Protecting A Clients Assets. A Holistic Approach (00125483 1)

PROTECTING A CLIENT’S ASSETS:
A HOLISTIC Here
Text APPROACH
BARRY P. SIEGAL

70 W. Madison, Suite 1500 Northbrook Office:
Chicago, IL 60603 633 Skokie Boulevard
Phone: 312-263-2300 Northbrook, IL 60062
Fax: 312-263-0939
Email: bpsiegal@golanchristie.com

Asset Protection Planning

Background

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A. WHO SHOULD BE CONCERNED ABOUT CREDITOR
PROTECTION?
• Physicians and other professionals
• Real estate developers and investors
• Commodity traders
• Members of corporate boards
• Any person who is exposed to liability


Background (cont.)

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Physicians and other Professionals
• Increased cost of malpractice coverage is causing
many physicians to under-insure or go “naked”.
• Judgment creditors increasingly following personal
assets of service providers.
• State laws regarding tort limits only apply to non-
monetary damages - physicians still exposed to
multi-million dollar claims.


Background (cont.)

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Real Estate Developers and Investors
• Many transactions require personal guarantees
• Real estate may have undisclosed environmental
issues
• Corporations and LLC’s don’t offer absolute
protection; i.e., piercing corporate veil.


Background (cont.)
B. Holistic Approach to Creditor Protection
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• Based on individual circumstances in each case – no
magic bullet.
• Factors include client’s risk tolerance, willingness to
relinquish control and cost.
• Use of various creditor protection techniques can
be cumulative.
• Cost of most successful asset protection programs
can be less than one year’s premium on malpractice
insurance.


Background (cont.)
C. Avoid “Fraudulent Transfer” Attack
• Any asset protection vehicle can be avoided if
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creditors can prove that transfer of assets was
“fraudulent” with regard to transferor’s creditors.
• Two tests:
• Objective Test – transfer made when transferor
is insolvent or transfer causes insolvency
• Subjective Test – transfer is made with the intent
to hinder, delay or defraud any creditor without
receiving equivalent value


Background (cont.)
How to Avoid Fraudulent Transfer Attack
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• Asset protection planning should be carried out
when no significant creditors who cannot be paid
from client’s remaining assets
• There should be valid non-creditor protection
purposes for engaging in the proposed transactions;
such as estate tax planning
• Advisor should protect herself by getting affidavit of
solvency


Techniques and Strategies
A. Transfer of Assets
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B. State and federal law exemptions
C. Family limited partnerships and limited liability
companies
D. Protecting business assets
E. Domestic asset protection trusts
F. Off shore trusts


Transfer of Assets
A. Transfers to Spouse
• Standard estate planning typically dictates that assets at least
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equal to federal estate tax exemption be owned by each
spouse.
• Spouse having greatest creditor exposure should own exempt
assets (see below) and other spouse should own non-exempt
assets
• Caution: avoid reclassifying assets as spouse’s separate
properties. (We have clients sign a letter agreeing that any asset
transfers are strictly for estate planning purposes and do not
change character of assets).


Transfer of Assets (cont.)
B. Gifts to Children
• Utilize annual gift tax exclusion
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• $5,120,000 lifetime exemption
Note: this opportunity may disappear on 1/1/13
• UTMA accounts
• 529 Plans – Illinois law recently changed to protect Section
529 Plan assets if: (a) not transferred to defraud creditors;
(b) transferred within 12 months prior to judgment, only
annual gift tax exclusion protected; (c) if transferred
between 12-24 months prior to judgment, twice annual
exclusion is protected
• Irrevocable gift trusts (2503(c) or Crummy trusts)


Transfer of Assets (cont.)
C. Other transfers
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• Grantor Retained Annuity Trusts (“GRAT”)
• Intentionally Defective Grantor Trusts (IDGT”)
• Qualified Personal Residence Trust (“QPRT”)
• Charitable Remainder Trusts (“CRT”)
Caution: since law isn’t clear, best practice is to set up
trust in debtor-friendly state, like Delaware or South
Dakota.


State and Federal Law Exemptions
A. Choice of Domicile
B. Text Here
Tenancy by the Entirety
C. Life Insurance and Annuity Policies
D. Qualified Employee Benefit Plans and IRAs


State and Federal Law Exemptions (cont.)
A. Choice of Domicile
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• Consider establishing domicile in “asset-
protection friendly state,” such as Florida, Texas
or Wyoming
• Establishing domicile requires physical presence
during majority of year plus other indicia of
residence (driver’s license, voting, statement of
intent)


B. Tenancy by the Entirety
• Specific form of joint tenancy ownership. In Illinois deed must
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specify “tenancy by the entirety”
• Only applies to principal residence
• Protects property against claims of creditor of either spouse, not
joint creditors
• Only applicable to married couple. Loses protection after death
of either spouse or divorce
• Illinois law now authorizes revocable living trusts of married
spouses to own property as tenants by the entirety
• U.S. Supreme court has held that even when property held in
tenancy by entirety still subject to lien for federal taxes. U.S. v.
Craft, US 274, 283 (2002)


C. Life Insurance and Annuity Policies
• Illinois law exempts life insurance proceeds payable by reason
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of insured’s death, as well as cash value of life insurance and
annuities, if beneficiary is spouse or child, parent or other
dependent, whether or not right to change beneficiary or
access cash value reserved by insured 735ILCS 5/12-1001
• Exemption appears to be all-inclusive, even for variable, high-
cash value and interest sensitive products
• Safest approach is to have policy owned by irrevocable life
insurance trust.


Background (cont.)
D. Qualified Employee Benefit Plans and IRAS
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• The Employment Retirement Income Security Act of 1974
(“ERISA”) provides for rules regarding certain pension,
profit-sharing and 401(k) plans for the benefit of a
company’s employees, where the plan meets certain
requirements.
• Vested amounts which are not subject to immediate
payout are not subject to creditor claims (Patterson v.
Shumate, 504 U.S. 753 (1992).
• ERISA does not give creditor protection to plans that only
cover the business owner, but no other employees.


4. Exceptions to general rule include:
• Qualified domestic relations orders involving
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payments in divorce proceedings
• Voluntary and non-voluntary assignments of benefit
payments
• Security for loans to participants subject to
limitations of IRC Section 9975(d)(i)
• Offsets of benefits against amounts owed to the plan
for crimes or breaches of fiduciary duty involving the
plan
• Enforcement of federal tax lien against plan benefits.


5. IRA’s:
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• Protection generally governed by state law
• Illinois law contains an exemption for individual IRA’s and
rollover IRA’s
• Under federal law up to $1 million in value (adjusted for
inflation) is exempted from bankruptcy estate
• Status of “inherited IRA” is somewhat unclear, although a
number of cases recently granted exemption to inherited
IRAs, both under state law and in bankruptcy, since a form
of “retirement” account. See e.g. In re Nessa, 426 BR 312.
Illinois bankruptcy case law is still that inherited IRA’s not
exempt. In re Taylor, 206 WL 1276400 (BK CD ILL)


Limited Partnerships (“LPS”) and
Limited Liability Companies (“LLCS”)
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A. Purposes: Consolidate ownership and
management of assets
• Shift income to lower bracket taxpayers
• Shift future appreciation to other family members
• Preclude double taxation incident to C corporations
• Eliminate technicalities of S corporation status
• Limit liability of business creditors to assets of the entity


LPS and LLCS (cont.)
B. Limiting Individual Creditor’s Rights Against
Assets of LP or LLC
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• Rights of a creditor of a partner or member determined by state
law of the domicile of the entity
• Judgment creditor of a partner or member typically obtains a
court order which allows creditor to obtain assets of LP or LLC
• Many states, like Delaware, provide that charging order is
“exclusive remedy” that creditor has with respect to LLC
• Creditor in “exclusive remedy” state is in the position of assignee
and can only receive distributions when made
• Judgment creditor, for income tax purposes, stands in shoes of
limited partner, and must recognize income allocated to partner
or member (Rev. RUL 77-137, 1977-1 C.B. 178).


C. Series LLC statues provides:
1. Text Here
Some states, like Illinois, provide for a form of LLC,
known as Series LLC – set up pursuant to Articles of
Organization
2. Articles create separate legal entities (series), for
separate assets or businesses but at a much lower cost
in filing fees, legal fees, etc.
3. Assets owned by each series are protected against
creditors of other series


Advantages:
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• Lower filing fees and annual fees with Secretary
of State
• Lower legal fees, since able to use single
operating agreement
• If each series is set up as a subsidiary of parent,
then considered “disregarded entities” and only
one income tax return is required
Note: Important to keep separate records and
segregate assets to avoid liability exposure


Protecting Business Assets
A. Separate different forms of assets
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• Professionals frequently maintain all assets involved in
practice within same entity. All assets subject to claims of
business creditors
• Real estate, equipment, and other fixed assets should be
owned by separate entities, then lease to professional
practice
• Ownership in other entities can be gifted to family
members


Protecting Business Assets (cont.)
B. Strip Equity from Practice Assets
• Largest asset in professional practice is typically accounts
receivable Text Here
• Value of accounts receivable can be “stripped” by
obtaining bank loan secured by interest in accounts
receivable
• Loan will normally be guaranteed by professional owner
and loan collateralized by other assets (such as
investments)
• Loan proceeds paid to business owner as loan or
compensation who then transfers funds to creditor
protected vehicle


Domestic Asset Protection Trusts
A. History
• Self-settled trusts historically cannot be sheltered from
creditors Text Here
• Applicable law based upon language in trust, and
connection with state in question (for example, situs of
trustee, administration of trust)
• Thirteen states have adopted statutes that offer creditor
protection for assets transferred to a trust established
under the law


Domestic Asset Protection Trusts (cont.)
B. General Requirements
• Trust must be irrevocable and unamendable by Grantor
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• All or a portion of property must be located in the
jurisdiction where trust located. Typically, this is member
interest in investment LLC
• One of the trustees must reside in state where trust
located. Some states require bank or trust company
• Some of trust administration including maintaining trust
records, must occur in state where trust is located
• Most states prohibit requirement that all income be
distributed to grantor or that grantor can direct
distribution of trust


C. Flexibility
• Trust can name third party as trust protector with ability
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to change trust, in fiduciary capacity, remove trustee or
move to another jurisdiction
• Grantor can typically have investment authority
• Grantor can retain power to change trustee to someone
other than himself or “subordinate person.”
• Some states allow Grantor to veto distributions
• Income sprayed among grantor, spouse and children


D. Concerns
• Grantor must give up control over distributions
•
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Bank will usually make requested distribution, but implied
agreement will negate creditor protection
• Distributions should be based on documented need
• Grantor should have other sources of income
• Currently no cases supporting validity of trust established in a state other
than state of residency
• Some people argue that full-faith and credit clause of the U.S.
Constitution will enable court in one state to obtain trust funds in
another state
• Battley v. Mortenson, Adv. D. Alaska, No. A09-90036-DMD, May 25, 2011.
Court held that new bankruptcy act was meant to restrict state law and
establishment of self-settled trust could be deemed evidence of intent to
defraud, even though grantor was solvent.


Foreign Asset Protection Trusts (“FAPT”)
A. Structure
• Similar to DAPTS
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Foreign trustee/trust protector
• Right to move trust to different jurisdiction


FAPT (cont.)
B. Advantages
• Lack of jurisdiction by U.S. Courts
• Lack of comityText Here
• Litigation commences de novo
• Need to retain local attorney
• No contingent fees
• Loser pays winners legal fees
• Fraudulent transfer rules
• Level of proof – beyond a reasonable doubt
• Creditor must prove transfer was fraudulent as to him
• No full faith and credit


FAPT (cont.)
C. Disadvantages
• Cost usually significantly higher
• Text Here
Distrust of U.S. courts
• Use of contempt power
• Concerns over political and economic stability of
country and/or banks

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