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 | Litigation and Asset Protection Information This information about Asset Protection is presented for educational purposes only. We suggest you talk to your attorney or accountant to see if this information would be beneficial to you and your business needs | |||||||
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Asset Protection & Privacy The Need for Asset Protection: Every three seconds another American is sued. We live in the most litigious society on earth. Many claims are frivolous and without merit, brought only to harass and squeeze settlement dollars out of an innocent party. In this environment it is prudent to protect your assets ahead of time. Once you have been sued the courts disapprove of moving or protecting assets. The Strategy of Asset Protection: Asset protection involves utilizing limited liability entities, such as corporations, LLCs and LPs, as well as certain trusts to minimize your personal exposure. As John D. Rockefeller said: “Own nothing and control everything.” When a plaintiff’s attorney is looking for people to sue, you want your profile to be low. If during an asset search your name does not show up as an owner, but you control your assets through a mix of limited liability entities and trusts with privacy protections, you will gain protection. The Right (and Wrong) Way to Protect Assets: There is a misperception that asset protection is only for the very rich. This is not true. Almost all asset protection strategies are very affordable to implement, especially when compared with the potential loss of a lifetime’s worth of wealth building. The problem arises when you implement a “poor man’s asset protection” strategy. Simply transferring assets to your brother, sister or friend in advance of a judgment in order to “look poor” is a bad idea for three reasons. First, the courts can look right through such late in the game transfers, and can find you in contempt for making them. Second, there are serious gift tax consequences when you give away assets that may bring the IRS to your door. Third, there are many cases when the “friend” refused to transfer the asset back. It is hard to sue to get your property back when it was fraudulently transferred in the first place. The best way to approach asset protection: The best way is to do it early (before you are aware of a lawsuit or get involved in any business or investing activity) and do it right. Using the right structures properly prepared and implemented will provide a lifetime of protection. To learn more about our asset protection consultations click here. BASIC ASSET PROTECTION TOOLS Liability Insurance: Insurance is your first line of defense. You will want coverage on your automobile, house, business and rental real estate assets. You may want to consider purchasing “umbrella” coverage on your homeowner’s policy to provide additional coverage. Although insurance is the first line of defense, it is a truism that some insurance companies find reasons not to cover you, go out of business or leave the state. This is why you need the second line of defense, which is asset protection planning. Homestead Exemptions: A homestead protects a certain dollar amount of equity in a person or married couple’s primary residence. In Texas and Florida this is an unlimited dollar amount. In Nevada $350,000 in equity is protected from creditor claims (which, as in all states, does not include debts secured by the property such as bank loans or IRS liens). In California the homestead amount is $75,000. Each state is different. For a list of state exemptions visit successdna.com under free reports. While a basic and easy protection many people fail to take the important step of homesteading the primary residence. Business Entities: Corporations, limited liability companies (LLCs) and limited partnerships (LPs) are business entities that were created for asset protection purposes. There are three major advantages to using these very affordable structures: WYOMING DYNASTY TRUSTS Dynasty trusts are trusts that can last for several generations, allowing the grantor of the trust to pass along money to subsequent generations without it being taxed at each step. Because of the incredible flexibility and control permitted in setting these trusts up, a grantor can be assured that the corpus will not be depleted either by taxes or their heirs. If you are the grantor of the trust you can control the assets for generations by leaving specific instructions with the trustee. If you do not want your grandchildren and their children and your future descendants to just kick back and collect money, the dynasty trust enables you to dictate how and when the beneficiaries can receive income. This kind of “control from the grave” may not please everyone, but it is a good way to assure that your wealth provides for and encourages generations of productive descendants. In a typical dynasty trust a person transfers assets to a trustee who holds and invests the assets for the beneficiaries. As long as the assets stay in the trust they can pass from generation to generation without estate or generation skipping taxes. A Wyoming Dynasty Trust is not liable for any state income tax, nor does it pay any federal income tax to on assets distributed to beneficiaries. Because of the Rule Against Perpetuities, Dynasty Trusts do not exist in many states. The rule has existed for centuries because the common law disfavored property being held forever in trust, so it was created to advance the marketability of property. The Rule acts to void any agreement which does not conclude 21 years after a life in being or one generation after those lives presently in being, plus 21 years. Because the Rule Against Perpetuities is state law, states have the option of relaxing or eliminating its constraints. While Wyoming has not abolished the Rule Against Perpetuities, it does allow Trusts to last one thousand (1,000) years. Because of this 1,000 year duration, the Wyoming Dynasty Trust exists as one of the most dynamic estate planning tools available today. Wyoming Dynasty trusts not only provide extraordinary estate tax savings, they also offer the bonus of asset protection for the assets placed in trust. John D. Rockefeller believed that the secret of his success was to "own nothing and control everything." This concept is at the heart of asset protection and a key tenant of Dynasty Trusts. The assets in a Dynasty Trust are protected because you don’t own them. The beneficiaries can enjoy the income from the trust assets without fear of losing them to a judgment creditor, your ex-spouse in a divorce, or medical bills and costs (outright distributions of wealth will likely make you ineligible for state or federal medical programs). Tax-free growth of assets combined with asset protection – what else could you ask for! You can also take advantage of discounted gifting through the use of a Wyoming Close LLC or a Limited Partnership to fund your Wyoming Dynasty Trust. Because it is possible to limit the control of certain members in a Wyoming Close LLC and because limited partners by definition have no control over the assets of a limited partnership, it is possible to superfund your dynasty trust through the use of these entities and the discounts allowed by the IRS. You do not have to live in Wyoming to set up a Dynasty Trust in Wyoming, you just need a trustee, or trust company, that is located in Wyoming. With Wyoming’s strong asset protection laws and lack of personal and corporate income tax, it is the perfect place to set up a Dynasty Trust. NEVADA ASSET PROTECTION TRUSTS What is an Asset Protection Trust? An asset protection trust is a trust that protects the trust assets from creditors and liabilities of the beneficiaries. That is, as long as the assets are in the trust they are not the personal property of the beneficiaries and therefore, not subject to the beneficiaries debts. Traditionally asset protection is afforded to beneficiaries of a trust through inclusion of a “spendthrift provision” which specifically prohibits creditors from making claims against a beneficiary’s interest in the trust and prevents the beneficiaries from transferring or pledging their interests in the trust. However, the creditor protection is generally unavailable to the creator of the trust. If an individual establishes a trust of which he or she is also a beneficiary, a “self-settled trust”, the trust is generally ignored for purposes of the creator/beneficiary’s debts and liabilities. What is different about a Nevada Asset Protection Trust? While the law is well established concerning the protection of assets within a trust from the creditors of a non-creator/beneficiary of a trust, the only way the trust assets could be protected from creditors of the creator of the trust (hereafter “Settlor”), was for the Settlor to give up complete control of and benefit from the trust and the trust assets. If the Settlor retained the power to serve as trustee of the trust, amend the trust, receive distributions from the trust, or to derive any benefit from the trust, creditors of the Settlor could attach assets in the trust to satisfy debts of the Settlor. In an attempt to provide Settlors a way to benefit from assets held in trust without having to give up complete control and benefit from the trust assets, some foreign jurisdictions created laws that allowed a Settlor’s assets in a self-settled trust to be protected from the Settlor’s creditors. These jurisdictions (such as the Bahamas and the Cook Islands) gave rise to so-called “offshore trusts” which offered Settlor’s an additional tool to help protect their assets from claims and liabilities. Unfortunately, some of the same features that made offshore trusts effective to discourage creditors (being geographically distant and subject to the obscure laws of a foreign jurisdiction), also created greater risks to the Settlor of loss or diminution of trust assets. This risk coupled with increased costs and the post 9/11 environment of greater reporting requirements for offshore trusts and holdings, has further reduced the attractiveness of the offshore trust. Nevertheless, people still desire to protect their assets from an increasingly litigious climate in the United States. In answer to the desire for additional creditor protection through domestic sources, Nevada has enacted legislation allowing for the creation of self-settled spendthrift trusts. The Nevada Asset Protection Trust (“NAPT”) allows the Settlor to create a trust with his or her own assets, be a beneficiary of the trust and, as long as the technical requirements are complied with (both in form and the function of the trust), the trust assets are protected from any subsequent claims against the Settlor. What kind of creditor protection does the NAPT provide the Settlor? The Nevada law limits the time period for a creditor to make a claim against the Settlor of a NAPT. If a creditor does not bring a claim against the Settlor within the prescribed period, the claim is barred. Under Nevada law, if a creditor was a creditor of the Settlor at the time the Settlor made the transfer to a NAPT, the creditor must commence an action to challenge the transfer within the later of (a) two years after the transfer, or (b) six months after the creditor discovers or reasonably should have discovered the transfer. A creditor who was not a creditor of the Settlor at the time the Settlor made the transfer to a NAPT must commence an action to challenge the transfer within two years of the transfer. The act that starts the statute of limitations running is the transfer of assets. Therefore, each time assets are transferred to the NAPT, a new transfer has occurred and the statute will begin to run on a claim against that asset. Even if the statute of limitations does not bar the claim, the creditor is required to show that the transfer was a “fraudulent conveyance.” A fraudulent conveyance is a transfer of an asset with the intent to hinder, delay or defraud the creditor. This may be difficult for the creditor to prove, especially if the creditor's claim arose after the transfer of assets to a NAPT. However, the intent to hinder, delay or defraud creditors can be inferred if the transfer renders the transferor insolvent. Therefore, the Settlor should not transfer all of his asset into a NAPT. Rather, the NAPT should be used in conjunction with other asset protection tools so the Settlor maintains some assets outside the NAPT, but all assets are afforded some level of creditor protection. What kind of powers and/or benefits can the Settlor have in a NAPT? Traditionally, to obtain creditor protection for the Settlor the Settlor could not retain any power or benefit from the trust. Under the NAPT, the Settlor is permitted to retain certain powers and benefits. Power of Appointment. It is important to remember that a NAPT is an irrevocable trust. Irrevocable trusts can be difficult to work with because once established, the Settlor cannot take back the assets and terminate the trust. Traditionally, for the Settlor to achieve asset protection meant that once the trust was established, the Settlor could not later affect the distributions from the trust. So, if the Settlor later changed his mind about distributions from the trust, there was little the Settlor could do. Now, with the NAPT, the Settlor can retain the ability to change where the trust assets are ultimately distributed. That is, it is permissible for the Settlor to retain a power of appointment with which the Settlor can change who the final beneficiaries are. Trustee. One of the reasons the NAPT can provide asset protection to the Settlor is that the powers and duties of the trustee can be allocated among several trustees. As a result, the Settlor can also serve as a trustee of the trust as long as the Settlor’s powers as trustee are permissible. For example, under a traditional trust usually a single trustee is responsible for making distributions from the trust, taking care of all administrative matters (such as filing tax returns and bookkeeping) and overseeing investment and management of the trust assets. Since the Nevada law on NAPTs only restricts the Settlor from being the sole trustee or having the power to make distributions to the Settlor, the Settlor could serve as a trustee of the trust with the authority only to invest and manage the trust assets. A second trustee could be responsible for distributions and/or general administrative matters. As such, the Settlor is complying with the Nevada law and thereby achieving the desired asset protection, but at the same time the Settlor still has the ability to manage and invest the assets as the Settlor chooses. Similarly, because the Nevada law requires that a trustee be a resident of Nevada, if a non-Nevada resident is establishing a NAPT, the general administrative tasks could be reserved to a Nevada resident trustee to perform to thereby satisfy the Nevada resident trustee requirement. Settlor as Beneficiary. What makes the NAPT unique is that the Settlor can also be a beneficiary of the trust. The only limitation is that the trustee cannot be required to make distributions to the Settlor. While this can be a limitation to the Settlor, it is outweighed by the benefits of the powers and controls the Settlor can retain and still have creditor protection from the trust. What are the Tax Implications of a NAPT? Because the Settlor retains powers and controls in the trust, the trust is treated as a grantor trust for tax purposes which means that all items of income and loss of the trust pass through and are reported by the Settlor on the Settlor’s tax return. Similarly, because the transfers into the trust are not a completed gift, there are no gift tax implications. However, the values of the trust assets are includible in the Settlor’s estate for estate tax purposes. Nevertheless, estate tax planning tools can be built into the NAPT to provide for utilization of the Settlor’s estate tax exemption and minimize the potential estate tax liability. Can this type of asset protection trust be formed in any state? There are some other states such as Alaska and Delaware that have adopted laws allowing for a self-settled asset protection trust similar to the NAPT. However, the Nevada laws are preferred because the statute of limitations for creditor claims is the shortest under Nevada’s laws. As discussed above, under Nevada law, a creditor must assert a claim either (a) two years after the transfer, or (b) six months after the creditor discovers or reasonably should have discovered the transfer. Under the laws of Alaska and Delaware the statute of limitations is 4 years after the transfer or 2 years after the transfer should have been discovered. It is to the Settlor’s benefit to limit the creditor’s ability to challenge the transfer to the shortest period possible, and therefore, Nevada’s law is preferable. Is a NAPT Right for You? A NAPT is powerful tool that can provide protection from creditors while still allowing the Settlor some benefit and control of the trust assets. NAPTs could be appropriate for a wide range of people such as professionals, officers, directors, fiduciaries, real estate owners with exposure to legal liability and business owners. However, it is important to remember that NAPTs or any other asset protection tool are only effective as protection against future claims and cannot be used to hide assets from existing creditors or claims. Whether a NAPT is right for you depends on your specific circumstances. Check with your attorney to see if this is right for you. SOPHISTICATED ASSET PROTECTION TECHNIQUES Irrevocable Trusts. There are a wide range of irrevocable trusts used primarily for estate planning purposes. However, irrevocable trusts can also provide asset protection benefits by insulating the trust assets from liabilities of trust beneficiaries and to some extent, the trust Settlor. The assets in an irrevocable trust are protected from the liabilities of the beneficiaries if the beneficiaries do not have a certain, defined interest in the trust (i.e., the beneficiaries interest is contingent on a future event or the interest is subject to the discretion of the trustee), or the trust agreement includes a “spendthrift” provision which prevents creditors from making claims against the beneficiaries’ interest in the trust and also prevents the beneficiaries from transferring or pledging their interests. If the trust includes these protections, the only time assets would become subject to creditors of a beneficiary is after the assets are distributed from the trust and become the beneficiary’s personal property. Consequently, as long as the assets are retained in the trust they are protected and can continue to provide for and benefit the beneficiaries beyond the reach of their creditors. The irrevocable nature of a trust can also limit the reach of creditors of the trust Settlor. Since the trust is “irrevocable” the Settlor cannot later change his mind and terminate the trust and take back the assets. Rather, upon transfer into the trust the Settlor has no power or authority to change the terms of the trust, use the trust assets or derive any benefit from the trust except as provided in the trust agreement. In the absence of fraud, generally creditors of a Settlor cannot reach an asset within an irrevocable trust if the Settlor gives up complete control over the trust. However, if the Settlor retains any interest in the trust or the power to change the trust terms or dispositions, the Settlor’s creditors may be able to reach the trust assets to the extent of the Settlor’s retained power or interest. Self-Settled Spendthrift Trusts. A Self-Settled Spendthrift Trusts (“SSST”) is a form of irrevocable trust that offers greater creditor protection to the Settlor while not requiring the Settlor to give up absolute control and benefit from the trust assets. Under a SSST, the Settlor can be a beneficiary of the trust and can retain certain controls and authorities within the trust, such as the ability to direct investments or change the trust beneficiaries. Once an asset is transferred to the trust, a creditor of the Settlor has a limited period of time within which to challenge the transfer as an attempt to avoid a debt and assert a claim against the asset. If the creditor does not make a claim within the proscribed time period, the asset is protected. Even if the Settlor later incurs a debt to the creditor, the creditor cannot reach the asset if the claim is not asserted within the proscribed time period. The SSST is now authorized in several domestic jurisdictions such as Alaska, Delaware and Nevada, but Nevada is the preferred jurisdiction due to the shorter time period for a creditor to assert a claim: 2 years in Nevada versus 4 years for Alaska and Delaware. More information about the Nevada Asset Protection Trust is available click here. “Off-shore” Trusts. These trusts garner their namesake due to the fact that they are trusts established outside the United States in a foreign jurisdiction. Generally these trusts attempt to provide the Settlor asset protection, while still allowing the Settlor control of the trust and benefit of the trust assets. Often the asset protection is derived from the fact that it is a difficult undertaking for a creditor to not only obtain a judgment against the Settlor’s assets in a foreign jurisdiction but then also to collect against those assets. In fact some foreign jurisdictions implemented laws to make this process difficult for creditors to thereby encourage Settlor’s to establish trusts in their jurisdictions (i.e., the Bahamas and the Cook Islands to name a few). However, some of the same aspects that make these trusts unattractive to creditors also create risk for the Settlors: the assets are located in a foreign country and are subject to foreign laws and regulations. The attractiveness of off-shore trusts has been further eroded by increased reporting requirements for offshore trusts and holdings since 9/11 and recent court rulings such as the Anderson case, wherein the court held that the debtors (the Andersons) could be jailed for failing to make assets held in an offshore trust available to the Anderson’s creditors. A safer alternative to provide asset protection for a Settlor is the Nevada Asset Protection Trust. Separation of Assets Between Spouses. A final technique that may be considered is the separation of assets and potential liabilities between spouses. It may be possible to isolate risks of one spouse (i.e., liabilities through a job or profession) to only that spouse’s separate assets, thereby gaining asset protection for the other spouse’s separate assets. To achieve this isolation of risk would require a written agreement between the spouses (such as a prenuptial agreement) that clearly defines the separate property of each spouse. To maintain the separation of assets would require diligent management of assets and resources during marriage to ensure that no community interest is created. This technique would also only be effective to the extent that in the event of a creditor claim, the debtor spouse can show that the liability was incurred by the one spouse individually and not through an undertaking for the community benefit. This type of asset protection planning would also have additional ramifications. In the event of divorce, the property agreement would apply. In addition, this technique could have estate tax consequences if the separate properties are significantly disproportionate and would also mean there would be no step up in basis for the assets of the surviving spouse on the death of the first spouse. Careful planning is suggested when using this strategy. Note: When considering taking steps to protect your assets, it is important to keep in mind that no asset protection technique will shield assets from a creditor if the transfer is made in attempt to defraud or hide assets from a creditor with a potential claim. In fact such attempts may only compound the problem by turning a financial liability into a criminal liability. It is also important to keep in mind that much like an estate plan, an asset protection plan must be carefully considered and tailored to meet each person’s individual circumstances. With the many tools available and the myriad of ways in which they can work together, asset protection planning should only be done with the guidance of experienced professionals who can correctly analyze your situation and help you formulate a plan to best meet you needs. | ||||
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