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If you work in a dangerous or risky profession, you may worry that you could lose everything in a lawsuit. The goal of asset protection planning is to place assets beyond the reach of potential future creditors. The inherent difficulty in asset protection planning is the desire to retain control over the assets. The more control a person retains, the more likely his or her creditors will be able to reach the assets.

What can creditors reach? Creditors can reach all nonexempt property that you own and property that you transferred improperly to another person or entity.

What can't creditors reach? Creditors cannot reach exempt property. Federal bankruptcy law defers to state law regarding the determination of exempt property. Illinois law is not particularly generous regarding exempt property. Under Illinois law, exempt property includes retirement plans and annuities, equity of $7,500 in a personal residence, equity of $1,200 in a car or other motor vehicle, and other personal property, including cash, worth $2,000.

Creditors also cannot reach property that you do not own. Creditors cannot reach your spouse's property unless your spouse is also liable on the debt or if the debt was incurred for "necessaries" such as housing. Creditors generally cannot reach a spendthrift or discretionary trust created by another person for your benefit. Therefore, if you anticipate receiving an inheritance, you may wish to ask your parents to leave the property to you in trust rather than outright.

In evaluating asset protection strategies, keep in mind that asset protection strategies must be employed before creditors' claims exist. Fraudulent transfers will not protect assets and can result in criminal prosecution. A fraudulent transfer is a transfer made with actual intent to hinder, delay or defraud a creditor, made for less than fair value, or one which renders the debtor insolvent. Actual intent to hinder, delay or defraud will create a fraudulent transfer as to existing or future creditors.

Preferential transfers can also be set aside. A payment of one creditor over others will be preferential if made three months or less before filing for bankruptcy. The preferential period is one year if the transfer is to an "insider" (generally a relative or an entity in which the debtor has an ownership interest).

So what can you do to protect your assets? You can maximize exempt property, such as retirement plans. You can also transfer property and retain no beneficial interest or control. Subject to the fraudulent transfer rules, giving property away will remove it from the reach of your creditors if you retain no interest in the property and no control over the property. For example, you could create a trust for the benefit of your spouse and children. You could transfer up to $1,000,000 to such a trust in 2003 without incurring any gift tax. You cannot serve as trustee, but your spouse can serve as trustee. The assets will be removed from your estate for federal estate tax purposes and will not be subject to the claims of your creditors because you no longer own the assets. Your spouse can be a beneficiary of the trust, allowing you to benefit indirectly from distributions made to him or her, however, the trust agreement must be irrevocable and unamendable. Therefore, in the event of death or divorce, any potential indirect benefit to you is eliminated.

Another option is an off shore asset protection trust. An off shore asset protection trust is a trust created under the laws of and administered in a country other than the United States. In an effort to gain trust business, these jurisdictions have enacted laws that allow a settlor to create a spendthrift trust for his or her own benefit. In addition, the preferential transfer time period is reduced to a minimal time period such as twenty-four hours or eliminated altogether. The settlor cannot serve as the trustee of such a trust for two reasons: (1) the foreign laws will require a local trustee, and (2) serving as trustee will negate the asset protection of the trust.

The obvious risks involved in creating an off shore trust are the trustworthiness of the trustee and the economic and political stability of the chosen jurisdiction. Because of these risks, settlors generally try to impose some degree of control over the off shore trust, often through the use of a "protector" who can transfer the trust assets, change trustees, etc. However, the more control the settlor retains, the greater his or her risk that the trust will fail. Off shore trusts are not the bullet proof solution they are often portrayed to be. In recent cases, courts have jailed defendants for contempt for refusing to repatriate the assets in their off shore trusts. In addition, beware that off shore trusts cannot provide any legal income tax avoidance for U.S. citizens. You are legally required to report all income, whether on or off shore, and to pay tax on all such income. The IRS has launched an aggressive campaign to find and prosecute people using off shore trusts to evade income tax.

In response to off shore trusts, some states have passed legislation creating domestic asset protection trusts. States have enacted these favorable laws in order to attract trust business. Alaska, Delaware, Nevada, Rhode Island and Missouri all have asset protection statutes. These trusts have not yet been tested, and it is not known whether a bankruptcy court will respect a domestic asset protection trust or disregard it.

Asset protection is a complicated area of the law. As with all financial matters, beware. Scams abound which can leave you in debt or in jail.
Posted in: July, 2003
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