Asset protection planning is a method used to shield assets that would otherwise be susceptible to legal judgments or claims by creditors or former spouses. A number of legal devices exist to ensure that both personal and business assets remain in the possession of the asset-holder. Individuals and businesses use asset protection to diminish creditors’ access to valuable property while ensuring the property holder does not violate the law.
Some assets are considered “exempt” under state and federal law and therefore cannot be reached by creditors. Exempt assets include personal property, such as household furniture, clothing, or jewelry, and tools of a trade or business. In some states, an individual’s primary residence, life insurance benefits, and annuities are considered exempt. Each state has laws shielding owners of corporations, limited partnerships, and limited liability corporations (LLCs) from liability. Additionally, federal law exempts qualified retirement plans governed by the Employment Retirement Income Security Act (ERISA). Qualified retirement plans include pension plans, employee stock ownership plans, profit sharing, and 401(k) plans. Assets to which one does not hold legal title are generally unreachable by creditors.
The process of asset protection involves assessing the current situation and identifying future goals, designing a strategy to accomplish these goals, and preparing the required legal documents to carry out this strategy. Common forms of asset protection include business succession planning, nuptial agreements, family limited partnerships (FLPs), LLCs, and trust creation. Property holders must also take care to minimize the impact of estate taxes, or taxes on that person’s property at death.
Did You Know?
If you are married, your state’s marital property laws may determine whether your spouse’s assets will be protected from legal judgments or claims against you.
An individual may shield property from creditors by transferring it to another person. However, the transferor runs the risk that the transferee will squander the property or subject it to the transferee's creditors. Trusts play a valuable role in asset protection planning by allowing the trust creator (the settlor) to establish the terms of the trust and ensure that the trust property remains protected from all creditors.
An individual seeking asset protection may also transfer his or her property to an LLC or FLP. LLCs and FLPs are distinct entities that remain wholly separate from their creators. An FLP is beneficial both as an asset protection device and as an estate planning tool. FLPs allow individuals and their spouses to own only a small portion of the partnership while maintaining control over the whole of the partnership and its assets.
Asset protection planning requires knowledge of federal and state exemption laws, bankruptcy laws, tax laws, trusts and estate laws, and business and corporation laws. A person with thorough knowledge of the law must assist in asset protection to prevent the property holder from committing the illegal acts of concealing assets, contempt, fraudulent transfer, tax evasion, or bankruptcy fraud.
In order to remain both legal and ethical, asset protection must take place before any event has occurred that may result in a claim against the asset holder. Asset transfers after that time may be considered fraud against creditors. An individual will be held liable if a creditor can show that the individual made the transfer with the intention of hindering, delaying, or defrauding the creditor. If an individual in debt has few assets, bankruptcy may be preferable to asset protection. If substantial assets are involved, however, proactive asset protection is recommended.