as published in The Business Press
by Marvin E. Blum
The Blum Firm, P.C.
Attorney, CPA, Board Certified – Estate Planning and Probate Law
Asset protection planning is not just for the very wealthy. Every professional or business owner should consider asset protection planning an integral part of an overall financial and estate planning program. There are five goals in a well-designed asset protection plan:
- Take full advantage of state law exemptions.
- Protect personal assets from business claims.
- Protect business assets from personal claims.
- Protect assets of one business activity from claims against another business activity.
- Protect inherited assets from creditors.
Unfortunately, many professionals and business owners do not think about asset protection planning until after a claim arises or a lawsuit is filed. By then, very little can be done. Steps taken at the eleventh hour can be set aside as fraudulent transfers. Asset protection planning is most effective when it is implemented without the threat of a lawsuit or creditor problems on the horizon. The time to act is now.
Asset protection strategies range from simple to complex. Asset protection for personal assets often starts with partitioning community property into separate property. In Texas, all property owned by husband and wife is presumed to be community property. Creditors of either spouse can generally reach 100% of the community property to satisfy a judgment against that spouse. However, if a husband and wife have previously entered into a marital property agreement to turn community property into separate property, creditors of one spouse cannot reach the other spouse’s separate property. After partitioning, spouses must keep separate property assets carefully segregated. As an extra precaution to avoid commingling, each spouse can fund the separate property into a revocable living trust for that spouse’s own benefit.
A carefully designed plan takes into consideration four exemptions offered by Texas law. The homestead and up to ten acres (200 acres if rural) are fully protected, regardless of value. Personal assets such as cars, furniture, and jewelry are protected up to $60,000. Life insurance (both cash values and death benefits) as well as annuity investments are shielded from creditors. Retirement plans are also exempt. It is often easy to protect any excess or exposed funds by directing them into one of the four exempt categories.
Anyone operating a business should form an entity such as a limited partnership or LLC (limited liability company) to operate the business. If not, a sole proprietor’s personal assets can be reached to satisfy business liabilities. By conducting the business through an entity, the owner’s personal assets are not exposed to business liabilities (other than claims for professional negligence). Although a corporation is also a type of entity that protects personal assets from business claims, the owner’s stock can be taken by personal creditors. For this reason, the limited partnership or LLC are the preferred entities, as they offer protection from both business and personal creditors. Through proper structuring, a corporation can be converted tax-free into a limited partnership or LLC.
In addition, each business activity should be in a separate entity. By segregating different lines of business into separate entities, the owner can protect the assets of one business activity from claims against another business activity. Be aware that each entity must operate separately and independently from the others, and all intercompany dealings must be at arms length. Otherwise, the court may disregard the separate legal existence of the two entities and allow creditors to reach the assets of both.
A Family Limited Partnership (“FLP”) is an excellent vehicle to hold investment assets such as marketable securities and real estate. A partner’s individual creditors cannot reach assets inside the FLP. Instead, they are limited to a “charging order,” which gives the creditors no voice in the FLP but does entitle them to the partner’s share of any distributions. In that case, the general partner may refuse to make distributions. Each investment activity that carries its own inside liability risks (such as real estate), should be in a separate FLP. Alternatively, a master FLP can be created, with each activity in a separate LLC owned by the master FLP.
Some professionals, especially doctors, are experiencing a skyrocketing cost of malpractice insurance with decreasing coverage amounts. If a judgment exceeds the malpractice limits, the most vulnerable assets are the accounts receivable of a practice. A professional or business owner can protect the accounts receivable or any other significant business asset by pledging these assets as collateral for a loan. The proceeds of the loan can then be used to fund a deferred compensation plan which can be structured to avoid the claims of creditors. By doing this, the accounts receivable are not only protected, but their value to the owners has been monetized without having to pay income tax currently.
Asset protection is also an important consideration in preparing a Will. If parents leave assets outright to children, creditors can reach them. Instead, they should leave assets to a trust for the child’s benefit. Through careful drafting, the child can be named as trustee. A high risk professional should ask his parents to leave his inheritance to a trust instead of outright. He can simplify the process by having the trust prepared by his own attorney, so the parents can make this change with a simple codicil.
Many legitimate techniques exist to protect assets from creditors. A good plan needs to be custom designed to fit the client’s individual situation. The key is to plan early and seek counsel before claims or lawsuits arise.