incorporate to protect assets?

[Martha]

Hyper, your estate planning/tax planning issue is out of my realm of experience. No hints for those non-US residents who run the risk of estate taxes here.

[Bob_Smith]

So Martha, what can a married couple do to minimize the risk of creditor's seizing assets besides continuing to hold assets in 403(b)s and 401(k)s?

--You mentioned keeping assets separate. Right now we hold all our assets jointly, primarily due to ease of transfer upon the death of one of us. If we split our joint assets, would my wife's half be protected if I were sued? Could you expound a bit on that? Are there downsides we should be aware of?

--What's your thinking on home/auto umbrella policies? Definitely yes? Maybe?

--Anything else the average, run-of-the-mill couple should consider?

Thanks. This is a very interesting and helpful discussion.

[Martha]

Bob, it is far easier for me to say what might be problematic strategies rather than give thoughts on what actually might work.

First off, my DH and I hold our assets jointly. I decided our risks of being sued individually do not outweigh the advantages and simplicity of joint ownership. We have good liability insurance with a two million dollar umbrella. I have good malpractice insurance.

When we had rental property, we held each property in a separate LLC. This provided at least some liability protection.

In contrast, I have a married couple as clients who both are involved in separate business ventures with separate risks. They keep their assets separate so if one loses everything, the other won't as well. They are Minnesota residents which is not a community property state. Therefore, neither is lliable for the business debts incurred by the other. If you consider holding assets separately, there are complications based on whether a state is a community property state and whether the state allows tenancies in entireties. Oddly, in some community property states a person can be liable for the debts of the other spouse unless certain formalities met, no matter how title is held.

Retire@40 mentioned family limited partnerships. I pointed out that they are not neccessarily bullet proof. However, it does provide a layer of protection. I believe there really needs to be a legitimate business purpose for the FLP. It is not a proper vehicle for your house and vacation home. Nevertheless a number people use FLP and LLCs to move assets such as vacation homes slowly to the next generation by giving gifts of interests in the FLP/LLC each year. This strategy is vulnerable to attack because of the lack of a business purpose. However, FLPs and LLCs can be decent vehicles for moving business assets to the next generation. However, there are often better ways to transfer businesses to the next generation, such as though basic corporations with voting and nonvoting stock.

It is helpful to know your own state's exemptions. For example, I believe that there currently is an unlimited homestead exemption in Kansas, Florida, Iowa, South Dakota and Texas. In those states, certainly don't transfer your home to a trust or any other vehicle as you might run the risk of losing the exemption. I would pay off a mortage on that home before ever paying off debt on a cabin or other non-exempt property.

Other states don't have a specific homestead exemption or a stingy one, so you should think about ways to try to protect the home in those states. States that come to mind which are problematic include DC, Delaware, New Jersey, Maryland, Pennsyvannia, Rhode Island, and Ohio.

One option to look at is a trust. If a trust is revocable, it isn't going to do you any good. However, if you set up an irrevocable trust you lose an element of control.

One problem with giving the next generation an interest in your assets before you are gone is that the next generation may have their own creditors. I was trustee in a number of bankruptcy cases where mom and dad put their home in a life estate with their children having "equitable" title to the land. I was always able to recover something for that child's interest and in fact, there are tables to value that interest based on the parents' life expectancy. Also, divorces by the children can cause a number of problems due to claims by exspouses.

Other advice gained from 20 years of bankruptcy experience:

Don't go bare on insurance unless you have nothing to lose
Don't guaranty the debts of your children
Don't be enticed by the pleasures of gambling
Don't borrow money from your retirement plan
Pay your taxes no matter what
Pay your child support no matter what
Pay your credit cards in full each month
Pay off your house
Live below your means
If you are a risk taker, try to position yourself so you don't take your family down with you if things don't work out

[Martha]

I didn't really expound much on Bob's question about liability of one spouse for the debts of the other. This again depends on state law. Minnesota law provides that a spouse is only liable for necessities of life of the other spouse. There is a lot of dispute as to what "necessities" are. For example, one area of dispute is whether you are liable for unpaid medical bills of your spouse. Medical costs seem like a necessity to me. However, if my husband is driving a car owned only by my husband, and he has an accident resulting from his negligence, I would not be personally liable for his debt. Therefore, there is some sense in holding assets separately.

However, in some community property states, no matter how title is held, all marital assets are owned by the "community". If one of the spouses incurrs a debt, the other and the other's property might be liable for for the debt, even if they had no involvement in incuring the debt and even if it wasn't for a necessity.

In community property states it is a good idea to have a marital property agreement to try to shield at least some assets from claims of creditors of one spouse.

I was a trustee in both Minnesota and Wisconsin. In Wisconsin (a community property state) on occasion I would seek assets from the nonfiling spouse of a bankruptcy debtor.

I'll shut up now.

[TallCotton]

I just checked in since posting my question, and WOW. I guess I picked something worth talking about. If I understand what I've read the advice I am given is to get an umbrella policy to give those creditors something to get instead of my house and other assets. But what's to say they would want to stop at 1 or 2 mil in the policy. Why not go for everything this poor sobs' got?

I remember a business owner in MI many years ago who owned a business that began to go under. This owner created a new business and borrowed all the remaining money in the going under business. He kept the gone under business alive in name only. When his second business failed and he claimed bankruptcy, the rules said he had to pay back his debts as he could. The second companies' first debt, and therefore the one that got paid back first was the debt to his former company. This stategy saved his ass. this is how I heard it anyway.

I've read some things about equity stripping and cross-collateralization. feelings on these?

TC

[retire@40]

Quote:

A family limited partnership is just a limited partnership of family members. *Whether a creditor can take a limited partnership interest is mostly a function of state law and the states I am familiar with do not provide any special *protection for those interests. People try to draft the agreement in a way to try to prevent creditor attack, but those provisions might not serve to prevent a creditor from seizing the interest, especially if it is the interest of the party who originally set up the partnership.

I read through your later posts and agree that the FLP must have a business purpose even if that business purpose is to earn rental income, interest, dividends, and capital gains.

However, I disagree with you that a creditor can take any assets of a limited partner. *The creditor cannot take anything out of the partnership nor can he step in with any controling powers. *If the creditor wins, he only wins the right to any distributions out of the FLP. *In the case where the FLP is in the business of earning investment income, that creditor would not be able to liquidate any of the partnership assets but would have to pay taxes on phantom income generated by the partnership.

I am basing this on the provisions of the Uniform Limited Partnership Act that is recognized in every state as far as I know.

[sailaway]

This may seem complicated but it works for my wife and I

Each income asset/company is held in a separate LLC. Therefore inherant liabilty from each is limited to the that LLC asset and cannot go outside it.

The LLCs are then owned by a Family Limited Partnership. The owners of the FLP is:

1% myself as General Partner
1% my wife as General Partner
49% wife's irrevocable trust
49% my irrevocable trust

This way we each get the lifetime exemption, unlimited marital deduction, total control of income coming out of all of the LLCs which we take as salary, protection from outside litigation, except for our 1% each ownership which we would not take any salary or distribution if a problem arised.

I gues it takes all kinds

[Martha]

Quote:

I read through your later posts and agree that the FLP must have a business purpose even if that business purpose is to earn rental income, interest, dividends, and capital gains. However, I disagree with you that a creditor can take any assets of a limited partner. The creditor cannot take anything out of the partnership nor can he step in with any controling powers. If the creditor wins, he only wins the right to any distributions out of the FLP. In the case where the FLP is in the business of earning investment income, that creditor would not be able to liquidate any of the partnership assets but would have to pay taxes on phantom income generated by the partnership. I am basing this on the provisions of the Uniform Limited Partnership Act that is recognized in every state as far as I know.

The Uniform Limited Partnership Act provides that a creditor cannot take assets of a limited partnership to satisfy the debt of a limited partner. Basically, the partnership isn't liable for the debts of the limited partners. It also provides that a creditor of a limited partner can "charge" that partner's interest to pay a judgement, and that the creditor will be treated like an assignee of the partnership interest. This does not mean that a creditor cannot take a limited partner's interest in the partnership to satisfy that partner's debt.

Some states do, however, limit the ability of the creditor to "take" the partner's interest. This is where your charging order comes in. The creditor will get an order of the court requiring any distributions to the partner be paid to the creditor. The creditor just sits and waits or settles with the debtor or other partners.

However, the trend is to allow the liquidation of partnership interests where the creditors judgment cannot be satisfied by the charging order. Because of this trend and the fact you can't be sure where you will get sued and what state's law applies, there is always the risk that a creditor or bankruptcy trustee will successfully obtain ownership of the limited partner interest.

The practical problem still remains, however. Even if the creditor gets ownership of the limited partnership interest, it is going to be hard to force a distribution. There also is the tax risk you mentioned, but I believe all the LPs will suffer the same consequence. Nevertheless, a determined creditor or trustee will likely be able to squeeze something out of the partnership interest.

It is worse for the debtor if the debtor is both the general partner and a limited partner. Say dad sets up a FLP. Dad is the GP and is a LP along with his kids. Dad ends up in financial trouble and files bankruptcy. As trustee, I would step into his shoes as GP and force a distribution to the LPS.

To protect himself, Dad might have formed a LLC to hold the general partner interest. This makes my job tougher but not neccessarily impossible. Dad files bankruptcy. His LLC is property of the bankruptcy estate. As trustee, I take action as the member of the LLC to cause the LLC to cause the GP to order a distribution to the LPs. It starts getting hard if the LLC has a number of members.

Martha

[Martha]

Quote:

This may seem complicated but it works for my wife and I Each income asset/company is held in a separate LLC. Therefore inherant liabilty from each is limited to the that LLC asset and cannot go outside it. The LLCs are then owned by a Family Limited Partnership. The owners of the FLP is: 1% myself as General Partner 1% my wife as General Partner 49% wife's irrevocable trust 49% my irrevocable trust This way we each get the lifetime exemption, unlimited marital deduction, total control of income coming out of all of the LLCs which we take as salary, protection from outside litigation, except for our 1% each ownership which we would not take any salary or distribution if a problem arised. I gues it takes all kinds

Sailaway, are you a beneficiary of your or your wife's irrevocable trust? If so, I might consider as a bankruptcy trustee an attack on your FLP if you personally filed bankruptcy. I would take the GP interest and try to force a distribution to beneficiaries of the trust. If you were a beneficiary, that distribution would go to the trustee.

The LLC idea is great because it minimizes your risk of personal liability and with all these layers of complication, most would stay away.

Martha

[Martha]

Quote:

I remember a business owner in MI many years ago who owned a business that began to go under. This owner created a new business and borrowed all the remaining money in the going under business. He kept the gone under business alive in name only. When his second business failed and he claimed bankruptcy, the rules said he had to pay back his debts as he could. The second companies' first debt, and therefore the one that got paid back first was the debt to his former company. This stategy saved his ass. this is how I heard it anyway. I've read some things about equity stripping and cross-collateralization. feelings on these? TC

I am not quite sure what happened with the Michigan business, but it sounds similar to what we call a corporate shuffle. A business is in trouble, it "sells" its assets to a new entity formed by the same owners. The sale price is the agreement of the new entity to assume secured debt. Secured creditors consent to the sale and allow the new entity to assume the debt. Trade creditors are stuck with nothing. Sometimes this strategy yields fraud claims by those creditors.

Equity stripping and cross collateralization? Don't get me started.

Martha

[smooch]

From Bob_Smith:

So Martha, what can a married couple do to minimize the risk of creditor's seizing assets besides continuing to hold assets in 403(b)s and 401(k)s?

My understanding is that 403(b)s and 401(k)s are NOT protected if one spouse is in need of long term care. Is there a way to protect the 403(b) of the healthy spouse?

[TallCotton]

Hi, I originally asked this question because I'm worried about ER without having medical benefits. I mean I'm going to pay premiums for self insurance, but somehow iI think if I really looked into the plans closely they would in actuality be stripped down things that when something really serious happened I wouldn't be covered.

The first five years of my ER plan calls for me to survive with the distributions from a couple of IRAs' and cash savings. I would be driveing a paid for truck and living in a paid for home. I would have a couple of other important assets (property.) But extra cash, no.

I worry if I get sick and end up in the hospital for a while and run up a load of bills and need long term care or something that I would not only be losing my health, I would also lose my house, truck, properties and maybe they'ld go after my pension and who knows what else.

Now, I've paid my bills all my life, but y'know, I have to admit I would sleep fine knowing I could skate around a couple of hundred thousand, or more, in bills owed to an insurance company. I've probably given them a million over the last 30 years.

So, if it meant I had to own my retirement home, and vehicles through seperate LLCs' inside an irrevocable trust, then so be it. As long as it would stay my roof over my head till I die, and I still had an income to keep the heat and lights on I could care less if some big corporation get shafted while I do it. I know they would do the same for me...

So I seek clues on how to hide my assets.

T "human resource" C

[Bob_Smith]

Martha, thank you!

[Bob_Smith]

Quote:

From Bob_Smith: So Martha, what can a married couple do to minimize the risk of creditor's seizing assets besides continuing to hold assets in 403(b)s and 401(k)s? My understanding is that 403(b)s and 401(k)s are NOT protected if one spouse is in need of long term care. Is there a way to protect the 403(b) of the healthy spouse?

Smooch, the only ways I know to cover LTC are to buy insurance, self-insure, or qualify for Medicaid. I chose to buy insurance and pay it off in one lump sum.

[BUM]

Quote:

Don't go bare on insurance unless you have nothing to lose Don't guaranty the debts of your children Don't be enticed by the pleasures of gambling Don't borrow money from your retirement plan Pay your taxes no matter what Pay your child support no matter what Pay your credit cards in full each month Pay off your house Live below your means If you are a risk taker, try to position yourself so you don't take your family down with you if things don't work out

This is pretty much how we live our lives in the BUM family, clueless grown children not included. Nearly all the risk I've shouldered over the years has been borne by my S corp. (healthcare related). As the activity winds down, my spirits wind up! Living under the daily threat of a possible lawsuit is troublesome enough even with liability coverage.

As ER unfolds I'm hoping that living by Martha's Ten Commandments will keep the wolves lunching elsewhere.
The S corp remains open however and pays for group health insurance benefits.

Thanks Martha

confession - Last week I broke commandment #3. I shamefully put a lottery ticket in my wife's birthday card.... mea culpa.

BUM

[Martha]

I feel the need for a little CYA. Making decisions about how to hold assets has a lot of factors. There are practical issues, tax issues, estate planning issues and creditor protection issues. This thread has only touched on a few. Each person's situation is different so no decisions should be made based on what we talk about here. Instead, you can take some of these ideas or concerns and talk about them with your own lawyer. We can only paint with a broad brush here and talk in generalities that might not apply to anyone's specific situation.

The general thrust of my comments has been that little of what you do is absolutely bullet proof and if you have significant assets, there is an incentive for an attack by an aggressive trustee or creditor.

EDIT: Another issue to emphasize is that the law is always in flux. Legislatures amend exemptions. Courts interpret them. Trustees find ways to attack. What is true today is not necessarily true tomorrow. The same is true with estate planning. Especially if you do sophisticated planning, you need to talk to your lawyer every once in a while to update that planning based on changes in the law.

[Martha]

Quote:

So, if it meant I had to own my retirement home, and vehicles through seperate LLCs' inside an irrevocable trust, then so be it. As long as it would stay my roof over my head till I die, and I still had an income to keep the heat and lights on I could care less if some big corporation get shafted while I do it. I know they would do the same for me... So I seek clues on how to hide my assets. T "human resource" C

Keep in mind the need to talk to your own lawyer about these issues as your lawyer will ask all the necessary questions and help determine a plan for you based on your situation. A lot of your issues will depend on what state you live in. Are you in a state that provides broad protection for your home? What kind of pension do you have? What types of protections does your state provide for that pension? Often defined benefit plan type pensions have broad protections. IRAs are all over the board and there is a lot of litigation concerning exemptions in IRAs. ERISA and the supreme court have provided fairly broad protection for ERISA qualified plans, such as 401(k)s.

Once you know what is exempt, then you can think about whether there is any suitable way to protect the non-exempt assets which have signficant value.

Slightly off topic. I have not used any asset protection planning yet, partly because it's a low priority right now
and partly due to the cost of hiring a "pro" to help.
However, to illustrate the differences which may exist
in state laws...................I am still battling over the court
order requiring me to fund a significant (to me) portion
of my youngest daughter's very expensive college
choice. In some other states I would have no obligation
whatsoever after age 18. I really got hammered on that
one.

JG

[Martha]

Quote:

My understanding is that 403(b)s and 401(k)s are NOT protected if one spouse is in need of long term care. Is there a way to protect the 403(b) of the healthy spouse?

Smooch, ERISA doesn't protect your retirement plan from claims of the IRS and claims of a divorcing spouse under a qualified domestic relations order. But even though a creditor might not be able to actually take money from the 401(k) or 403(b), you won't get public assistance until you spend certain of your assets down, whether or not those assets are exempt from creditors. So you are stuck having to use the retirement money for long term care .

Planning to move all your assets to the next generation so that you are eligible for Medicaid is a very very dangerous area.

As Bob said, long term care insurance. This insurance seems best for those who don't have quite enough to finance long term care with their own assets, but yet have enough assets to have a lot to lose if they had to pay for nursing home care.

[sailaway]

To Martha Re: assets owned as LLCs owned by FLP owned by irrevocable trusts

Each irrevocable trust is taylored only to that spouse alne without mention of the other. In addition there is an arms length distance by each trustee to that trust to maintain the independence with creditor protection guidlines built into the trust documents.

Sailaway