Lawsuits are filed for all sorts of reasons. Some are justified, some are frivolous and meant to shake down a settlement. Unexpected things also happen, and sometimes they lead to suits. And people who are perceived as having assets are easy targets to blame . . . and sue.
So how do you hedge the bet? Do some common sense things to protect your assets. They won’t protect themselves.
I can wait, right? Waiting for something to happen or for a lawsuit to be filed against you before acting is locking the barn door after the proverbial horse is out. Waiting for a judgment before acting is like locking that barn door after the horse is glue.
Won’t my liability insurance protect me? Maybe. It’s great to have coverage, so the insurance company’s lawyers come in to handle when you’re sued and the insurance can cover any damages.
But what if you’re sued for something which isn’t a covered risk? You’d be amazed at what is and isn’t covered, and what changes over time in your policies. So while it may not be great entertainment, invite your insurance agent to give you a face-to-face guided tour through your policies’ liability provisions.
Holes in the umbrella? An umbrella policy is great protection. But gaps can cost you plenty. If your home, auto, or other basic policy protects you to $1 million, and your umbrella coverage starts at $2 million, you could be in for a bad day in court. An umbrella policy needs to be synchronized with your other policies.
What about taking assets off the table? You can shield your investments. The best way isn’t tough: put your assets in your own limited liability company.
With the right drafting, a judgment creditor can only reach what the L.L.C. might distribute; a creditor cannot take the L.L.C. shares themselves. And with the right modeling and strategy, the L.L.C. might not ever distribute what a creditor could get.
Face it: if you were in business, you’d be protecting yourself by running the business in a corporation or an L.L.C. The same kind of protection can cover your bank accounts, stocks, bonds, mutual funds, CDs, et al. And whatever you do with your investments in an L.L.C. will not generate any additional income taxes. Done right, the L.L.C. is invisible for I.R.S. purposes.
What’s the catch? You have to form an L.L.C.; you just don’t find it in your front porch, wrapped in a basket. You then need an “Operating Agreement” with particular features in it, if you want the L.L.C. to be truly effective. And you have to put your assets into the L.L.C. a particular way.
Afterward, you pay the Secretary of State a $50 annual fee. You pay your accountant to do a tax return for the L.L.C. (though remember, an L.L.C. never pays any income tax, unless you gum things up). And you run the L.L.C. like a business.
And that’s not bad for effective asset protection that’s simple.
Can’t I protect assets in a trust? As a general rule, most trusts do not protect what’s in them from creditors. The big exception: if the trust is irrevocable, your creditors can’t reach what’s in it. But you can’t either . . . and protecting the assets from yourself is not what you really meant by asset protection, right?
What if the trust is a “little bit” irrevocable, so you can get to what’s in it? Then your creditor can get to it, too.
Now there are times when an irrevocable trust makes sense. It can save taxes. It can do good things, for example: a charitable remainder trust is a type of irrevocable trust.
But beware: before signing away your assets to an irrevocable trust, get professional advice. And run like crazy if you encounter someone touting “pure trusts,” “constitutional trusts,” and “common law trusts.”
More? We’ll discuss more about asset protection in future columns. If you want to know about particular aspects and tools, email us.
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