In the pandemic world, there has been increased focus on asset protection. Quarantining time and observation of widespread economic troubles have drawn sharp attention to one’s sense of vulnerability.
Asset protection is the organized use of techniques to make assets unattractive. The reality is lawsuits are profitable business. The most worthwhile cases are against defendants with substantial personally owned assets.
Most affluent families have employed asset protection in one form or another. The majority have insurances and operate and own assets through entities.
In the asset protection world, there are multiple enhancements to improve an asset protection program to something more robust. Entities act as a barrier but should not be considered ironclad. A common misconception is that entities cannot be sued. While creditors of an owner cannot enforce their judgment against an entity, the entity itself can be sued by itscreditors. For example, if a business owner has a car accident and is personally sued, the creditor can sue for assets he owns personally but will have great difficulty attaching to his business LLC ownership. Creditors of an owner are prohibited from accessing the entity. However, if the business LLC was sued for its product injuring someone, the LLC itself can be sued but only lose what it owns. Going beyond the LLC to its members assets is quite difficult and usually is not possible.
To amplify, for any assets more likely to attract litigation (such as businesses, real estate, recreational vehicles) we limit each LLC to a specific asset so if a risk develops, we minimize what assets are available. We also “strip” assets out of the entity to reduce available assets and limit cross-liability. Limiting cross-liability is an important factor in enhancing protection and accomplished by segregating assets. Segregation also can be employed creatively within multi-asset ventures, such as businesses. The business may own a variety of assets and a claim against the business can threaten all its assets. In lieu of the business owning all, we create a network of related entities. For example, maintaining the operational company as is, but inventory owned by Inventory LLC with a fulfillment contract with Business LLC. The trademarks, patents and other intellectual property would be spun off into IP LLC and licensed to Business LLC. With assets decentralized, a lawsuit against Business LLC would be challenging as the business entity has no substantive assets. Aggressive creditors may try to attack the business’ revenue, however there are priority creditors first in line – the related entities. This structure serves insulation goals, but also permits great flexibility for tax and future business sales. With the owner able to modify rent, license fees, interest rates (within reason), the owner can control where profit is sourced and balance tax load and deductions.
Segregating assets involves distinctive ownership for each asset, but some assets or situations make that challenging. Residential mortgages, club memberships, coops, time shares, and the like, often require personal ownership. Personal consulting contracts, name/image/likeness licenses, and accounts receivable similarly usually require personal ownership. When performing case economic analysis, the first questions of the litigator are (i) can we reach the asset and (ii) is there is enough equity to justify the effort. In cases where personal ownership is logical, we will “equity strip” the asset – engineering a loan to reduce equity. For example, a residence is worth $5M and carries a $1M mortgage thus $4M of equity is exposed. The investment/cash LLC makes a loan against the property, and records a mortgage for $3.8M, now the available equity is now minor. While a creditor could claim a related party mortgage is suspect, if done properly (promissory note, mortgage, etc.) the argument falls flat. In most cases, claims against an unattractive asset aren’t filed as the economic incentive has been reduced.
Each tool has pros and cons rather than a universal “best”. As it is hard to predict where a family will go and what issues will arise, the ability to adjust course cannot be overemphasized. Layering entities to work in combination can enhance an insulation program with additional flexibility and harness synergistic benefits.
For example, the owner buys a crypto currency position and believes it will make a 100X return. He could give it to his children but would have no control and the asset would be vulnerable to the children’s creditors. Alternatively, we can create a limited partnership to own the portfolio from inception, gift the limited units (non-voting) to an irrevocable trust at today’s modest value. If we use a well-designed asset protection trust, it will avoid estate taxes and creditor claims in perpetuity. The limited partnership allows gift/estate tax discount (due to non-voting nature of limited units) and owner can operate the general partner (control). If owner needs access, rather than undoing a gift, he can take a salary, management fee, or loans. He could use and benefit from assets the entity owns (i.e. real estate, vehicles). He now has protection, control, access, estate tax avoidance, generational benefits, and has leveraged the gift.
Offshore has an exotic but nervous feel to it. Offshore entities can be the most advanced protection available. Some commentators feel offshore is risky and invites IRS audits. They are no riskier than any other tool, but the international realm is riddled with misinformation and inexperienced practitioners, which drives some of the hesitancy. The allure stems from the fact that a US judgment would not be enforced by a foreign court thus putting assets out of reach. The presence of a foreign entity is intimidating as plaintiffs understand that any litigation will be longer, more expensive, and significantly less likely to succeed. The best jurisdictions are those who have become the Delawares of the world and passed laws to attract trust business; Cook Islands, Nevis, Jersey, Isle of Man, New Zealand, Guernsey, Lichtenstein. The desirability is sourced from pro-owner rules, such as no public registration, short statute of limitations, higher proof standards, limited rights and remedies. We seek those with good infrastructure, reputation, and case history. Most of all, we rarely grant them access or control over any assets. The majority of plans use a foreign entity as a holding vehicle and the assets actually remain in their entity with the trust only owning non-voting entity equity.
The tax aspects of foreign entities are usually US centered rather than foreign. Most jurisdictions with attractive entity laws have low/zero tax rates. The IRS seeks information disclosures to reduce tax evasion and money laundering, and has significantly increased reporting. The reporting requirements shouldn’t be a deterrent to using international entities as any program that relies mostly on secrecy is hardly an asset protection plan.
Asset protection plans should be like other planning; evolving over time as a family changes. The initial plan is the largest investment of energy and periodically revisited to ensure it meets the family’s needs. Tools of the more sophisticated families are well known, but can often be augmented by the thoughtful application of more advanced concepts.
