For business owners and executives, potential creditor claims may damage their net worth far more than taxes. Liability can arise from contractual or tort claims. Increasingly, liability is being imposed on those who personally did no wrong. For example, liability may be incurred for damages caused by someone for whom you are deemed responsible (e.g., employees) and for accidents that occur on your premises.
Advisers who focus solely on tax reduction strategies are not providing comprehensive planning for you and your business. Identifying potential creditors, valuing potential claims and implementing protective techniques are essential to protect your business and personal assets.
The type of entity through which you conduct business will affect the level of asset protection afforded. You want to operate the business in an entity that protects your personal assets from the risks of the business. Corporations, limited liability companies (LLCs) and limited partnerships afford the greatest protection for the personal assets of the owners.
Generally, neither a shareholder of a corporation, a member of an LLC, nor a limited partner who is not involved in managing the limited partnership has personal liability for the business entity’s obligations in excess of his or her investment in the entity.
Because of the management issue, corporations and LLCs are generally preferable to limited partnerships. A personal creditor of an LLC member or limited partner cannot reach the assets held in the business entity, but can only obtain a charging order against the owner’s economic interest in the entity, which is generally ineffective.
There are techniques to protect personal assets. For example, qualified retirement plans and IRAs are generally protected from creditors. Life insurance and annuity contracts which are payable to a spouse, child or other dependent, or to a trust for their benefit are exempt from creditors. Maximizing annual contributions to these plans is an easy way to protect assets.
Making gifts can also be effective. With outright gifts, the assets are protected from your creditors, but you lose control and the assets are available to the donee’s creditors. Gifting assets into an irrevocable trust can protect property not only from your creditors, but from the trust beneficiary’s creditors as well.
Assets owned by a spouse will generally not be subject to the claims of your creditors. You can achieve assets protection by gifting assets to a spouse, who has less risk of creditor claims, to equalize assets for estate tax planning. So-called family limited partnerships and family LLCs, often involving spouses and children, are frequently used to reduce estate and gift taxes as well as to provide asset protection for personal assets.
Asset protection planning must not involve a fraudulent conveyance. Generally, if a transfer of assets is made with actual intent to hinder, delay or defraud existing creditors, or if the transferor is insolvent or becomes so as a result of the transfer, then the transfer is considered a fraudulent conveyance, and the assets are available to creditors. Careful planning can avoid this situation.
In many cases, insurance may fully cover a creditor’s claim. The purchase of a personal liability umbrella policy is often recommended. Asset protection planning is not meant to act as a substitute for insurance coverage. If litigation does arise, the plaintiff’s attorney may focus only on the insurance to the exclusion of business or personal assets.
Asset protection planning is generally most effective if business and estate planning purposes are the primary objective, with asset protection merely a resulting benefit. There are common sense steps and techniques that can be implemented to not only accomplish your goals and objectives, but provide a better night’s sleep.
Bryan Hogue is chairman of Carlile Patchen & Murphy’s family wealth planning group. Reach him at (614) 228-6135 or [email protected].