The Tools of Domestic and International Asset Protection
Greenville Estate Planning Council January 19, 2016 Greenville, SC Elizabeth L. Morgan (formerly Elizabeth Morgan Schurig) Elizabeth L. Morgan 10415 Morado Circle | Building I, Suite 310 | Austin, Texas | Office | Fax Is It Appropriate for Estate Planning Attorneys to Render Asset Protection Advice?
Some commentators suggest that estate planning attorneyshave a duty to render asset protection advice Most estate planning advice has an asset protection orwealth preservation component premarital or post marital agreements protection against spousal creditors entity structures protection against business and other third party creditors wills & trusts protection against governmental and other third party creditors disability documents protection against unwanted personal results How Do You Know Whether A Client Needs an Asset Protection Vehicle?
Everyone needs asset protection to some degree The greater the net worth the more difficult it isto achieve asset protection without a protectivetrust or entity structure Isnt Asset Protection Against Public Policy?
[T]he doctrine that the owner of property, in the free exercise of his will indisposing of it, cannot dispose of it, but that the object of his bounty must hold it subject to the debts due his creditors is one which we arenot prepared to announce as the doctrine of this court [E]very Statein this Union has passed statutes by which a part of the property ofthe debtor is exempt from seizure [for] the payment of his debts To property so exempted the creditor has no right to look as ameans of payment when his debt is created [and] this court has steadilyheld that [such exemptions are] invalid as to debts then in existence [but]as to contracts made thereafter, the exemptions [are] valid.Thisdistinction is well founded in the sound and unanswerable reason, that thecreditor is neither defrauded nor injured by the application of the law to hiscase, as he knows, when he parts with the consideration of his debt, thatthe property so exempt can never be made liable to its payment.1 1Nichols v. Eaton, 91 U.S. 716, (1875) (Justice Samuel Freeman Miller). United States Legal System
The U.S. legal system is different from otherWestern legal systems in many important ways. Contingency fees allowed Pleadings are protected speech Punitive damages are allowed in civil cases against individuals (rather than only in cases involving corporate products liability) There is no bond requirement, except for appeals There is no loserpay system The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
Expands list of nondischargeable consumer debt Amends means test so that, in general, debtorswith income greater than state median householdincome can not get discharge and will be requiredto reorganize Methods to Achieve Asset Protection
Retirement Plans Homestead Life Insurance & Annuities I. Spendthrift Trusts for and Gifts to Descendants CLIENT Spendthrift Trusts for and Gifts to Spouse II. Limited Partnerships Limited LiabilityCompanies Protective Trusts III. Creditor Protection: Fraudulent Transfer Law
General rule A gratuitous transfer of property with the actual or constructive INTENT to avoid creditors is fraudulent and may be set aside by creditors Any transfer of assets from nonexempt status to exempt status should be tested to assure that it is not a fraudulent transfer Three classes of creditors Present creditor solvency analysis Potential subsequent creditor badges of fraud Unknown future creditor Creditor Protection: Fraudulent Transfer Law (cont.)
Statute of limitations Statute of limitations on fraudulent transfer claimsin most states is four years from the transfer, or,for existing creditors, within one year of when thetransfer could reasonably have been discovered, iflater A bankruptcy trustee can have a fraudulenttransfer set aside if the transfer is made withintwo years of bankruptcy certain transfers to aselfsettled trust or similar device subject to a tenyear statute of limitations Solvency Test Total value of assets Liabilities (including contingent)
Creditor protected assets (e.g., homestead) Amount that can be transferred Less: Less: Equals: Retirement Plans In most states, unlimited exemption as long as the plan qualifies under the Internal Revenue Code ERISA contains anti-alienation provisions Fully protected in bankruptcy if they are exempt from taxation under IRC 401, 403, 414, 457, or 501(a) Protection for IRAs (under IRC 408 and 408A) in bankruptcy capped at $1,000,000 adjusted for inflation every three years ($1,245,475 through March 31, 2016 and will be adjusted on April 1, 2016) Rollover amounts to IRAs are excluded from bankruptcy cap Homestead State homestead exemptions based upon eitheracreage (for example, Florida, Texas, andKansas) or value (for example, California andMissouri) 2005 Bankruptcy Act Amendment possibly limitsequity obtained in homestead during 40 monthsprior to bankruptcy to $125,000 adjusted forinflation every three years ($155,675 throughMarch 31, 2016 and will be adjusted on April 1,2016) Life Insurance and Annuities
Many states exempt cash value and policyproceeds of life insurance and annuities, even ifthe insured retains the power to change thebeneficiary or the insured or the insureds estateis a contingent beneficiary In some states this exemption extends to policyproceeds in the hands of the beneficiary andprotects those proceeds from the beneficiaryscreditors as well Life Insurance and Annuities: Protective Planning Opportunities
Advise the client to move exposed cash into a lifeinsurance or annuity product that is protectedunder the state statute If the costs of the product are low enough (boththe product and tax costs) then the purchase willbe both a good investment and a prudentprotective device If the product chosen is life insurance rather thanan annuity then the investment return inside theproduct will also avoid income tax Life Insurance and Annuities: Protective Planning Opportunities (cont
If there is no available cash then consider movingequity out of other assets and into the lifeinsurance or annuity contract Section 529 Plans Some states exempt the assets held in 529plans if the debtor resides in that state and theplan assets are held by that states authorizedplan Other states, like Texas, exempt the plan assetsregardless of where the assets are held as longas they are held in a state qualified tuitionprogram that meets the requirements of IRC529 Section 529 Plans (cont.) Bankruptcy Code exempts funds in 529 plans butgenerally limits the exemption to the contribution limits contained in 529 and specifically limits theexemption by completely disallowing contributionsmade 1 year before bankruptcy and only exemptingcontributions that do not exceed $5,000 perbeneficiary that were made between 2 years and 1year before bankruptcy In states that allow debtors to choose state ratherthan federal bankruptcy exemptions 529 plans maybe fully exempt in bankruptcy 16 Section 529 Plans: Protective Planning Opportunities
Because Section 529 Plan assets can be used tobenefit any beneficiary, including the Grantor,the plan assets can be a valuable protected classof assets Move available cash into Section 529 Plans If there is no available cash then consider movingequity out of other assets and into Section 529Plans What is a Spendthrift Trust?
A spendthrift trust is one in which the beneficiary isprecluded or restrained from voluntary orinvoluntary transfers of trust assets.In somestates, this includes a prohibition on the ability topledge as collateral any interest in a trust.Theconsequences of these types of provisions in trustdocuments is that the beneficiarys creditors areprecluded from reaching trust assets.In moststates, settlors cannot utilize a spendthrift trust toprotect assets from the settlors creditors. Spendthrift Trusts Primarily statutorily created not a part ofEnglish common law Some states have no spendthrift statutes, butjudicial decisions have validated spendthriftprovisions (Hawaii, Maryland, Massachusetts,Michigan, Minnesota, and Vermont) Uniform Trust Code 2000 contains provisionsvalidating spendthrift provisions in trusts andaddressing rights of settlors creditors Trusts for Family Members With Spendthrift Protection
Trusts for Descendants Crummey Trust $14,000 per donee annual exclusion possible 2503(c) Trust Contributions to trusts for children under age 21 are not gifts of a future interest Life insurance trust Trusts for Family Members With Spendthrift Protection (cont.)
Inter vivos QTIP after partition All income to spouse required, but document candisallow distribution of principal on the happeningof some event like divorce Consider funding interest in the family businessinto an inter vivos QTIP Spendthrift Trusts: Protective Planning Opportunities
Draft the trust document to contain a purelydiscretionary distribution standard rather than anascertainable standard Consider forming the trust in a jurisdiction thathas either repealed the common law rule againstperpetuities (for example, Delaware, SouthDakota, or Arizona) or has extended theperpetuities period (for example, Alaska 1,000years, Florida and Tennessee 360 years,Nevada 365 years) Spendthrift Trusts: Protective Planning Opportunities (cont.)
Include a provision stating that it is the Settlorsintention that all property of the trust will be theseparate property of the beneficiaries and that noproperty of the trust will be the communal ormarital property of any beneficiary Include provisions allowing the trustee to changethe situs or governing law of the trust Include provisions allowing for amendment of thetrust document by either the trustee or protector Spendthrift Trusts: Protective Planning Opportunities (cont.)
Consider establishing the trust in an assetprotection jurisdiction like Nevada or Alaska andallowing the settlor to be a permissiblebeneficiary (see PLR ( )) Advise Clients to Enter Into Premarital and Post Marital Agreements
Properly drafted marital agreements createclearly defined property parameters, therebylessening exposure to each other on divorce In the case of second or successive marriages orother relationships, property agreements willprotect children and other interested parties onthe death of one of partners to the marriage orother relationship Properly drafted marital agreements cansegregate property of the underexposed spouseso that creditors cannot reach them Marital Property Agreements: Protective Planning Opportunities
If the creditor concern is third parties rather than spouses, divide assetsso that the exposed spouses assets consist of exempt assets and so thatthe unexposed spouses assets consist of nonexempt assets Consider unequally severing the assets so that the exposed spousereceives less than the unexposed spouse, and then the unexposed spousecan create an intervivos QTIP for the benefit of the exposed spouse Planning reminder in community property states, this type of planningcauses a loss in the basis step up in the surviving spouses property so itmust be used cautiously and in a considered fashion. Charitable Planning Certain charitable gifts protect assets as well
Gift of home to a qualified charity with a retainedlife estate Bargain sale to a qualified charity Charitable Lead Trust Charitable Remainder Trust Limited Partnerships and Limited Liability Companies
Aggregate Theory (historical view) The partnership is not a distinct legal entityseparate from the partners Each partner owns an undivided interest inpartnership property making turnover of assets tocreditors without impact on non-debtor partnersimpossible Charging Order as a remedy protected both thecreditor and the non-debtor partners LLC statutes were modeled on partnership statutes,and so they adopted the partnership statutesCharging Order provisions Limited Partnerships and Limited Liability Companies (cont.)
Entity Theory (current view) The partnership is a distinct legal entity separate from itspartners Partners do not own a interest in partnership property;instead, they own an interest in the entity Under the entity theory, there is no real distinction betweenpartnerships, LLCs, and corporations; thus, it is difficult toargue that Charging Order laws are needed to protect thepartners Under the entity theory, the only thing standing in the wayof a creditors ability to divest a partner of his interest inthe entity is the applicable state statute It is interesting to note that Nevada has passed a Charging Orderstatute applicable to corporations (NRS 78.746) Charging Order A charging order is an order issued by a courtpursuant to statute which charges the debtorsinterest in the entity with the amount due to thejudgment creditor.Under a charging order, thecreditor only gets distributions from the entity tothe extent of the debt.Once the debt isextinguished, the charging order is fulfilled.Thedebtors interest in the underlying partnership orcompany assets is preserved. Foreclosure If a creditors lien on a debtors interest in a partnership isforeclosed upon, the debtor loses the partnership interest andall of the future benefit in that interest forever (even if thatbenefit greatly exceeds the debt) including a right to thatpartners pro rata share of the new assets at liquidation (TheUniform Limited Partnership Act (2001) 702(b)).In addition,upon foreclosure, the debtor-partner may also lose themanagerial rights afforded him by 702(b) if the otherpartners consent to expel him in accordance with 601(b)(4).Depending on the relationship with the other partners, thiscould be incentive for the partner to settle with the creditorinstead of forcing a settlement the other way around. Foreclosure (cont.) Uniform Limited Partnership Act (1976) 703 is silent as toforeclosure Uniform Limited Partnership Act (2001) 703 states that acharging order constitutes a lien that can be foreclosedupon by order of the court Uniform Limited Liability Company Act (1996) 504(b)states that a charging order constitutes a lien that can beforeclosed upon by order of the court Uniform Limited Liability Company Act (2006) 503(c)states that a court may order foreclosure upon a showingthat distributions under a charging order will not pay thejudgment debt within a reasonable time Evolution of Limited Partnerships
Man has utilized partnerships to conduct his affairs withothers from the beginning of timeevidence of use inBabylon, classical Greece, and Rome.1 General partnerships are simply contracts amongindividuals who have joined together for a common, usuallycommercial, purpose. Forerunner of the limited partnership was the commendaby which nobles and clergy, who had the capital but couldnot directly engage in commercial enterprise, could obtainthe benefits of such enterprise without personal liability. The result being that capital that would have otherwisebeen unavailable to the merchant and trading classesprovided the foundation for the elevation of these classes toinfluential status.2 1Bromberg & Ribstein, Partnership Vol. I, 1.02(a) 2Bromberg & Ribstein, Partnership Vol. III, 11.02(a) Evolution of Limited Partnerships (cont.)
England codified its common law and mercantile lawconcerning partnerships in the Partnership Act of 1890 andits Limited Partnership Act in 19073 The U.S. codified its partnership common law in 1914 in theUniform Partnership Act Early limited partnership law in the U.S. was codified onlyat the state level and was based on the French CommercialCode of 1807, Sections 23-28, because of its uniqueprovisions avoiding the doctrine of partnership liability tothird persons 3Bromberg & Ribstein, Partnership Vol. I, 1.02(b) Evolution of Limited Partnerships (cont.)
The first Uniform Limited Partnership Act was codified in and it reduced the liability exposure of limitedpartners from that contained in existent state statutes The Revised Uniform Limited Partnership Act (1976) wasdrafted to address the needs of the large, multi-partnerpartnerships that were in existence at that time and movedcloser to the corporate or entity model than the earlieraggregate model 2001 revision of the Uniform Limited Partnership Act hasproduced the Uniform Limited Partnership Act (2001) Individuals and/or trusts
Limited Partnerships General partner manages the entity and is liable for partnershipliabilities Limited partners liable for partnership liabilities only to extent ofcontribution to partnership Helpful planning tools but it is important to undestand theirlimitations LLC or Corporation Individual Individuals and/or trusts 99% LP 1% GP Assets / Operations Limited Partnership Evolution of Limited Liability Companies
Historically a South American concept Wyoming was first state to adopt an LLC Act effective June 20, 1977, which created an entity that provided owners with limited liability from business debts like a corporation but is taxed as a partnership Hamilton Brothers Oil Company formed a Wyoming LLC in 1977 and immediately applied to the IRS for an administrative ruling that it qualified as a partnership for federal income tax purposes IRS granted the ruling on a private basis in 1988 (Rev Rul 88-76) By 1996 every state had enacted an LLC Act Most modeled on partnership statutes because of desire to be taxed as partnership Since IRS issuance of the Check the Box Regulations in 1997, which provide absolute tax certainty with regard to LLCs, partnership characteristics are no longer necessary and are being removed from the state statutes Limited Liability Companies
Management of the entity is by outside manager or bymembers Members liable for company liabilities only to extent ofcontribution to the company Corporate formalities must be followed Member(s) / Manager(s) 100% Limited Partnership LLC/Corporation/ Individual Manager % Assets / Operations Establish entities in protective jurisdictions
Limited Partnerships and Limited Liability Companies:Protective Planning Opportunities Establish entities in protective jurisdictions Draft operating, company, and/or partnershipagreements to restrict transferability of interests Use supermajority provisions to protect control ofthe entity Transfer control of the entity away from anycreditor exposed owner Segregate entity assets into separate entities Entity Structural Options Master Limited Partnership Structure
Foreign Trust as Limited Partner (or Individually Owned) Foreign or Domestic LLC as General Partner Master Limited Partnership Potential Future Trusts for Children as Limited Partners Management Agreement These assets could instead be owned by a foreign trust Investment LLC Real Estate LLC Business LLC Intellectual Property Interest LLC Airplane LLC Liquid Assets Real Estate Business Intellectual Property Lease License Centralized Holding Company Structure
Owner Holding Company Management, LLC LLC License Agreement $ Trademarks, patents, etc. Operations Decentralized Business Structure
Grantor Trust $ Owner/ Settlor Promissory note Owner/ Settlor Foreign Trust $ Grantor Trust Owner/ Settlor Owner Owner Promissory note $ $ Owner Operating Company Consulting Agreement $ LLC $ Lease Owner Consulting Agreement $ Equipment Owner/ Settlor Employees Accounts receivable Protection for Accounts Receivable
Professional firm assets are primarily accountsreceivable rather than hard assets To the extent that contractual liens can becreated over the accounts receivable, thecreditors holding such liens will have priority oversubsequent creditor liens or judgments Accounts Receivable Leveraged Transaction
Life insurance, annuity, protective entity, or trust $ Professional Service Organization Owner Loan or distribution Collateral Assignment Bank $ Loan $ Life insurance, annuity, protective entity, or trust Owner Loan or distribution Accounts receivable What is a Protective Trust?
Definition The Settlor (the person who transferred assets tothe trust) is a beneficiary of the trust; and The assets that the Settlor transferred to the trustare protected from the claims of the Settlor'screditors Protective Trusts Two Very Different Options
Domestic Available in Delaware (1997), Alaska (1998),Nevada (1999), Rhode Island (1999), Utah (2003),South Dakota (2005), Tennessee (2007), Wyoming(2007), New Hampshire (2008), Hawaii (2010),and to a lesser extent, Colorado (1994),*Oklahoma (2004), and Missouri (2005), Virginia(2012), Ohio (2013), and Mississippi (2014). Foreign Available in many foreign countries Vulnerabilities of Domestic Protective Trusts
Access to trust assets through U.S. court system U.S. Constitution Availability of punitive damages and attorneysfees Offshore Protective Trusts Offer Additional Benefits
Creditors cannot reach assets through U.S. courtsystem U.S. judgments are not enforceable Cost of pursuing assets offshore is high; loser pay systems Offshore Protective Trusts Offer Additional Benefits (cont.)
Punitive damages and contingent fee contractsnot allowed Secrecy and privacy laws prevalent and strictlyenforced When To Settle a Protective Trust
Before Insolvency Cannot make a fraudulent transfer under state lawor bankruptcy law a 10year clawback periodmay apply in bankruptcy A gratuitous transfer of property with the actual orconstructive INTENT to avoid creditors is fraudulent Before a claim arises Greater distance in time between transfer andclaim against assets results in superior protection Control and Contacts Less Asset Protection More Asset Protection
Greater Settlor control More U.S. contacts Less Settlor control Few or no U.S. contacts Typical Protective Trust Structure (Domestic)
Investment Advisor(s) Settlor Settlor and family are lifetime beneficiaries Settlor has limited power of appointment at death Trustee Protector Wholly discretionary (rather than ascertainable) distribution standard Trustee can add and remove beneficiaries Redomiciliation permitted Typical Protective Trust Structure (Foreign)
Investment Advisor(s) Custodian Settlor Settlor and family are lifetime beneficiaries Settlor has limited power of appointment at death Trustee Protector Wholly discretionary (rather than ascertainable) distribution standard Trustee can add and remove beneficiaries Redomiciliation permitted Independent investment advice the norm Two Fundamentally Different Offshore Strategies
EXPORT THE ASSETS IMPORT THE LAW Foreign Trustee Foreign Trustee Trust Protector Settlor Domestic Limited Partnership General Partner Settlor Foreign Trust Foreign Protector Foreign Custodian JURISDICTIONALLY SEVERED JURISDICTIONALLY CONNECTED Check and Balance System
Trustee Protector Custodian Bank Representative Trust Structures
57 Nest Egg Trust EXAMPLE Settlor has $20M total assets
Settlor has $10M investment assets Settlor retains $5M of investment assets personally and funds trust with $5M Investment advice to Settlor and to Trustee may be provided by pre-selected investment advisor Contributions to trust are not subject to gift tax Settlor is subject to income tax on all earnings of the trust Trust assets are includible in settlors estate for estate tax purposes Foreign Trustee Settlor $5M Trust Protector Investment Advisor(s) Custodian Multiple Trusts EXAMPLE Settlor has $250M total assets
Trustee Trustee EXAMPLE Protector Protector $25M Settlor has $250M total assets Settlor has $150M investment assets Settlor retains $50M of investment assets personally and funds four trusts with $25M each Liechtenstein Trust Jersey Trust Custodian Custodian Investment Advisor(s) Investment Advisor(s) Trustee Trustee Protector Protector Isle of Man Trust $25M $25M Bermuda Trust Custodian Custodian Investment Advisor(s) Investment Advisor(s) Domestic or Foreign Dynastic Trust
All of the benefits of a basic wealth protection trust, including Settlors retention of beneficial interest and Settlor can make a completed gift (which might use exemption equivalent amount) and allocate GSTT exemption Assets may not be included in Settlors estate for federal estate tax purposes Establish in jurisdiction where perpetual trusts are allowed Investment advice to Trustee may be provided by pre-selected investment consultant Dynastic Trust Investment Advisor(s) Custodian Settlor Settlor and family are lifetime beneficiaries Trustor for Settlors family arise at Settlors death Trustee Protector Combination of Trust Structures
Limited Liability Company 80% Member/ Manager 20% Member Foreign Trustee Protective Trust Settlor Protector Dynastic Investment Assets Trust Implementation 62 Selection of Jurisdiction
Traditional Jurisdictions Jersey Guernsey Liechtenstein Isle of Man Bermuda Selection of Jurisdiction (cont.)
Established Asset Protection Jurisdictions Cayman Islands Bahamas Gibraltar Belize Selection of Jurisdiction (cont.)
New Asset Protection Jurisdictions Cook Islands Nevis Turks & Caicos Mauritius Niue St. Lucia Liechtenstein Loserpay (and deposit 1015% of asserteddamages with court before filing suit) No punitive damages No contingent fee contracts Must engage Liechtenstein counsel Liechtenstein (cont.) No enforcement of foreign judgments (exceptSwiss and Austrian judgments) Legal proceedings conducted in German No specific asset protection laws Cook Islands Highly specific asset protection laws
Fraudulent transfer Burden on creditor to prove beyond a reasonable doubt that: transferor specifically intended to defraud creditor-claimant; and transferor rendered insolvent by transfer Cook Islands (cont.) Statute of limitations
No transfer made more than two years before cause of action accrued is fraudulent Creditor must sue within one year after transfer to Cook Islands trust Negotiation of Fees Start-up On-going Legal fees Legal fees
Trustee fees Foreign taxes/duties On-going Legal fees Accounting fees Trustee fees Protector fees Custodial fees Money management fees Foreign taxes Due Diligence (Standard for all Jurisdictions)
Certified copies of settlors passport and residentialutility bill In some jurisdictions, the same is required of all currentbeneficiaries Letter of recommendation from attorney or bank Professional curriculum vitae for settlor, if applicable Statement as to source of wealth Financial statement (including current and contingentliabilities) accompanying an affidavit of solvency Additional Due Diligence (Varies by Jurisdiction)
Due diligence forms and additional requirements vary fromjurisdiction to jurisdiction, but typically include: Personal details for settlor and settlors immediatefamily Current occupation of settlor and business/career history(source of wealth) Information on proposed trust structure, including nameof trust, beneficiaries, protector, etc Information on proposed trust funding, including sourceof funds, type and amount of assets to be contributed,and plans for future investment and handling of trustassets Preparation of Documents
Trust instrument Affidavit regarding financial condition Trustee and protector fee agreement letters Form SS-4: Application for EmployerIdentification Number Authorization of agent (IRS) Account opening documents (including Forms W9and W-8IMY - withholding certificates) Tax Considerations and Reporting Requirements
74 Income Taxation Typically Tax Neutral
Income Tax: taxed as Grantor Trust if Settlor andat least one beneficiary are U.S. persons (IRC679) All items of income, deduction, and credit flowthrough to Grantor Capital Gain Taxation: IRC 684
Incomplete Gift Trust: no tax on transfer ofappreciated assets when trust is a Grantor Trust;no tax on appreciated assets at Grantors death. Completed Gift Trust:no tax on transfer ofappreciated assets when trust is a Grantor Trust;but tax is imposed on appreciated assets atGrantors death. Gift Taxation Typically Tax Neutral
Gift Tax: gifts can be either complete (gift tax due on transfers) or incomplete (no gift tax due on transfers); incomplete gift requires retention by grantor of special power of appointment Estate Taxation Typically Tax Neutral
Estate Tax: assets not includible in estate forfederal estate tax purposes if there was acompleted gift made at time of transfer, but areincluded if there was an incomplete gift made attime of transfer Primary Foreign Trust Filing Requirements
Form 3520: Annual Return to Report Transactions withForeign Trusts Form 3520-A: Annual Information Return of ForeignTrust with U.S. Owner Form 1041: U.S. Income Tax Return for Estates andTrusts (with Grantor Trust Information Letter attached) Form TD F :Report of Foreign Bank Accounts Form 8938:Statement of Foreign Financial Assets Primary Foreign Trust Filing Requirements (cont.)
Form 8858: Information Return of U.S. Personswith respect to Foreign Disregarded Entities TDF : Report of Foreign Bank andFinancial Accounts Form 709: United States Gift (and Generation- Skipping Transfer) Tax Return