These are two fine examplesof the outlandish litigiousnessthat plagues ournation. The resoundingtheme in all of these courtcases is that someone is looking to makesomeone else responsible for some real orperceived injury, loss, or trauma. Sinceour legal system provides very littledownside for filing a frivolous lawsuit,we can expect this problem to get worsebefore it gets better. And doctors knowthe dangers of this better than anyone.
Awareness of the Cutoff
Once an event occurs that ultimatelyleads to a lawsuit, the window ofopportunity for protecting assets isclosed. Fraudulent transfer statutes willallow the court to reverse any transferof assets and make the assets availablefor recovery. Therefore, it is critical tostructure the ownership of your assetsin a way that will discourage a lawsuit.Most lawsuits would never have beenfiled if the likelihood of recovery hadbeen small. Very few attorneys wouldfile the lawsuit when working on a contingencybasis. They simply would allocatetheir time on a better prospect.
Many people mistakenly believe thatasset protection is as simple as puttingassets in your spouse's name. This strategyactually affords little to no protectionand may leave the asset owner witha false sense of security. In general, assetprotection involves using the avenuesafforded by the laws of the various 50states, federal statutes, and the laws offoreign countries to protect assets. Forexample, many of the states offer somelevel of exemption from lawsuits for theprimary residence and for life insurance.Likewise, federal statutes exempt pensionplan assets.
Asset protection is graded on a scaleof -5 to +5. Owning an asset in yourown name would be a -5. Owning anexempt asset like life insurance or a pensionwould be a +5. Experts rate jointownership only slightly higher than the-5 given for individual ownership.
Categories of Asset Protection
Generally, asset protection strategiescan divide into the categories of exempt,onshore, and offshore. Some or even allof the primary residence may be exemptfrom lawsuits. Further federal lawsexempt plans based on the EmployeeRetirement Income Security Act(ERISA) from lawsuits in order to protectthe pension plan participants.Likewise various states exempt some orall of the cash value and or death benefitof life insurance. The list of exemptassets available varies from state to state,and physicians carving out their assetprotection strategy should consult legalcouncil knowledgeable in the laws oftheir home state.
Onshore involves any domesticstrategy designed to protect assets; itdoes not include exempt assets. Themost common of onshore strategiesinclude limited liability companies(LLCs) and trusts. For example, creatinga single-member LLC and transferringinvestments to it would afford betterprotection than owning the assetsindividually. Due to recent court casesthat have called into question the effectivenessof single-member LLCs, multiple-owner LLCs appear to offer astronger level of protection.
The main reason for the increasedasset protection afforded by LLCs isthat most jurisdictions only provide acharging order as the means of recovery.Should a charging order be awardedagainst the defendant's LLC, the managingmember of the LLC would berequired to redirect any distribution forthe benefit of the defendant to the holderof the charging order. Since the chargingorder does not require any distributionsto be made, the managing memberwould normally forgo distributions.
If the LLC is taxed as a flow-throughentity, such as a partnership or S-corporation,the holder of the charging orderwould get the K-1 (ie, the tax form usedto report an individual member's shareof the LLC's income) instead of thedefendant. This creates an interestingsituation where the defendant, whomay also be the managing member, caneffectively make the plaintiff pay taxeson the LLC's income while giving themno distributions. Likewise, properly settingup an irrevocable trust and transferringassets to it would result in a veryhigh level of protection unless the courtruled that the assets actually were underthe control of the grantor.
Offshore strategies are very similar toonshore; however, the LLC or trust is setup in a country selected, because it makesit extremely difficult to access the fundswithout winning a second lawsuit in thehost country. There have been many negativeitems in the press concerning offshoretax-evasion strategies. The use ofoffshore entities for asset protection hasnothing to do with these schemes. US citizensmust fully declare their offshoreincome and pay all taxes due on thatincome. Additionally, the existence offoreign accounts requires a certain scheduledisclosing the detail of the accounts.
The reason that offshore strategiescan be so effective in asset protection canbe illustrated through a description ofthe laws affecting Nevis LLCs. Nevis is asmall former British commonwealthnation located just below the VirginIslands. The local language is Englishand their legal system is based on Britishcommon law, just like ours. Like mostUS states, Nevis law allows a chargingorder as the only remedy for recovery.
What makes Nevis different is thatit does not recognize US judgments.Therefore, the plaintiff would have tofile suit in Nevis and also win the lawsuitthere. Furthermore, Nevis legalcouncil must be used (they do notwork on a contingency fee basis), anda significant bond must be posted sinceNevis is a "loser pays" jurisdiction. Allof this adds up to a very unfriendly climatefor the plaintiff.
Obtaining a Debt Shield
Debt Shield is an interest strategythat can protect real estate but can alsoresult in significant increases in after-taxretirement income. Under the DebtShield strategy, the property ownermortgages as much of their propertyvalue as possible, often up to 100%.Interest-only payments are made on themortgage so that no equity is grown onthe real estate other than the increase inmarket value. The interest-only strategyalso improves the cash flow to the pointthat often a 100% mortgage (ie, interest-only mortgage) may be close to thesame payment being made for a conventionalmortgage.
The idea with Debt Shield is to movethe equity into exempt assets while protectingthe real estate through the highlevel of financing. Every 5 years or so,the property would be refinanced toremove the additional equity that wasavailable through the increase in marketvalue. As was illustrated in a recentmagazine article, as long as theafter-tax return on the exempt assets isgreater than the after-tax interest cost ofthe mortgage, the strategy will generatea positive benefit for the propertyowner while protecting the real estate.
While this is a critical strategy forstates where the primary residence haslittle to no statutory protection, it is avery valid strategy for states likeFlorida, where the home is completelyprotected due to net positive spread.Additionally, it should be consideredfor second homes, office buildings, andother real estate.
Before pursuing any of these assetprotection strategies, contact a knowledgeableand trustworthy expert in thisfield to walk you through the pros andcons of each of these tactics.
Christopher R. Jarvis is a lecturer, and authorof Wealth Protection MD. He is also a cofounderof the Wealth Protection Alliance(WPA), a nationwide network of elite independentfinancial advisory firms whose goalis to help clients build and preserve their wealth. Beryl N.(Sandy) Stokes is president of Stokes Accounting & BusinessConsultants, PA, and provides sophisticated businessplanning to physicians around the country. Stokes Accounting& Business Consultants, PA, is a charter memberof the WPA, and can be reached for questions or commentsat 800-554-7233. For a 40% discount on Jarvis & Mandell'sbook, Wealth Protection MD (Guardian Publishing LLC; 2004),or for an audio CD on asset protection, please call 800-554-7233 or e-mail firstname.lastname@example.org.