The “asset protection” concept has spawned a new sub-specialty within the estate planning community. Asset protection involves the creation of one or more entities to prevent, limit or hinder a creditor's attempt to seize and sell a debtor's assets in satisfaction of a debt.
How Asset Protection Works
Asset protection works by changing the character of a debtor's assets, making it difficult, if not impossible, for a creditor to seize and sell them. By transferring assets into certain types of trusts or limited liability entities (corporations, limited partnerships and limited liability companies) a future creditor is restricted to only the debtor's right to distributions from the entity (which can be restricted), but has no access to the assets themselves. There are two general types of asset protection:
(1) Using off-shore jurisdictions to place assets outside the reach of creditors and the U.S. court system; and
(2) Using entities formed within one of the states with favorable debtor protection laws. Usually, these jurisdictions permit the creation of barriers to a judgment against the debtor.
Domestic Asset Protection
Domestic asset protection, where the entity formed is located in the U.S. and the transfer of assets is not intended to defraud a known or potential creditor, provides a potential debtor with a solid layer of protection. When a debtor is challenged in court, the debtor has firm statutory and case law supporting the structure and the inquiry inevitably becomes whether there was a fraudulent transfer of assets.
Note: Asset protection does not work when there is an existing creditor or if a claim arises within a period of years (usually between 2 to 4 years, depending on state law) after the asset protection structure is placed into service. Too often, clients requesting asset protection run afoul of applicable state fraudulent transfer laws. Form your asset protection entity as soon as possible, do not wait until a lawsuit is threatened or pending.
Off-Shore Asset Protection
In contrast to domestic asset protection concepts which are grounded in U.S. law, offshore asset protection schemes are usually an expensive and worthless deception. Attorneys, bankers and foreign countries enrich themselves by convincing naive, paranoid, and often nefarious citizens to spend thousands of dollars creating trusts and companies in foreign jurisdictions which have favorable debtor laws.
There is a "sleaze" factor involved with offshore asset protection - the attempt to hide one's assets offshore -- that is absent from domestic asset protection. Also, with offshore asset protection, the debtor is challenging the jurisdiction of the U.S. court system, a dangerous argument to make before a judge with the power to toss you in jail for contempt.
For additional information on domestic asset protection and asset protection techniques in general, see the Tax Prophet's Tax Class on Asset Protection.