Whether you are a business owner or you are concerned about your estate, proper asset protection planning is essential. We addressed asset protection for business owners in another article. Here we plan on giving a bird’s eye view of asset protection planning to create awareness of the many areas of your financial kingdom that may be vulnerable to attack from a would be profiteer.
What happens to a house of cards when the wind blows? What happens to a chain when there is a weak link and gravity takes a toll? When just moments earlier, everything seemed OK and if just a little bit of wind or pressure is applied, things can fall apart very quickly.
Not to be grim at the start of a new year but I’m sure you agree that success comes with careful preparation and attention to detail.
This article is all about paying attention to the details AND avoiding common mistakes by applying 10 Top Asset Protection Basics to your asset protection plan…whether you’re using protected financial products, such as cash value life insurance, limited liability companies, or a trust.
First a few ground rules…
In our prior article about how to title your assets, we talked about what an asset is…which we defined as anything you own that has value.
Personal assets would be assets owned by you, individually, or possibly titled with a spouse jointly.
Business assets would be assets owned by your business entity (such as an LLC or Corporation).
Asset protection is…
taking the appropriate legal steps to make sure that you’re creating maximum legal anonymity and a shield of protection for the assets that you own.
Asset protection is not…
taking deceptive measures to hide assets illegally from the IRS, active creditors, or anyone else.
With those ground rules in place, here are…
Top 10 Best Asset Protection Strategies for your Asset Protection Plan
1. Understand that Your Revocable Trust Doesn’t Provide You With Asset Protection
This is an “all too common” area of confusion concerning your revocable living trust. Revocable living trusts offer many estate planning benefits as discussed in our previous article, but they DO NOT provide asset protection for the person or couple who set up the Living Trust. By virtue of the fact that your living trust is revocable, it is not asset protected because it is not an “entity” that is separate or distinct from you. When setting up a revocable living trust, you use your own social security number and there is no need for filing a separate tax return or file it anywhere…this makes it a tool that is very easy to use for estate planning.
However, it is the separateness of the entity in general that gives it asset protection. An important point to clarify is that your revocable living trust WILL PROVIDE asset protection for the YOUR BENEFICIARIES upon your death (or the death of the last grantor or trustor, i.e. creator, if a joint revocable living trust). Asset protection is available to your beneficiaries at that point because your living Trust “vests” and is assigned an independent tax id number…unfortunately, you won’t be around to enjoy it.
For larger estates, an irrevocable trust may be an asset protection option to consider. States like Delaware offer favorable asset protection laws for assets and these trusts may be used for various reasons such as protecting children in the event of a second marriage. Typically, this kind of planning is not appropriate for smaller accounts of less than a million dollars.
For average estates and small businesses, using simple business entities such as limited liability company is a very common asset protection strategy.
2. Title Your Assets to Maximize Protection
How to title your assets is an extremely important concern for estate planning and is equally important for asset protection. Certain state laws (i.e. Florida asset protection law) offer a broad ability to title assets jointly as “husband and wife” which is the designation of tenants by or a tenancy by the entireties. When assets are individually owned, they are vulnerable to the attack of a creditor; however, when jointly titled, they receive an additional layer of asset protection. However, if both spouses apply for a loan or sign a contract together, they will both be liable regardless so joint titling won’t offer asset protection.
Assets may also be titled in LLCs and Trusts for maximum protection, and various states around the country offer asset protection products based upon their favorable state laws to enhance asset protection benefits. Another aspect of asset titling concerns how your LLC is titled or who, in terms of members, owns it. In some jurisdictions, it is better to have more than 1 owner for asset protection purposes due to state asset protection laws favoring “multi-member LLCs”.
For the reasons discussed, it is also a bad idea to title your assets jointly with your adult children for estate planning purposes. Simply put, adult children are typically more risky due to the likelihood of divorce or bankruptcy AND THUS it is not a good idea to put them on the title of your assets.
3. Balance Non-Asset Protected Investments With Asset Protected Investments
Non-qualified accounts such as CD’s, money market, or stock trading accounts are NOT protected under state asset protection laws.
This can be a tough one to digest for many people who have the bulk of their investments in non-qualified accounts. Non-qualified accounts are rightly viewed as much more “liquid” than qualified accounts such as IRA and 401(k) accounts due to the IRS restrictions on 401k withdrawals from these accounts. However, for purposes of your asset protection plan, qualified accounts are essentially provided creditor protection and thus may be “judgment proof” by statute. Another less known category of asset protected accounts is cash value life insurance as well as other insurance products such as annuities, and the amount of protection for these assets is based upon the state laws in your jurisdiction.
Thus, it is highly advisable to at least balance your unprotected stock trading account and CDs with a mix of qualified retirement accounts (although we don’t often endorse these accounts for other reasons) AND cash value life insurance as a preferred asset protection vehicle due to its flexibility and death benefit.
4. File for Protection of Your Personal Residence
Homestead protection, referring to asset protection for your primary residence, is also a “no brainer” and may be an enormous benefit if you live in a state like TX or FL. In these favorable states, your primary home (NOT a second home or investment property) is protection from creditor liens and a forced sale in a certain amount ranging up to 100% of its equity from all creditors except for, of course, your home mortgage provider.
In less favorable states, your level of protection may be less but still offer significant protection for a portion of the equity in your home. This action is often distinct from your homestead tax exemption that is more about getting a deduction on your income taxes.
Homestead protection states often provide similar protection for life insurance and insurance products. Thus, if a state such as Texas provides great homestead protection, it also often provides great asset protection for cash value life insurance under state laws.
5. Sign Your Contracts Properly
People often sign contracts without reading the fine print or considering “how” they are signing the contract. Notice that I said “how” and not “what” they are signing. If you’re signing a business contract and have a business entity such as an LLC, then the contract should be signed by the LLC Manager and there is a specific way that the signature block should be arranged for maximum protection.
It is also important to be aware of any request for a “Personal Guarantee” and determine whether such a guarantee is even necessary because this makes your personal assets liable for the performance of the contracts. A huge area of concern is when applying for loans and understanding whether the individual, the business or both with be responsible for repayment.
6. Business Partnerships Require Proper Legal Protection
Partnerships that seemed wonderful at the beginning can turn sour quickly when the inherent pressures of life and business take hold. Often times, folks saunter into partnerships without a care in the world, or a clear agreement, and do not realize that they can be held liable for the actions of the partner that are conducted on behalf of the partnership.
A Limited Liability Company (LLC) with a well prepared Operating Agreement to be discussed below can offer the needed protection concerning this common and expensive litigation inducing problem. If an LLC isn’t used for the business, then at a minimum a solid partnership agreement should be created to spell out the rights, obligations and remedies of each partner in the event of a breach or other lawsuit.
7. Understand the Benefits of An LLC Verses a Corporation
Often times, when people are starting a business, they are advised by a non-lawyer, often the tax preparer, to set up a standard corporation or an “s corporation”. The reason for this is simply that corporations have a longer history than LLCs and are a bit simpler for the tax folks to handle tax filings. While a s corp vs a c corp can be very effective for tax purposes, it is easy to overlook the asset protection limitations.
Historically corporations have not had the same level of asset protection as the LLC, and specifically have lacked what is called “charging order” protection. Thus, where a creditor would be unable to attach a lien and force a sale of the LLC membership interest, he could historically do just that with corporate stock. Some states have attempted to address this issue by firming up the corporate statutes in the State. It is important to understand your state laws and the level of asset protection that is being offered by a corporation verses an LLC.
8. Do an Operating Agreement for Your LLC
The “self help” LLC is a common asset protection move that is easy to do through “self help” legal services and the willingness of non-lawyer professionals to facilitate the creation of an LLC. However, it is so easy for people set up an LLC for themselves to hold business assets or investment property by just filing it with the state and never taking the important step of preparing an Operating Agreement. I believe this is a huge oversight because the asset protection of your LLC is greatly enhanced through a well drafted Operating Agreement.
The Operating Agreement is the agreement that governs how the members of the LLC will conduct themselves with one another as well as “third parties”. “Third parties” would include a creditor who seeks to attach a lien or otherwise pursue the assets that are held by the LLC. The assets of the LLC may include buildings, inventory, leases, contracts and intellectual property. If there is no Operating Agreement, the LLC will default to that state of organization’s limited liability company statutes.
As common sense might tell you, state laws are much more limited than what a skilled asset protection attorney can include in an Operating Agreement, even if the State is a good asset protection jurisdiction such as Nevada or Wyoming. By key asset protection provisions, I am talking about sections in the Operating Agreement that prevent creditors from attaching to a member’s interest or forcing the foreclosure of a member’s interest, or, disallowing creditors from asking for a mandatory payment from the LLC.
Also, the Operating Agreement should be customized in order to create asset protection for the members as it pertains to the other members.
9. Consider LLCs to Hold Valuable Assets In Addition to Business and Real Estate
It often a “no-brainer” to use an LLC for your business and real estate investments. However, a lesser known asset protection strategy is to use LLCs in more innovative ways for OTHER assets. One strategy is to title your unqualified investment account (etrade account) in an LLC that was preferably filed in a favorable jurisdiction such as Wyoming. This adds a shield of protection to your otherwise unprotected investment. Again, we are talking very generally and not recommending a specific strategy, but LLCs are used for many types of assets and this essentially creates what is called “charging order” protection.
Expensive assets such as boats and RVs may also be titled in an LLC and there may even be tax advantages if these assets may be used for business purposes. Assets being held within the LLC may be protected where the creditor is outside (pursing the individual owner) and assets outside of the LLC may be protection where the creditor is inside (pursuing the business or investment entity).
10. Do Not Mix Personal and Business Assets
A key strategy for business owners is to protect the asset protection stability of your business entity by keeping business assets separate from personal assets. Essentially this means that business assets should be used for business.
Bank accounts should be kept separately for the business and in the business name and tax id number. Business vehicles should be titled as such and leases and contracts should strictly be signed by a designated appropriate authority on behalf of the business (i.e. a manager or officer).
Life insurance policies are also either owned by the business entity or the individual owners and you need to be sure to understand the difference when dealing with key person insurance, executive bonus plans or deferred compensation plans.
Remember to start your asset protection planning now so you can get fully protected for the coming year.