asset protection

What is the best asset protection?

A variety of steps can be taken to protect assets from creditors. One simple step is to transfer your assets to your spouse. Of course, this assumes you have a healthy marriage and that your spouse’s creditors are not a problem. It may also interfere with planning to avoid estate taxes. Other devices which are sometimes used are:

Statutory exemptions from enforcement of judgments. In most states by statute, a creditor cannot reach certain assets. For example, creditors cannot get your residence in most states if its equity is below a certain level. In Illinois, this is $15,000 for a single person or $30,000 for married persons. In some states, the amount of the exemption is unlimited. Under the bankruptcy laws, the assets protected by state law are also exempt assets in bankruptcy.

Retirement vehicles. In most states, pension, profit-sharing, IRAs, and other retirement plans are exempt from execution on judgments and in bankruptcy if they are in tax-exempt plans and are the debtor’s retirement funds.

Corporations and other limited liability entities. For liabilities incurred by a corporation or other limited liability entity, only the entity’s assets are at risk, not your other assets outside the entity. This does not work when you create certain liabilities yourself, such as when you are driving the company truck that runs someone over. It also does not work for certain professionals like doctors or lawyers concerning their malpractice liability. However, more and more states have provided for entities where professionals are liable only for their own malpractice and not the malpractice of their partners or co-owners. The limited liability does work with respect to contract liability, so long as you sign the entity’s name and do not personally guaranty the contact. It also does not work against liabilities generated outside the business. For these, the creditors can get your interest in the business and then liquidate it.

Limited liability companies and limited partnerships. If you own an interest in such an entity under some states’ laws, your creditors cannot get your interest in the entity. They can only get a charging order which allows them to get distributions that might otherwise be made to you for the interest if there are any.

Tenancy by the entirety. This is a type of joint tenancy between spouses in a residence. The creditors of only one of the spouses cannot get the property.

Bearer stock. In some countries, corporate stock can be issued to a bearer, not to a named person. No records of ownership are kept. If your creditors can’t find your assets, they can’t get them. However, creditors can require you to tell them under oath what you own, so using this device involves potentially breaking the law. You can be sentenced to jail for perjury or contempt of court if your answers are shown to be false.

Foreign assets protection trusts. Usually, these are trusts set up in certain foreign countries where it is difficult to enforce U.S. judgments. When it takes the creditor to get anywhere, you can move the assets to another country with similar laws. These arrangements are very expensive, and at least one U.S. court has ordered the trust owner who lives here to produce the assets or go to jail.

Domestic asset protection trusts. Alaska, Nevada, Delaware and a few other states allow someone to create a trust with his or her assets for his or her benefit where a creditor cannot get the assets in the trust. However, these are probably not good outside the state that authorizes them because of various legal difficulties.

Spendthrift trusts. Someone can create a trust for the benefit of someone else that provides that creditors of the beneficiary cannot get the trust assets. This is called a spendthrift trust and is upheld in most states. However, the beneficiaries’ creditors can get charging orders requiring any distributions from the trust to be paid to them.

Living trusts. After your death, your creditors cannot get the trust assets.

Liability insurance. For non-contract liabilities, this is the primary asset protection device.

If you use these devices, you must do so before you have lawsuits or judgments against you and preferably before you incur debts that you wish to avoid. For example, transferring your assets for less than their full value would be a fraudulent conveyance and void if you made the transfer to avoid a creditor and the transfer rendered you insolvent. The creditor can get the assets in that case. Some of the above devices also have to wait periods before they take effect. These principles limit asset protection planning to those left with enough assets to satisfy all reasonably foreseeable claims. In other words, you have to do it before the claim you fear may arise does arise.

Stepped-Up Basis/Carryover Basis

A person who dies possessing increased value assets never paid capital gains taxes on the increase in value. The person never sold the assets and never realized the gain. All the gain escapes income tax because of something called a stepped-up basis. Whoever gets the assets on death takes as their basis (cost) the date of death value of the assets. When they sell the assets, they pay a tax only on the increase in value (if any) since the date of death. For this reason, elderly people with appreciated assets often keep them.

When a lifetime gift is made, the beneficiary takes the donor’s basis, not the value as of the date of the gift. This is called carryover basis.

Marital Deduction Trust

This allows the deductible gift to the surviving spouse to be made in trust so a trustee can manage the investments. The tax law provides that the gift, while not absolute, still qualities for the marital deduction if the spouse must get all the income and has the power to say who gets the money remaining in the trust at his or her death. This is usually used together with a family or credit shelter trust, which takes advantage of the exclusion to pass $5,340,000 free of U.S. tax (but subject to some Illinois tax.) Remember, the spouse can get all the income from that trust too, but cannot have the power to say who gets the remaining assets of the family trust on his or her death. That power would cause the family trust assets to be in the surviving spouse’s taxable estate.

Sometimes it is desired to restrict the surviving spouse’s rights to say who gets the assets in the marital trust after he or she dies. This can be done, and the trust can still qualify for the marital deduction if a Q-tip trust is used. This is often done to prevent a second spouse or the children of a second marriage from getting the assets.

Marital Deduction

All property passing to a spouse is deductible – whether by lifetime gift or at death. This means that while the value of these transfers is in the estate, it is also deductible. Whatever is given to a spouse is not taxable. For example, if you give your spouse $10 million during life or at death, there is no tax. But when the spouse dies later, there is no marital deduction unless the spouse has remarried. At this time, the spouse could give your property to his or her second spouse unless you take steps to avoid it.

There is also a tax free amount (called the applicable exclusion amount) of $5,430,000 as of 2014 ($4,000,000 under the Illinois tax). This exclusion has always been used in conjunction with the marital deduction to pass children free of tax assets. Basically, in large estates, both spouses want to take advantage of their tax free amount to pass their tax free amount to the children. Thus the first to die does not leave everything to the surviving spouse. First, the tax free amount is given to the kids. Then, everything over that is given to the surviving spouse. The gift to the kids usually goes to a trust (called a family trust), and the spouse can get the income from it, even though it is classified as a gift to the kids because they get trust assets when the surviving spouse dies. If one spouse has all the assets, at least the tax free amount is transferred to the other spouse, so both will have that much to leave to the children regardless of who dies first.

In the past, if the first to die left everything to the surviving spouse, this spouse’s tax free amount was wasted. Only the survivor could leave anything to the kids and use the one tax free amount. Therefore the estate plans of both provided for the gift to the family trust by the first to die. In this way, the ultimate tax free gift to the kids was doubled. Everything over the tax free amount was given to the surviving spouse, and the marital deduction applied, so there was no tax on the first death.

Now the tax free amount is portable. Under many circumstances, what one spouse does not use can be added to the other spouse’s estate on the second death. Thus, if everything is given to the survivor on the first death, the second to die will have a $10,680,000 tax free amount, although there are some exceptions, such as when the survivor remarries. If portability is going to be used, an estate tax return must be filed on the death of the first to die, even if there is no tax due

Antenuptial Agreement

This is a written agreement entered before a marriage that usually deals with what happens to the parties’ assets and income in the event of divorce or death. For instance, it can specify what a surviving spouse gets on the death of the other spouse. In addition, it can increase or decrease inheritance rights. To be enforceable, each party should have separate legal counsel, each party should fully disclose all income, assets and other material facts, and no duress should be involved. This is also called a pre-nuptial agreement.

Disclaimer: Always consult an attorney with legal matters. This article is not a substitute for professional legal advice.

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George Meszaros is the editor and co-founder of Success Harbor where entrepreneurs learn about building successful companies. Success Harbor is dedicated to document the entrepreneurial journey through interviews, original research, and unique content. George Meszaros is also co-founder of Webene, a web design and digital marketing agency.

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