ASSET PROTECTION DEFINITION

Asset Protection planning is the process of utilizing planning techniques available to preserve and protect accumulations of wealth from the multitude of potential claims arising from future litigation, bankruptcy, foreclosure, government expropriation, financial or political collapse, and other threats to your estate. This can involve a wide variety of situations and many different areas of law. The key questions to ask are: What potential sources of liability are you exposed to that would suggest use of asset protection strategies are advisable to protect your estate? Who are the potential plaintiffs that might initiate litigation against you and ultimately seize your assets? The term “creditor” is used in this outline to refer to anyone that might initiate litigation and obtain a judgment against you.

FAPT refers to a Foreign Asset Protection Trust which is also known as an Offshore Trust. DAPT refers to Domestic Asset Protection Trust created under the law of a state of the United States. APT more generally refers to an Asset Protection Trust which could be based upon the law of a foreign country or the state law of a state of the United States.

Asset protection planning is not based on hiding assets or secrecy. Although the confidentiality respected by the offshore centers is appreciated by most clients, it will not make any difference in the ultimate protection of assets. If you appear in Court or are legally required to disclose your financial information in any context, your failure to disclose a FAPT or other asset will be fraudulent, a violation of law and possibly a criminal violation.

Asset protection planning is not a means to evade or avoid taxation in the United States. This is not possible under the U. S. income, estate and gift tax laws as discussed later in this outline.

Asset protection planning is not a means or any part of making a fraudulent conveyance. If a Court judgment has been entered, a lawsuit has been filed, or even threatened, it is generally too late to do asset protection planning.

ESTATE & ASSET PROTECTION PLANNING INTEGRATION

Why should asset protection planning be part of your traditional estate planning? Estate planning focuses on what happens when you pass away. Your Will or Trust designates who will receive your estate and upon what terms. However, what will happen if you are sued and a Court judgment is entered against you for a sum of money large enough to consume your whole estate ? The creditor may collect and there will be no estate when you pass away. More importantly, there may be no estate when you are ready to retire. Thus, asset protection planning should be part of everyone’s estate planning and, for business owners, part of their business planning.

Most lawyers should now be integrating asset protection planning tools into estate planning with a sharp focus on both the tax collector and the potential creditor, both well armed wealth predators.

a) Contract Creditor, Debt or Guarantee
A normal consumer debt or a bank loan could result in a claim against your assets. If you guarantee or sign on a loan for another person, you could end up paying for the loan in full.

b) Partnership Obligations
A partner or business associate can create liabilities or expose you to a lawsuit. In general, a partner is legally responsible for all acts of the other partners even if they were not at fault.

c) Business Owners
Business owners are exposed to lawsuits from a variety of sources depending on the nature of the business. In recent years, employee lawsuits for wrongful discharge, discrimination, sexual harassment, Americans with Disabilities Act and the Family & Medical Leave Act have resulted in large verdicts against employers.

d) Corporation Unlimited Liability
The general rule is that the corporate structure limits the liability of the shareholder to losing only their investment in the corporation and they are not personally liable for any corporate debts or judgments. However, under the pierce the corporate veil legal theory, the shareholders can be held personally liable and plaintiff s attorneys have had success in utilizing this legal argument. This legal theory was not part of the very first corporate laws passed by the legislature but was created by court decisions over the years.

e) Officer’s & Director’s Liability
A corporate officer or director can be held to be personally liable for the corporation’s liabilities in spite of the limited liability feature of the corporation. Officers and directors of corporations can also be personally liable under numerous provisions of securities laws, tax and other regulatory laws for their acts associated with corporate activities. Many such officers and directors of failed financial institutions have been held to be personally liable for bad loans or real estate development investments.

f) Tort Lawsuit
The United States is the world’s most litigious country. Incidents ranging from car accidents, accidents at your home by a guest, to spilled hot coffee can form the basis for a multi-million dollar lawsuit against you. For more examples of lawsuits, go to the following websites: American Tort Reform Association (www.atra.org) and California Citizens Against Lawsuit Abuse (www.cala.com).

Tort Reform Legislation: There have been bills introduced in Congress to enact tort reform measures such as limits on non-economic damages, caps on punitive damages etc.. in medical malpractice cases and tort cases in general. Ohio has enacted medical malpractice reform with the following provisions:

1) Limits damage awards for non-economic loss to the greater of a) $250,000, b) or 3 times economic loss but not to exceed $350,000 per plaintiff or $500,000 per occurrence.

2) However, the maximum limits for non-economic loss from permanent disability or deformity are $500,000 per plaintiff or $1,000,000 per occurrence.

3) There is no limitation on economic loss awards.

The above limitations do not apply to a wrongful death action which has no limitation on damage verdicts for non-economic loss.

Ohio law sets forth requirements for the filing of a medical malpractice action as follows: a) Certificate of review by a medical expert prior to filing an action; b) Qualifications for expert witnesses; c) Affidavit of Noninvolvement for defendants who should not be included in the lawsuit; d) Expedited discovery; e) Inadmissibility of “I’m sorry” statements by physicians.

Such legislation is generally a positive development from an asset protection point of view. The new laws have their own exceptions to the general rules limiting damages or liability. If a particular plaintiff can fit within one of the exceptions, then you are exposed to unlimited liability. Unless specifically provided for in the tort reform law, such new laws will not necessarily result in lower medical malpractice or liability insurance premiums. It will be up to the insurance industry to voluntarily lower their premiums after such legislation.

g) Environmental Laws
Anyone owning real estate could be charged with the responsibility of environmental clean-up costs for any violation of the environmental laws. This is true even if you are not the present owner or if you purchased with no knowledge of any problems. Prior owners of real estate can be held legally responsible by virtue of their ownership without any fault in creating the problem. Thus, you could be held liable in a court judgment or administrative action for real estate that you sold a long time ago. Directors and officers of corporations have been held to be personally liable on the grounds that they had substantial control over the land.

h) Liability Insurance Non-Coverage
Liability insurance that appears to promise coverage for some type of liability often provides only a limited coverage or is negated by the numerous exceptions buried in the policy. Some insurance companies are known for a practice of denying coverage or payment of claims. Reading one of your malpractice, umbrella or other liability policies can be an enlightening exercise revealing a large number of situations for which you have no coverage. A common exception that resulted in large jury verdicts against real estate owners was liability for asbestos related injuries. The insurer could also file for bankruptcy and go out of business.

i) Divorce Court
A divorce proceeding can of course have a dramatic effect on anyone’s estate. A premarital agreement done prior to the marriage can effectively protect ones premarital estate in the event of a subsequent divorce. However, premarital agreements have often not been enforced by the Courts and alternate legal theories have been advanced to allow recovery by a divorcing spouse. Similar concerns can arise in the context of an estate plan to protect the inheritance of the children in the event of their marital problems.

j) Nursing Home Costs
If you should need nursing home care, this will cost $80,000 to $120,000 per year and will not be covered by Medicare or supplemental insurance. The best planning option is to obtain long term care insurance coverage. Legal planning for Medicaid eligibility can also protect a person’s estate from nursing home costs. These materials do not cover this topic which is the subject of a separate outline and seminar presentation.

k) Economic Concerns
The United States economy is burdened by a staggering deficit, financially unsound Social Security and Medicare programs, interest on the federal debt and government spending. Foreign markets and currencies may provide a more stable investment vehicle and the opportunity for diversification not available in domestic markets or with mutual funds.

The purpose of the above is to alert the reader to some of the potential exposures to legal liability that could result in a loss of your estate. All possible lawsuits or potential liabilities can not possibly be explored or predicted in these materials. Each person must assess their potential exposures to liability based upon their activities, profession, business, ownership of assets or other circumstances. You must weigh these potential liabilities against your aversion to risk and consider to what extent you will engage in asset protection planning.

FAMILY LIMITED PARTNERSHIPS

Family Limited Partnerships (FLP’s) became a popular estate planning tool during the 90’s. It is now one of the most popular estate & asset protection planning strategies. An FLP is simply a partnership used to hold a family business or all assets or investments of the family estate. An FLP is not just for persons who own a business. Investments can be the sole assets of an FLP. However, you cannot transfer a personal residence to a FLP for estate & asset protection planning. Such personal assets held in a FLP would result in adverse income tax consequences. Thus, a FLP is used in a manner similar to a trust to achieve estate & asset protection planning objectives. The family members, mom, dad, children or other heirs, are the partners. Through use of tax-free gifts and valuation discounts to the FLP the estate and gift tax burden can be greatly reduced.

If the general partner or limited partners are sued by outside creditors, they cannot seize or force a sale of the underlying assets of the FLP. Remember that once you set-up a FLP you do not own the assets. Technically, the FLP owns the assets. Of course, you control the FLP and manage the assets. An outside creditor can only seize assets legally titled in your name. The partnership shares are in your name but partnership law generally limits a creditor to a “charging order” against the partner. This order gives the creditor the right to receive any distributions of income that may be made to the partners. The creditor cannot force a distribution and the general partner has full authority to decide to make no distributions. However, the creditor will receive a form K-1 and, thus, will probably have to report this taxable income on its income tax return.

The effect of this charging order provision is that a creditor will probably receive nothing for its efforts and this will discourage any enforcement action by creditors. 

DOMESTIC ASSET PROTECTION TRUSTS

Introduction

Some States have enacted statutes that change the common law rule of trusts that permit a self settled trust to protect the settlor’s assets from creditors of the settlor. These States are: Nevada, Alaska, Ohio, South Dakota, Delaware, Hawaii, Utah, Wyoming, Oklahoma, Missouri, Mississippi, Michigan, Tennessee, West Virginia, Virginia, Rhode Island, New Hampshire, Indiana and Connecticut . The terms of these trusts are similar to those of the Foreign Asset Protection Trust (FAPT). The specifics of each State’s APT statute vary substantially and each State may offer advantages or disadvantages for a particular person or situation. Each person considering a domestic APT should review their potential exposure to liability and seek legal advice on which State is best for their situation.

This may be more comfortable to some persons than a FAPT since your assets are still within the U.S. However, being within the U.S. legal system will result in less asset protection. Plaintiff’s lawyers are very creative in formulating new theories of recovery and judges with an inclination to expand plaintiff’s remedies will find a way to do so. The I.R.S. and other government agencies will also have powerful legal means at their disposal within the U.S. legal system. The obstacles to a lawsuit against a FAPT are not present for a domestic APT. A motivated creditor will certainly initiate a lawsuit and attempt to enforce their judgment against this type of trust.

b) Ohio Legacy Trust Act

The Ohio Legacy Trust Act was passed effective March 27, 2013 adding new provisions for the creation of an asset protection trust and other non-trust related changes to the statutes. The Ohio version of a domestic asset protection trust is known as a “Legacy Trust.”

The requirements of a legacy trust are as follows:

▸ The trustee must be a person who is not the transferor and must be an Ohio resident. The transferor, usually the same person as the grantor, is the person who transfers property into the trust. The trustee may be a bank or an individual.
▸ The trust must be irrevocable.
▸ The trust must contain a spendthrift clause.
▸ The trust must be governed by the laws of the State of Ohio.
▸ There must be a qualified disposition of property to the trust.
▸ The Act also requires that the transferor sign a qualified affidavit stating as follows: the trust property was not derived from unlawful activities; the transferor has full right, title and authority to transfer the property; the transferor will not be rendered insolvent after the transfer; the transferor does not intend to defraud any creditor by such transfer; there are no pending or threatened court actions or administrative proceedings against the transferor; the transferor does not contemplate at the time of transfer filing for bankruptcy.

The Act specifically provides for the enforceability of the spendthrift clause to protect the interest of any beneficiary including the transferor/grantor. However, the statute does provide for exceptions to this protection for the following: child or spousal support or alimony for the grantor’s spouse, former spouse or children; the division or distribution of property in favor of the grantor’s spouse or former spouse.

The Act specifically states that no creditor of the grantor may bring a lawsuit of any kind against the trust property, trustee or grantor related to the property in the trust. However, an exception is provided that a creditor may bring an action to avoid the qualified disposition to the trust on the ground that the transfer was made with the specific intent to defraud that specific creditor. The statute of limitations for bringing this action is the later of eighteen months after the disposition to the trust or six months after the disposition is or reasonably could had have been discovered by the creditor. If the creditor became a creditor after the disposition to the trust, then the statute of limitations is eighteen months. The statute also provides that a public notice may be made by filing a recording with the County Recorder’s office stating the property that was transferred to the trust. This filing and notice would be binding upon any creditors since it is considered to be a public notice.

The Act specifically provides that the grantor of the trust may retain certain powers which shall not adversely affect the protections provided by the Legacy Trust Act. Some of these powers are as follows:

▸ Power to veto a distribution from the trust.
▸ A limited power of appointment.
▸ The right of the grantor to receive trust income.
▸ The power of the grantor to withdraw 5% of the trust principal annually.
▸ The grantor’s right to remove the trustee and appointed new trustee.
▸ The grantor’s use of real estate or tangible personal property owned by the trust.

The Act also adds some special provisions to deter and limit the effect of any lawsuits that may be brought against trust. If a creditor is successful in a lawsuit, the disposition to the trust is only avoided to the extent to satisfy that creditor’s claim. All other dispositions and the trust itself remain valid and effective. The trustee has a first lien and right of payment from the trust property for attorney fees incurred in defending any lawsuit. Any distributions to a beneficiary that were made will not be required to be returned as long as the beneficiary did not act in bad faith. The statute also requires the court to award reasonable attorney fees and costs to the prevailing party.

FOREIGN ASSET PROTECTION TRUST (FAPT)

1. A Foreign Asset Protection Trust (FAPT), also known as an Offshore Trust, is a trust created under the trust laws of a foreign country and administered by a trustee located in an offshore financial center (OFC). A FAPT is not really that exotic or different from the more common trusts used in the United States. The drafting of a FAPT is very similar to domestic trusts.

The common law trust principles applicable to domestic trusts also form the basis for a foreign asset protection trust. The professionals in these OFC generally speak, write and use English.

2. Motivations For Establishing a FAPT
There are generally two reasons that clients use offshore trusts: 1) asset protection; 2) and meaningful economic diversification. Generally speaking, a portfolio of at least $1 million is required in order to initiate a FAPT. There are many other non-asset protection motivations that might or should form the basis for going offshore such as the following:

a) Economic diversification: There are many investment opportunities available in the international marketplace that are not available in the United States because of burdensome SEC requirements and restrictions. It is estimated that 53% of the world’s market capitalization resides outside the U.S. The sophisticated international banks operating in these offshore financial centers (OFC) provide access to these opportunities.

b) The achievement of a low-profile or anonymity with respect to wealth: OFC provide by law that disclosure of any trust information to a foreign government (i.e., United States) or any other organization or person is prohibited. Thus, you can expect greater privacy of your affairs than with a U.S. trust.

c) The avoidance of forced dispositions: Most state’s laws provide for some type of requirement that a surviving spouse is entitled to inherit a certain percentage of the deceased spouse’s estate regardless of the provisions of a Will or Trust. Some European countries provide similar inheritance rights to children. In Ohio, a surviving spouse is entitled to a certain percentage (one third to one half) of the probate estate. However, in Ohio use of a funded revocable living trust can avoid a spousal claim against the estate since such claim is only against the probate estate and not trust property. There have been bills introduced in the Ohio legislature to expand the spousal claim to cover trust property and all other non-probate property.

d) Premarital planning: Premarital agreements have often not been enforced by the Courts and alternate legal theories have been advanced to allow recovery by a divorcing spouse. Use of a FAPT can assure the intended disposition of the estate in the event of marital problems.

e) Estate tax planning (e.g., establishing a vehicle for exemption equivalent trusts and generation skipping transfer tax exemption trusts) : a FAPT can be used in the same manner as other trusts to reduce U.S. federal estate and gift tax.

f) Planning for the contingency of changing one’s domicile or citizenship.

g) Securing offshore private placement life insurance.

h) Preplanning in anticipation of currency controls or restrictions on ownership of bullion.

i) Liability protection, tax planning, or strategic advantage in the context of an active trade or business abroad.

Tax Savings?

A FAPT does not provide any exemption or savings from U.S. income, estate or gift taxes. Income you receive from the FAPT is subject to U.S. income tax. Do not be misled by promises of secrecy of the FAPT. There are U.S. tax reporting requirements and other procedures designed to ensure reporting of income. There have been successful criminal prosecutions by the IRS of persons who did not report income from a FAPT.

3. Why Your Assets Are Safe from Creditors

a) Comity
An offshore country by its laws does not recognize the validity of a judgment obtained against you in a U.S. Court. This is called a lack of comity. Therefore, a creditor would have to initiate a new lawsuit in the foreign country. Also, the creditor may be required to use an attorney in the foreign country, thus, increasing their cost of pursuing the case.

b) Statute of Limitations
Laws often require that any lawsuit be brought within a short time (e.g. two years) after the cause of action occurs. After this time, the lawsuit related to that event is prohibited. Some countries also require the plaintiff to post a bond and pay the defendant’s legal cost if the plaintiff is not successful.

c) Flight Clause
The trustee also has the power to move the location of the trust to another country in the event of a lawsuit.

d) Exception: Fraudulent Transfer
As with U.S. law, the law in the OFC prohibits fraudulent transfers. These OFC do not want assets from someone attempting to evade existing creditors. Thus, you need to create a FAPT before any financial problems.

The 61 OFC vary greatly in the specifics of their laws and how they provide asset protection. A detailed legal analysis of each of these countries is required before deciding which is best to achieve your objectives.

U. S. INCOME TAX

Introduction

The income of the FAPT is taxable income to the Settlor. This is true even if the income is not actually distributed to the Settlor or beneficiaries. Note the two questions on Form 1040, Schedule B, items 7 & 8, of your income tax return. This is the schedule listing your interest and dividend income. See .

Prior to the Tax Reform Act of 1976, the tax rule was different and income generated outside the United State by assets of a foreign trust was free of U.S. income tax. This former rule may be responsible for the common misunderstanding that an FAPT is tax-free.