated asset protection planning into their estate planning. Sometimes asset protection planning is simply structuring matters so as to reduce taxes. Often, estate planning attorneys protect their clients' assets for family members by setting up trusts and/or entities, such as limited liability companies and limited partnerships.
These trusts and entities often protect the assets from income, estate, gift, and generation skipping transfer taxes. They also often protect the assets from the beneficiary of the trust making unwise decisions and wasting assets needed for their support.
Trusts for family members are often designed to mitigate the possibility that the assets can be reached by a creditor of the beneficiary or the spouse of the beneficiary, in the event of a divorce. These types of trusts are often called "Spendthrift Trusts."
It was made clear by our new trust code that these are allowable in South Carolina. They are effective tools to protect assets; although, there are some limitations. They are also easier to establish under our new trust code than they were in the past.
However, they can not be used for self-settled Spendthrift Trusts. This basically means that you can not set up such a trust for yourself in South Carolina. Although you cannot set them up for yourself, you can set them up for your beneficiaries, but there are some limitations. These limitations relate mostly to the beneficiary's obligation to support his or her own family.
Attorneys also often set up corporations designed to make sure that the creditors of a business can not reach beyond the business assets. Similar considerations apply to Limited Liability Companies, also called LLCs, which are often set up for similar reasons. Most businesses engage in this type of asset protection planning. This type of planning is also often incorporated into estate planning.
In states like Florida, North Carolina, and New Jersey, but not in South Carolina, assets are often placed into a husband's and wife's name as tenants by the entirety. With a tenancy by the entirety, creditors of one of the spouses can not take the property even by a judicial proceeding, unless the other spouse dies first or also has creditor problems.
Often individuals engage in what is referred to as "Poor Man's Asset Protection Planning," which is simply transferring assets to their spouse's name. Obviously, this entails a different type of risk considering that the divorce rate is now in excess of 50%.
It also assumes that the spouse receiving the assets does not have any creditor claims or similar problems. The spouse with the assets should not be a co-signer or a guarantor on any loans; otherwise, they could find themselves with creditor problems at a later date. When using a spouse for asset protection planning, the idea is to try to make sure that the spouse with the assets is free of actual or potential creditor claims or problems. With the divorce rate being what it is, this type of planning should not be engaged in unless the marriage is very stable.
With respect to the divorce rate, another common form of asset protection planning when contemplating marriage is a Prenuptial Agreement. These are agreements that can protect assets from a marriage in the event of death, divorce, or other circumstances. Although these are helpful in a first marriage, they are almost a necessity in second marriages, especially if there are children from a previous marriage or relationship who need to be protected.
Going back 20 or 30 years or so, individuals in high risk occupations began to set up offshore trusts to protect their assets from lawsuits and creditor claims. Such individuals usually transferred a substantial portion of their assets, but reserved certain benefits, and the assets were thought to be beyond the reach of their creditors. Often the laws of these countries do not honor or have limited recognition of judgments issued by United States Courts.
Even with these so-called self-settled spendthrift asset protection trusts, the countries where they are set up will not recognize them if there are creditors who are being defrauded, hindered, or delayed in the collection of their debts. However, often the burden of proof required by creditors as to whether they are being defrauded, hindered, or delayed, is much higher and much harder to prove than in the United States. In addition, the time limit for challenging the trust on these grounds is much shorter than in most United Statesjurisdictions.
One problem with offshore trusts is that many people are afraid to set up trusts and transfer significant assets into them, if they are in other countries. This is especially so since most offshore asset protection trusts are set up in small island republics that simply changed their debtor-creditor laws to attract trust business. However, they do not necessarily have armies, navies, and other infrastructure needed to protect themselves or the assets, or so it is perceived by many investors.
Some states such as Alaska, Delaware, Nevada, Missouri, Oklahoma, Rhode Island, Utah, South Dakota, Tennessee, and Wyoming, allow self-settled Spendthrift Trusts, which can compete with these offshore trusts. Such trusts are somewhat similar to the offshore trusts and are designed to own assets of high risk, high net worth individuals. Depending upon which state the trust is set up in, the persons setting up the trust can retain certain lifetime benefits and yet protect their assets from their creditors for themselves and for their families or other beneficiaries.
Also, many states protect retirement plans, annuities, and insurance policies from creditors without the use of these types of trusts, but there are differences. For instance, South Carolina offers more limited protection than a state like Florida. However, South Carolina protects wages from garnishment much more than Florida does, which has somewhat limited protection.
However, Florida has a more or less unlimited homestead exemption built into its constitution, which prevents creditors from taking the family homestead so long as it is not on more than ½ of an acre in a municipality or not more than 160 acres outside a municipality, no matter what its value. South Carolinaoffers a much more limited protection.
The problem with most "self-protection" planning is that you may not be able to successfully transfer assets to protect them if the purpose is to hinder, delay, or defraud a creditor from collecting their debt. This is because of what is referred to as the Statute of Elizabeth in South Carolina and what in others states is called the Uniform Fraudulent Transfer Act. If the statute is violated, then a creditor can undo the transaction and recover the transferred assets to apply against their debt; although, the process of doing so can be quite expensive.
These laws are somewhat different from state to state. Although there is some disagreement among practitioners, South Carolina's version may be one of the more strict versions of all of the states due to its very broad wording. It is considered pro-creditor by many practitioners. States such as Florida are somewhat more favorable to the debtor, as are a number of other states.
Many people wait until it is too late to engage in asset protection planning and there is not as much that can be done. The planning needs to be engaged in when there are no current or contemplated creditor problems.
Notwithstanding the limitations, there are planning techniques that may be legitimately engaged in, which may protect assets in the event of serious creditor problems. However, the planning needs to take place before the problems become too serious. Otherwise, you have to employ damage control measures that entail much more risk, effort, and cost, and are much less certain.
Some of the planning works completely, while other types of planning serves more to give the debtor more room to negotiate with the creditor. This is due in large part to the fact that the creditor may have to engage in expensive legal processes to get at the assets that have been transferred to asset protection trusts, other persons, other entities, or that have been converted from non-exempt property to exempt property.
There can also be a fine line between legitimate asset protection planning as part of your estate planning and engaging in fraudulent transfers under the Statute of Elizabeth or otherwise unlawfully delaying or hindering a creditor. Again, this is a good reason to engage in the planning before matters have already become serious and the creditors are more or less known.
Sometimes people engage in their own asset protection planning or do so with minimal input and advice from a qualified attorney. Asset protection planning is not something that people should try on their own. It can be quite risky and a "trap for the unwary."
There are also many misconceptions and, quite frankly, a lot of bad advice on how to achieve asset protection planning. Even the best of plans designed by a qualified attorney can fail, much less one with little or no input from a qualified attorney.
Also, creditors' attorneys seeking to upset asset protection planning on behalf of their clients are getting better and better at their jobs. More and more employ the assistance of attorneys who have created and set up these asset protection plans and know where the weaknesses are and how to exploit them.
If you think that you may need to incorporate self-protection planning into your estate planning, then you should not wait until it is too late or, at least, very difficult to implement. Procrastination may also lead to having to declare bankruptcy.
With respect to bankruptcy, often people do not realize that there is a difference in terms of property that is exempt in a bankruptcy proceeding and assets that are exempt from judgment creditors, if there is no bankruptcy. Sometimes bankruptcy becomes the only viable option. In other cases, it is best not to declare bankruptcy because you may lose, or have severely limited certain protections that are granted under state law.
These are complex matters that require careful planning and not an impulsive act. Asset protection planning is a serious legal matter and should not be engaged in or considered without the advice and input of a qualified attorney who can fully assess the planning options and then help implement the plan.
For those of our returning clients who are seriously interested in estate planning that incorporates asset protection planning into it, we have educational CDs that you can borrow, listen to and return. If you have a serious interest in asset protection planning and want to borrow the CDs to learn more, please give us a call and we will arrange for you to pick up the CDs.
As far as the cost of serious or significant asset protection planning, it is much more expensive than normal or standard estate planning. We provide estimates for normal or standard estate planning services in our fee schedules, but it is difficult to do so when a major focus is asset protection planning.
For this reason, we can only provide estimates on a case by case basis. However, just to arrive at an estimate normally takes several hours of meetings and information review. We charge hourly for all time that we spend on a case, subject to our credit for up to one hour of attorney time against any charges for the initial consultation.
Please review the Free Consultation section of our website for more detail. In addition, you need to listen to the CDs prior to coming in to obtain the credit. Note that for Asset Protection planning, the credit is also for returning clients, and not just for prospective clients.