Protecting Assets Against Creditors

By: A.J. Cook

Would a $50 million lawsuit against you or your company wipe you out?

Considering the millions of dollars juries award and the impossibility of adequate insurance, devastating litigation becomes a possibility. Because of this, an asset protection plan should be considered by the mom and pop operation, the surgeon and the large conglomerate.

With any plan, accepting two facts will be necessary: protecting all assets is impossible, and sheltering assets usually entails relinquishing control. Furthermore, each step has tax traps for the unwary.

The plan should include one or more of the following:

1. Transfer Assets to Another Entity. Separate the hazardous activity and its operating assets from other assets protected with a firewall. Consider the following:

1. Use a corporation or a limited liability company to operate the hazardous activity. This will usually limit liability to the assets owned by the company.
   
2. For an existing corporation, establish a subsidiary to operate the hazardous activity and a parent to hold the assets not needed by the subsidiary.
   

Even a separate entity, however, won't protect you if your own negligence caused the damage suit you are trying to protect yourself from or you previously signed an agreement to accept personal liability.

Here are a few of the tax questions:

• Should the new corporation be a flow-through corporation to prevent double tax? Will a later liquidation of the corporation trigger a tax?
  
• Should the new corporation be structured to be eligible to file consolidated returns with its parent?
  

2. Invest in Protected Assets. Shift cash to exempt categories that the law protects from creditors, e.g. home, insurance, etc. Which assets are protected and the amounts depend on the law of the state or sometimes federal law. Some protection may be available where a husband and wife hold assets in joint names where on death the assets go to the survivor.

• Should a trust own the life insurance to avoid estate taxes?
  

3. Give Assets Away. Give nonoperating assets to someone you trust. Or transfer assets to an irrevocable trust for someone else's benefit, where you give instructions on investments and distributions.

• Will the transfer trigger a gift tax?
  
• If the transfer is to a trust, is it drafted to minimize taxes?
  

Conclusion:

• Don't become a general partner in a volatile business. Even a minor ownership can subject your personal assets to all partnership liabilities.
  
• Generally don't use offshore trusts or foreign corporations. There are sharks in those waters.
  
• Seek assistance from a tax expert. The issues listed are only a few of the questions a tax professional should answer. Involve an attorney or CPA specializing in bankruptcy or creditors rights.
  
• Even with a plan, generally a transfer can be reversed: (1) if the debtor intended to hinder, delay or defraud the creditor or (2) if the debtor is "insolvent" after a gift. Insolvency exists where liabilities exceed market value of assets.
  
• Protect your assets before you get into trouble. Don't wait until the heart transplant turns bad, your pizza delivery person hits a pedestrian or your customer finds a roach doing the back stroke in his soup.