Asset Protection: A Matter of Degree

As advisors to physicians throughout the country, we are often asked to help doctors to protect assets against future lawsuits. From this experience, we often learn what misconceptions physicians have regarding how to protect their assets from potential lawsuits. In this article, we hope to dispel some of the incorrect assumptions that you may have and shed some new light on opportunities for further asset protection.
Personal vs. practice protection
The first misconception that most physicians have is that they should only protect their personal assets from potential lawsuits. Nothing could be further from the truth.
In fact, the practice’s important assets are the most vulnerable to lawsuits, especially in a group practice. That is because any malpractice claim or employee claim (sexual harassment, wrongful termination, etc.) against any of the doctors threatens all of the assets of the practice. In other words, if you are in a group practice, you are underwriting all of the acts and omissions of all of your partners, to the extent of your practice assets.
Certainly, your cash flow and income are the most important assets. The good news is that the tools that protect your cash flow also typically help you save on income taxes and build retirement wealth. These include qualified retirements plans (including defined benefit plans to 401(k)s to combination plans and more), no-qualified plans, fringe benefit plans, captive insurance arrangements and more.
Beyond your cash flow, the practice’s accounts receivable (AR) are typically an important asset. Your AR is what you, in fact, work for. What most physicians don’t realize is that a lawsuit against the practice itself, created by a wrongful act of any of the partners, threatens all of the AR in a typical practice setup. Certainly, there have been cases where physicians had to work for free for a number of months because of the lawsuit judgment resulting from the act of one physician created a loss of the AR for the entire practice. Don’t let this be you.
Other important practice assets include the practice real estate, if any, and valuable equipment. If your practice has valuable real estate or equipment, it must separate these assets from the main practice. There are a number of tactics to protect real estate and valuable equipment from potential lawsuits against any of the physicians or the practice itself.
Degrees of personal protection
The most common asset protection misconception that physicians have regards their personal asset protection — shielding their personal assets from potential lawsuits.
In this endeavor, asset protection attorneys approach a challenge much in the way a physician approaches being a patient. Like physicians, asset protection professionals first will try to get a client to avoid “bad habits.” For a medical patient, bad habits might mean smoking, drinking too much or maintaining a poor diet. For a client of ours, bad habits might include owning property in their own name, owning it jointly with a spouse or operating any medical practice with business assets exposed.
In fact, we use an asset protection rating system for a client’s overall situation: from –5 (totally vulnerable) to +5 (superior protection). Exposing business assets, owning property in your own name, etc. — these are examples of –5 situation.
In this way, before we implement any sophisticated asset protection planning, we want to move the client from a -5 to at least a low negative or neutral number. This means eliminating any of the “bad habits” named above and others.
If you see yourself as a physician who has business assets exposed and owns personal assets in your name or jointly with a spouse, you should talk to an asset protection advisor immediately. You don’t want linger too long in the -5 category, as it’s only a matter of time until you get “sick.”
Basic asset protection
If you are in a situation where you want good, basic asset protection, but do not want to pay more advanced tools, then basic asset protection tools like family limited partnerships (FLPs) and limited liability companies (LLCs) should be used. Essentially, these tools will provide good asset protection against future lawsuits, allow for maintenance of control by you, and can provide income and estate tax benefits in certain situations.
Specifically, these tools generally will keep a creditor outside the structure through “charging order” protections. These protections typically allow a physician to create enough of a hurdle against creditors to negotiate favorable settlements. For these reasons, we often call FLPs and LLCs the “building blocks” of a basic asset protection plan. We may also layer in domestic irrevocable trusts, such as life insurance trusts or charitable remainder trusts.
In essence, these tools will provide adequate asset protection relating to an asset protection score of +2. Obviously, these asset protection benefits are reliant upon proper drafting of the documentation, proper maintenance and respect for formalities, and proper ownership arrangements. If all these are in place, the physician can enjoy basic asset protection for a relatively low cost.
Advanced strategies for ultimate asset protection
For many physicians, a basic asset protection plan, which has some potential vulnerability, is not good enough. A +2 on their asset protection score is not enough to give them the psychological comfort that they want. Other clients realize that the best protection comes from tools that actually can help clients create wealth. For this reason, these clients use advanced structures to put themselves at a +4 or +5, the ultimate asset protection score.
Like a physician giving the ultimate medicine or most effective surgical procedure, asset protection consultants rely on a number of tools to provide ultimate asset protection.
Qualified Retirement Plans
The term “qualified” retirement plan means that the retirement plan complies with certain Department of Labor and Internal Revenue Service rules. You might know such plans by their specific type, including pension plans, profit sharing plan, money purchase plans, 401(k)s, or 403(b)s. Under federal bankruptcy law, and nearly every state law, these plans are totally protected against lawsuits and creditor claims — enjoying +5 protection status.
Non-qualified and fringe benefit plans
These allow a physician to put funds away at the practice level and enjoy them in retirement. Also, these types of plans can be used in addition to qualified plans. In many states, they can be funded by exempt (+5) asset classes. Even in the states where there is no (+5) exemption, a (+2) LLC can typically be used to provide a solid level of protection.
Captive Insurance Companies (CICs)
In this technique, the owners of a medical practice actually create their own properly-licensed insurance company to insure all types of risks of the practice. These can be economic risks (reimbursements drop), business risks (electronic medical records are destroyed), litigation risks (coverage for defense of harassment claims or HCFA audits) and even medical malpractice (keeping some risk in the captive and reinsuring the rest). To maximize the protection of the CIC, many physicians establish trusts to own the CIC.
Funding of exempt assets
Each state law has assets that are absolutely exempt from creditor claims, thereby achieving a +5 status. Many states provide unlimited exemptions for cash within life insurance policies, annuities, and primary homes. Make sure you seek an expert on this to find out the exemptions in your state.
Protect and grow your wealth
Asset protection planning, like any sophisticated multi-disciplinary effort, is a matter of degree. Nothing in life is 100% certain (except perhaps death and taxes — subjects of other articles). For asset protection planning, this adage holds true.
In your asset protection plan, make sure you understand the cost and benefits of the various tools you employ. It will help you not only protect the wealth you have already built, but may assist you in building greater after tax wealth for your retirement and beyond.
David Mandell, JD, MBA is a principal of the financial consulting firm OJM Group. Chris Jarvis, MBA is also a principal. David and Chris have co-authored For Doctors Only: A Guide to Working Less and Building More, which is available for free (plus $5 S&H) by calling (877) 656-4362.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.