AN ASSET PROTECTION CHECKLIST AND DIGEST

By Vernon Jacobs, CPA,
Research Press, Inc.

The most effective form of asset protection from creditors involves the use of a wide range of both domestic and foreign structures. There is a great temptation to try to "keep it simple" by just relying on one method. However, there are a variety of tactics that should be considered so that one right one for the circumstances can be adopted.

First, the legitimate focus of asset protection is on avoiding the loss of all your assets as a result of a future lawsuit from an event that hasn't yet occurred. If you are concerned about protecting your assets from a current judgment creditor, you should be talking to a bankruptcy attorney in your state. Even if you are concerned about a potential lawsuit from an event that has already happened, you are "treading on thin ice" and the advice of a qualified attorney is essential. However, if you are concerned about the possibility of a future lawsuit from a potential future event, then you can take some or all of the following steps now to protect your assets from legal confiscation in the future.

A certain amount of basic liability insurance is assumed to be in place to take care of "normal" claims by anyone who is injured by you--a child of yours or someone who works for you. Homeowners insurance, auto liability, professional or product liability insurance, and a personal liability umbrella policy would be essential. However, sometimes a claim is far greater than the amount of coverage provided by any "normal" policy. And, there are a host of ways that an insurance company can try to avoid the liability when they are faced with paying a claim against a policyholder.

Then, before you start divesting yourself of assets by transfers to family members, family partnerships or offshore trusts, conduct a solvency analysis. Basically, you add up all of the assets you own in your name and in joint ownership with the right of survivorship. The value of the assets should be based on current fair market values, given a reasonable time to find a buyer. Fair market value would be the value after deducting any valuation discounts for lack of marketability or for minority interests. However, you would exclude any assets that are protected in any way by state law. One example is a residence that is protected by a homestead exemption or by joint tenancy. Another is a life insurance contract. A third would be any pension assets that are protected by ERISA (Employees Retirement Income Security Act).

Then you would deduct the full amount of any liabilities and any contingent liabilities such as loan guarantees. (However, any liabilities that can reasonably be satisfied with predictable future income could be excluded as liabilities or the future income could be treated as an asset.) What's left is the value of the property you can give away without becoming insolvent and without depriving your creditors of their legal rights to your property.

After you have determined the extent of the assets you can legally dispose of, you can use various combinations of the following strategies to protect those assets from the claims of future and unknown plaintiffs.

Sever joint ownership of assets. As a general rule, any jointly held assets are subject to the claims of creditors of either joint owner. In many cases, the property really belongs to one of the two joint owners, so put the assets in the name of the primary owner. If you need a way for someone else to "carry on" any family business, use an agency account, a power of attorney or a living trust--with the other party (former joint tenant) being a co-trustee.

Avoid total direct control of a family business. If you own a business, it's probably your most valuable single asset. Yet, about 74% of the businesses in the U.S. are operated as unincorporated proprietorships, about 18% are operated as corporations, and the rest (8%) are partnerships. In most cases, the corporate form is far better than either of the others. However, whoever controls more than 50% of the voting stock in a corporation controls the corporation. So divide up enough of your voting stock among family members (or other legal entities) so that if a creditor gets your stock, he won't get control of your business. An alternative to the corporation is a limited liability company.

Segregate business assets into different entities. Another way to protect the assets in your family business is to divide the business into different segments. One business might do the marketing, another might do the administrative work, and a third might own all of the operating assets. Other legal entities might own other critical assets that are leased to the business. Different companies might cater to different markets or sell different product lines. A claim against one part of the business won't result in losing the assets of the related businesses. It does make your business life more complicated, and it may increase the costs of doing business. How far you should go in segregating the assets of your business depends on the level of your litigation risk and the amount of money that you could lose in a lawsuit.

Establish protection for retirement plan savings. The best form of protection for retirement plan assets is to have the assets in an ERISA qualified retirement plan in which employees other than the owner (and his/her spouse) are participants. If that's not possible, you might try to have your qualified plan assets invested in Swiss annuities or limited partnerships. For more information on Swiss Annuities, you might want to attend one of the 1996 Swiss Wealth Protection Seminars.

Move some investment assets into a Swiss annuity contract. A Swiss annuity contract in which a spouse or child is the beneficiary is protected from creditors by Swiss law. The same protection is available in most states in the U.S. for life insurance contracts, but not for annuities. In addition, the Swiss annuity can protect your savings from inflation of the U.S. dollar. (For more information on Swiss annuities, write to JML, Baarerstrause 53, 6304 Zug, Switzerland or call (011-41) 42-26 55 00.)

Establish protection of your
personal residence. If your home equity isn't protected by a generous homestead exemption in your state, check into whether your state permits "joint tenancy in the entireties." That's a form of ownership between spouses where a creditor can only attach the property if the creditor has a claim against both spouses. Or, look into a qualified personal residence trust or the ownership of the home by a foreign grantor trust. Another tactic is to borrow heavily against the home and put the cash into a protected entity.

Put other assets into a family
limited partnership. Family limited partnerships can be a very effective form of asset protection for any assets that are not protected through other methods. However, be sure not to put personal use assets into a FLP without being prepared to pay your partnership for the use of the property. I am dubious about putting a residence into a FLP.

Put appreciated securities into a charitable trust. For retirement security and tax benefits for multiple generations, the advantages of a charitable remainder unitrust are far greater than most people realize. In addition, the property is no longer owned by you, so it's not available to your creditors. You can dispose of highly appreciated assets without an immediate capital gains tax, you can achieve long term income tax deferral, you can dramatically reduce your estate taxes and you can leave a substantial legacy to an organization that you would like to help.

Transfer some assets by direct gift to family members. This strategy is often rejected by those who are uncomfortable with their marriage, with their relationship with their parents or with their children. But for those who have strong family relationships, one of the most effective methods of asset protection is to make outright gifts of assets to a spouse, to parents or children. This divides the ownership of corporations and prevents a creditor from taking control of it. This strategy often has some substantial estate tax and income side benefits.

Put some assets into a foreign asset protection trust. A specialized foreign asset protection trust is the "final step." Easier and less expensive forms of asset protection should be used first. However, the "final step" doesn't mean that you should put your last dollar of assets into a foreign trust. It just means that it's the final and most effective way to remove assets from the reach of future creditors in the U.S.

These basic tools of asset protection should not be used to make you insolvent or even to strip you of all your assets. The logical and cost effective purpose of asset protection planning is to isolate some of your assets from the grasp of future judgment creditors. For some, it might be enough to protect Ad of their assets as a nest egg to start over if they should be wiped out by a lawsuit. For others, it might be as much as 75% of their assets. However, care must be taken to be sure that you aren't trading one risk for another. If your asset protection plan puts your assets under the control of another person, you need to be really sure that you are comfortable with the integrity of that person.

Other Benefits of Asset Protection Planning

When asset protection planning involves the transfer of assets to other family members, there are some other benefits and some other problems that need to be addressed.

The transfer of assets to your heirs during your lifetime is nearly certain to
provide substantial estate tax benefits
for your family. There are no instances in which lifetime transfers of property
to children or grandchildren isn't
more cost effective than transfers
after death.

In addition, gifting assets to other family members can result in substantial income tax benefits to the extent that the income generated by those assets is transferred to family members who are in a lower tax bracket. Some methods of asset protection also provide estate tax and income tax savings. For example, the charitable remainder unitrust can provide all three benefits.

In some cases, effective asset protection planning can result in substantial liability insurance premium savings. Even though some liability insurance should be a part of your plan and your asset protection structure, you may not need as much insurance protection if you have some assets that are secure from judgment creditors.

Some Costs and Pitfalls of Asset Protection

However, there are very few things in life where benefits are obtained without some "costs." Asset protection planning may require the help of expensive professional specialists. The transfer of assets that are not traded on a national securities exchange may require an appraisal. For a business, a valuation analysis and report can be fairly expensive.

Another disadvantage is that you will find yourself saddled with a seeming multitude of different legal entities. You and your family will have to manage multiple corporations, multiple partnerships, and multiple trusts. The ownership of these numerous entities will be dispersed among all of your family. The process of financial planning and tax planning will become far more difficult. *

Editors note: The author of this article is also the publisher of Asset Protection Strategies, a monthly publication. A special offer has been made to our readers who would like a sample copy. Send $5 to Asset Protection Strategies 4500 W. 72nd Terrace, Box 8137, Prairie Village, KS 66208, Tel. & Fax (913) 362-9667.

Editor:
Milton Miller, CPA

Contributing Editors:
Alan Fogelman, CPA
Clarfield & Company P.C

William Bregman, CPA
A. Kozak & Co.