Asset Protection ~ Facts & Fiction
Recently, I read a column that suggested asset protection strategies should be used by those with modest estates. While I appreciate the premise, I respectfully disagree. Asset protection strategies used by high-net worth or ultra-high net worth individuals require a substantial investment in resources – specifically time and money. Most families with modest estates don’t have $2-5 million in liquid assets, a mortgage free million dollar primary residence, a second vacation home, watercraft, and insurance to cover the value of all of these assets. Let’s be real, if: (1) Your family residence is still subject to a mortgage, you don’t actually own the asset to protect. (2) You own 1 or 2 multifamily income producing properties that are still subject to mortgage, you don’t actually own the asset to protect. You do, however, own the income, which is what umbrella insurance and LLCs are for. (3) You don’t have the funds readily available to replace your mortgage-free family home, the only way to protect that asset is with a robust homeowners insurance policy. Economic uncertainty is frightening. And ways exist for families with modest estates to protect what they have and undergird their wealth accumulation efforts. However, if you’re thinking about asset protection consider the above and think again: AFFORDABILITY. The legal fees alone are generally $10,000 or more, and they generally do not end because asset protection or wealth preservation is not a “set it and forget it” endeavor. CURRENT JURISDICTION. All states (or jurisdictions) don’t allow you to establish an asset protection plan or recognize asset protections trusts. IT TAKES A TEAM. Lawyers, tax professionals, appraisers, insurance professionals, and, even, security professionals depending on your other family members and the size of your estate. Experienced estate planning and wealth preservation professionals will do what they can within legal parameters to set you and your family up for success. But, it’s not like the movies and if a wealth preservation professional snaps their fingers and agrees with everything you say, run…fast…and far.
The Smallbiz Entity Trap
When researching what type of business entity to select, entrepreneurs often seek the most popular option – a Limited Liability Company (LLC). LLCs are popular because they don\’t require the administration that S-Corporations (S-Corps) require – filing quarterly tax returns, holding annual meetings, paying employee wages. Additionally, LLC participants, aka “members,” don\’t own the LLC property, which provides members with some liability protection. (Hence, Limited Liability Company.) LLCs can have one or more members, single-member LLCs (SMLLCs) or multiple-member LLCs, respectively. Furthermore, unless an LLC selects to be treated as an S-Corp, LLCs are treated as partnerships, where the loss or gain of profits flow through to the members. However, when approached about entity selection, while administration and tax issues are important, for start-ups, it\’s critical that liability protection is thoroughly considered. If a judgment is placed against an LLC, the judgment creditors can generally only place liens on the distributions or the LLC property. So, if an LLC member of a multiple-member LLC is sued, the judgment is placed solely against that member’s distribution, whereby the other members can receive their distributions. But, if the LLC is an SMLLC, treated as a partnership, and a judgment is entered against the distribution, then that member won\’t be able to receive their distribution (share of the profit) until they settle the judgmentd. What’s a partnership of one? A sole proprietorship. Who gets sued in sole proprietorships? The proprietor. Whose assets are subject to judgments in sole proprietorships? The proprietor\’s. Ergo, depending on the jurisdiction, S-Corps are sometimes more suitable; they provide an extra layer of liability protection. Because an S-Corp owner/employee would be treated as an employee for the S-Corp, if the S-Corp was sued, the S-Corp owner/employee, unlike an LLC manager/employee, would still be able to receive wages and, thus receive part of the profits. (Ownership shares of an S-Corp are not wages.) As mentioned above, an LLC can seek to be treated as an S-Corp, whereby the owner is also paid as an employee. But, that means that the administrative burdens that accompany S-Corp status are now also a part of the LLC. And that defeats the simplicity purpose of establishing an LLC. THE TAKEAWAY…Potential smallbiz owners should consider liability as an important factor when selecting a legal structure: Choosing the wrong entity can mean the difference between a great launch or great flop .
Time to Make the Soup
Recently, our office, sent a client alert regarding IRS news that hit the estate and financial planning communities late this summer. If you or someone you know has a small business, the information below will probably be of interest. What Is Given Can Be Taken Away In August, the Internal Revenue Service (“IRS”) issued Proposed Regulations that could have a dramatic impact on estate and business succession planning by eliminating valuation discounts traditionally available to closely held businesses. Discounts are currently used to help protect a family or closely held small business from the risks of future divorce, lawsuits, or malpractice claims while maximizing the value of the underlying assets. When a Valuable Business Can\’t Be Sold: Discounts Explained Consider this example: Thomas has a $7M estate that includes a $5M family business. He gifts 40% of the business to a trust to grow the asset out of his estate. The gross value of the 40% business interest is $2M. Since a minority 40% shareholder (the trust) cannot force a sale or redemption of its interest, the non-controlling interest in the business transferred to the trust is worth less than the pro-rata fair market value of the underlying business. Thus, the value of the business interest should be reduced to reflect the difficulty of marketing the non-controlling interest. As a result, the value of the 40% business interest transferred to the trust might be appraised, net of discounts, at $1.2M. The discount has reduced the estate by $600,000. From another perspective, consider the issue if Thomas\’ children buy the business and the taxes they would have to pay for a business interest that isn\’t \”marketable\” were it not for the valuation discount. Timing Is Everything Once the Proposed Regulations eliminating or decreasing discounts are effective, which could be as early as December 31 of this year, the ability to obtain discounts might be substantially reduced or eliminated, thus curtailing wealth planning flexibility. Furthermore, as the 2016 year–end gets closer, it will become more difficult and, at some point, will become impossible to have banks and trust companies create trust accounts. If you’re unsure of what you might wish to do, you may want to take the preliminary steps as soon as possible. For example, if you don’t already have trusts that could serve as appropriate receptacles for 2016 discounted gifts, it would be wise to establish trusts immediately. You can always determine later which assets and how much to transfer. Get in the Kitchen Make that alphabet soup, i.e., contact your planning team. A collaborative effort is essential to solid, effective wealth planning. Your wealth transfer strategy team, i.e., your attorney, CPA, CFP, and insurance professional, can review strategic wealth transfer options that will maximize your benefit from discounts while still meeting other planning objectives. Projections completed by your wealth manager could be essential to confirming how much planning should be done and how. ***Disclaimer*** The Law Offices of Max Elliott advises clients on legal strategies regarding estate and wealth planning issues; we do not provide financial planning or tax planning advice. We\’re only one letter – albeit a good one – in the alphabet soup.
Not the \”Bump\” Couples Want…
High income households can strategically plan their income tax payments to better limit their Alternative Minimum Tax (AMT) liability exposure. The AMT structure differs from the regular tax system in that it subtracts fewer deductions and instead deducts one significantly larger exemption. This exemption phases out once a threshold is reached and as income increases. The AMT applies a tax rate of 26% on the first $175,000 of income and 28% thereafter. Households pay the AMT when a great tax liability results when using the regular system; thus, paying the AMT usually results in reduced marginal tax rates. However, as the AMT exemption phases out, the marginal tax rate increases and approaches a “bump zone” of tax rates. The marginal tax rates jump to 32.5% and 35% until the exemption completely phases out. After this, the marginal tax rate returns to 28%. Appropriate tax planning allows households to avoid “the bump” of rising marginal rates. Deferring income at the lower end will preserve the exemption taken. If income is higher, accelerating additional income to exit the zone and completely phase out the exemption would return the 28% marginal rate. However, accelerating too much income may subject a taxpayer to the regular 39.6% marginal tax rate instead of the 28% AMT rate. The phaseout threshold depends on the taxpayer’s state income tax rate and how much in excess AMT-adjusted deductions the taxpayer has. To maximize the AMT exemption and avoid the unwanted \”bump,\” taxpayers should consult with their tax advisor to discuss anticipated income and deductions in addition to identifying potential areas of liability. Timing can be everything. — Danielle Haseman, Team Max Elliott Law
Jennifer\’s Story – A Fiduciary\’s Tale, Part 1
Fiduciaries are individuals who are held to a higher standard of legal accountability than others with whom folks may enter into agreements. The high standard is attributed to fiduciaries because usually they\’re responsible for making very important decisions or taking critical actions on behalf of others. In Estate Planning and Estate Administration, professional fiduciaries help families and individuals create and implement plans that will protect their interests. Professional fiduciaries include bankers, lawyers, financial advisors, doctors, and accountants. So, the interests these important folks protect involve money, one’s life, or confidential information about the same. The information you share with professional fiduciaries should be considered and treated as trusted confidential information, to be shared with only those individuals you expressly authorize to receive the information. If that trust is not respected, i.e., breached, because fiduciaries are held to a higher standard of accountability, the professional usually can be hauled into court. The down n dirty scoop on fiduciaries can start with Jennifer\’s story*: Jennifer was visiting her grandmother when she learned that her parents were involved in a horrible car accident. Jennifer flew back home immediately, heading to the hospital directly from the airport. At the hospital, she was informed by one doctor that both parents were placed in a medically-induced coma. Additionally, her brother, Alex, who had been estranged from the family for 10 years was standing in the ER speaking with another doctor. It was clear to Jennifer that the doctor had presumed Alex had authority to make decisions for her parents and was providing Alex with information about her parents health. When Jen asked the doctor why he was sharing information with her brother, the doctor informed her that the nature of the situation required the medical staff to engage with the next of kin to determine and obtain permission for urgent care and treatment. Yet, was that legally the case? Jennifer’s parents had healthcare powers of attorney on file with their preferred hospital. However… Stay tuned… Jennifer\’s Story – A Fiduciary\’s Tale, Part 1 | 2 | 3
Our Readers\’ Top 5 Articles from 2013
Like most, The Shark Free Zone took a little time off to reflect over last year’s work and our readers’ preferences. So before the “reflection” month of January is over, below are the top 5 articles from 2013. Enjoy! NUMBER ONE. The popularity of our top article for 2013 may have had a little to do with its melodramatic title, “Infants, Stairwells, & Burning a Million Dollars.” The premise was less dramatic than the title, but still important: If professionals or smallbiz owners fail to protect their assets by not planning, they might as well set their income and belongings on fire. Of course, we’re not advocating arson, but if someone slips and falls on your property or a toddler visiting with Mom finds his or her way into a non-child-proof cabinet, oh woe… Click here to read the star of The Shark Free Zone for 2013 and feel free to pay it forward. TWO. \”What the Civil Union Means…to Many,\” was a spillover all the way back from 2011, providing useful information on LGBTQ couples considering or entering into Illinois Civil Unions. It\’s continued popularity was likely because it resonated with many concerned about the economic benefits that can be reaped when discrimination ends. It’s a somewhat moot now that Illinois has passed the Religious Freedom and Marriage Fairness Act, providing marriage equality to Illinois LGBTQ couples. However, the article has many relevant points, so you can read it here. Our article on marriage equality in Illinois is forthcoming, so stay tuned! THREE. Smack dab in the middle is our series, whose information, is rising to the top of the news charts as more statistics and reports are being shared daily about the large aging Baby Boomer population. We first mentioned the Baby Boomer issue, or “Silver Tsunami,” a few years ago. It is now abundantly clear to all advisors that almost everyone is or will be affected by the Boomer generation, especially families that are unprepared. Don’t get caught by the Boomer wave. Prepare for the Silver Tsunami by checking out this middle entree. FOUR. Fourth in last year’s popular articles again involved marriage equality, particularly DOMA’s undoing. Our series, “The IRS Takes a Bite Out of DOMA” highlighted the complex estate and financial planning machinations LGBTQ couples had to take before the U.S. Supreme Court’s ruling in U.S. v. Windsor and the subsequent IRS ruling 2013-17 that removed a lot of that complexity for legally married LGBTQ couples, and especially those in \”friendly\” states. Tap here to read the beginning of this important 4-part series. FIVE. Rounding out our top 5 is “The Money Talk.” Recently, a relative became engaged, which will likely happen with many couples next month on Valentine’s Day. As couples take this loving step, it’s critical to know and understand each other’s mindset as it relates to saving, spending, investing, charitable giving, and a host of other related issues. So before you say “yes” or consider putting a ring on it, consider having this conversation. So there you have it: The top interests of 2013 were about love, money, and justice. What else is there to be interested in, except a pair of good looking shoes, right?
Wealth Preservation: When Your Pocket Shouldn’t Be the Payroll
People often confuse estate planning with wealth preservation, aka “asset protection.” The confusion is understandable for 2 reasons. First, estate planning and wealth preservation have overlapping areas and considerations. Second, and probably the most popular reason is that legalese is confusing when it refers to almost everything. Estate planning, while it involves planning for asset maintenance during your lifetime, that planning typically addresses emergencies. Accordingly, the documents needed are powers of attorney and medical release forms. Some trusts may also assist in asset maintenance, such as Qualified Personal Residence Trusts (QPRTs) and even revocable living trusts that provide income during the life of the beneficiary/trustee. However, estate plans generally address the transfer of assets to loved ones upon death. Wealth preservation, conversely, addresses the issue of keeping and enjoying the fruits of your labor during your lifetime and, most importantly, keeping it out of the reach of others. Many individuals think that the big other is Uncle Sam. The contrary is true. Most lawyers who prepare wealth preservation plans repel the idea of tax evasion; it’s against the law. Do we use the law to help minimize tax burdens? Yes. But the operative phrase is “use the law” not evade the law. Thus, we only work with clients who are willing to comply with tax laws and if potential clients don’t like the sound of that, those of us who want to keep our licenses, gently tell those potential clients to seek counsel elsewhere. The “others” we really want to keep away from your “fruits” are menacing, frivolous plaintiffs. These plaintiffs are individuals who believe that because you work in a particular profession, that they should be on payroll even though they don’t deserve a penny of your earnings. Usually, the clients who confront menacing plaintiffs are either business owner or those in “high risk professions” that attract unwarranted lawsuits – doctors, lawyers, architects, engineers, and hazardous chemical delivery. Occasionally the lawsuits are valid and settlements are reasonable and on other occasions, the lawsuits are unwarranted or the settlements are egregiously large, causing the defendant to lose everything. To prevent financial disasters such as this, clients seek the services of attorneys who provide wealth preservation services that include a number of strategies: Liability insurance in the millions of dollars. A Limited Liability Company (LLC) or a Family Limited Partnership (FLP) and if one is nearing retirement, we look to maximize retirement earnings being mindful however, that retirement vehicles are often emptied in large risk events such as a litigation settlement; A Domestic Asset Protection Trust (DAPT) in a state that allows DAPTs and to ensure that you have a substantial relationship to that state. FYI – Illinois is not a DAPT state; and An international trip to a jurisdiction that allow offshore trusts whereby the financial institution is the trustee and you are the beneficiary. Admittedly, many individuals don’t like the idea of living in one country while most of their assets are in another but when they learn of the thousands of frivolous lawsuits that are filed because a plaintiff thinks they should have a payday of which they are non-deserving, some change their mind. Hopefully, you found this helpful and have started planning for both your today and tomorrow, as well as the tomorrow of your loved ones, and the plan isn’t being an unwarranted payroll.
3 Reasons to Be Stingy
The primary problem with financial accounts held jointly is that one cannot predict the financial outlook of another person. These days, we can barely predict our own financial future, let alone anybody else’s, even if that person is a spouse. People still, however, assume that married couples are safe when they join finances, but let’s look at Keith and Richard. As newlyweds, Keith and Richard were head over heels in love. So when the CPA suggested that they keep their own separate accounts and establish a joint account for household expenditures, they smiled and told her she didn’t understand how they wanted to share everything. Ms. CPA just politely smiled back. Several months later, Keith phoned her to find out how to recover money from long overdue child support payments that were taken out of his and Richard’s joint account by Richard’s former partner who lived across country and was the mother of his child. The CPA recommended that Keith contact a lawyer who specialized in child support issues. However, the damage was done; even if the lawyer could recover what was withdrawn, Keith still had to pay the lawyer. So Keith also started thinking about calling another different kind of lawyer. Next: It\’s typical and, at first glance, reasonable for a senior loved one to place a younger family member on the senior’s account jointly. Grandma Adams may say to her granddaughter, “Liz, if I get sick, I want someone to be able to pay my bills and take care of me.” Liz says, “OK, Grandma.” Liz has the best intentions in the world because she has a nice job and doesn’t need Grandma’s money. However, what Grandma and Liz don’t know is that Liz is about to be laid off because her company just lost its best an only client and, as a result, must shut its doors. Liz has a car note, insurance, credit cards, and charge cards. Even if Liz doesn’t touch Grandma’s money, Liz’s creditors can if she stops making payments. Elderly parents, like grandparents and for the same reasons, also consider it a good idea to allow children to be on their account jointly, even if the parents have more than one child. Yet, what if the parent wanted the children to split everything equally upon the parent’s death? Do we really believe that Chloe isn’t going to keep all of the remaining money in the account to herself and not split it with her brother? The best way for an elder to manage this issue is to designate someone as an agent under a property power of attorney. That way, he or she must comply with a higher standard of legal ethics, must keep detailed records, and the agent\’s creditors cannot touch the principal’s funds.
Infants, Stairwells & Burning a Million Dollars
Wealth preservation aka “asset protection” is slowly rising to the top of the mainstream American lexicon, much like estate planning did a couple of decades ago. However, though related, the 2 activities are quite different. A solid estate plan’s end goal is to ensure that your intended beneficiaries obtain what you intend for them in the most efficient and least adverse manner possible. Retirement and tax planning are a substantial part of the estate planning process but the primary beneficiary at the end of the game is someone else, not you. Conversely, a solid wealth preservation plan will ensure that you don’t go broke before, during, or after retirement and fulfill your intentions toward your beneficiaries, tying it into estate planning. But the primary beneficiary of wealth preservation is not someone else; the primary beneficiary is you. Estate planning and wealth preservation are technically linked because the core documents and the fiduciary roles are primarily the same. Both include trusts and, consequently, trustees. Both might even include a LLC. The fundamental distinction is jurisdictional, i.e., what law governs the trust. Typically the laws in states that have asset protection statutes and are referred to as Domestic Asset Protection Trusts (DAPTs) govern wealth preservation instruments whose jurisdiction is in the U.S. Instruments whose jurisdiction is outside the U.S. are governed by the laws, or lack thereof, in those particular countries and are known as “offshore” trusts. Now before you start getting all antsy with thoughts of tax evasion, let me squash that thought like a bug. The only way to ensure that one doesn’t incur Uncle Sam’s penalties is by being completely compliant with the U.S. tax code. Now before going too far into the different schools of thought surrounding DAPTs and offshore trusts, you may be thinking, “I don’t have a gazillion dollars, so this doesn’t apply to me.” But before I lose you to Facebook or an incoming text message – wait. If you live in America, you live in one of the most lawsuit crazed countries in the world. So while you may not have a gazillion dollars, consider the following stats: 99% of doctors in high risk specialties will be sued; 75% of doctors in low-risk practice areas will be sued; Every 6 minutes a child under the age of 5 is treated for an injury sustained on a residential stairwell; In 2012, a woman was awarded about $833,000 for an injury sustained on her landlord\’s property ; Over a 10-year period, 15-21 lawsuits were filed per 100 architect firms; I won’t mention lawyers, it’s a given, people hate us, think we have deep pockets, so they sue us. So if you know your liability insurance won’t cover a potential lawsuit or the cost of litigation in successfully defending an unscrupulous claimant, how comfortable are you holding a “fire sale”? If you’re not thrilled about selling your home and liquidating all of your assets, including your retirement portfolio, to settle a claim, then wealth preservation may be needed sooner rather than later. Then again, maybe you have a million dollars to burn…
3 Lessons about Grapes and Taxes
As Baby Boomers start retiring, thoughts of mortality and legacy planning begin to dance in their heads. While most boomers don’t have taxable estates…for now…the future is still a question mark for many. While enjoying retirement – golf course, cruises, mountain climbing, museum walks, wine tasting, and theatre galas – plans should be made for a time when the retirement funds must be transferred to someone else. It is critical to know how to transfer retirement proceeds properly so the distributions won\’t be literally and figuratively taxing: Claire and Cliff are in their mid 60’s. They’ve a modest estate – home valued at about $250K with most of its equity remaining, life insurance, and retirement benefits at about $2 million. Half of the retirement proceeds is in a 401(k), 25% is in an IRA, and 25% is in an annuity. They also have 2 kids: Lenny and Lisa. Lisa’s a starving artist, who is barely in the 15% tax bracket but who also has a vivacious and smart teenager. Lenny is 10 years older than Lisa and a savvy professional about to move into the highest tax bracket and has no intention of marrying or ever having children. Claire and Cliff want to distribute their estate to Lisa and Lenny equally and have been told to give the retirement proceeds to Lenny and Lisa outright. Before doing that, however, I would ask them to consider the following in a simultaneous death situation, where Claire and Cliff went down with the Titanic III: An outright gift from a 401(k) or a traditional IRA will be taxed and if the beneficiary is over 59 ½, the 10% penalty may also apply. For Lenny, who’s Mr. Money Bags, that doesn’t present too much of a problem, though no one wants to pay taxes. For Lisa, that would be a boon indeed. But an outright distribution to Lisa would yield less than what she would receive were the proceeds titled to a trust because of income tax consequences. Pick the fruit too young and the wine will be bitter; too old and you may taste too much oak. Claire and Cliff could have the proceeds placed in a trust for Lenny and Lisa. Here, part of Lisa’s benefit would be driven by Lenny’s life expectancy because he is the oldest, which would provide her with fewer years of income. Additionally, Lenny and Lisa must be sure to withdraw at least as much as the minimum required distribution annually or face a hefty penalty. Different varietals require different soils. In a qualified (retirement) annuity, the entire amount of the contract must be withdrawn over the 5-year period following Claire and Cliff’s death. Again, okay for Lenny, but not so okay for Lisa. Tax consequences also apply to this issue. Cabernets are as good as zinfandels; it\’s the consumer\’s tolerance that is key. Just like no 2 families are alike, no 2 children are alike. So make sure that your children know how to make decisions about the different types of distributions they can choose, after you enjoy your fruits. That way, the remaining fruit will, in fact, go to your children and not the community jelly jar.