Estate Planning Through an Asset Protection Lens

Transcription

1 Estate Planning Through an Asset Protection Lens Gideon Rothschild, J.D., C.P.A. Moses & Singer LLP 405 Lexington Avenue New York, NY Telephone:

2 ASSET PROTECTION PLANNING IS THE PROCESS OF ORGANIZING ONE S AFFAIRS TO INSULATE ONESELF FROM FUTURE CREDITOR RISKS 2

3 ASSET PROTECTION PLANNING IS NOT A MEANS TO ENGAGE IN FRAUD OF CREDITORS OR TO CONCEAL ASSETS FROM CREDITORS 3

4 The Need For Asset Protection Legal System No Longer Links Liability to Causation Increasing Theories of Liability Unpredictable Judges and Juries Emotional Distress of a Defendant Reducing Appeal as a Defendant Government Expropriation 4

5 Candidates for Asset Protection Planning Professionals Officers and directors Fiduciaries Real estate owners with exposure to environmental claims Individuals exposed to lawsuits arising from claims alleging negligent acts, intentional torts (discrimination, harassment, libel), or contractual claims As a pre-nuptial alternative Government expropriation Forced heirship 5

6 FRAUDULENT CONVEYANCE ISSUES The Law prohibits transfers made with the intent to...hinder, delay or defraud creditors. Differentiate between: Present creditors - the transferor has notice of these creditors when making the transfer Subsequent creditors - the transferor had actual fraudulent intent against these creditors, even if the actual claim arose after the transfer Potential future creditors - those nameless, faceless persons of whom no awareness existed when the transfer was made 6

7 Traditional Methods Transfers to Spouse Corporate Formation, Limited Partnerships and Limited Liability Company Joint Ownership of Property State and Federal Exemptions (other than ERISA) ERISA Based Exemptions 7

8 Transfers to Spouse Such transfers involve surrendering: all rights to control the transferred assets, and any certainty that the transferor can continue to enjoy the benefits of the transferred assets. Potential for undesirable consequences in event of divorce or death of spouse. Possible imposition of constructive trust doctrine can lead to attachment by creditors. Courts will unwind a fraudulent conveyance. 8

9 Can/should portability be relied upon for estate tax efficiency? REASONS WHY ONE SHOULD NOT RELY ON PORTABILITY Portability is temporary Portability does not apply to state estate taxes Portability does not apply to the GST exemption The amount subject to portability is not adjusted for Inflation Portability requires an affirmative election and likely disclosure Portability requires privity between the spouses Credit shelter trusts provide the trust type benefits that portability cannot SITUATIONS WHERE ONE MIGHT RELY ON PORTABILITY... Where the decedent s estate has a large IRA or qualified plan and few other asset To save state estate taxes on the decedent s estate To generate a stepped up basis on the decedent s assets 9

10 Joint Ownership Tenancy by the Entirety: Form of joint ownership between a husband and wife recognized in 20+ states. Generally limited to ownership of real estate, but in some states can also be used with respect to intangibles. Creditor of one spouse only cannot foreclose against the property unless tenancy by the entirety is severed (whether by death, divorce or some other transfer). Non-debtor spouse receives property 100% free and clear, but if debtor spouse is survivor, and period has not expired, creditor can exercise rights against the property. 10

11 TENANCY BY ENTIRETIES TRUSTS A few states have enacted legislation providing protection for TBE property held in trust. These are Delaware, Hawaii, Illinois, Indiana, Maryland, Missouri, Tennessee, Virginia and Wyoming Benefit is to provide same creditor protection for TBE property through a trust vehicle In some states the deceased spouse s half is protected from the surviving spouse s creditors. In Tennessee the separate creditors of the surviving spouse may reach trust assets only to the extent that the surviving spouse remains a beneficiary of the trust and possesses a non-fiduciary power to vest title to property in himself/herself individually. 11

12 State and Federal Exemptions Pension and ERISA qualified retirement plans are protected from creditors. Life insurance and annuities are generally protected. Homestead exemption under some state laws. Asset protection planning can never be used to evade taxes - IRS can also invade retirement plans, insurance and annuities. 12

13 IRAs and Asset Protection Planning An IRA is generally protected from the claims of creditors or the IRA owner. However, it is unclear whether an inherited IRA is protected from the claims of the beneficiary s creditor. The vast majority of cases have denied creditor protection to inherited IRAs, but recent cases have bucked this trend. 13

14 Creditor Protection of IRAs Bankruptcy law specifically exempts from a debtor s bankruptcy estate retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, or 501(a) of the [Code]. 11 U.S.C. 522(b) (2), 522(b) (3) (C), and 522(d)(12). Limited to $1,000,000 (adjusted for inflation and currently $1,245,475), excluding amounts attributed to rollover contributions. 11 U.S.C. 522(n) 14

15 Creditor Protection of Inherited IRAs Question as to whether an inherited IRA constitutes retirement funds under the Federal bankruptcy exemption Supreme Court held not retirement funds=not exempt State law exemptions v. Federal exemptions State law controls outside of bankruptcy context 15

16 Planning to Protect Inherited IRAs Designate a trust as the beneficiary Conduit Trust Advantage: beneficiary s life expectancy used to determine amount and timing of the mandatory distributions Disadvantage: distributions from the inherited IRA will no longer be protected from creditors following their payment to the trust beneficiary Accumulation Trust Advantage: greater asset protection Disadvantage: all beneficiaries must be taken into consideration in calculating mandatory required distributions (even if merely contingent, or permissible appointees under a special power of appointment) and non-individual beneficiaries (such as charities) may not be permissible beneficiaries (See Treas. Reg (a)(9)-5 (Q-7 & A-7)) 16

17 Formation of Limited Partnership or LLC Owner of property contributes to an LLC or LP and retains interest as a member or limited partner. Need a valid business purpose for LLC/LP. Assets are generally secure from claims of creditors because assets are owned by entity rather than individual member/partner. Creditor can generally only get a charging order remedy and cannot step into the shoes of LLC/LP Manager or GP to sell off the assets or liquidate the LLC/LP. 17

18 Charging Order Protection A charging order is a court order that dictates that the LP or LLC must make distributions that would normally be paid to the debtor to the creditor. BUT, court cannot mandate timing or amount of distributions. LLCs or LPs should be formed in states that provide for the charging order as exclusive remedy. See Prof. Carter G. Bishop s Fifty State charts at: and Currently, Wyoming and Nevada are the only states that provide for exclusive charging order remedy for single-member LLCs. But see In re Cleveland where the US District Court gave trustee power to liquidate single member Nevada LLCs. 18

19 Trusts, in General What is a trust? A trust is a contractual relationship between a grantor, a trustee and a beneficiary for the trustee to hold legal title to property, formerly owned by the grantor, for the benefit of the beneficiary. Why does a trust protect against creditors? Most succinctly stated in Latin, cujus est dare, ejus est disponere 19

20 What is the major limitation on a trust s protection? Public policy - an argument that it is unfair to let a man enjoy the fruits of a trust that he himself has established for his own benefit, while at the same time denying his legitimate creditors payment on their claims. 20

21 Third-Party Irrevocable Trusts Third-party trusts are irrevocable trusts in which the Grantor is not a beneficiary The $5 million gift tax exemption opens up huge opportunities Trust for Spouse - QTIP election Trust for Spouse and Descendants Trust for Descendants 21

22 Trust for Spouse and Descendants Settlor retains the power to fire and hire trustees Use a floating spouse provision 22

23 Discretionary Trust Discretionary Trusts are the most protective Sole and absolute discretion Unreviewable by a court of law Doesn t have to rely on a spendthrift provision 23

24 Inter-vivos QTIP/Marital Trusts with special power to donee spouse General rule: relation back doctrine applies The following states have enacted legislation to negate general rule Arizona Delaware Florida Kentucky Maryland Michigan North Carolina Oregon South Carolina Texas Virginia Wyoming 24

25 Other Non-Self Settled Trusts Power to add grantor given to third party Give beneficiary power to appoint to grantor Spousal Lifetime Access Trust with floating spouse provision Non-reciprocal trusts (but see A.R.S (E) which appears to protect reciprocal trusts Add grantor as beneficiary after ten years 25

26 Domestic Trusts Advantages Probate Avoidance Confidentiality Spendthrift Protection for Beneficiaries Disadvantages Self-Settled Trust Rule Applies in Most States Subject to Domestic Legal System Subject to Fraudulent Conveyance and Sham Trust Challenges New Legislation Alaska Delaware Hawaii Mississippi Missouri Nevada New Hampshire Ohio Oklahoma Rhode Island South Dakota Tennessee Utah Virginia West Virginia Wyoming 26

27 Domestic APTs Advantages Settlor can be Beneficiary and Protector Statutory Protection from Creditors Will Substitute Protection for attorneys, advisors Settlor may retain income or principal under ascertainable standard. Can be structured as either a completed or incomplete gift Disadvantages Subject to full faith and credit Statute of limitations open-ended for existing creditors Ten year statute of limitations in bankruptcy 27

28 Incomplete Gifts What retained powers required? CCA Chief Counsel memo concludes transfer was a completed gift notwithstanding Settlor s retained testamentary power of appointment. To ensure incomplete gift treatment settlor should retain either a lifetime limited power or a veto power over distributions. Prior issued rulings and Treas. Reg (b) suggest testamentary power is adequate. 28

29 Domestic Trust Planning Structure Example: Trust in Delaware, Settlor in New York Client Manager Delaware Trustee Client Investment Account LLC Trust Protector Mr. Client Mrs. Client Child Client 29

30 Foreign Trusts Advantages Settlor can be Beneficiary and Protector Statutory Protection from Creditors Short Statute of Limitations Period Standard of Proof to Succeed in Fraudulent Conveyance Action U.S. Judgments not Recognized Confidentiality Grantor Trust - Tax Neutral during Grantor s lifetime Will Substitute 30

31 Foreign Trusts (cont d) Disadvantages Reporting Requirements U.S. Court Perception/Contempt Foreign Trustee Concerns Section

32 EXAMPLE Dynasty Trust W/O Trust Initial Amount (Grantor 50 Years Old) $5,000,000 $5,000,000 Value at Grantor s Death(7% Growth 25 Years) $27,137,160 $27,137,160 Estate 40% $0 10,854,864 27,137,160 $16,282,296 Value at child s Death 50 Years (7%) 147,285,135 88,371,065 Estate 40% $0 35,348,259 $147,285,135 53,022,806 Value at Grandchild s Death 75 Years $799,380, ,777,708 Estate 40% $0 115,111,083 $799,380, ,666,625 32

33 Service s Ruling in PLR : Grantor proposed to create a trust for the benefit of himself, his wife, and his descendants. Under the terms of the trust, the trustee could, but was not required to, accumulate all income or pay income and/or corpus to one or more of the beneficiaries, including the grantor. The IRS citing Rev. Rul :...the trustee s discretionary authority to distribute income and/or principal to Grantor, does not, by itself, cause the Trust corpus to be includible in Grantor s gross estate under However, the IRS refused to rule whether the trustee s discretion to distribute income and principal to the settlor, when combined with other facts (such as, but not limited to, an understanding or preexisting arrangement between Grantor and trustee regarding the exercise of this discretion), would cause inclusion under

34 Questions? Gideon Rothschild J.D., CPA Moses & Singer LLP 405 Lexington Avenue New York, NY Telephone: Disclaimer Viewing this PowerPoint or contacting Moses & Singer LLP does not create an attorney-client relationship. This PowerPoint is intended as a general comment on certain recent developments in the law. It does not contain a complete legal analysis or constitute an opinion of Moses & Singer LLP or any member of the firm on the legal issues herein described. This PowerPoint contains timely information that may eventually be modified or rendered incorrect by future legislative or judicial developments. It is recommended that readers not rely on this general guide in structuring or analyzing individual transactions or matters but that professional advice be sought in connection with any such transaction or matter. Attorney Advertising It is possible that under the laws, rules or regulations of certain jurisdictions, this may be construed as an advertisement or solicitation. Copyright 2013 Moses & Singer LLP All Rights Reserved 34