In our litigation-happy society, every individual who has accumulated assets risks losing those assets to unanticipated lawsuits. This client alert describes several methods used to protect personal assets, ranging from the mundane-but-still-effective to the relatively-new-and-exotic.
Protecting Personal Assets
All individuals can use the following methods to protect personal assets:
Traditional "Estate Planning" Techniques
Traditional estate planning employs a number of techniques that, while designed primarily to reduce estate taxes, can also shield assets from creditors. For example, establishing a "QPRT" or a "GRAT" (Qualified Personal Residence Trust and Grantor Retained Annuity Trust, respectively) can help transfer assets to children or grandchildren free of estate taxes while simultaneously protecting the assets from claims of third parties after the retained interest time period of the trust ends.
Individuals can protect assets by purchasing liability insurance, including an "umbrella" policy.
Life Insurance and Annuities
Some life insurance policies and annuities allow the owner to contribute substantial amounts to the policy in excess of the amount actually necessary to fund the premium. The excess amounts are invested inside the policy. Some states, like Florida, exempt the excess amounts, as well as the death benefits themselves, from the claims of creditors.
Holding Assets Jointly
In some states, including Pennsylvania and Florida, it can be beneficial for husbands and wives to own assets jointly, as "tenants by the entirety," rather than separately. However, the exemption does not always apply to tax liabilities.
Transferring Assets to Others
A transfer of assets to someone else, such as a spouse or children, can protect the transferred assets--as long as the transfer is not found to be a "fraudulent transfer" under state law or the Federal Bankruptcy Code.
Transfer Assets to a Family Limited Partnership
Many families establish a "family limited partnership" (or family limited liability company) to hold assets like real estate and securities. Structured properly, a family limited partnership can help shield assets from creditors and reduce estate taxes at the same time. However, a court in Florida recently held that a limited liability company with only one member did not protect assets from creditors.
Transfer Assets to Qualified Retirement Plans and IRAs
Under federal law, assets held in a qualified retirement plan (e.g., a 401(k), pension, or profit sharing plan) are generally exempt from creditors, except for tax liabilities. Individual retirement accounts are also now generally exempt, but limited to $1,095,000, excluding amounts rolled over into an IRA from a qualified retirement plan.
Change State of Domicile
The laws of some states, notably Florida, make it easier for individuals to protect certain assets from creditors. Moving to one of these states--buying a house, registering to vote, obtaining a driver's license, actually living there--can therefore help to protect personal assets.
Transfer Assets to a U.S. Trust
Some states, including Delaware, Nevada and Alaska, allow for the creation of trusts that are designed specifically to protect assets from creditors. The laws are relatively new and have not been widely tested in court.
Transfer Assets to an Offshore Trust
Those who want to push the envelope might consider transferring assets to a trust established outside the U.S., for example, in the Cook Islands. In general, the transferor must place control over the assets in the hands of an unrelated trustee, who is a resident of the foreign jurisdiction, although these trusts are often used in conjunction with a "protector" whereby another person is given some control. The advantage of these arrangements is that the foreign jurisdiction is chosen because it does not recognize judgments of American courts. The potential disadvantages are that (i) giving up control means giving up control, (ii) the arrangement may be challenged as a sham, and (iii) the use of a foreign jurisdiction may introduce political and legal uncertainty.
Additional Steps for Business Owners
Individuals who own businesses should take the following additional steps, to help ensure that liabilities of the business do not extend to personal assets:
Use a Limited Liability Entity to Conduct Business
The simplest step a business owner can take is to conduct the business in a format that provides some protection against personal liability, typically a corporation, a limited liability company or a limited partnership. A limited liability entity does not protect the assets of the business itself--the business can be sued for everything it has. And in some situations the entity will not even protect the personal assets of the owner, for example where the owner personally caused the harm or personally guarantied a debt. Nevertheless, using a limited liability entity should be the first step for every business.
Think About Corporate Structure
A company that distributes flowers and manufactures asbestos should think seriously about putting each of those businesses in a separate entity, so that the liabilities of the asbestos business do not threaten the profits of the flower business. So, too, should every business spend a moment thinking about whether some aspects of its activity are more "dangerous" than others, and revising its corporate structure accordingly.
Use Good Contracts
A business can reduce its potential liability significantly by using good contracts. A good contract with customers, for example, will disclaim all consequential and punitive damages and limit actual damages to a pre-determined amount.
It goes without saying that every business should carry insurance, but the kinds and amounts vary from one business to the next. Insurance agents or third-party "risk consultants" can help select appropriate insurance coverage.
* * *If you would like our help in protecting your assets--assets you have already accumulated as well as assets you expect to accumulate in the future--please contact one of our business and corporate law attorneys.