By Edward D. Brown, JD, LLM, CPA; Andrew Bechel, JD, LLM; and Eric Kaplan, JD
Much has been written about asset protection strategies, such as offshore trusts, limited liability companies (LLCs), insurance, and exemption planning. The focus of this article is to identify which of those strategies are best suited to high-risk professionals, whose risk exposure derives from the provision of professional services (as opposed to risky investments or predators who target the megawealthy). Some of the strategies discussed below reflect ways to reduce a professional’s financial profile and accordingly, the size of the targets on their backs.
Exemption Planning
We first address the most basic technique, which involves safeguarding assets from creditor attachments using protections available under applicable federal and state laws. Exemption planning is an important asset protection tool, as this type of planning takes advantage of categories of assets that are legally exempt from attachment by judgment creditors. Exemptions exist under both state and federal law and may apply in either a bankruptcy or nonbankruptcy context. If an exemption is available for specific property, the debtor retains all rights of ownership and enjoyment of the property free from creditor interference.
Federal exemptions exist under the U.S. Bankruptcy Code, the Employee Retirement Income Security Act of 1974, the Social Security Act, and the Consumer Credit Protection Act. Many states have statutes that provide more liberal exemptions related to (1) homestead, (2) life insurance or annuity contracts, (3) wages and earnings (or at least a portion thereof), (4) nonwage income, (5) personal, household, and other possessions, and (6) retirement benefits. As such, in some states, a professional could claim the more liberal state exemption in bankruptcy matters as opposed to the stricter federal exemption.
The homestead exemption represents one of the most significant protections under the law and can be extremely beneficial for high-risk professionals. However, state laws generally impose some type of limitation on the homestead exemption. For example, while Florida and Texas have unlimited dollar-amount exemptions, both states limit the homestead exemption to a maximum specified amount of land. Other states have adopted a monetary limitation, which varies dramatically by state: coverage is as high as $605,000 in Nevada and as low as $2,500 in Arkansas (with an accompanying acreage limitation).
Insurance
Insurance can be an important component of asset protection planning. However, insurance may not be able to cover all liability risk, and policies typically have exclusions that may limit their usefulness. Many high-risk professionals, such as doctors and lawyers, utilize malpractice insurance but also hold general business insurance policies and personal liability insurance policies (such as car insurance, homeowner’s insurance, and umbrella policies). Malpractice policies typically have numerous exclusions that may limit their effectiveness, for example, for intentional or grossly negligent conduct. Furthermore, professionals who primarily serve wealthy clients may not be able to purchase sufficient coverage to protect themselves against all risks at a reasonable cost. Thus, while insurance is an important aspect of any asset protection plan, other strategies must also be employed to offer the maximum protection possible.
Limited Liability Companies
The limited liability company (LLC) has proven to be a highly effective asset protection tool because it traps liability at the entity level similar to a corporation. It also provides what many consider to be the added advantage of being taxed as a partnership or disregarded entity unless an election to be taxed as a corporation is made. LLCs preclude an LLC member’s creditor from accessing LLC assets to satisfy the member’s personal debt. Further, they protect the member from liability that may arise from the assets held in the LLC (e.g., liability due to a slip-and-fall accident at a rental property owned by the LLC), as only assets owned by the LLC are exposed to such liability, not the member’s personal assets. As discussed below, multiple LLCs can be formed to separate hot assets (i.e., assets such as the aforementioned rental property that could be a source of liability) from cold assets (i.e., assets that do not expose the member to liability).
Transferring assets into an LLC provides asset protection for an LLC member because their personal creditors may be limited to obtaining a charging order for debts that arise after the formation of the LLC. A charging order is a statutorily created means for a creditor to reach a debtor’s beneficial interest in an LLC. This charging order protection also shields the interests of other LLC members by preventing the debtor member’s creditor from reaching the LLC’s assets to satisfy their claim. A charging order functions similarly to an assignment of income: future distributions from the LLC that would otherwise be made to the debtor are instead made to the creditor who obtained the charging order until the debt is paid. Thus, the creditor is unable to reach an LLC’s assets except for distributions made to the debtor. If the debtor member is also the LLC’s manager, the debtor member may, in some circumstances, remain in control of when (and if) such a distribution is ever made.
Foreign LLCs may offer stronger protections than their domestic counterparts and make it more expensive for a creditor to pursue a charging order against a debtor. Using a foreign LLC in jurisdictions such as . . .
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