protecting a clients assets. a holistic approach (00125483 1)

Text HereBARRY P. SIEGAL

70 W. Madison, Suite 1500 Northbrook Office:

Chicago, IL 60603 633 Skokie Boulevard

Phone: 312-263-2300 Northbrook, IL 60062

Fax: 312-263-0939

Email: [email protected]

PROTECTING A CLIENT’S ASSETS:

A HOLISTIC APPROACH

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Asset Protection Planning

Background

A. WHO SHOULD BE CONCERNED ABOUT CREDITOR PROTECTION?

• Physicians and other professionals

• Real estate developers and investors

• Commodity traders

• Members of corporate boards

• Any person who is exposed to liability

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Background (cont.)

Physicians and other Professionals

• Increased cost of malpractice coverage is causing many physicians to under-insure or go “naked”.

• Judgment creditors increasingly following personal assets of service providers.

• State laws regarding tort limits only apply to non-monetary damages - physicians still exposed to multi-million dollar claims.

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Background (cont.)

Real Estate Developers and Investors

• Many transactions require personal guarantees

• Real estate may have undisclosed environmental issues

• Corporations and LLC’s don’t offer absolute protection; i.e., piercing corporate veil.

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Background (cont.)

B. Holistic Approach to Creditor Protection

• Based on individual circumstances in each case – no magic bullet.

• Factors include client’s risk tolerance, willingness to relinquish control and cost.

• Use of various creditor protection techniques can be cumulative.

• Cost of most successful asset protection programs can be less than one year’s premium on malpractice insurance.

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Background (cont.)C. Avoid “Fraudulent Transfer” Attack

• Any asset protection vehicle can be avoided if creditors can prove that transfer of assets was “fraudulent” with regard to transferor’s creditors.

• Two tests:

• Objective Test – transfer made when transferor is insolvent or transfer causes insolvency

• Subjective Test – transfer is made with the intent to hinder, delay or defraud any creditor without receiving equivalent value

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Background (cont.)

How to Avoid Fraudulent Transfer Attack

• Asset protection planning should be carried out when no significant creditors who cannot be paid from client’s remaining assets

• There should be valid non-creditor protection purposes for engaging in the proposed transactions; such as estate tax planning

• Advisor should protect herself by getting affidavit of solvency

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Techniques and Strategies

A. Transfer of AssetsB. State and federal law exemptionsC. Family limited partnerships and limited liability

companiesD. Protecting business assetsE. Domestic asset protection trustsF. Off shore trusts

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Transfer of AssetsA. Transfers to Spouse

• Standard estate planning typically dictates that assets at least equal to federal estate tax exemption be owned by each spouse.

• Spouse having greatest creditor exposure should own exempt assets (see below) and other spouse should own non-exempt assets

• Caution: avoid reclassifying assets as spouse’s separate properties. (We have clients sign a letter agreeing that any asset transfers are strictly for estate planning purposes and do not change character of assets).

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Transfer of Assets (cont.)B. Gifts to Children

• Utilize annual gift tax exclusion

• $5,120,000 lifetime exemption

Note: this opportunity may disappear on 1/1/13

• UTMA accounts

• 529 Plans – Illinois law recently changed to protect Section 529 Plan assets if: (a) not transferred to defraud creditors; (b) transferred within 12 months prior to judgment, only annual gift tax exclusion protected; (c) if transferred between 12-24 months prior to judgment, twice annual exclusion is protected

• Irrevocable gift trusts (2503(c) or Crummy trusts)

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Transfer of Assets (cont.)

C. Other transfers

• Grantor Retained Annuity Trusts (“GRAT”)

• Intentionally Defective Grantor Trusts (IDGT”)

• Qualified Personal Residence Trust (“QPRT”)

• Charitable Remainder Trusts (“CRT”)Caution: since law isn’t clear, best practice is to set up trust in debtor-friendly state, like Delaware or South Dakota.

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State and Federal Law Exemptions

A. Choice of DomicileB. Tenancy by the EntiretyC. Life Insurance and Annuity PoliciesD. Qualified Employee Benefit Plans and IRAs

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State and Federal Law Exemptions (cont.)

A. Choice of Domicile

• Consider establishing domicile in “asset-protection friendly state,” such as Florida, Texas or Wyoming

• Establishing domicile requires physical presence during majority of year plus other indicia of residence (driver’s license, voting, statement of intent)

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Asset Protect ion Planning

State and Federal Law Exemptions (cont.)B. Tenancy by the Entirety

• Specific form of joint tenancy ownership. In Illinois deed must specify “tenancy by the entirety”

• Only applies to principal residence

• Protects property against claims of creditor of either spouse, not joint creditors

• Only applicable to married couple. Loses protection after death of either spouse or divorce

• Illinois law now authorizes revocable living trusts of married spouses to own property as tenants by the entirety

• U.S. Supreme court has held that even when property held in tenancy by entirety still subject to lien for federal taxes. U.S. v. Craft, US 274, 283 (2002)

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State and Federal Law Exemptions (cont.)C. Life Insurance and Annuity Policies

• Illinois law exempts life insurance proceeds payable by reason of insured’s death, as well as cash value of life insurance and annuities, if beneficiary is spouse or child, parent or other dependent, whether or not right to change beneficiary or access cash value reserved by insured 735ILCS 5/12-1001

• Exemption appears to be all-inclusive, even for variable, high-cash value and interest sensitive products

• Safest approach is to have policy owned by irrevocable life insurance trust.

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Background (cont.)

D. Qualified Employee Benefit Plans and IRAS

• The Employment Retirement Income Security Act of 1974 (“ERISA”) provides for rules regarding certain pension, profit-sharing and 401(k) plans for the benefit of a company’s employees, where the plan meets certain requirements.

• Vested amounts which are not subject to immediate payout are not subject to creditor claims (Patterson v. Shumate, 504 U.S. 753 (1992).

• ERISA does not give creditor protection to plans that only cover the business owner, but no other employees.

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State and Federal Law Exemptions (cont.)4. Exceptions to general rule include:

• Qualified domestic relations orders involving payments in divorce proceedings

• Voluntary and non-voluntary assignments of benefit payments

• Security for loans to participants subject to limitations of IRC Section 9975(d)(i)

• Offsets of benefits against amounts owed to the plan for crimes or breaches of fiduciary duty involving the plan

• Enforcement of federal tax lien against plan benefits.

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State and Federal Law Exemptions (cont.)

5. IRA’s:

• Protection generally governed by state law

• Illinois law contains an exemption for individual IRA’s and rollover IRA’s

• Under federal law up to $1 million in value (adjusted for inflation) is exempted from bankruptcy estate

• Status of “inherited IRA” is somewhat unclear, although a number of cases recently granted exemption to inherited IRAs, both under state law and in bankruptcy, since a form of “retirement” account. See e.g. In re Nessa, 426 BR 312. Illinois bankruptcy case law is still that inherited IRA’s not exempt. In re Taylor, 206 WL 1276400 (BK CD ILL)

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Limited Partnerships (“LPS”) andLimited Liability Companies (“LLCS”)

A. Purposes: Consolidate ownership and management of assets

• Shift income to lower bracket taxpayers

• Shift future appreciation to other family members

• Preclude double taxation incident to C corporations

• Eliminate technicalities of S corporation status

• Limit liability of business creditors to assets of the entity

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LPS and LLCS (cont.)B. Limiting Individual Creditor’s Rights Against

Assets of LP or LLC• Rights of a creditor of a partner or member determined by state

law of the domicile of the entity

• Judgment creditor of a partner or member typically obtains a court order which allows creditor to obtain assets of LP or LLC

• Many states, like Delaware, provide that charging order is “exclusive remedy” that creditor has with respect to LLC

• Creditor in “exclusive remedy” state is in the position of assignee and can only receive distributions when made

• Judgment creditor, for income tax purposes, stands in shoes of limited partner, and must recognize income allocated to partner or member (Rev. RUL 77-137, 1977-1 C.B. 178).

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LPS and LLCS (cont.)

C. Series LLC statues provides:

1. Some states, like Illinois, provide for a form of LLC, known as Series LLC – set up pursuant to Articles of Organization

2. Articles create separate legal entities (series), for separate assets or businesses but at a much lower cost in filing fees, legal fees, etc.

3. Assets owned by each series are protected against creditors of other series

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LPS and LLCS (cont.)

Advantages:

• Lower filing fees and annual fees with Secretary of State

• Lower legal fees, since able to use single operating agreement

• If each series is set up as a subsidiary of parent, then considered “disregarded entities” and only one income tax return is required

Note: Important to keep separate records and segregate assets to avoid liability exposure

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Protecting Business Assets

A. Separate different forms of assets

• Professionals frequently maintain all assets involved in practice within same entity. All assets subject to claims of business creditors

• Real estate, equipment, and other fixed assets should be owned by separate entities, then lease to professional practice

• Ownership in other entities can be gifted to family members

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Protecting Business Assets (cont.)B. Strip Equity from Practice Assets

• Largest asset in professional practice is typically accounts receivable

• Value of accounts receivable can be “stripped” by obtaining bank loan secured by interest in accounts receivable

• Loan will normally be guaranteed by professional owner and loan collateralized by other assets (such as investments)

• Loan proceeds paid to business owner as loan or compensation who then transfers funds to creditor protected vehicle

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Domestic Asset Protection TrustsA. History

• Self-settled trusts historically cannot be sheltered from creditors

• Applicable law based upon language in trust, and connection with state in question (for example, situs of trustee, administration of trust)

• Thirteen states have adopted statutes that offer creditor protection for assets transferred to a trust established under the law

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Domestic Asset Protection Trusts (cont.)B. General Requirements

• Trust must be irrevocable and unamendable by Grantor

• All or a portion of property must be located in the jurisdiction where trust located. Typically, this is member interest in investment LLC

• One of the trustees must reside in state where trust located. Some states require bank or trust company

• Some of trust administration including maintaining trust records, must occur in state where trust is located

• Most states prohibit requirement that all income be distributed to grantor or that grantor can direct distribution of trust

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Domestic Asset Protection Trusts (cont.)C. Flexibility

• Trust can name third party as trust protector with ability to change trust, in fiduciary capacity, remove trustee or move to another jurisdiction

• Grantor can typically have investment authority

• Grantor can retain power to change trustee to someone other than himself or “subordinate person.”

• Some states allow Grantor to veto distributions

• Income sprayed among grantor, spouse and children

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Domestic Asset Protection Trusts (cont.)

D. Concerns• Grantor must give up control over distributions

• Bank will usually make requested distribution, but implied agreement will negate creditor protection

• Distributions should be based on documented need

• Grantor should have other sources of income

• Currently no cases supporting validity of trust established in a state other than state of residency

• Some people argue that full-faith and credit clause of the U.S. Constitution will enable court in one state to obtain trust funds in another state

• Battley v. Mortenson, Adv. D. Alaska, No. A09-90036-DMD, May 25, 2011. Court held that new bankruptcy act was meant to restrict state law and establishment of self-settled trust could be deemed evidence of intent to defraud, even though grantor was solvent.

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Foreign Asset Protection Trusts (“FAPT”)

A. Structure

• Similar to DAPTS

• Foreign trustee/trust protector

• Right to move trust to different jurisdiction

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FAPT (cont.)

B. Advantages

• Lack of jurisdiction by U.S. Courts

• Lack of comity

• Litigation commences de novo

• Need to retain local attorney

• No contingent fees

• Loser pays winners legal fees

• Fraudulent transfer rules

• Level of proof – beyond a reasonable doubt

• Creditor must prove transfer was fraudulent as to him

• No full faith and credit

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FAPT (cont.)

C. Disadvantages

• Cost usually significantly higher

• Distrust of U.S. courts

• Use of contempt power

• Concerns over political and economic stability of country and/or banks

protecting a clients assets. a holistic approach (00125483 1)

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