The Art of the Impossible
The solution to the riddle of asset protection
requires a discussion of tax and estate planning. The
laws that have evolved to protect creditors from
certain common and prohibited acts by debtors require
having an overall plan that has benefits besides
protecting yourself from lawsuits. If the plan only
was designed to protect against lawsuits, the courts
can set it aside on the grounds that it was an attempt
to defraud future creditors.
By making the extra effort to set up your
structure correctly, you will find that income and
estate tax savings will far exceed the cost of creating
the plan in the first place.
So first lets examine what you cannot do to
protect yourself from lawsuits.
Badges of Fraud
All 50 states have laws that guard against the
common practice of dodging judgments by transferring
assets. Example: Dr. Paul gives Mrs. Paul all of his
assets. He tells his judgment creditor "all I have is
yours, but..." This does not work. Any transfer made
for less than valid consideration can and will be
undone. The transferee (Mrs. Paul) will be treated as
a trustee for the transferor (Dr. Paul). The court
will unzip the transfer and the value of the asset will
be available to satisfy the judgment. Any transfer
that leaves the transferee insolvent or substantially
unable to pay his current creditors may be treated as a
fraud against the creditors. However, there is no
prohibition on the transfer of assets to a different
form of ownership, such as into a corporation or
partnership. There are several tests that determine
that a transfer does not have the badges of fraud, and
the transferor must pass all of them; in this case a
transfer is guilty until proven innocent! As part of
an estate plan it is permissible to transfer assets to
a family limited partnership provided that you receive
back an equal value of the partnership itself. In
other words, instead of owning $1,000,000 of real
estate in fee simple which is easily attachable by your
creditor, owning $1,000,000 of limited partnership
interest is not a fraud on creditors; any resulting
difficulty in attachment is a result of the laws of
partnership and does not wear any badges of fraud.
The Thin Corporate Veil
The use of a corporation to shield one from
liability may be crucial and effective. Too often,
however, forming a corporation is only useful as a
first line of defense. Too many individuals mistakenly
rely completely on this maneuver. The first problem
with it is that the corporation may be penetrated
(piercing the corporate veil is the legal term),
exposing all officers, directors, and even shareholders
to direct and personal liability. Many minor failures
on the corporate owner's or officer's part may lead to
its failure in asset protection. Such failures
include, but are not limited to:
- Failure to capitalize the corporation -- did
you really pay for the stock?
- Failure to hold annual meetings -- did you stop
treating the corporation as a separate entity?
- Commingling the corporate bank accounts with
your individual check book - do you occasionally (or
frequently) use the corporate checks or credit card to
fund personal expenses?
- Failure to file all necessary corporate papers
with the state - have you ever done business in
California with your Nevada corporation, or in New York
with your Delaware corporation?
- Failure to keep all incorporation papers
current - have you filed your corporate reports with
your state of incorporation?
- Failure to file tax returns - your inactive
corporation didn't need one? Well, now it does!
- Failure to hold corporate meetings - do your
corporate minutes reflect the type, change in, and ebb
and flow of your business?
If you cannot correctly answer all of the above,
then your corporation may not provide the shelter you
expected of it.
The Folly of Corporate Control
Over the years substantial abuses have been
visited upon shareholders of corporations by
"insiders." As a result any majority of shareholders
have the right to force the sale of the corporation,
its dissolution, distribution of assets, etc. As a
share of stock is an item of personal property, similar
to a bank account, certificate of deposit, or cash, it
can be ordered sold, or, in effect, transferred to the
creditor, to (partially) satisfy a judgment debt. Thus
a person who hides behind corporate ownership may soon
find himself the former owner, or, the president voted
out of office.
Worthless Insurance
Less than one in a hundred readers of this report
have actually read their insurance policies. Insurance
companies are in business to make money. They do this
by limiting risks. Probably only one in five know
where their policies are to read them if they wanted
to. Most insurance covers you for only a portion of
the risks that you assume. For example, if you are
sued for unlawful discharge of an employee (average
verdict: $300,000) are you covered? Does your
automobile coverage protect you when you drive your
vehicle off-road to a picnic site? The fire that
started in your bushes and spread to your neighbor's
property - are you covered? Are your limits adequate,
or were they set years ago and never adjusted? Make
sure that you have a separate Umbrella Coverage policy
that fills in the cracks left by your other policies.
Many people in the United States have recently found
that the coverage afforded by their medical plans was
no better than the financial well-being of their now-
defunct insurance companies. After the savings and
loan mess, are we absolutely sure that the insurance
industry is fiscally sound?
