Questions on Asset Protection – Hess Kennedy Company

HESS KENNEDY COMPANY

2007/8/3

Questions on Asset Protection – Hess Kennedy Company

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@ 01:07 PM (28 months, 3 days ago)

What protection is available by a revocable ‘living’ trust?

A revocable living trusts is a vehicle that is very helpful in avoiding probate. During your lifetime, you can transfer ownership of your assets to the revocable trust so that it is owned by the trust at the time of your death, and thus not subject to probate.

A revocable trust is not a very good asset protection technique - assets that you transfer to the trust will remain available to your creditors. However, it does make it more difficult for creditors to access these assets; before doing so, the creditor must petition a court for a charging order to enable the creditor to get to the assets held in the trust.

In addition, in most instances a revocable trust becomes irrevocable, usually upon the death of the grantor. Once it is irrevocable, a typical "anti-alienation clause" protects the assets held in the trust form being used as collateral by the trust beneficiaries. While the assets are held in the trust, the beneficiaries do not have control over the property, and any distributions are subject to the trustee's discretion. Creditors cannot force a trustee to make a distribution to the trust beneficiaries; thus the assets held in a trust can remain outside the reach of the beneficiaries' creditors (until distributed into the hands of the beneficiary).

What protection is available through a family limited partnership?

A Family Limited Partnership ("FLP") is a limited partnership that is formed to manage and control jointly-owned family property. All the requisites of a limited partnership must be followed in order to have a valid FLP. Upon formation, the assets of the family are assigned or transferred into the FLP for ownership, management and control. In most FLP's, the parents are the general partners with a 1% interest, while the children and siblings share the remainder as limited partners. Thus the parents' exposure to risk of loss of property held by the FLP is greatly reduced. Even if a charging order is obtained by a creditor, the partnership can limit distributions (for legitimate purposes) to reduce exposure.

An FLP also can have a dramatic effect on gift and estate taxes. By transferring assets to a FLP, general partners can use valuation discounts to lower values. With lower valuations, the amount of tax imposed can be substantially reduced.

Can I use bankruptcy to protect my assets?

Bankruptcy can protect your assets in several ways. In a Chapter 7 (liquidation) case, the trustee will take all your non-exempt assets for the benefit of your creditors. But sometimes you can convert nonexempt assets into exempt ones prior to filing. Exemption planning requires advice from a local attorney because rules vary between states and even between judges within a single state. If a judgment creditor (someone who has won a lawsuit against you) obtains a lien on your property, and if that lien impairs an exemption to which you’re entitled under the Bankruptcy Code, you can “avoid” that lien. Avoiding the lien wipes it out, which prevents the lien holder from seizing your property and selling it to satisfy your debt. Some states have homestead laws that protect you only from subsequent creditors. In those states, a bankruptcy filing will probably allow you to use the state homestead exemption against all your creditors, even if you file the homestead the day before the bankruptcy.

Finally, in a Chapter 13 case, your plan may allow you to pay off the arrears on your mortgage or car loan, thereby avoiding foreclosure or repossession.

What about foreign trusts and other off-shore entities?

For people who have larger estates, and thus larger potential creditor exposures (running into millions of dollars), "off-shore" foreign trusts can be used to provide a high degree of asset protection. Common destinations for these trusts, such as the Bahamas, Bermuda, the Turks and Caicos Islands, the Cayman Islands, the Cook Islands, Gibraltar, and the Isle of Man, have laws which tend to insulate and protect grantors. In establishing a foreign trust, you transfer ownership of your assets a trust that has only foreign trustees (with no offices or agents in the United States), which manages and administers the trust property from the off-shore sites. When your creditors begin looking for your assets, even if they discover the off-shore trust they will have to deal with the foreign trustee. The creditors may then find that there is no available remedy obtainable against an uncooperative foreign trustee. This is because the courts here in the United States have no jurisdiction over foreign trustees, and therefore are unable to provide any relief to creditors. Further, the actual geographic distance between the creditor and the trustee poses significant real barriers to creditors.

However, care must be taken prior to establishing and funding a foreign trust. The grantor should execute a statement of solvency with a balance sheet (or other appropriate financial statement) showing a positive net worth. This is essential in order to establish that you are not entering into this transaction in order to defraud creditors. Such a statement of solvency will also help those who assist you, so that they will not be attacked on the basis that they were co-conspirators in a fraudulent scheme.

Further, not all of your property should be placed into the foreign trust. You should retain locally assets sufficient to sustain your lifestyle, and transfer the remaining bulk of the estate to the off-shore foreign trust for protection. Remember it may be nearly as difficult for your family to recover your money from a foreign trust as it would be for your creditors to do so.

It is also possible to put foreign trusts, corporations, and other entities together into a limited partnership. In this case, creditors may be forced to wade through several layers of protection before they can get to your assets. Multiple entity structures serve to dissuade casual creditors as only the most sophisticated and well financed creditors have the knowledge, resources, and time to penetrate multiple entity structures. While the cost to you to establish multiple entities is increased, often the level of protection afforded is exponentially increased.

Why do I have to be careful about ‘fraudulent transfer rules?’

There are many federal and state statutory prohibitions regarding efforts you take to deter creditors.

Whenever you employ an asset protection technique, you must be careful not to trigger prohibitions against fraudulent transfers. A fraudulent transfer occurs whenever you transfer your property in an effort to stop a legitimate creditor from taking the asset, in order to satisfy a legitimate debt. Further, if you transfer your property away while you know of the existence of a creditor, or have reason to know that a potential creditor exists, such a transfer may be considered fraudulent. The transfer could be undone, and you could be charged with a crime and face fines, restitution orders, probation or incarceration.

Many attorneys are reluctant to assist people in certain asset protection schemes because of the fraudulent transfer rules. An attorney who participates in a fraudulent transfer scheme can be regarded as a co-conspirator in the fraud, and can be subject to the same penalties as his/her client. By creating a statement of solvency prior to the proposed transfer, you can protect the transaction from being labeled as fraudulent.

How can a trust lower the federal transfer tax liability?

Everyone gets a "credit" against Federal Estate Taxes of $550,800 on an exemption amount of $1.5 million in 2004 and 2005 (or $2 million in 2006, 2007 and 2008). (Unless previously used up, in whole or in part, as a result of gifts of more than $11,000 to any one person in any year, or $12,000 to any person in any year starting in 2006).) Individuals and married couples with a total estate value less than the current exemption level don't have to worry about Federal Estate or Gift Tax (the exemption amount slowly increases in steps to $3.5 in the year 2009 but then drops back to $1 million when the estate tax is reinstated in 2011).

For those who are married, there is an unlimited marital deduction. All estate taxes can be avoided upon the death of the first spouse to die. However, the surviving spouse would have to remarry and give his/her entire estate to the new spouse in order to get another unlimited marital deduction. Most people would rather their children or other relatives benefit from the estate than a new spouse and his/her family.

An estate plan can take advantage of certain tax avoidance techniques for those who have accumulated some wealth; this gets more of your property to your intended beneficiaries and less to the federal government. By using a Trust, you can establish a tax by-pass Trust at your death to hold property for your children but enable it to provide for your surviving spouse during his/her lifetime. This enables you to place up to $1,000,000 (or the current exemption amount) in a Trust for the benefit of your surviving spouse and children (which will not be subject to estate tax upon the death of your surviving spouse). Coupled with your surviving spouse's estate and gift tax credit, this enables your spouse and you to send up to $2,000,000 (or the applicable exemption level in that calendar year) to your children free from Federal Estate and Gift Tax. (Some states also have state estate or inheritance taxes.)

How can a trust prevent a conservatorship proceeding?

A Trust is used to hold the property, and the Trustees manage the Trust estate. In the event of your incapacity your pre-appointed Successor Trustee(s) will manage the Trust estate in accordance with the instructions that you have provided. Thus, a properly prepared and funded Trust can enable you to avoid a conservatorship proceeding over your estate. Compared with the cost of a conservatorship proceeding, a Trust can be very attractive.

Since my spouse died, I was thinking about adding the names of my adult children to my house deed. Is this a good idea?

While sharing title to property avoids probate after your death, naming "joint tenants" has legal and tax consequences. In effect, adding a joint tenant to your home deed means that you have now gifted a portion of that property to those named. And when you make gifts in excess of $10,000 (increased in 2002 to $11,000) in value within a calendar year to someone other than a spouse, the IRS may expect you to file a gift tax return, and in some cases pay gift taxes.

When gifting an interest in your home to anyone, you also are jeopardizing your own financial security. If the person named on the deed owns the home in its entirety, then he or she can decide to sell the home out from under you. Also, if you transfer property in some states you may lose certain property tax and other exemptions you enjoy as a senior, veteran, or homesteader.

A better idea is to create a Living Trust and name your children as beneficiaries of the Trust after you die. This has the advantage of avoiding probate, yet it gives you total control of your house prior to transferring ownership. You can also change beneficiaries if you so desire, and also provide for the circumstance if one child predeceases you.

I am middle age, engaged to be married shortly. I have a 19 and 24-year old; my fiancé has a 12 and 10 year old. Each of us has wills leaving our assets to our own children. When we marry, what should be done in regard to our estates? Our assets are not likely to exceed $600,000.