The goal of this series is to explain different principles upon which asset protection planning rests. In this article, we will explore in what specific scenarios asset protection planning may be of particular significance, and some tools that are available for implementation.
One of the simplest strategies of asset protection involves various exemptions allowed under both federal and state statutes. This type of property, in effect is untouchable in the eyes of the law, should it ever come to pass that a creditor is attempting to access the assets that are protected. Generally, these exempt assets are not subject to the fraudulent transfer laws (which will be covered in Part 3), and range from offering protection in some specific amount for someone’s home or automobile, for example. You must understand the limits of exempt asset protection and the options they present. It is also important to understand, however, that certain debts supersede these exemptions and most states provide exceptions for claims related to child support, alimony, and other marital property divisions. Moreover, these exemptions apply only to individuals and not to business entities established by an individual. Therefore, the statutory exemptions will not apply, for example, to a single member LLC.
Another scenario, or a vehicle in which asset protection planning can be utilized, is a retirement plan. These plans come in many varieties, including tax qualified plans such as 401(k)s, individual retirement plans such as IRAs, and other deferred compensation plans. Typically, when someone retires and begins withdrawing funds from these plans, those withdrawals are taxed as ordinary income. It is no secret that the overall goal which these plans offer center on deferring income either for purposes of insulating the income from creditors, or for purposes of tax planning, or both. One should always work with a tax specialist as well as with an asset protection attorney when fine tuning the specific goals in question.
Whereas living trusts were previously thought to be relegated strictly to the appearance of estate planning principles in order to avoid probate, in recent years they have become an invaluable asset protection tool. A trust can allow a person to give away assets in a controlled manner, thus protecting him or her from the claims of his or her own creditors because ownership is no longer held in the name of the trust creator. This simply means that if the trust is properly structured in the appropriate jurisdiction, assets can remain free from the creator’s creditors, as well as the creditors of the beneficiaries of the trust.
Specifically, it is important to understand that the trust is no more than a legally recognizable agreement between someone who will be entrusted with assets of one person for the benefit of someone else. The trust is merely a legal fiction in the same manner as is a corporation. Simply, the trust has no existence other than what is recognized by the laws of the jurisdiction in which it has been created. As stated, while they have historically been efficient vehicles for transferring wealth, the laws of some states now allow them as vehicles for shielding assets from creditors. It is therefore important to remember that asset protection planning should be a chief component of anyone’s overall estate planning.
Some examples of important trusts that are utilized for purposes of both estate planning and asset protection planning are: the spendthrift trust; the discretionary trust; and the domestic asset protection trust (DAPT).
Spendthrift and Discretionary Trusts:
A spendthrift trust is one in which the beneficiary cannot transfer his interest in the trust to a third-party and where the beneficiary’s right to distributions can be cut off if the distribution would otherwise go to a creditor of that beneficiary. Such a trust can also be referred to as a discretionary trust, in that whether or not to make distributions at all may be solely within the discretion of the trustee. In other words, the beneficiary has no right to compel a distribution of assets to himself from the trust. Accordingly, these trusts are simply designed to preserve not only the trust assets of a beneficiary not wise enough to ensure their preservation himself, but also to keep the creditors of that beneficiary from reaching trust assets. Except in only a handful of states, spendthrift clauses do not, however, protect trust assets from creditors of a beneficiary who is also the creator of the trust. In other words, someone cannot form a trust for his or her own benefit and expect that it will be held up as valid against creditors in most states in the union. Such attempts to create these types of trusts are specifically labeled self- settled spendthrift trusts or, as we will see shortly, more particularly known as domestic asset protection trusts (DAPT’s).
It is important to remember that even in a situation where spendthrift clauses are valid, once assets have, in fact, been distributed to the beneficiary, they naturally then become available to a creditor’s claim. The potential solution therefore is for the trust agreement to provide for distributions to the beneficiary only at the discretion of the trustee. Therefore, if the spendthrift clause is not effective in preventing the beneficiary’s creditor from reaching his or her interest in the trust, the creditor will not have access to assets if they are not distributed by the trustee in the first place. Likewise, if the beneficiary has judgment creditors, the trustee can simply withhold distributions or can apply trust assets for the beneficiary’s benefit.
Courts have long held the notion that one particular type of spendthrift trust is considered to be abusive precisely because it was used to defeat creditors in a way that courts perceived to be unfair. This, of course, is the self-settled spendthrift trust by which a person creates an irrevocable discretionary spendthrift trust naming him or herself as the beneficiary. Now more colloquially known as the domestic asset protection trust, the simple theory behind the DAPT is that it allows a debtor to gift his assets to a trust and then argue that those assets are the property of the trustee of the trust, rather than the debtor. Accordingly, when creditors come for those assets, the debtor argues that the trust owns the assets and that because the trust has done nothing wrong and owes no money to the creditor, those assets cannot therefore be reached. Until very recently, most legislatures have been reluctant to acknowledge the sanctity of these specific types of trusts.
States that disallow the protection afforded by DAPTS do so for the reason that they violate long-standing public policy. While courts of one state usually show a degree of respect for the laws of other states, a serious problem develops when one state decides that the law of the other violates its own public policy. This creates what is known as a classic conflict of law situation between the states that allow DAPTS and the majority that do not allow them. Therefore, to the extent that DAPTS protect assets from creditors, generally both the assets and the debtor should physically be in the state where a DAPT is accepted law at the very least. One should always consult with an asset protection specialist in order to determine what states sanctify DAPTS and what rulings, if any, have come down concerning challenges to this type of trust.
Remember that this asset protection overview could never cover all the tools and scenarios available, much less one that is particular to an individual reader’s specific situation. Therefore, any and all state and asset protection planning principles that are both adaptable and potentially recommended for one individual, may not necessarily apply to another. Once again, it is important to consult with a professional with regard to your specific situation.
The final part of this series will address challenges to asset protection strategies, including potential litigation and the Uniform Fraudulent Transfers Act (UFTA).
This series is presented by WFB Legal Consulting, Inc., Lawyer for Business–A BEST ASSET PROTECTION Services Group.