Protect Your Hard Earned Assets
By: Beth S. Cohn
In a volatile economic climate, such as the current economic
downturn, there is a significant increase in litigation and
bankruptcy filings. When the economy is flourishing, people focus
on acquiring assets and doing "deals". During slower times,
business people may look to protect their assets from potential
creditors' claims. There are numerous planning tools - entity
selection, separation of personal and business assets, homestead
exemption, adequate insurance, retirement account funding and
gifting - that may protect your assets.
Entity Selection
The choice of entity is vital for asset protection. A quirk in
the law provides special asset protection features for limited
liability companies ("LLC") and family limited partnerships
("FLP"). If a creditor obtains a judgment against a person or
entity that is a member of a LLC or partner of a FLP, the judgment
creditor cannot attach the judgment debtor's membership or
partnership interest. Rather, the judgment creditor's only remedy
is to obtain a "Charging Order." A Charging Order gives the
creditor only the right to receive whatever distributions the
managing member or manager of the LLC or the general partner of the
FLP chooses to distribute to the member/judgment debtor. Since the
managing member/general partner is usually the judgment debtor or a
friend or relative of the judgment debtor, it is extremely unlikely
that there will be any distributions while the Charging Order is in
place.
IRS regulations provide that the judgment creditor holding the
Charging Order stands in the shoes of the member for tax purposes.
In other words, the judgment creditor obtaining the Charging Order
will be liable for the taxes owed on any income attributable to the
judgment debtor.
The creditor will have no vote or participation in the
management of the LLC or FLP and it will not receive information
regarding the business, nor will it have the right to review the
books and records.
Needless to say, this combination of factors makes it extremely
undesirable for a judgment creditor to attempt to satisfy its
judgment by attacking the judgment debtor's membership interest in
a LLC or partnership interest in a FLP. It is important to note
that single member LLC may not have this protection.
Homestead Exemption
There is a $150,000 homestead exemption for a personal
residence. Married couples can only claim one homestead exemption.
Judgments will become a lien on real property for five years except
for $150,000 homestead exemption. A consensual lien such as a
mortgage or deed of trust, a mechanics lien, or a lien for spousal
maintenance/child support will still attach to the property. Tax
liens will preempt the homestead exemption.
The homestead exemption continues after a sale for the shorter
of eighteen months or until the proceeds are reinvested in a new
homestead property, as long as the proceeds are placed in a
separate bank account. It also continues if the property is
transferred to a revocable trust. No recording of the homestead is
required.
If the equity is greater than the homestead exemption, one
option is to borrow against the property using a home equity credit
line and contribute proceeds to family LLC or FLP for investment
purposes and start a gifting program.
Other Asset Protection Tools
Because Arizona is a community property state, review how title
to property is held as the community is responsible for community
debts. If both spouses sign a personal guaranty, the spouses'
community property will be collectible by the judgment creditor in
whose favor the guaranty was executed.
A gifting program may protect your assets. Always consider
fraudulent transfer laws so that property is not inadvertently
available to creditors. Gifts in irrevocable trusts may protect
property from creditors while gifts or transfers in trust for
spouse can't protect spouse from community debt.
Maximize contributions to qualified retirement plans such as
IRAs and 401(k) plans and consider funding Section 529 education
savings plan accounts. Maintain adequate levels of liability
insurance to further protect your assets.
It is important to start planning before problems occur to
maximize the benefits of asset protection.
About the author: Beth S. Cohn is a partner at the Phoenix
law firm of Jaburg & Wilk, P.C. She is a certified tax
specialist and a CPA. Beth works with families and businesses
assisting with their business structuring and succession plans as
well as estate plans and asset protection.
3200 North Central Avenue
. Phoenix . Arizona