The proper titling of assets combined with entities and irrevocable trusts can significantly enhance the protection of your assets and your family’s wealth. This does not mean that everyone needs a complex pre-packaged structure of entities and trusts. In fact, we spend a significant amount of time unwinding these complex structures because of changed circumstances, limited effectiveness or the structures have been incorrectly implemented or too expensive to maintain. Review and prioritizing your goals is essential before implementing complex legal structure. Below are some of our thoughts on titling and other creditor protection techniques designed to protect your family’s assets.
Sole and separate property.
Keep sole and separate property segregated from community assets. In Arizona all assets are presumed to be community property. By clearly defining your sole and separate property you protect these assets from the sole and separate debts of your spouse in addition to protecting yourself in the event of separation or divorce. Of course, this must be balanced with the income tax planning and the desire to obtain a step-up in basis at the first spouse’s death.
Adding non-owners to title.
Adding cousin Charlie to the title. Don’t do it. Keep non-owners off of title to your assets. What happens if Charlie runs his car into a group of neurosurgeons at the hospital? If the joint account is seized by his creditors, you will spend significant resources trying to recover the funds. Worse, what happens if Charlie runs into financial problems and “borrows” some funds. If you are concerned about succession planning, use a power of attorney, trust, beneficiary designation or pay on death designation to achieve your objectives.
Retirement account assets are already protected from attachment by your creditors under Arizona law. See A.R.S. §33-1126(B) and specifically including IRAs In re Herrscher, 121 BR 29 (D.Ariz. 1990). Therefore, no further planning is necessary for such accounts.
LLCs, Limited Partnerships and Corporations. The use of corporate entities as a legal structure to protect your family’s assets from business liabilities is common and simple. Businesses, rental properties and other assets that third parties use or come in contact with should all have a corporate wrapper. The most common approach is to operate your business through a corporation, limited liability company or limited partnership. More complex structures can have liabilty protection and income tax attributes that are benecial. If the entity is properly documented and operated, a liability incurred by the business will not affect assets held outside the business. Make sure you satisfy the entity’s formalities, properly title assets in the name of the entity and update your corporate records regularly. Failure to do could result in a court piercing the corporate veil and attaching your personal assets.
What about using an LLC to own your family’s assets? Holding your rental properties in an LLC makes great sense to give yourself a layer of protection beyond insurance. You can also achieve additional protection from high risk assets such as boats, planes and ATVs by placing these assets in entities. This does not mean that every asset you own needs to be owned by an entity. Your house is a good example. There are a lot of variables that must be addressed when determining whether to put your house in an LLC. You must balance the risk of losing Arizona’s homestead exemption of $150,000 (A.R.S. §33-1101-1105) and its anti-deficiency statutes (A.R.S. § 33-729(A) and 814(G)) if your personal residence is transferred to an entity. Likewise, additional tax benefits such as the mortgage interest income tax deduction and home sale exclusion can be lost depending on how the entity is treated for income tax purposes. Confidentiality is another factor to consider. A complex structure can effectively enhance the privacy of the true owner. You must prioritize your objectives and evaluate the consequences before committing to a particular structure. Often the best result is achieved by you, your accountant and attorney working together to design a structure that meets your objectives without adverse tax or other implications. For more on satisfying corporate formalities see our post on what documents are required here.
Under Arizona law revocable trusts offer no asset protection while the trust is revocable. See A.R.S. §14-10505(A). Irrevocable trusts on the other hand can offer significant protection from the beneficiary’s creditors or spouse if they are appropriately drafted. By combining a spendthrift provision and giving the trustee discretion whether to make a distribution subject to an ascertainable standard, the assets of the irrevocable trust will be beyond the reach of the beneficiary’s creditors. For example, by leaving assets in trust for a beneficiary, rather than giving them outright, the assets of the trust are protected from the beneficiary’s creditors. This technique is well settled under Arizona and US law. Unfortunately, you can not create an irrevocable trust for yourself and have it be effective against your creditors under Arizona law.
Domestic Asset Protection Trusts.
Some states (notably Nevada, Alaska, South Dakota and Delaware) have statutes permitting individuals to create self-settled domestic asset protection trusts a.k.a. DAPT using a third party trustee. These trust effectively allow the grantor to create a trust where she is the grantor and the primary beneficiary and after a period of time, usually two years, the assets in the trust are protected against creditors. While Arizona does not permit DAPTs, it expressly allows a person to create a trust for his or her spouse and the assets will be protected from creditors. See A.R.S. §14-10505(E). However, the DAPT is a relatively new legal structure, has bankruptcy limitations and has not been fully tested in the court system. Therefore, some practitioners question whether the DAPT is enforceable against creditors in other states under the US Constitution. In fact, one Alaskan Supreme Court case has refused to use its state DAPT shield to real estate in Montana. See Toni 1 Trust v. Wacker, 2018 WL 1125033 (Alaska, Mar. 2, 2018).
Unlike domestic trusts, offshore trusts are not subject to the US Constitution or the laws of other states. Therefore, they offer an additional layer of protection that you can’t get stateside. Unfortunately, they also come with some hefty annual administration fees, therefore making this structure uneconomical unless you already have assets or income outside the United States or you are able to move a couple million dollars into the structure and forget about it. Commonly jurisdictions include the Channel Islands, Cayman Islands and Cook Islands. The key is to find a jurisdiction that has a strong infrastructure and is reliable and well suited to your situation.
Again, a legal structure appropriately tailored to your circumstances can substantially enhance the protection of your family’s wealth. However, you can not simply purchase the structure and through it in a closet. To be effective you must consistently adhere to its formalities and update it regularly. If you would like us design your legal structure or review your existing structure to insure it is appropriate with your circumstances, please give us a call.
For a description of other important defense strategies see the post on protecting family assets here.