Estate Planning Through an Asset Protection...

Estate Planning Through an Asset Protection Lens

Gideon Rothschild, J.D., C.P.A.Moses & Singer LLP

405 Lexington AvenueNew York, NY 10174

Telephone: [email protected]

www.mosessinger.com

ASSET PROTECTION STRATEGIES

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ASSET PROTECTION PLANNING IS THE PROCESS OF ORGANIZING ONE’S AFFAIRS TO INSULATE

ONESELF FROM FUTURE CREDITOR RISKS

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ASSET PROTECTION PLANNING IS NOT A MEANS TO ENGAGE IN FRAUD OF CREDITORS OR TO

CONCEAL ASSETS FROM CREDITORS

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The Need For Asset Protection

• Legal System No Longer Links Liability to Causation

• Increasing Theories of Liability• Unpredictable Judges and Juries• Emotional Distress of a Defendant• Reducing Appeal as a Defendant• Government Expropriation

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Candidates for Asset Protection Planning• Professionals• Officers and directors• Fiduciaries• Real estate owners with exposure to environmental claims• Individuals exposed to lawsuits arising from claims

alleging negligent acts, intentional torts (discrimination, harassment, libel), or contractual claims

• As a pre-nuptial alternative• Government expropriation• Forced heirship

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FRAUDULENT CONVEYANCE ISSUES

• The Law prohibits transfers made with the intent to “...hinder, delay or defraud” creditors.

• Differentiate between:– Present creditors - the transferor has notice of

these creditors when making the transfer– Subsequent creditors - the transferor had actual

fraudulent intent against these creditors, even if the actual claim arose after the transfer

– Potential future creditors - those nameless, faceless persons of whom no awareness existed when the transfer was made

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Traditional Methods

• Transfers to Spouse• Corporate Formation, Limited Partnerships and

Limited Liability Company• Joint Ownership of Property• State and Federal Exemptions (other than

ERISA)• ERISA Based Exemptions

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Transfers to Spouse

• Such transfers involve surrendering:– all rights to control the transferred assets, and– any certainty that the transferor can continue to

enjoy the benefits of the transferred assets.• Potential for undesirable consequences in event

of divorce or death of spouse.• Possible imposition of “constructive trust

doctrine” can lead to attachment by creditors.• Courts will “unwind” a fraudulent conveyance.

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Can/should “portability” be relied upon for estate tax efficiency?

• REASONS WHY ONE SHOULD NOTRELY ON PORTABILITY…

• Portability is temporary• Portability does not apply to state

estate taxes• Portability does not apply to the GST

exemption• The amount subject to portability is not

adjusted for Inflation• Portability requires an affirmative

election and likely disclosure• Portability requires “privity” between the

spouses• “Credit shelter” trusts provide the trust

type benefits that portability cannot

• SITUATIONS WHERE ONE MIGHT RELY ON PORTABILITY...

• Where the decedent’s estate has a large IRA or qualified plan and few other asset

• To save state estate taxes on the decedent’s estate

• To generate a “stepped up” basis on the decedent’s assets

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Joint Ownership

• Tenancy by the Entirety:– Form of joint ownership between a husband and wife

recognized in 20+ states.– Generally limited to ownership of real estate, but in some

states can also be used with respect to intangibles.– Creditor of one spouse only cannot foreclose against the

property unless tenancy by the entirety is severed (whether by death, divorce or some other transfer).

– Non-debtor spouse receives property 100% free and clear, but if debtor spouse is survivor, and period has not expired, creditor can exercise rights against the property.

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TENANCY BY ENTIRETIES TRUSTS• A few states have enacted legislation providing protection for

TBE property held in trust. These are Delaware, Hawaii, Illinois, Indiana, Maryland, Missouri, Tennessee, Virginia and Wyoming

• Benefit is to provide same creditor protection for TBE property through a trust vehicle

• In some states the deceased spouse’s half is protected from the surviving spouse’s creditors. In Tennessee the separate creditors of the surviving spouse may reach trust assets only to the extent that the surviving spouse remains a beneficiary of the trust and possesses a non-fiduciary power to vest title to property in himself/herself individually.

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State and Federal Exemptions

• Pension and ERISA qualified retirement plans are protected from creditors.

• Life insurance and annuities are generally protected.

• Homestead exemption under some state laws.• Asset protection planning can never be used to

evade taxes - IRS can also invade retirement plans, insurance and annuities.

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IRAs and Asset Protection Planning

• An IRA is generally protected from the claims of creditors or the IRA owner.

• However, it is unclear whether an inherited IRA is protected from the claims of the beneficiary’s creditor.

• The vast majority of cases have denied creditor protection to inherited IRAs, but recent cases have bucked this trend.

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Creditor Protection of IRAs

• Bankruptcy law specifically exempts from a debtor’s bankruptcy estate “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, or 501(a) of the [Code].”– 11 U.S.C. §§ 522(b) (2), 522(b) (3) (C), and 522(d)(12).

• Limited to $1,000,000 (adjusted for inflation and currently $1,245,475), excluding amounts attributed to rollover contributions.– 11 U.S.C. § 522(n)

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Creditor Protection of Inherited IRAs

• Question as to whether an inherited IRA constitutes “retirement funds” under the Federal bankruptcy exemption – Supreme Court held not retirement funds=not exempt

• State law exemptions v. Federal exemptions• State law controls outside of bankruptcy context

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Planning to Protect Inherited IRAs –Designate a trust as the beneficiary• “Conduit Trust”

– Advantage: beneficiary’s life expectancy used to determine amount and timing of the mandatory distributions

– Disadvantage: distributions from the inherited IRA will no longer be protected from creditors following their payment to the trust beneficiary

• Accumulation Trust– Advantage: greater asset protection– Disadvantage: all beneficiaries must be taken into

consideration in calculating mandatory required distributions (even if merely contingent, or permissible appointees under a special power of appointment) and non-individual beneficiaries (such as charities) may not be permissible beneficiaries (See Treas. Reg. § 1.401(a)(9)-5 (Q-7 & A-7))

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Formation of Limited Partnership or LLC

• Owner of property contributes to an LLC or LP and retains interest as a member or limited partner.

• Need a valid “business purpose” for LLC/LP.

• Assets are generally secure from claims of creditors because assets are owned by entity rather than individual member/partner.

• Creditor can generally only get a charging order remedy and cannot step into the shoes of LLC/LP Manager or GP to sell off the assets or liquidate the LLC/LP.

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Charging Order Protection

• A “charging order” is a court order that dictates that the LP or LLC must make distributions that would normally be paid to the debtor to the creditor.

• BUT, court cannot mandate timing or amount of distributions.• LLCs or LPs should be formed in states that provide for the

charging order as exclusive remedy.

– See Prof. Carter G. Bishop’s Fifty State charts at:http://ssrn.com/abstract=1565595 andhttp://ssrn.com/abstract=1542244

– Currently, Wyoming and Nevada are the only states that provide for exclusive charging order remedy for single-member LLCs. But see In re Cleveland where the US District Court gave trustee power to liquidate single member Nevada LLCs.

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Trusts, in General

• What is a trust?– A trust is a contractual relationship between a

grantor, a trustee and a beneficiary for the trustee to hold legal title to property, formerly owned by the grantor, for the benefit of the beneficiary.

• Why does a trust protect against creditors?– Most succinctly stated in Latin, “cujus est dare,

ejus est disponere”

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What is the major limitation on a trust’s protection?

• Public policy - an argument that it is unfair to let a man enjoy the fruits of a trust that he himself has established for his own benefit, while at the same time denying his legitimate creditors payment on their claims.

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Third-Party Irrevocable Trusts

• Third-party trusts are irrevocable trusts in which the Grantor is not a beneficiary

• The $5 million gift tax exemption opens up huge opportunities

• Trust for Spouse - QTIP election• Trust for Spouse and Descendants• Trust for Descendants

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Trust for Spouse and Descendants

• Settlor retains the power to fire and hire trustees

• Use a “floating spouse” provision

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Discretionary Trust

• Discretionary Trusts are the most protective

– “Sole and absolute discretion”– “Unreviewable by a court of law”– Doesn’t have to rely on a spendthrift provision

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Inter-vivos QTIP/Marital Trusts with special power to donee spouse

• General rule: relation back doctrine applies• The following states have enacted legislation to

negate general ruleArizonaDelawareFloridaKentucky MarylandMichigan

North Carolina OregonSouth Carolina TexasVirginia Wyoming

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Other Non-Self Settled Trusts

• Power to add grantor given to third party• Give beneficiary power to appoint to grantor• Spousal Lifetime Access Trust with floating

spouse provision• Non-reciprocal trusts (but see A.R.S. §14-

10505(E) which appears to protect reciprocal trusts

• Add grantor as beneficiary after ten years

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Domestic Trusts• Advantages

– Probate Avoidance– Confidentiality– Spendthrift Protection for Beneficiaries

• Disadvantages– Self-Settled Trust Rule Applies in Most States– Subject to Domestic Legal System– Subject to Fraudulent Conveyance and Sham Trust Challenges

• New LegislationAlaskaDelawareHawaiiMississippiMissouri

NevadaNew HampshireOhioOklahoma Rhode Island

South DakotaTennesseeUtahVirginiaWest VirginiaWyoming

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Domestic APTs

• Advantages– Settlor can be Beneficiary and Protector– Statutory Protection from Creditors– Will Substitute– Protection for attorneys, advisors– Settlor may retain income or principal under ascertainable

standard.– Can be structured as either a completed or incomplete gift

• Disadvantages– Subject to full faith and credit– Statute of limitations open-ended for existing creditors– Ten year statute of limitations in bankruptcy

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Incomplete Gifts – What retained powers required?

• CCA 201208026 - Chief Counsel memo concludes transfer was a completed gift notwithstanding Settlor’s retained testamentary power of appointment. To ensure incomplete gift treatment settlor should retain either a lifetime limited power or a veto power over distributions. Prior issued rulings and Treas. Reg. §25.2511-2(b) suggest testamentary power is adequate.

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Domestic Trust Planning Structure

Client Manager DelawareTrustee

Client Investment

AccountLLC Trust Protector

Child ClientMrs. ClientMr. Client

Example: Trust in Delaware, Settlor in New York

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Foreign Trusts

• Advantages– Settlor can be Beneficiary and Protector– Statutory Protection from Creditors– Short Statute of Limitations Period– Standard of Proof to Succeed in Fraudulent Conveyance

Action– U.S. Judgments not Recognized– Confidentiality– Grantor Trust - Tax Neutral during Grantor’s lifetime– Will Substitute

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Foreign Trusts (cont’d)

• Disadvantages– Reporting Requirements– U.S. Court Perception/Contempt– Foreign Trustee Concerns– Section 684

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EXAMPLEDynasty Trust W/O Trust

Initial Amount (Grantor 50 Years Old) $5,000,000 $5,000,000Value at Grantor’s Death(7% Growth – 25

Years) $27,137,160 $27,137,160Estate Tax @ 40% $0 10,854,864

27,137,160 $16,282,296

Value at child’s Death – 50 Years (7%) 147,285,135 88,371,065Estate Tax @ 40% $0 35,348,259

$147,285,135 53,022,806

Value at Grandchild’s Death – 75 Years $799,380,150 287,777,708Estate Tax @ 40% $0 115,111,083

$799,380,150 172,666,625

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Service’s Ruling in PLR 200944002:

• Grantor proposed to create a trust for the benefit of himself, his wife, and his descendants. Under the terms of the trust, the trustee could, but was not required to, accumulate all income or pay income and/or corpus to one or more of the beneficiaries, including the grantor.

• The IRS citing Rev. Rul. 2004-64: “...the trustee’s discretionary authority to distribute income and/or principal to Grantor, does not, by itself, cause the Trust corpus to be includible in Grantor’s gross estate under § 2036.”

• However, the IRS refused to rule whether the trustee’s discretion to distribute income and principal to the settlor, when combined with other facts (such as, but not limited to, an understanding or preexisting arrangement between Grantor and trustee regarding the exercise of this discretion), would cause inclusion under §2036.

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Questions?

• Gideon Rothschild J.D., CPA• Moses & Singer LLP• 405 Lexington Avenue• New York, NY 10174• Telephone: 212.554.7806• [email protected]• www.mosessinger.com

Disclaimer

Viewing this PowerPoint or contacting Moses & Singer LLP does not create an attorney-client relationship. This PowerPoint is intended as a general comment on certain recent developments in the law. It does not contain a complete legal analysis or constitute an opinion of Moses & Singer LLP or any member of the firm on the legal issues herein described. This PowerPoint contains timely information that may eventually be modified or rendered incorrect by future legislative or judicial developments. It is recommended that readers not rely on this general guide in structuring or analyzing individual transactions or matters but that professional advice be sought in connection with any such transaction or matter.

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