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Protecting client assets.

How far should clients go to protect their assets from creditors? With the profusion of articles and seminars espousing specific techniques, confusion is understandable. Almost anyone with more than a small amount of property to protect may wish to consider taking one or more steps before bankruptcy proceedings make it too late. Because CPAs typically have the most knowledge of a client's financial affairs, with no vested interest in promoting a particular technique, they are in a unique position to initiate and participate in the asset protection planning process.


Asset protection planning is the analysis of a client's assets to consider ways to hold, transfer and invest them to protect them from creditors' claims. Effective planning may not completely protect assets but can enhance a client's negotiating position, permitting a fresh start with certain assets and possibly avoiding the stigma of bankruptcy. But planning must consider a client's estate planning goals. Potential fraudulent transfer problems may be avoided by proving the transfers achieve legitimate estate planning goals.

What can give rise to liability? Malpractice of doctors, lawyers, accountants or other professionals easily comes to mind. Other areas include: an automobile accident (both driver and owner); accidents in and around the home; accidents caused by someone a client is responsible for, such as an employee, partner, subcontractor or family member; income tax liability; negligence as an officer or director of a company; divorce; environmental hazards exposure (which in many jurisdictions can pierce the corporate veil); contractual responsibility (personal and spousal guarantees); and liability as a landlord. No matter how careful a client is, the odds are high that most will face unexpected liability to a third party at some point.

Asset protection planning involves numerous ethical considerations that are most likely to concern fraudulent transfers (discussed below). If a CPA recommends any transaction that has no beneficial tax or other family planning objective, he or she may face serious problems. The American Institute of CPAs and virtually all state regulatory authorities have rules that limit the services CPAs may provide to matters in which they meet the necessary professional standards--applying knowledge and skills with reasonable diligence. Moreover, because there are significant legal aspects to this type of planning, the AICPA and states contemplate that CPAs will work with others (attorneys) to supplement their expertise.


Transfers or other strategies often have significant income, gift or estate tax ramifications. The brief summary of commonly used techniques below should help CPAs assist clients in identifying opportunities and implement estate plans.

United credit. One basic concept in planning for spouses is to ensure that each one has at least $600,000 of assets in his or her own name to preserve full use of the unified estate and gift tax credit. If a spouse does not have at least that amount, the wealthier spouse should transfer assets to the other, either outright or in trust.

Testamentary trusts. For married couples, a standard estate plan provides for two trusts--a credit shelter trust and a marital trust that qualifies for the qualified terminable interest property (QTIP) election. No tax win be due on the first spouse's death and afl assets will be available for the survivor's benefit; only the marital trust will be included in his or her taxable estate. These trusts generally contain so-called spendthrift provisions that significantly limit, if not totally protect, trust property from the claims of the creditors of trust beneficiaries--the surviving spouse and descendants. Two trusts avoid wasting the first spouse's unified credit by including all assets in the survivor's taxable estate.

Asset transfers. Transferring assets, typically to younger generations, should put them beyond the reach of a client's creditors and reduce the estate. If a client retains control over transferred property, however, Internal Revenue Code sections 2036 and 2038 may bring it back into the gross estate. For asset protection planning purposes, a transfer will escape the transferor's future creditors unless it is deemed fraudulent. Virtually all states have enacted fraudulent transfer statutes that examine the debtor's intent--determined by factors such as the amount received for the property--the client's solvency at the time of transfer and the relationship of the persons involved. Bankruptcy rules also typically void fraudulent transfers.

Life insurance trusts. Clients unwilling to give up control over property during their lifetime may have a different view of life insurance. A life insurance trust typically buys a policy or receives an existing policy. At the client's death (or after the death of both spouses with a second-to-the policy), the trust holds the proceeds for the benefit of its beneficiaries. Annual transfers to the trust, the value of the policy and the proceeds will not be included in the deceased's taxable estate (if carefully structured) and will not be subject to the claims of the insured's creditors, the spouse or other beneficiaries.

Shareholder agreements and other techniques. Properly structured, bona-fide shareholder agreements (with buy--sell provisions) between family members establish a value for a family business on an owner's death; this value should be upheld for estate tax valuation purposes. A client may be able to control the company even though he or she owns less than 50% of the stock by retaining a majority of the voting shares. The corporate structure may allow that client to benefit from lack of transferability and control discounts, either through gifts or at death, making corporations an excellent vehicle for various transfer and estate freeze transactions. Discounts may be as much as 40% and represent enormous tax savings.

Corporations generally insulate individual shareholders from contractual and tort liability but offer less protection than family partnerships from the claims of shareholders' general creditors. Creditors can use a process known as "execution" to force the sale of a shareholder interest or they can retain the interest in partial or complete satisfaction of the obligation. For a creditor to truly benefit from the execution process, it must get control of the corporation. Even if the client's interest in a business is noncontrolling, he or she can enjoy substantial economic benefits while negotiating with creditors from a position of strength.

When doing planning, some clients may not be receptive to the idea of giving up control of their business--even to protect it from creditors. Such clients can, by agreement, maintain control but put plans in place that will allow them to shift it to someone else if certain events occur, such as the filing of a bankruptcy action or entry of a substantial judgment.

Family partnership agreements and techniques. With investment assets, family partnerships generally are more flexible than corporations. One advantage is the ability to make simple transfers of infinitely divisible interests, rather than transfer direct interests in properties. An additional plus is that the partnership agreement may allocate losses or cash flow. Liability protection requires a limited partnership and that the general partner be a corporation. Family partnerships may have significant income tax advantages both during the client's life and at death compared with corporate ownership due to the unique ability to step up basis and, to a great extent, increase depreciation deductions. Accordingly, family partnerships offer the dual benefit of tax-efficient asset transfer to other family members and insulation of the retained partnership interest from creditors.

Another unique advantage when liabilities arise outside the partnership's operations is that unlike with virtually any other asset, a creditor's sole remedy with a family partnership interest is a so-called charging order. This means a creditor cannot force the sale of a partnership interest; the obligation is satisfied only if and when distributions are made.

Freeze techniques. Freezes pass future appreciation to younger generations on an estate and gift tax-free basis. They are appropriate for clients who own business or investment assets that are expected to significantly appreciate. To the extent wealth is transferred to younger generations, it is removed from the estate forever (and presumably from the reach of creditors).

Freezes generally can be divided into two categories:

* Those governed by chapter 14 of the Internal Revenue Code, such as preferred interest freezes and grantor retained annuity trusts and unitrusts.

* Other freezes, including intrafamily installment sales, private annuities, self-canceling installment notes and straight loans to finance new ventures.

Chapter 14 freezes tend to be very technical and are subject to a complex statute of limitations unfavorable to clients. Noncontrol discounts often are used to greatly enhance their efficacy. The "price" of a freeze generally is the "interest" paid to the client after the transfer is made. Often, a freeze is best accomplished by using a trust for the beneficiary.

Qualified retirement plans and individual retirement accounts. If a plan is governed by the Employee Retirement Income Security Act (ERISA), then the act's spendthrift provision exempts benefits from creditors. Many states also exempt tax-qualified retirement plans. Unfortunately, some of those statutes have been held to be preempted by ERISA and may not apply. IRAs are not governed by ERISA, but many states have enacted laws that exempt them from creditors. As with state laws exempting qualified plans, however, ERISA preemption is an issue.

Nonqualified deferred compensation. These arrangements usually are

* A completely unfunded promise by the corporation to pay deferred compensation to a key employee.

* Funded indirectly with insurance on the key employee's life.

* Funded through a separate taxable trust.

The promise to pay deferred compensation may be characterized for asset protection planning purposes as payment of wages to the head of a household, thereby qualifying for a state law wage exemption (discussed below). Moreover, the right to deferred compensation may not be part of the client's estate for bankruptcy purposes if the payment purpose does not occur before bankruptcy (or possibly six months thereafter). Deferred compensation funded through a trust would include a spendthrift provision under which creditors could not reach the assets.

Form of ownership. Estate planning often simply involves advising clients on the ramifications of taking tide to property. Property held in the name of a married couple as tenants by the entirety typically is protected from only one spouse's creditors. There is no protection for joint debt and spouses should take care not to own property that may result in joint liabilities. Property owned as joint tenants with right of survivorship is not treated the same and one tenant's interest in such property generally may be reached by his or her creditors, perhaps through partition of the debtor's interest. State laws vary, however, and should be reviewed carefully. Property held as tenants in common may be reached by one tenant's creditors.

Life insurance and annuities. Several states' statutes exempt annuities and the cash value and proceeds of life insurance from creditors, provided they are not paid to the insured's probate estate. In those states, effective planning may involve no more than advising clients to invest in these types of exempt assets.

Homestead property. Several states provide a statutory or constitutional protection from forced sale for homestead (primary residence) property, both during life and at death (for certain heirs). A commonplace asset protection planning technique is to use nonexempt assets to reduce the mortgage on exempt homestead property. Homestead property has unique estate planning aspects and its ultimate disposition must be carefully considered to ensure the intended asset protection planning after death.

Wage exemption. Some states exempt a head of household's wages from garnishment. This exemption generally is not available to independent contractors or partners, however, on the theory that amounts due them are not strictly from personal services.

Foreign asset protection trusts. These trusts are appropriate for sophisticated clients who want to gain maximum protection and are willing to pay significant fees to do so. The situs of a foreign asset protection trust should be in a debtor-friendly jurisdiction, such as the Channel Islands, the Isle of Man, Gibraltar, the Bahamas, the Cayman Islands or the Turks and Caicos Islands. These trusts usually contain change-of-situs, trustee and governing law provisions so they are moving targets for creditors.

Of particular importance is that the jurisdiction not enforce judgments by US. courts and have limitations on the rights of creditors with respect to fraudulent conveyances. These limitations include

* A relatively short statute of limitations.

* Substantial limits on fraudulent conveyances.

* Permitting use of trust assets to defend fraudulent conveyance actions and avoiding the possibility of freezing trust assets. Clients will retain some control over the trust.

In a typical situation, a foreign asset protection trust owns a 99% limited partnership interest in a family partnership controlled by the client or, in certain situations, owns a substantial portion of closely held corporate stock (including S corporations). In this way the client maintains control over investment or business assets on a day-to-day basis and only when an event of duress-the entry of a substantial judgment or a bankruptcy petition--occurs would the entity be dissolved and the assets transferred offshore.

Foreign trusts may be attacked either by a direct action within the foreign jurisdiction or a determination by a US. bankruptcy court that, based on the client's control, the trust should be deemed an asset of the bankrupt's estate. When inconsistent with a client's previous financial practices, the mere creation of a foreign asset protection trust may be considered evidence of fraudulent intent.


Even if fraudulent conveyances and similar problems make planning impossible, other considerations remain. If a client expects to receive an inheritance or a trust distribution, a trust rather than outright distributions should be used. In addition, as an ill-fated business winds down, clients often consider and even invest in new activities. To the extent possible, such investments should be made by other family members or by trusts for their benefit.


The only effective approach to asset protection planning, both to achieve a client's goals and avoid unreasonable risks on the part of the CPA or other professional involved, is a sensible, comprehensive and cohesive estate plan individually designed for the client's specific needs and goals. The various laws on creditors' rights and remedies are ever-changing. Accordingly, overreliance on one technique or device may not only put the client unreasonably at risk but also may indicate the CPA has not fulfilled his or her professional responsibilities.


* ASSET PROTECTION PLANNING considers ways to hold, transfer and invest a client's assets to protect them from potential creditors' claims. * PLANNING MAY NOT COMPLETELY protect assets from creditors but can enhance a client's negotiating position and allow them to make a fresh start-possibly avoiding bankruptcy. Planning should not be attempted without considering-a client's estate objectives. Fraudulent transfer claims may be limited if there is evidence the transfers resulted from legitimate estate planning goals. * A CPA WHO PARTICIPATES IN OR recommends any transaction with no beneficial tax or other family planning objective could face serious problems. The AICPA and virtually all state regulatory authorities Emit the services CPAS may provide and anticipate that CPAs will work with others, such as attorneys, to supplement their expertise. * AMONG THE COMMON ESTATE PLANNING techniques are testamentary trusts, asset transfers to younger generations, life insurance trusts, family partnerships and estate freezes. * FOREIGN ASSET PROTECTION TRUSTS ARE appropriate for clients who can afford maximum protection. The situs should be a debtor-friendly jurisdiction that does not enforce judgments by U.S. courts and has limitations on the rights of creditors with respect to fraudulent conveyances.

H. ALLAN SHORE, CPA, JD, LLM, is an attorney with Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quentel, PA, in Miami. SHARON QUINN DIXON, JD, LLM, is an attorney-shareholder of Stearns, Weaver, Miller, Weissler, Alhadeff & Sitterson, PA, in Miami.
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Author:Dixon, Sharon Quinn
Publication:Journal of Accountancy
Date:Dec 1, 1995
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