Introduction to Asset Protection Planning

Introduction to Asset Protection Planning FPA of Phoenix, Arizona September 2011 Thomas P. Langdon, Esq. Asset Protection Planning Defined Protecting wealth from creditors & predators Lifetime/multi-generational Estate Planning Asset Protection does not involve Tax evasion Hiding assets Defrauding legitimate non-judgment creditors The Client comes to you and says, This is my Castle. Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 1

Growing Concerns Litigation Outlaws (Monster-in-laws?) The Me Generation Government Social instability Spend & pay for it later mentality Politicians inciting class warfare Geographic diversification of wealth Goals of Asset Protection Planning Protect Assets From private & government seizure Minimize exposure to taxation Deter Litigation Level the playing field Enhance bargaining position Create incentives for early & cheap settlement Asset Protection Involves Estate, Trust, and Gift Tax Law Business Law Family Law Pension Law Debtor/Creditor Law Social Insurance Considerations Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 3

How to Dig the Moat Avoid Ownership Maintain Privacy Insurance & Annuities Business Entities Trusts Premarital Agreements Avoiding Ownership Client perspective matters Asset vs. Income focus Time Horizon Individual vs. Family focus Reversal of the Golden Rule & the Ego need for wealth Avoiding Ownership Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 4

Maintaining Privacy Simple measures are growing in popularity Use of electronic banking/delivery of statements Shredders Data security Inversely related to ego need for wealth Look at my Big Pile mentality The truly wealthy don t put on a show for others Preparing for the Defensive Battle Avoid Fraudulent Conveyances Fraudulent Conveyance A Conveyance or transfer of property, the object of which is to defraud a creditor, or hinder or delay him, or put such property beyond his reach. - Black s Law Dictionary Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 5

Sources of Fraudulent Conveyance Law The Statute of Elizabeth (1571) Still in force in most states Uniform Fraudulent Conveyances Act of 1918 (UFCA) Uniform Fraudulent Transfer Act of 1984 (UFTA) Federal Bankruptcy Law Fraudulent Conveyances Result from: inaction a waiver of defenses termination of a lease extension of a loan use of a disclaimer incurring an obligation Fraudulent Conveyances Result from: Actual intent to defraud facts and circumstances test can be imputed from one party to another debtor must be competent to formulate intent Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 6

Badges of Fraud show intent Inside deal Debtor retains possession & control absconds Undisclosed/concealed/secret transactions Removal or concealment of assets Transfers through a straw man Transfer in anticipation of suit or incurring debt Debtor is insolvent, became insolvent, due to the transaction FRAUD Removing the Taint of Fraud Satisfy pre-transfer claims Prove the claim is invalid Invoke the doctrine of laches Wait for the expiration of the Statute of Limitations Creditor abandons the claim What can Creditors do? Restrain the disposition of property Appoint a receiver to take charge Set aside the conveyance or obligation Apply to a court, which may impose any order required by the circumstances Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 7

Planning Issues Violation subjects parties, including the planner, to civil and criminal liability. Solvency is determined by assets available to creditors Recall that asset protection planning can render a client insolvent Structure the transaction to avoid badges of fraud How planners can protect themselves Fraudulent Transfers are determined at the time the transfer is perfected. Implement the plan ASAP!!! Put timelines on recommendations. Have client sign affidavit of solvency. Step 1: Adequate Insurance Property Coverage Homeowners Insurance Auto/Boat Life Insurance Health Coverages Medical/Dental Long-Term Care Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 8

Step 1: Adequate Insurance Income Coverage Disability Business Continuation Liability Coverage Appropriate Limits on Property Policies Umbrella Policy Professional Liability Exempt Property Types of Exempt Property Employee Benefit & Qualified Retirement Plans Personal Residences (Homestead Rights) Life Insurance & Annuities Corporations Limited Liability Companies Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 9

Asset Protection & Retirement Plans Spendthrift Clause is the key to protection from creditors. Non-qualified plans are not fully protected Plans out of compliance Sole participant plans IRAs, SEPs, SIMPLE IRAs Welfare Benefit Plans Top Hat Plans IRAs & Qualified plans not fully protected 2005 Bankruptcy Act provides protection for up to $1 million of value State law preferences, if elected in bankruptcy, can provide additional protection Arizona protects the full value of IRAs and Roth IRAs in bankruptcy Homestead Rights Protect the value of a personal residence May not be effective against all creditors Government/IRS Homestead rights in Arizona $150,000 in Arizona (Ariz. Rev. Stat. 33-1101A) Tenancy in Entirety not protected in Arizona Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 10

Asset Protection & Life Insurance Life Insurance & Asset Protection Insured s Creditors Depends on state law Most states protect Life Insurance Policies Beneficiary s Creditors Once paid, creditors have access Consider annuity settlement option if beneficiary has creditor issues Life Insurance & Asset Protection - Arizona Cash Value (Ariz. Rev. Stat 33-1126A6) Fully Protected Death Benefits (Ariz. Rev. Stat. 33-1126A1) Up to $20,000 if payable to Surviving Spouse Child Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 11

Life Insurance & Taxation Life Insurance is subject to estate tax if: Proceeds are payable to the executor of the decedent s estate. [IRC Sec. 2042(1).] Decedent held, at the time of his death, incidents of ownership in a policy on his life. [IRC Sec. 2042(2). ] Within 3 years of death, decedent transferred incidents of ownership in a policy by gift. [IRC Sec. 2035.] Irrevocable Life Insurance Trusts Proper use of an ILIT will Avoid estate tax inclusion Achieve creditor protection, since the insured does not own the policy Gifts to the ILIT may be fraudulent conveyances. The grantor must be solvent when contributions are made to the trust. Foreign ILIT may provide additional protection Life Insurance & Buy-Sell Agreements Cross Purchase Agreement policies are owned by associates of the insured if a business owner files for bankruptcy, insurance policies funding buy-sell agreements may be included in the bankruptcy estate. Alternative: use a trust to hold the policies Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 12

Annuities & Asset Protection State Law Specific Generally, if the contract is annuitized, a creditor can only get to the payments Principal is protected Arizona Law protects 100% of cash value and payments (Ariz. Rev. Stat. 33-1126A7) Arizona & Other types of potentially exempt property Arizona does not protect 529 plans from the claims of creditors Asset Protection & Choice of Business Entity Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 13

Family Limited Partnerships Mom & Pop Business Interest Family Limited Partnership Mom & Pop General Partnership Interest Children Limited Partnership Interests Advantages of FLPs Control Simplified annual giving Avoid ancilliary probate Transfer restrictions -- valuation discounts Creditor protection for some members Vicarious liability for other (a disadvantage) Facilitate family communications Corporate Characteristics Continuity of Life Centralized Management Limited Liability Free transferability of Interest Potential for double taxation Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 14

Additional Advantages of LLCs Limited Liability for all members Any member may materially participate in management Achieves pure pass-through tax treatment Double taxation is avoided No gain on contribution of appreciated property No realization event upon termination Disadvantages of LLCs Tough passive activity rules Subject to franchise tax Limited Liability not absolute Some fringe benefits excluded from income of Partners Taxable distribution upon conversion from Corporation to LLC Trusts The Ultimate Asset-Protection Tool Put not your trust in money. Put your money in trust. - Benjamin Franklin Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 15

Moatbuilding Trusts Spendthrift Discretionary Support Trust Personal Trust Children s Trusts Self-Settled AP Trusts Dynasty Trusts Foreign Trusts Dynasty Trusts Long-Term, preferably perpetual trusts Objective avoid transfer taxation by restricting ownership of trust assets ownership does not vest in any individual beneficiary Taxation of Dynasty Trusts Income Tax complex trust under Subchapter J Gift Tax Completed gift, requiring allocation of credit or payment of tax GSTT must have a zero inclusion ratio for GST purposes. Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 16

Generation Skipping Transfer Tax Applies to Direct Skips Taxable Distributions from Trusts Taxable Terminations of Trusts Tax is a flat 35% of the Transfer After December 31, 2012 the tax is a flat 55% Minimizing the GSTT The Lifetime Exemption $5 Million until December 31, 2012 $1 Million after December 31, 2012 Direct gifts subject to the Gift Tax Annual Exclusion Currently $13,000 per donee per year Educational and Medical Expenses paid to the service provider Rule Against Perpetuities (RAP) Heneage Finch 1 st Earl of Nottingham Lord Chancellor Nottingham No interest [in real or personal property] is good unless it must vest, if at all, not later than 21 years after some life in being at the creation of the interest. Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 17

Why the RAP? Arrangements for the distant future are likely to result in an inefficient use of resources brought about by unforseen contingencies. - R. Ponsor, Economic Analysis of the Law, p. 486, (3rd Edition, 1986) Some States have outlawed RAP South Dakota but has anti-alienation statute Delaware only applies to personal (not real) property Alaska Wisconsin Idaho, Illinois, Maryland, Rhode Island, New Jersey, & Others Typical Dynasty Trust Provisions Name the Trustee(s) Grants discretion to the Trustee Spendthrift Clause Change of Situs Provisions Assets purchased for beneficiary use Permits the trustee to refuse contributions Definition of Terms Issue Spouse Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 18

Incentive Trusts Encourage favorable behavior Sample Provisions Income Match Payment for charitable service Bonuses Special Purpose Dynasty Trusts Scholarship Trusts Health Care Trusts Crown Jewel Trusts Family Bank Entrepreneurship Trusts Self-Settled Asset Protection Trusts At Common Law, self-settled trusts are void Some states have enacted self-settled trust legislation Grantor creates a trust Grantor has right to receive distributions at discretion of independent 3 rd party trustee. Most notable self-settled trust jurisdictions Alaska Delaware (potential problems from estate-tax perspective) Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 19

Beneficiary Defective Trusts The perfect onshore asset protection trust. Steps Grantor transfers $5,000 to trust for beneficiary Beneficiary has crummey withdrawal right Crummey right expires Beneficiary is trustee for all purposes except distribution Beneficiary Defective Trusts Crummey withdrawal right over all of the contributions to the trust triggers BDT status Beneficiary can, without tax consequences Sell property to the trust Loan money to the trust Control the assets inside of the trust Beneficiary Defective Trusts No creditor access Grantor made a completed transfer Trust is not self-settled Beneficiary is prohibited from making distributions to him/herself Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 20

Spousal Limited Access Trust A BDT for the spouse The person to whom I am married from time to time Permits Leveraging of gift and estate tax exemptions More money can be transferred to children tax free Access to funds during marriage, if needed Spousal Limited Access Trust Years/ROR 6% 8% 10 69,858 78,227 20 211,735 280,239 30 554,439 808,406 40 1,174,548 1,948,680 50 2,285,067 4,410,446 Assumes maximum annual contribution of lapsing amount (greater of $5,000 or 5%) capped at annual exclusion (currently $13,000). Offshore Trusts Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 21

Offshore Trusts Offer Favorable Standards of Proof & Judgments Favorable Statute of Limitations Avoidance of Forced Heirship Rules Avoidance of the RAP (Rule Against Perpetuities) Flight Provisions Potential Consequences of Offshore Trusts US Judgments may be enforceable US Courts may not recognize the foreign trust Presence of an Offshore Trust may result in denial of discharge in bankruptcy DO NOT save Income Taxes. Premarital Agreements Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 22

Premarital Agreements Defined A legal contract entered into by prospective spouses prior to marriage but in contemplation and in consideration thereof; by it, the property or other financial rights of one or both of the prospective spouses are determined or are secured to one or both of them or their children. Uniform Premarital Agreement Act Adopted in 1983 Currently in force in several states limited in scope Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 23

Permissible Content ANYTHING, not in violation of public policy Generally, courts will only enforce financial provisions. A Prenup is Enforceable if: Threshold tests of offer, acceptance, and consideration are met It is a WRITTEN agreement It does not violate public policy encourage divorce forces one spouse to become a public charge adversely affects a child s rights Successful Asset Protection Planning Copyright 2003, 2011. Thomas P. Langdon. All Rights Reserved. 610-357-5233 24