Asset Protection Benefits
When most people first approach the subject of asset protection, their concern is usually the result of some immediate judgment, lien or lawsuit.
The law provides generous protection for the rights of creditors. Any efforts to delay, hinder or defraud creditors of their just claims can be overturned by the courts. Asset protection can be accomplished with respect to a general (not specific) concern for potential future lawsuits, so long as the process is not solely for the purpose of asset protection.
Thus, to be effective, any asset protection plan must also provide other benefits, as described in this article.
In a like manner, the tax law gives the IRS the legal power to disregard some arrangements if the IRS contends that the only purpose of the arrangement is to avoid or to evade taxes. However, the tax benefits are far more likely to survive a challenge if the financial arrangements can be shown to have some purpose other than tax avoidance. Lawsuit protection is usually an effective justification.
Here is a brief checklist, with comments, of the six primary benefits of asset protection planning.
Greater Financial Privacy
Negotiate very favorable settlements With Future Creditors
Save on liability insurance costs
A nest egg to start over
Save on income and estate taxes
When you make an effort to arrange your financial affairs so that predatory lawyers and entrepreneurial plaintiffs will have a hard time getting any liquid assets, you will greatly reduce the chances of being sued in the first place. The most effective way to avoid a civil lawsuit is to be "judgment proof". Those who are devoid of assets or insurance are not an attractive target for a lawsuit. Lawful methods of asset protection don't make you judgment proof, but they can make you much less attractive as a potential defendant.
Essentially, the lawful methods of asset protection convert your attractive, liquid assets into what some people call "ugly assets". However, just a child may be ugly to others, it's often a sight of great beauty to its parents. In a like manner, the form in which your assets are owned may present a future creditor with an ugly asset, but those assets may be even more attractive to you because of the added tax benefits or other advantages of owning assets in legal entities that are unattractive to future judgment creditors.
Asset protection generally results in the transfer of your assets into legal forms that are not as highly visible to those who might want to pry. If you have less personal assets in your own name, you will usually have less income in your own name.
The credit reporting agencies are building huge databases with an extremely detailed history of everyone's financial activities - what they own, what they owe, what they buy, how much taxes they pay, etc., etc., etc. For those who know how, the information in these databases is accessible for a modest fee.
By reducing your financial profile, you become less interesting to the IRS and other predatory regulators. Mind you, I'm not suggesting that asset protection involves illegal tax evasion. It just divides your assets and income into more pockets, making you less of a target.
In addition, some of these asset protection entities are not a
matter of public record - such as a trust. And, if you have a foreign
trust that owns a foreign corporation that owns your assets, there is
simply no record of your assets in any public database. However, there
are reporting obligations with respect to foreign trusts, corporations
or financial accounts that are onwed or controlled by U.S. persons.
Greater privacy may be available with a foreign life insurance policy.
Even if you can't prevent someone from suing you, if you lose a future lawsuit, the plaintiff will soon discover that it will be very time consuming and expensive to get a full settlement of his or her judgment. You will often be able to negotiate a settlement for 10% to 25% of the judgment.
Consider the plight of a future judgment creditor who has won a lawsuit against you because of an accident caused by an employee or by one of your children - or even a grandchild. If you have your assets properly owned by a family limited partnership, the only remedy available to the creditor would be to get what's called a "charging order". That order requires the general partner to give your creditor any distributions otherwise payable to you. But if the general partner is your wife, or a corporation owned by your family, the general partner might decide not to make any distributions for a few years. Meanwhile, the creditor may be liable for any income tax due on the share of the income that has been awarded to the creditor. Thus, the creditor has a "double ugly" asset. He has to pay income taxes on an asset that doesn't generate any cash flow. Don't you think that creditor would be willing to negotiate a settlement of his claim for about 10% of the amount of the judgment?
Asset protection is a form of risk management, and is partly an alternative to buying costly insurance. When the cost of liability insurance is totally prohibitive, asset protection may be the only option. With a sound asset protection plan, you can gradually reduce the upper limits of your insurance coverage and offset the cost of asset protection with substantial reductions in insurance premiums.
Some advisors strongly recommend that you retain at least enough liability insurance to get the help of an insurance company's legal staff - but not enough to be attractive to a creditor after the legal fees are paid. And, it's not advisable to cut back on your insurance coverage right away. Reduce your coverage gradually or increase your deductibles in order to reduce your premiums.
It isn't reasonable to expect an asset protection plan to protect every dime you have from every possible legal contingency. The most practical approach is to use an asset protection plan to safeguard enough assets so that you can start over if you ever become the victim of a ruinous lawsuit.
Asset protection is much like investment diversification. It doesn't make sense to put all of your investments into one mutual fund in order to get diversification. In a like manner, it makes better sense to utilize an assortment of asset protection devices, with some of your assets being in a trust outside the U.S. and beyond the reach of anyone.
One of the most effective forms of asset protection involves the transfer of legal ownership of property to your children and grandchildren, even though you may retain control of a limited partnership or limited liability company that owns the assets. This will usually result in substantial income tax and estate tax savings as well as creditor protection.
NOTICE: This Information is intended only for educational purposes and may be regarded as controversial by some legal experts. Readers should consult with a qualified professional who is familiar with their specific financial and tax circumstances before adopting any ideas that are discussed in this article.
About the author:
Vernon Jacobs is a CPA who works as a tax author and consultant. He can be reached by phone or fax at (913) 362-9667.
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