Asset protection is a concern for almost all individuals because of the litigious nature of society and the high rate of divorce, but family business owners and other high net worth individuals may face increased liability exposure. The following factors can increase exposure to risk:
1. Having employees or household staff
2. Offering retirement plans/benefits to employees
3. Participation in fiduciary roles
4. Ownership of unique, high-value assets
Additionally, simply having substantial wealth can increase potential liability because of the view that such individuals have “deep pockets” in the case of lawsuits.
As a result, a primary component of business, tax and estate planning should be asset protection planning. Some assets, like qualified retirement plan assets, receive protection from bankruptcy and other third-party creditors, but most assets are not automatically protected. Asset protection strategies do not come with a guaranty; rather, adoption of strategies merely places assets in a more favorable position than if no actions were taken at all. Furthermore, while assets may successfully escape the reach of future creditors, strategies will generally be ineffective against existing claims. Here are several measures that could be incorporated as part of other planning to further the objective that family assets remain in the family.
Asset titling: Proper titling of assets is a basic element of asset protection. Depending upon the circumstances, it may be beneficial to title assets in the name of the spouse who is not involved in the business or to hold assets as tenants by the entirety, a form of ownership available to married couples that offers protection against claims of a creditor of a single spouse (excluding federal tax creditors). Certain assets can be owned in an LLC or other entity and, in some circumstances, segregated in separate entities to bifurcate liability.
Insurance: Insurance is another basic but often overlooked asset protection measure. Excess liability insurance policies and specialized property policies should be reviewed to ensure coverage is adequate to cover potential losses. Coverage should minimally reach $5 million and even more ideally, match net worth. When employing business employees or household staff, consider purchasing employment practices liability insurance (EPLI), which provides coverage against employment-related claims (allegations of discrimination, wrongful termination, harassment, etc.). Officers and directors of profit or not-for-profit organizations should confirm directors and officers (D&O) coverage is in place to protect against claims or alleged or actual wrongful actions of past, present and future officers and directors. With some exceptions, death benefits of a life insurance policy are exempt from claims of an insured’s creditors, and cash value of policies can be protected if the policy is owned by an insurance trust during life. Life insurance also is critical for providing liquidity to fund buy/sell arrangements or to pay tax creditors, thereby preventing a fire sale of the family business upon death.
Trusts: Trusts can be a very useful tool to preserve family assets. It is often impossible to predict whether descendants will end up in a bad marriage or have other creditor issues. Assets inherited in trusts can be protected from creditors so long as the assets remain in trust and the trust beneficiary does not have the right to demand trust assets. Consider lifetime trusts to hold assets gifted to descendants today or adding testamentary trusts as part of an estate plan. In the case of existing trusts, review trust terms to determine if modifications are necessary to create stronger protection for the beneficiary (for example, restructuring a trust that directs outright distributions into a lifetime trust with discretionary distribution terms).
Michigan permits individuals to receive protection for assets transferred to a trust in which the transferor is a permissible beneficiary. “Self-settled” asset protection trusts have been authorized since Michigan adopted the Qualified Dispositions in Trust Act in March 2017. Care must be taken in structuring and administering the trust, but in certain circumstances, the complexity and cost may be worth the additional protection.
Corporate structure: Strategic use of corporate entities also may help position assets favorably against attack by future creditors. Convert an existing entity to a structure that offers greater protection, such as an LLC or limited partnership, or eliminate situations where the same person is sole member, partner or manager. Creditors of a member or partner generally have no right to assets of a company until actually distributed — consider contributing certain assets or existing business interests to a multimember or multipartner family entity to add an additional layer of protection.
Cybersecurity/privacy: Assets and information must be protected from cybersecurity threats. Best practices include conducting a regular cyber vulnerability analysis, working with advisors to determine procedures for requesting, storing and disposing of sensitive information, and considering cyber, crime and fraud insurance coverage.
Risk exposure depends upon many factors — an individual’s personal tax and financial situation, the nature of the business and assets owned, and estate and business succession planning goals. The analysis as to whether assets are adequately protected should be performed periodically, because asset type and value, as well as applicable law, changes over time. An ideal moment to address asset protection is when an estate plan is being created or revised, and estate planning advisors, as well as accountants, and investment and insurance advisors, can provide recommendations on the range of techniques available to minimize risk exposure.
Laura A. Jeltema is an attorney with Warner Norcross & Judd LLP. She focuses her practice on estate and tax planning for individuals, families and owners of closely held businesses. Laura can be contacted at (616) 752-2161 or email@example.com.