An Overview of the Asset Protection Spectrum By: Leah Del Percio, Esq. In our increasingly litigious society, the threat of lawsuits, debt and liability is at an all-time high for individuals and their families during their lifetimes and even after they pass away. Even though many individuals and entities use business and professional malpractice insurance to offset future liability, these policies usually contain significant limitations. Luckily, there are asset protection planning strategies available for almost any type of asset one can own, including business interests and professional practices. Asset protection planning is the process of organizing and managing one s assets and affairs as a pre-emptive measure to insulate their assets against future risks to which the assets could otherwise be subject. Though commonly thought of as a risky subset of estate and trust planning, asset protection, in its simplest form, has become a required element of almost all well drafted estate plans, and, in its more complex forms, can be of critical importance to one s livelihood should a problem arise. A successful asset protection plan can be considered one that ensures certain assets are beyond the reach of creditors without fraud, concealment or evasion on a state and federal level. It is a set of tools that can be used to frustrate and potentially prevent, rather than resolve, issues with creditors that may or may not arise at some point in the future. Asset protection planning operates on a needs-based spectrum. The type of plan that is appropriate for one individual may not be appropriate for another. The proper plan for an individual can be determined by balancing the level of protection that is needed by the individual, against their ability to withstand certain costs that come along with higher levels of protection. Such costs include the level of legal and financial risk they are able to tolerate in order to achieve such protection, the amount of control they are willing to relinquish over their assets, and the literal administrative costs involved with the creation and maintenance of certain asset protected vehicles, all of which need to be fully disclosed. The spectrum onto which various asset protection techniques fall spans from more complicated techniques where one side offers protection of assets that is as impenetrable by creditors as possible, to common planning and gifting strategies that many estate planning attorneys incorporate into their standard estate plans for clients, to even extremely simple built-in tools, which can still provide considerable protection. The techniques on the more complicated end of the spectrum tend to have an elevated risk based on other factors involving the proposed planning such as the timing, if there is a threat of insolvency on the horizon, etc. The built-in tools on the simpler end of the spectrum consist of things such as having a retirement account governed by ERISA 1 or by naming an individual beneficiary or trust (as opposed to your estate) on your pre-existing life insurance. In fact, most people probably have some of these built-in tools already. There are two factors to keep in mind when building a comprehensive asset protection plan: 1. One must relinquish their reach without losing the asset: The rule of thumb in crafting any type of asset protection plan is that if one (or the intended beneficiary) can reach their assets, then their creditors (or the creditors of the intended beneficiary) can reach them as well. Most asset protection planning involves crafting a strategy where one cannot reach their 1 Employee Retirement Income and Security Act of 1974, as amended. Page 1
assets, yet they (or your intended beneficiaries) can still derive a benefit from such assets. To do so, one will usually need to relinquish their direct control over the assets, which often involves transferring title/ownership to a third party or trust (where a trustee other than yourself controls). 2. Timing is Everything: Due to federal and state laws prohibiting fraudulent conveyances, the strategy chosen and level of protection that can be afforded to an individual largely depends on timing, and the stage at which they begin to plan. For an individual where the threat of insolvency is imminent, there is little, if anything, that can be done to protect their assets while they are still alive. However, such individuals may still be able to ensure that the assets of their estate are protected from creditors (and thus will pass to their intended beneficiaries) by creating an estate plan that accounts for their estate to have debts and liabilities that outweigh their assets. For a solvent individual with no current legal or financial issues, there are far more options available to protect their assets or the assets of their businesses or professional practices during their lifetime, in the event that a future problem arises (for instance, a physician in the process of forming their own medical practice, a lottery winner, a financier with an aggressive investment plan, or the owner of a new business). Generally the appropriate time for lifetime asset protection planning (as opposed to asset protection planning within one s estate plan), is when one has no preexisting creditors or no foreseeable future creditors, so that they do no run afoul of the laws against fraudulent transfers and they feel comfortable that they will not have an issue during all applicable statutes of limitations on such transfers. Most states have adopted the Uniform Fraudulent Transfer Act (the UFTA ) and the federal laws against fraudulent transfers can be found in Section 548 of the Bankruptcy Code. Both the UFTA and the federal laws define a transfer as fraudulent if such a conveyance or transfer is made with actual intent to hinder, delay or defraud any creditor of a debtor. 2 Whether a transfer is fraudulent or not under these laws generally turns on the circumstances of the debtor at the point at which the transfer was made. 3 The determination of the intent to hinder, delay or defraud is ordinarily a question of fact and in most states, must be proven by varying evidentiary standards. 4 Circumstances surrounding a transfer, such as whether the transfer was between spouses, the timing of the transfer and whether the transfer lacked consideration, are also used to demonstrate that a transfer was effected with the required intent to defraud. 5 For all transfers of assets in an asset protection plan, one must take careful consideration to avoid such circumstances. As a result, asset protection techniques such as transferring assets to a third party or trust are not appropriate if a client (or their business) has had legal action taken against them or can reasonably expect to in the foreseeable future, or for a client who is in the process of filing 2 11 U.S. Code 548 (a)(1)(a). 3 Neshewat v. Salem, 365 F. Supp. 2d 508. 4 States with more favorable laws require clear and convincing evidence of the intent to hinder, delay or defraud. 5 Generally, if the debtor denies an intent to defraud creditors, there are certain badges of fraud, that are so commonly associated with fraudulent transfers that their presence gives rise to an inference of an intent to defraud. The factors include but are not limited to the following: secretly done; hastily done; for inadequate consideration; made to a family member or close friend; transferor continues to control that property; and scienter, as in, knowledge of the creditor s claim, and knowledge of the inability to pay it after the transfer. Page 2
for bankruptcy or under other similar circumstances. However if such a client has already transferred the assets previously, before they could reasonably foresee legal action being taken against them or their creditor issues arose, then depending on the type of transferee, the assets could potentially be protected from said lawsuit or creditors in bankruptcy. This is why it is imperative to do such planning as a preventative measure only. Below is a brief and very general overview of some of the trusts and estate planning techniques that fall within the above discussed Asset Protection Spectrum. 1. Estate Planning As many estate planners can attest, the key factor in a great estate plan is whether the scrivener, in drafting, provided enough flexibility to account for unforeseen future circumstances in meeting their client s goals. Building a flexible estate plan that insulates and protects the assets of one s estate for the use and enjoyment of one s beneficiary(ies) in the event that those such beneficiary(ies) become insolvent or have future legal problems can be crucial to one s family, yet is too often overlooked. This is also a key consideration in gifting assets to a beneficiary in trust (discussed below). In Tannen v. Tannen, 6 a New Jersey case impacting a matrimonial situation, Wendy Tannen was sole beneficiary of a trust settled by her parents, and she and her parents were Trustees. The trust had discretionary distribution terms and did not require mandatory payments to Wendy. The trust was at issue in an appeal from a divorce judgment which required the trustees of the trust to pay Wendy $4,000 per month from the trust, in order to impute the trust s income to her with regard to alimony, equitable distribution and child support. The issue on appeal was not whether Wendy actually received income from the trust but the degree of control and access to them. The Tannen court acknowledged that the beneficiary of a purely discretionary trust, in which the trustees have unfettered discretion whether or not to distribute trust assets, cannot compel payments from the trust unless the trustees have abused their discretion. 7 Wendy s trust, however, was a so-called discretionary support trust, meaning that the trustees discretion was governed by a standard related to her health, education and more importantly, maintenance and support. The court grappled with whether the trust s language of maintenance and support gave Wendy a presently enforceable right to trust income, thus allowing her to control trust assets. The Appellate Division reversed the judgment of the trial court, holding that (a) the terms of the trust limited Wendy s ability to compel distributions of income from the trust, and (b) assets placed in thus such discretionary trust will not be considered as belonging to the trust s beneficiary for the purpose of calculating alimony under current New Jersey law. This decision was later affirmed by the Supreme Court of New Jersey. 8 Though the terms of the trust afforded the trustee with a good deal of flexibility to distribute trust assets to Wendy for her benefit, thanks to proper and well thought out drafting, the Court was still able to treat the assets in trust as beyond Wendy Tannen s reach, and thus, beyond the reach of her judgment creditor. 6 Tannen v. Tannen, 416 N.J. Super 248. 7 Id. at 271. 8 Affirmed by Tannen v. Tannen, 208 N.J. 409, 31 A.3d 621, 2011 N.J. LEXIS 1267 (2011). Page 3
2. Gifting In Trust or Otherwise As long as the timing is appropriate as discussed above, a somewhat simple way to protect one s assets from the reach of creditors while planning their estate is to give them to a third party, such as their spouse, children, grandchildren and/or other relatives, so long as they wish for those assets to ultimately be used for that third party s benefit anyway. In making a gift to a third party, one must decide whether to make the gift outright or in an irrevocable trust. If the individual is gifting for the purposes of protecting the asset, the likely choice is to gift the asset to the intended beneficiary(ies) in trust, and not outright. That way, one can continue to insulate the assets from the beneficiary s potential future creditors as well, and in some cases, the future creditors of the descendants of the beneficiary(ies). In making gifts to a trust in excess of one s annual gift tax exclusion, which is currently $14,000, as adjusted for inflation, they will use a portion of their lifetime gift tax exemption. Before using a gifting strategy, it is important to undergo a full review of the individual s current assets, any prior gifts made, and their future financial outlook in order to ensure that (a) the exemption is available; and (b) it makes sense to use their gift tax exemption the manner proposed under the gifting plan. With this in mind, it is usually worthwhile to fund the trust with life insurance or certain assets that are expected to appreciate over time, after the transfer is made, as well as employ other, related strategies in order to maximize the use of their lifetime gift tax exemption. Additionally, it is important to add provisions to the trust where their annual gift tax exclusion(s) are utilized to make annual gifts to the trust each year through the beneficiaries. Typically, this is effectuated by making a gift of the annual exclusion amount to the beneficiary (or beneficiaries) that they are able to withdraw from the trust. Withdrawal powers of beneficiaries such as the one described, as well as other types of lifetime withdrawal powers and powers of appointment could potentially cause such a trust to be attached by creditors, if not drafted correctly. 9 In order to protect trust assets when withdrawal powers are needed so that a creditor of a beneficiary in bankruptcy cannot compel the beneficiary to withdraw trust funds to pay off debts, one can add simple language that removes the withdrawal power of a holder in the event that they file for bankruptcy. Any irrevocable trust should be drafted in an extremely careful and detail oriented manner that takes into account many the potential income tax issues and other variables that could arise and provides a great deal of flexibility to the trustee. For instance, in drafting such a trust, if the situation allows, the trustee or a third party, such as a trust protector, can be authorized to have discretion to merge the trust into a new trust with updated terms, or change the situs of the trust to a state with more favorable creditor protection laws (see discussion below) in the event that circumstances or relevant laws change and the trust assets become less protected from creditors than intended. 3. Asset Protection Trusts Foreign and Domestic Under the laws of most states, a individual cannot set up a trust for himself that is protected from that individual s creditors, as most states allow the grantor s creditors to access as much of the trust as can be distributed to the grantor, regardless of whether there are other beneficiaries. An 9 In re Behan, 506 B.R. 8 (Bk.D.Mass., Feb. 25, 2014). Page 4
Asset Protection Trust ( APT ) is an irrevocable trust established under the laws of a jurisdiction that permits an individual to create, and fund a trust in which they (and often among others), are the beneficiary, yet the trust assets are still protected from their creditors. The jurisdiction can be in another country (a Foreign APT or FAPT 10 ) or domestic (a DAPT ), as there a handful of states which allow such protections. 11 For DAPTs, all of these such states have varying statute of limitations periods which determine how much time is required to pass between the date of transfer to the DAPT and the date upon which the transferred asset are considered protected from either pre-existing creditors and future creditors under the state s laws. 12 There is usually a tolling of the statute of limitations period, with respect to preexisting creditors in order to protect those creditors. A self-settled Domestic APT (a DAPT ) is an irrevocable trust (such as the ones discussed for gifts to third parties in section 2 above), set up under the laws of a favorable state into which the grantor transfers assets in order to protect those assets from the grantor s creditors, and the grantor is also able to benefit from the trust. Once the State s statute of limitations over the transfer has run its course, those assets are arguably protected from most of the grantor s future creditors. Many of the above referenced states also have classes of exception creditors who have the ability to pierce through the DAPT. For example, even though most creditors would be barred by a DAPT-friendly state statute from accessing such a trust s assets, many states provide an exception for divorcing spouses, alimony claims, and/or child support creditors. 13 Many of the states have an exception creditor statute for preexisting tort creditors and other classes of exception creditors as well. It is important to note that much of the existing discourse regarding the use and effectiveness of DAPTs involves: (a) whether a DAPT could have the laws of another, less DAPT-friendly jurisdiction imposed on it where the factual circumstances allow; and (b) if federal law, where applicable, can enable certain creditors to reach the assets of a DAPT (for instance, if the creditor can prove that there was a fraudulent conveyance under Section 548 of the Bankruptcy Code and such section applies to the transfer to the DAPT). CONCLUSION This overview only scratches the surface in describing the capabilities of many asset protection techniques, as well as the construction and design of a many of the trusts that can be used to hold one s business interests, property, and financial assets. Should you wish to learn more about this important part of trust, estate and tax planning, please contact an experienced attorney that specializes in this area of practice. 10 FAPTs require a far more detailed overview and often involve significant risks to both the trust creator and the attorney drafting the trust (e.g., risk of imprisonment, possible application of the foreign trust rules for income tax purposes, and financial risk if the jurisdiction experiences political change). Unless the circumstances are dire, an FAPT is usually not an attractive option for many people. 11 Examples of states that are considered to have favorable laws for asset protection planning include but are not limited to : Nevada, South Dakota, Ohio, Tennessee, Alaska, Wyoming, Delaware, Utah, Missouri, Rhoda Island, Hawaii, Oklahoma and New Hampshire. 12 The statute of limitations period varies between the states and also whether the creditors are pre-existing or non-pre-existing. 13 Examples of such state exception creditors as defined under state law include but are not limited to the following: Code of Ala. 19-3B-503; Tenn. Code Ann. 35-16-104 Page 5
Leah Del Percio, Esq. is a Senior Associate in the Asset Protection, Estate Planning, and Tax Department at Fein, Such, Kahn & Shepard, P.C. Fein, Such, Kahn & Shepard, P.C. is a general practice law firm of more than 50+ attorneys serving clients in New Jersey and New York. For over 25 years the firm has offered innovative solutions to business and individuals in the areas of asset protection business planning, civil litigation, creditor representation in the areas of foreclosure, bankruptcy and collections, elder law, family law, personal injury, tax, and trusts and estates. For more information, go to www.feinsuch.com. This Article does not constitute legal advice nor create an attorney-client relationship. Fein, Such, Kahn & Shepard, P.C., all rights reserved. Permission is granted to reproduce and redistribute this article so long as (i) the entire article, including all headings and the copyright notice are included in the reproduction, and (ii) no fee or other charge is imposed. Page 6