Estate planning is not just about saving taxes, it is also about managing and protecting your assets against future creditors, both for you and for your beneficiaries. Economic turmoil is quickly followed by a rise of litigation, not only by individuals seeking to recover some of their losses, but also by governments seeking to claw back the profits made, unfairly, during the crisis. Not only that, but if you receive funds from a person or business that files for bankruptcy, some or all of what you have been paid can be drawn back into the bankruptcy court.
The key to understanding when your assets might be vulnerable to attachment during a law suit is the Fraudulent Conveyance Laws. These laws render a transfer void if there is explicit or constructive fraud during the transfer. Explicit fraud is when you know that it is likely that an existing creditor will seek to attach your assets. Constructive fraud is based on your transferring an asset without receiving reasonably equivalent consideration. If you make a transfer that rendered insolvent, leaves you with an unreasonably small amount of capital, or you are about to incur debts that are beyond your ability to pay (i.e. when a law suit is pending) the transfer is considered to be void as a fraud against present or future creditors. Because the Laws void the transfer, a future creditor, who had no relationship with you whatsoever at the time you made the transfer, can use the Laws to attach your assets.
Receiving reasonably equivalent consideration for any transfer of assets avoids having your transfer treated as constructive fraud. In estate planning, reasonably equivalent consideration includes:
1) Funding a protective trust at death to provide for a spouse or children,
2) The transfer of assets in return for interest in an LLC or LLP, or
3) A transfer that exchanges for an annuity (or other interest) that protects the principal from claims of creditors.
When funding a trust at death, the trust asset protection provisions effective for trusts include a Spendthrift Clause; discretionary powers for an independent trustee on making distributions to a beneficiary; limiting distributions to health, education maintenance and support of the beneficiaries; blending many beneficiaries interest in distributions; provisions that limit the use of real or tangible property to personal use, and provisions that allow the state where the trust is governed to be changed to those more favorable to asset protection such as Alaska.
Limited Liability Companies (LLCs) can be an asset protection entity since, once the assets are transferred into the LLC, your creditors have limited rights to gain access to those assets. Unlike a corporation, there is little basis for a creditor to obtain a charging order to “pierce the veil” of the LLC. As with a corporation, your interest in the LLC can be attached, but you can create restrictions on the sale or transfer of interests that can reduce the value of that interest and even define the term by which sale proceeds must be paid out. LLCs are not “set and forget” entities; however, you have to treat them as a business in order for the courts to treat them as a business. So, if you use the LLC as if it were your personal property, then the courts will ignore the LLC and treat it as personal property.
Annuities are created when you exchange assets for a contractual right to receive payment over a period of time. Most people are familiar with annuities sold by insurance companies. The function is similar, but these annuities are private and do not involve an insurance company. Private annuities are very similar to insurance company annuities, and have some income tax consequences, but do protect the principal against attachment.
There are also trusts which use annuities called split interest trusts. Some are where you (as the Grantor) gift assets but retain the right to receive payments. This right to payments can be a fixed amount annually with a Grantor Retained Annuity Trust (or GRAT.) Another method is receiving a variable amount based on the value of the assets in the trust each year by utilizing a Grantor Retained Uni-Trust or GRUT. If the assets are vacant land, artwork or other tangible property, or being gifted to someone who is not your sibling, parent, child or other descendant, you can keep the income from the assets by using a Grantor Retained Income Trust (or GRIT). Grantor Retained Trusts have been, and remain, in the cross hairs of the Democrats to eliminate or severely restrict their use for estate planning purposes. This does not affect the asset protection aspects of the trust, but you should consider drafting and funding such trusts now to maximize your benefit.
In addition to trusts where you gift to an individual, you can protect assets and receive a charitable deduction, if you make a gift to charity through trusts. These trusts include ones where you keep an annuity or a variable payment annually, with the remainder of the trust assets going to charity at the end of the term (a Charitable Remainder Trust or CRT); and, trusts where you gift a fixed of variable annuity to charity for a term of years, the remainder either back to yourself or to others (a Charitable Lead Trust or CLT).
In summary, to maximize your asset protection, you should draft and fund protective trusts for your spouse, children and other beneficiaries; hold and administer assets in Limited Liability Companies, and convert assets into a private annuity or a split interest trust. Hopefully, you will never be sued. If you are, you can be assured that some of your assets will be protected from attachment.