Asset Protection refers to a group of legal techniques that protect a person's property from creditors and judgments. While there have always been protective measures available to persons to safeguard their assets, there has never been as great an interest in asset protection until recent years. The litigation explosion of the latter part of the last century prompted overwhelming interest in the property protection area.
The statistics are overwhelming: Nearly every American business and every US individual will be sued at some point in their life. An even greater number will be threatened with lawsuits. Despite these dismal statistics, only a slim percentage of Americans bother with any property protection considerations at all. Asset protection preparation ranges from simple tool s such as transferring assets to a retirement account, to more complex arrangements such as offshore trusts. In 1997, a judgment entered against celebrity O.J. Simpson in the amount of roughly $33,500,000 in a civil case brought by the family of his former spouse and the family of Ron Goldman following their alleged murders by OJ.
One might think Mr. Simpson's assets would have to be relinquished to satisfy this enormous judgment. Yet OJ lives in a lavish Florida home, and enjoys a robust pension. Sure, some assets have been seized, but the bulk of OJ's property remains out of reach of his creditors. In fact, Simpson has never declared bankruptcy or taken other action to extinguish the liability.
How is this possible? The answer is that OJ arranged his financial affairs in a completely legal manner that left his assets out of the reach of creditors. Florida, his adopted home state, just so happens to be one of the most advantageous states for property protection. When asked about his choice of domicile, Simpson responded in an interview that while he intended to move to Florida anyway, 'an added benefit is some of the laws here in Florida.'
Asset Protection planning can be effected in basically three ways. The first is divestiture, by which an individual transfers his holdings to another, either by outright transfer or by having liens or mortgages placed upon the asset. This method relies on the simple truth that a creditor cannot have what a debtor does not possess. The second way is through exemption planning, where an individual transfers assets to a statutorily protected class of assets, such as residential homestead, life insurance, or an IRA . These classes of protected holdings vary widely by state. The third way is through the use of liability shielding entities such as corporations and LLCs. Hiding one's assets is not part of responsible or effective property Protection planning. First, it may be against the law, and second, it doesn't work well.
Themes in property Protection
Several general themes apply in property protection:
*No asset protection plan can ever give anyone absolute protection from creditors; asset protection preparation can only safeguard most of a person's assets from creditors. Some property will always be exposed.
*The proper goal of an asset protection plan is to frustrate creditors and their lawyers by changing the creditor's economic analysis of a lawsuit (by making it more expensive and uncertain for the creditor). In other words, the plan itself doesn't give the protection; how a creditor perceives the plan gives the protection.
*Timing is important. An asset protection plan must be put in place well before a creditor or plaintiff emerges. Otherwise, the plan will be exposed as a transparent last-minute effort to thwart creditors.
*An useful property protection plan can be made even more useful by 'layering' different legal protections over the same assets.
* Compartmentalization is an potent asset Protection preparation tool. For example, an owner of rental properties (rental properties generally carry a high risk of liability) can place each separate leased property in a separate LLC or corporation. If one rental results in liability, a creditor will be forced to pursue liability against only one entity, and will not reach either the owner or her other properties.
*A simple property protection plan is generally more potent than a complex plan.
How Plaintiffs Operate
The key to property protection is to step into the mind of the plaintiff . First of all, the creditor can't just go around taking a debtor's assets until the underlying dispute is heard in court. Only after winning the suit can the plaintiff proceed to the collection phase of his suit. The creditor wants a quick, inexpensive trial. After that, the plaintiff wants a quick, inexpensive, and productive collection phase. Lawsuits are economic events and require economic analysis. Only a foolish creditor would pursue a case without some certainty of recovery. property protection seeks to deter lawsuits by confounding the certainty of a creditor 's recovery.
Safeguarding the Family Home: Homestead and Liens
For most Americans, the most valuable property they own is their personal residence. The residence offers some of the simplest and most potent asset Protection planning device s. The first tool is the homestead. A Homestead is, quite simply, a legal tool that protects a person's residence (or a portion of it) from creditors. A judgment creditor cannot levy on the homestead portion of a person's residence. The sum of homestead Protection differs widely by state. Texas and Florida offer unlimited homestead Protection (unlimited in value, but limited by acreage), while Alabama offers a meager $5,000 homestead exemption for single persons and $10,000 for a married couple. In practice, a creditor attempting to levy on an Alabama residence can reach all the equity (after mortgages and liens) except for the homestead shielded amount.
In the event of a forced sale of the residence, the ousted creditors would receive the homestead exemption in cash. Homestead Protection is afforded automatically in most states, but it's always a good idea to file appropriate papers to claim the homestead. In states with low homestead protection, mortgages and liens provide a very effective means of protecting the personal residence. This process is sometimes referred to as 'equity stripping.' A residence with liens on it is essentially owned by the bank. The home's lienholders have priority over subsequent creditors. Any creditors who levy a home with one or more existing liens take a disadvantaged position behind the lienholders. In the event of a sale, the creditor is less likely to get a recovery. A assets owner can lien up his or her own holdings by increasing the size of an existing mortgage, or by getting a home equity line of credit (HELOC). Most HELOC loans do not require the assets owner to ever draw money on the loan, drawing on the HELOC is optional but once the HELOC is in place, it discourages later creditors from pursuing the owner. Placing liens on holdings works similarly well for other assets, such as cars, art collections, business inventories, securities, and a wide range of other assets
Asset Protection Through property Exemptions
Every state shields certain classes of assets through property exemption laws. The property exemption laws serve a dual purpose. First, they denote types and amounts of property that are unreachable by creditors. Second, these statutes also denote types and amounts of holdings that cannot be lost by a debtor in bankruptcy. A bankruptcy court is a de facto creditor, so a bankruptcy court can only reach what a creditor can reach. This principle applies to homestead laws as well, except for some recent erosion built into the 2005 bankruptcy law revisions. So, good asset Protection preparation is also potent pre-bankruptcy preparation. So, the holdings exemptions are plainly valuable.
Again, assets exemptions differ greatly by state. Texas places the full amount of all Individual Retirement Account s beyond the reach of creditors, while California exempts retirement accounts 'only to the extent necessary to provide for the support of the judgment debtor when the judgment debtor retires and for the support of the spouse and dependents of the judgment debtor.' California's subjective test for retirement account exemption results in frequent disputes. Florida exempts an automobile of up to only $1,000 in value, while Texas exempts one car of unlimited value per spouse. Florida and Texas exempt wages from garnishment, which most states do not. The property exemptions also contain some historical oddities. Texas' generous property exemptions include 'two horses, mules, or donkeys and a saddle, blanket, and bridle for each; 12 head of cattle; 60 head of other types of livestock; and 120 fowl.' In order to take advantage of the holdings exemptions, one must first investigate the assets exemption laws in one's state of residence this state's holdings exemption laws will govern. assets exemption planning is simply the process of transferring non-exempt holdings into exempt holdings. The simplest and most common example is to arrange and select the most appropriate retirement account. Moving cash into an IRA in most states will protect the asset from creditors. In other states, certain types of retirement accounts are more protected by others. assets exemption planning also means avoiding assets transfers that expose safeguarded assets. There have been cases where uniformed debtors cashed out their pensions (pensions are fully asset safeguarded by federal law) and moved the proceeds into non-exempt assets, thereby exposing the property to creditors.
Using Corporations and LLCs
Nearly every business owner can protect their personal assets by conducting their business operations through a liability shielding entity, a corporation or LLC. Both forms of entity serve the same indebtedness shielding purpose. LLCs and corporations serve the specific purpose of isolating the liabilities of a business enterprise with the entity. This approach should always be the business owner's first line of defense in shielding their personal holdings. A debt arising out of the corporation's operation attaches to the corporation only, and cannot reach the owner's or owners' assets. Of course, extreme misuse of the corporate or LLC form can erode that indebtedness protection.