Risk Management and Asset Protection

Question 1

Risk

Answer 1

• A variation from an expected outcome
• Quantifying risk, for purposes of insurance analysis, compares loss exposures relative to:
  a. the loss frequency versus loss severity
  b. the cost of insurance

Question 2

Insurance on Collectibles

Answer 2

Blanket coverage:
– Coverage up to $1 million
– Per-item limits of up to $50k
– No inventory required
– Best for collections with many, smaller items
– Rates are higher because of uncertainty
Specialty coverage:
– Coverage into the millions per item
– Documentation and verification are required
– Considered efficient protection / unit of coverage
– Special policies are often written for unique situations

Question 3

Umbrella Liability Insurance

Answer 3

• Coverage amounts from $1-$10 million
• Covers bodily injury, property damage, and personal injury liability
• Only pays claims in amount “above” required property and casualty coverages (check for gaps in coverage)
• Covers insured and family members living in household
• Possible exclusions (particularly important for HNW)
– Use of aircraft and watercraft
– Director and officer activities
– Business activities

Question 4

Insurance

Answer 4

• Most states exempt life insurance and annuities from the reach of creditors.
• Many states do however impose restrictions on those exemptions.
• Many states extend protection to cash surrender value (interpolated reserve).
• Private Placement Life Insurance is typically protected

Question 5

Real Estate

Answer 5

• Almost all states offer homestead protection.
• Most states have placed restrictions on this protection, including limiting the value of the exemption.
• The homestead exemption may protect a debtor in cases of bankruptcy but not against IRS liens.

Question 6

Retirement Funds

Answer 6

• Qualified Retirement Plans are generally protected from the claims of creditors under ERISA.
• Traditional (and Roth) IRAs have protection generally limited to $1 million (adjusted for inflation currently around $1.3m)
• IRA rollovers consisting entirely of QRP assets that were rolled into an IRA are not subject to the protection cap above.
• Inherited IRA assets are at risk from creditor claims, including in cases of bankruptcy

Question 7

Assets at Greater Risk

Answer 7

• Assets registered to individuals
• TIC and JTWROS account assets
• Second homes, vacation homes
• Non-qualified retirement accounts and assets
• IRA rollover and Roth IRA assets above $1m (adjusted to approximately $1.3m today)
• Real estate and other large assets (aircraft, autos, etc.) not owned by entities or p-ships
• Assets transferred to protected structures within statute of limitations for fraudulent conveyance

Question 8

Entities

Answer 8

• Trust assets may be protected from creditors due to a spendthrift provision.
• Corporate, LLC, and LP assets may be subject to creditors of the corporation or entity but not typically to claims of shareholders.
• In some cases, partnership assets may be attached due to claims against partners, but these assets are considered “ugly” given lack of control and potential tax liabilities.
• Charging orders (discussed later) are the most common form or creditor reach into an entity.

Question 9

Entity Protection

Answer 9

• In order to secure a claim against the individual debtor’s assets within such an entity is fraud or gross negligence.
• Entity must show that it has been managed with proper care and in a professional manner in accordance with state law and standards

Question 10

Aggregate Theory (historical view)

Answer 10

• Partnership is not a distinct legal entity separate from the partners
• Each partner owns an undivided interest in partnership property making turnover of assets to creditors without impact on non-debtor partners impossible
• Charging Order as a remedy protected both the creditor and the non-debtor partners
• LLC statutes were modeled on partnership statutes,
  and so they adopted the partnership statutes’ Charging Order provisions

Question 11

Entity Theory (current view)

Answer 11

• Partnership is a distinct legal entity separate from its partners
• Partners do not own a interest in partnership property; instead, they own an interest in the entity
• There is no real distinction between partnerships, LLCs, and corporations; thus, it is difficult to argue that Charging Order laws are needed to protect the partners

Question 12

Family Limited Partnerships (FLPs)

Answer 12

• Type of partnership typically designed to help families manage a family business, farm, assets.
• Offer a form of creditor protection
• Most FLPs include mom and dad as general partners with children and grandchildren named limited partners.
• Mom and dad transfer assets to the limited partners over time and often use valuation discounts to reduce the amount of exposure to gift tax.
• Discounts may include, among others, lack of marketability, lack of control (minority interest), etc.
• Mom and dad may still retain some form of control albeit this is limited when gifts are made irrevocably.

Question 13

Grantor Trusts

Answer 13

Grantors retain certain powers and control over grantor trusts.

• • Not considered a separate entity
• • Income passes through to the grantor
• • Grantor trusts offer little, if any, creditor protection

Question 14

Non-Grantor Trusts

Answer 14

Grantors give up most powers and control over a non-grantor trust.

• • Treated as a taxable entity (not a pass-through)
• • Assets are owned by the trust
• • Certain non-grantor trusts offer significant creditor protection

Question 15

Dynasty Trusts

Answer 15

• Created to shift wealth over generations.
• Common for the Dynasty Trust to last 21 years past the life of the last living beneficiary who was alive when the trust was established.
• Trusts are irrevocable and include a spendthrift provision

Question 16

United States Legal System

Answer 16

• Contingency fees are allowed in the U.S. (while not
allowed in most countries)
• 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 loser–pay system in the U.S.

Question 17

Offshore Jurisdictions benefits

Answer 17

• Creditor must retain offshore counsel
• Contingent fee cases typically not allowed
• Losing party may have to pay winning party’s attorney fees
• Judgments of other situs courts generally not recognized
• Offshore creditor normally must file suit in offshore
  jurisdiction
• Statute of limitations expiration may be very short
• Creditor may have burden of proving fraudulent transfer

Question 18

Incomplete Gift Trust:

Answer 18

No tax on transfer of appreciated assets when trust is a Grantor Trust; no tax on appreciated assets at Grantor’s death.

Question 19

Completed Gift Trust:

Answer 19

No tax on transfer of appreciated assets when trust is a Grantor Trust; but tax is imposed on appreciated assets at Grantor’s death.

Question 20

Gift Tax:

Answer 20

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

Question 21

Estate Tax:

Answer 21

Assets not includible in estate for federal estate tax purposes if there was a completed gift made at time of transfer, but are included if there was an incomplete gift made at time of transfer

Question 22

Domestic Asset Protection Trusts

Answer 22

• Typically created as discretionary spendthrift trust, contain additional provisions, may offer substantial protection
• Restrictions and issues do apply, among these:
• • Support or alimony for former spouse
• • Creditor claims arising prior to trust creation
• • Fraudulent conveyances

Question 23

College Savings Accounts

Answer 23

• Some states exempt the assets held in 529 plans if the debtor resides in that state and the plan assets are held by that state’s authorized plan
• IRS rules for 529 plans including: no tax on account growth if conditions are met, contributions may be deductible for state income tax, and the limit on the number of times one can change current investment to twice per year per beneficiary.

Question 24

Fraudulent Transfer Law

Answer 24

• 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
• Statute of limitations on fraudulent transfer claims in most states is FOUR years from the transfer, or, for existing creditors, within ONE year of when the transfer could reasonably have been discovered, if later

Question 25

Spendthrift Trust

Answer 25

• The beneficiary is precluded or restrained from voluntary or involuntary transfers of trust assets
• In some states, this includes a prohibition on the ability to pledge as collateral any interest in a trust.
• Beneficiary’s creditors are precluded from reaching trust assets
• Settlors cannot utilize a spendthrift trust to protect assets from the settlor’s creditors.
• Trusts with spendthrift clauses are often primarily established for asset protection purposes.

Question 26

Charging Order

Answer 26

• An order issued by a court pursuant to statute which charges the debtor’s interest in the entity with the amount due to the judgment creditor.
• Creditor only gets distributions from the entity to the extent of the debt
• Once the debt is extinguished, the charging order is fulfilled. The debtor’s interest in the underlying
  partnership or company assets is preserved.

Question 27

Prenuptial Agreements

Answer 27

• Must be voluntary

- Usually requires full disclosure of assets. Financial disclosure however may be waived in some cases.

Question 28

QDRO: Qualified Domestic Relations Order

Answer 28

• Effective during life and/or after death
• Could be based on a dollar amount or percentage of benefits
• Alternative payee may not be someone other than a spouse, former spouse, child or other dependent of the participant