Asset Protection in the United States: Financial Security in Tumultuous Times

Introduction

The ‘litigation crisis’ which has hampered the United States (US) in the past is increasing exponentially as the financial meltdown, foreclosures and bewildering governmental actions are piled upon threats to our financial security and well-being. For anybody resident in the US, anybody coming to these shores, or anybody even investing here, lawsuits can be filed under almost limitless theories of liability.

Nearly all business people, professionals and even retired people are worried that they will not be able to protect their money and other assets from the creditor confiscation system which in the US is called litigation. Everyone wants to keep whatever amount of hard-earned wealth they have managed to accumulate after tax, or were fortunate enough to inherit. For these people, in the US as elsewhere around the world, asset protection is the number one priority after good health.

Each case is unique and there is no one-size-fits-all solution. Asset protection for legal liability requires a thoughtful and contemplative approach which takes into account a number of factors such as the nature of the liability exposure, the expected frequency of occurrence and the severity of potential loss. These factors must then be balanced on the basis of a cost/benefit analysis of the available risk management tools or legal liability protection strategies that can be used. Most importantly, all of this planning must take into account an understanding of the human dynamics and dysfunctions involved.

Two Thoughts of Caution

It should be made clear right from the beginning that asset protection planning does not hide assets. Secrecy is a myth, and anything that can be known, will be known. The reality is that a creditor can take the debtor’s deposition and ask him, “and what did you do with all your prior assets?” Now the debtor has the choice of telling the truth or engaging in perjury, which may lead to even more serious consequences.

Asset protection planning cannot be used to evade tax. Under the reporting regime that exists today there is a significant degree of reporting and filing that is required. Failure to comply may involve the imposition of civil or criminal penalties (or both) for the person/s whose assets are being transferred as well as for any others who may be responsible for making filings with the relevant tax authorities. These penalties are in addition to any which may be imposed under money laundering laws and other federal or state statutes.

It is important to understand that tax laws and other relevant statutes do not obstruct proper asset protection planning, including the use of offshore centres. What is required is correct and timely filing of tax forms, payment of the proper amount of taxes, or making required informational disclosures. If nothing else, the recent tax laws underscore the legitimacy of asset protection planning when done in proper compliance with applicable laws.

Fraudulent Conveyance Law Considerations

Essentially, fraudulent conveyance law is applied under two separate sets of law in two different legal forums. First are state laws, such as the Uniformed Fraudulent Conveyance Act or the Uniformed Fraudulent Transfer Act or similar, which may be applicable during the normal course of state litigation prior to bankruptcy. These are not the only state laws which may be applicable. Second, is the Federal Bankruptcy Code, which applies a form of fraudulent conveyance law, and may impact the state’s application differently from state to state. In fact, case law, even under the Uniform Acts, will vary from state to state. The older decisions, of course, will have to be compared to relatively recent decisions by the US Supreme Court and precedents in other courtrooms which impact creditor-debtor law today.

However, whether under state law or federal code the protection of creditors’ rights is premised upon the ability of the creditor to challenge transfers of property. What a fraudulent conveyance simply means is that a creditor can go after assets even if they are transferred out of the control of the debtor. This legal mechanism enables a creditor to gain control of the assets or obtain powers over the person or entity who controls the assets. Where the creditor can obtain jurisdiction, then the fraudulent transfer statutes can possibly negate the transfer of the property by the debtor/transferor to a transferee.

Because the fraudulent conveyance or fraudulent transfer law is a remedy, the focus is on insolvency. If the creditor can prove that the debtor/transferor transfers rendered them insolvent or unable to meet their obligations, then the courts may apply a remedy allowing the creditor to recover the property from the transferee.  

Strategies for Asset Protection

Employing good risk-management will help minimise the adverse impact of losses. This is true whether the risk is physical, economic, tax or legal liability. The best asset protection plan is one which involves a planned action that avoids problems entirely, limits their frequency or severity, or has pre-planned the paying of associated costs. An exposure not identified does not go away. Risk management provides the risk conscious an opportunity to make a decision on how to handle or deal with identifiable areas of risk.

Ownership of assets requires that property title and control be properly thought through. While real estate lawyers, corporate lawyers and others have a great deal of intimate knowledge about their own areas of law, their considerations in how properties should be owned, titled or controlled is generally not directed towards the objective of protecting those assets from creditors. Real estate lawyers, for example, focus on the quantity of property and the quality of title. Corporate lawyers focus on due diligence. The clients, of course, think of nothing but having property placed under their own name – after all, they do own it. How to own property is really an asset protection issue.

Limited liability entities such as limited partnerships and limited liability companies have become favoured methods of owning property. There is the possibility of employing other structures, such as a statutory land trust, in a limited number of states. With a statutory land trust, legal and equitable title are held by the trustee, so the beneficiaries do not have an interest upon which a creditor could attach. Effectively, the creditor is left with getting a charging order, which would be the same outcome with a limited partnership or limited liability company in general.

The Internal Revenue Service (IRS) issued a rule a number of years ago that held that a creditor obtaining the charging lien would be liable for the taxes on the share of income even if there was no distribution of that income. The ruling applied to a partnership but the principle may be applied, it seems, to any transparent entity. Where there is enough money involved, this alone could be a decided disincentive to a creditor.

Insurance is an important part of asset protection. In fact, insurance seems to be the most popular risk-transferred device ever devised. The critical point in obtaining insurance is to make sure that it actually insures all the risks that are expected. There are numerous types of insurance, each with their own special benefits as well as limitations. It has been said, perhaps with tongue in cheek, that insurance companies obey the three D’s – Deny, Delay, and Don’t pay. With this thought in mind, it is important to acquire insurance of the kind that will actually pay when the claim is made.  

Many states have exemption laws which favour insurance and annuities by providing that they are at least partially, if not fully, exempt from creditors. Annuities provide one of the most financially effective income tax deferral mechanisms allowed. Life insurance is the guarantee that the correct amount of liquidity necessary to pay estate tax or other estate needs at death will be available at the right time. The common practice in the US is for estate-planners to use an irrevocable life insurance trust, whether onshore or offshore, to own or to take or to receive the proceeds of life policies. Placing insurance into an irrevocable trust, particularly offshore, will help protect the assets and limit their reachability by creditors whether under an exemption law or under a fraudulent transfer action.

Exemption planning under state law is a straightforward and effective means of protecting assets from creditors. All states allow some forms of assets to be virtually exempt from creditors, though these vary quite considerably from state to state. For example, states such as Texas and Florida allow houses which qualify as homestead to be fully exempt regardless of value from creditors, while other states allow the homestead to be exempt only to a limited amount of value. Wages, life insurance, annuities and an odd assortment of other assets are also potentially exempt. Funds held in qualified retirement plans can also be exempt from creditors. While retirement plans under federal Employment Retirement Income Security Act (ERISA) law are exempt in all states, there is no simple general rule even for states which provide retirement plan exemptions – each state must be carefully analysed and then compared against the impact of federal bankruptcy law.

Offshore trusts for wealth protection have become a popular planning technique. Now that the IRS has provided specific forms for reporting on the transfer of assets to a trust, the trust vehicle has become more mainstream, a standard estate planning and wealth protection planning vehicle. It is particularly useful for liquid assets such as cash, traded securities, and financial instruments. It seems only logical that if someone is going through the process of doing an estate plan and is using an inter-vivos trust for all the benefits that can be gained from that exercise, then it makes little sense to maintain the legal jurisdiction of the trust in the US – where the trust assets are exposed to creditors – when the benefits of asset protection can be gained by merely making the trust subject to a different legal regime in a more protective jurisdiction.

A number of jurisdictions outside the US, as well as a number of states within it, have established updated trust laws which provide specific protections to limit the ability of creditors to attack trust property. When people realise that it may not be legally possible to protect from confiscation the assets of even a modestly wealthy person subject to the US courts and legal process, then if any protection exists at all, it lies in making the assets legally unreachable by judgment creditors. If legal unreachability is the objective, then the planning solution may be to place assets in an asset protection trust or other asset protection entity in a suitable jurisdiction.

Goals of Asset Protection

Asset protection planning against legal liability requires that any plan integrate with standard income and estate planning strategies. It is part of a deliberate and conscious process to enable anyone to possess, accumulate and protect property. Having financial security is essential in creating a psychological assurance that goes along with achieving peace of mind.

Nothing is achieved without a cost, in terms of money as well as time. It does little good to pay this cost when all may be lost to a creditor because of an occurrence which was unintended, unexpected or unforeseen. Yet these events regularly occur at the most inopportune times. The art of planning is not to ignore controversial problems. Indeed, the whole underlying concept of asset protection planning posits that there will be legal and personal problems and difficulties somehow and in some way.

The more successful plans for protecting assets from legal liability are contained within a user-friendly structure. Any plan which is overly complex becomes inefficient, generally overly expensive, and ultimately not successful. Although complexity is sometimes required because of the impact of tax law or other considerations, a successful overall plan generally has a strong sense of aesthetics and symmetry.

Conclusion

For those involved in asset protection planning, what is important is enabling their client to retain wealth, if for no other reason than professionals like wealthy clients who can continue to pay their fees! The fact is that, without retained wealth, no other estate, tax, or financial planning is needed.

What good asset protection planning comes down to is integrating the traditional financial or business plan (as drawn from the regular lawyer’s point of view) with a plan that includes the litigator’s point of view. We are living in tumultuous and unpredictable times. It is clear that we must look to placing assets where they cannot be taken away or lost. Protecting assets, whether physically, economically, from taxes or from legal liability, is the key to surviving the maelstrom that is impacting upon the US – and virtually everywhere else in the world.

Denis Kleinfeld
Denis Kleinfeld is highly regarded as a lawyer, teacher and author. His private legal practice, Kleinfeld Legal Advisors, is located in North Miami Beach Florida. He is an Adjunct Professor at the LLM Wealth and Risk Management Program, Texas A & M School of Law. His private practice focuses on strategy planning of domestic and international tax, legal, financial, matters involving the wealth and risk management for private clients and private businesses. He is co-author of the two-volume treatise, “Practical International Tax Planning,” 4th Ed. published by Practicing Law Institute. He is the contributing author on Foreign Trusts published in “Administration of Trusts in Florida” by The Florida Bar and authored chapters for the American Bar Association’s in “Asset Protection Strategies: Wealth Preservation Planning with Domestic and Offshore Entities Vols. I and II.” He is a contributing author to the “LexisNexis Guide to FATCA”.