Asset Protection is a concept that has spawned a new sub-specialty within the estate planning community. Asset Protection involves the creation of one or more legal entities to prevent, limit or hinder a creditor's attempt to seize and sell a debtor's assets in satisfaction of a debt owed by the debtor to the creditor. Usually, the creditor is seeking payment arising from an award of damages obtained in a lawsuit, but asset protection will protect against most creditor's claims, regardless of origin.
Often, entities are formed in off-shore jurisdictions which have laws favorable to debtors. Invariably, these plans are dismissed by U.S. courts as shams and offer the debtor no real legal protection.
How Asset Protection Works
Asset Protection (including domestic asset protection) changes the character of the assets held by the debtor from one that can be easily seized and sold, to an asset that the creditor cannot legally seize and sell. By transferring assets into certain types of trusts or limited liability entities (corporations, limited partnerships and limited liability companies) in which the debtor owns a portion of the interest in the entity and not the asset, such as a beneficiary of a trust, stock, partnership interest or membership interest in an LLC, the creditor is restricted to the debtor's interest in the entity.
Domestic Asset Protection
In contrast to the off-shore asset protection schemes that have failed each and every time they have been challenged in court, domestic asset protection does not attempt to hide assets or interfere with a creditor's right to enforce a judgment. Instead, domestic asset protection uses the laws of a favorable jurisdiction (such as Delaware or Nevada) to limit the creditor's rights so severely that a prudent creditor would not want the asset to begin with. Under domestic asset protection, it is possible to limit the creditor's right to a "charging order" against a debtor's "economic interest" in an entity. A charging order carries no right to vote, manage, liquidate or control the entity or the assets held by the entity.
For additional information on domestic asset protection and asset protection techniques in general, see the Tax Prophet's Tax Class on Asset Protection.
The Tax Prophet