GTH Estate Planning Blog

The final topic in Duncan's mini-seminar to Lars and Bernie, on asset protection: self-settled trusts. This is something newish to Lars, and seemingly rather complicated in an intriguing sort of way, like a TV drama. So he's looking forward to clearing up his thoughts on the subject.

Duncan, as usual the good explainer, starts by saying the law is generally that, if Bernie sets up a trust and makes himself a beneficiary of it, the trust is available to Bernie's creditors. That's the law of Bernie's home State of Washington, for example. However, in recent years some enterprising states, looking for trust business, have changed their laws to give protection to such self-settled trusts. Thus, Bernie and Liza may put assets in a trust in Alaska or Delaware, and if done properly this will allow them to be beneficiaries and at the same time enjoy protection of the trust from their creditors.

A couple of the key elements of a self-settled trust are that the trustor or settlor (the person or couple who sets it up and funds it) may not be the trustee, and they may not be guaranteed distributions from the trust. They may, however, name a friendly party as trustee, who may distribute funds from the trust to them under a discretionary standard. In addition, the trust must have some Alaska (or Delaware) connection to take advantage of the favorable law. The connection might be an Alaska LLC or Alaska property contributed to the trust, and a meaningful account with an Alaska bank.

Lars's meeting with Duncan and Bernie resumes. Duncan says the effect of a married couple's liabilities on their community and separate property is a little tricky, but it's important in cases where the question arises. He gives an illustration. A woman from a wealthy family marries a guy who's a budding obstetrician. If she allows her separate property to become community property, either by agreement or by commingling, and a medical malpractice case arises against her husband, then her property is exposed to the case. If she keeps it segregated and makes no community property agreement, the claimant may not get at it.

Duncan lines out part of the theory. The income of a married person from work is community property. The idea is a married couple is like a partnership, with each performing a different part of the work, but with both contributing to the overall effort. So the income from work is community, but so are the liabilities. Not so with the wife's separate property. If the assets from her family were in trust for her, that would likely be even better protected than separate property.

Duncan's next main point is that certain lifetime transfers, to children and charities, can be asset protection. Bernie has already done some of this, for example in creating 529 education accounts for his grandchildren. This move actually has protection of two sorts, partly because it is a transfer (the current topic) and partly because the funds have gone into an asset specially treated (the subject just before this).

Bernie could also give liquid assets or real estate LLC interests to his children or grandchildren, or to trusts for them, so long as there were none of the fraudulent conveyances Duncan had described. In Bernie's case there would be estate tax savings as well as asset protection achieved, because the balance of 2012 is an unusually good time to make tax-saving gifts.

Lawyer Duncan, CPA Lars, and client and developer Bernie move on to the next topic in their meeting on asset protection for Bernie: certain assets with statutory protection from claims. The sun is just hitting the horizon out Lars's window. About halfway through the agenda.

Duncan says life insurance proceeds and retirement plans may not be taken by a creditor. These are among the most important exempt assets generally, but this isn't all that great for Bernie, who has skimped on life insurance and retirement plans, putting everything he has into real estate. He could take some of his liquidity now and invest it in a big life insurance policy, even one with a significant current cash value. Duncan says the statute actually only talks about proceeds of life insurance, not cash value, but he believes the investment element of a policy on a person still living, would have protection. This idea doesn't thrill Bernie or at least he doesn't respond to it. Lars guesses that Bernie is either uninsurable, or doesn't want to invest in life insurance (or both).

Bernie: "Isn't my house exempt? Isn't that what saved O. J. Simpson, at least for a while?" Duncan: "That's in Florida. In Washington only a certain amount of equity qualifies. I think it's $125,000."

There are other statutory exemptions, like 529 education accounts and GET college credits. Bernie does show a little interest in these. He has a lot of descendants.

The sun is almost setting in the window Lars is facing, at the meeting on asset protection ideas for Bernie. What a great time is fall, leaves and some blue sky, later daybreak for early Sunday walks at the beach. Football too, but the drama of too many important games wasn't doing it for Lars. Is he less of a guy now? Duncan moves on to the subject of entities as asset protection.

Duncan asks and Bernie tells him he has a mix of entities. He hasn't done any real estate development just in his own name. Good; that would bring full personal liability for all losses and claims. Much of the work was done in limited partnerships, with Bernie as general partner. Not much better for Bernie, says Duncan - a general partner has full liability. In more recent years Bernie used limited liability companies (LLCs). These are better - they can limit each participant's liability to his or her investment in the project. Except of course those who guarantee loans, but they are protected from other kinds of claims. And Duncan says now even a limited partnership in Washington can get LLC-like protection for all including the general partners, by electing limited liability limited partnership (LLLP) status.

We're back to the meeting of CPA Lars, lawyer Duncan, and real estate developer Bernie, on asset protection for Bernie and his wife Liza. Duncan has just wrapped up the insurance discussion by calling for overall review by a good broker. Duncan will move now to the subject of fraudulent conveyances, the second in what he indicated were 6-8 topics for today that are supposed to take a couple hours. He's good at taking charge of agendas and meetings. Then Duncan will write a letter, then the three will meet again to start applying the ideas to Bernie's situation.

The insurance discussion had gone quickly, about ten minutes. Even though he finds the subject interesting, Lars is doing an over/under thing in his mind about the length of the meeting, and making marks on it indecipherable to others. Duncan offers a recent local case that went to the State Supreme Court, to give the basic notion of fraudulent conveyances: Thompson v. Hanson. The plaintiffs had a judgment for about $70,000 against a development company. Seemingly unfortunate for the plaintiffs, the company was insolvent (had no net value) by the time the judgment was obtained, partly because it had distributed some of its remaining real estate to the individual owner of the company. The plaintiffs then sued the owner on the notion he had received a fraudulent conveyance from the company, and won in Superior Court and the Court of Appeals, but then the owner appealed the case to the Supreme Court.

Wednesday afternoon rolls around and Lars arrives at the meeting at lawyer Duncan's office, with client Bernie who is seeking asset protection for his real estate empire. Lars gets to the little round table first, so he can position himself to look out the window. He learned long ago, in college, that he feels and works better with a leafy view. He felt so stifled in that one brightly lit interior room, with fellow students and an instructor who could all interpret literature better than he.

Lars hands out a financial statement for Bernie that Duncan has asked him to bring. Duncan says they'll begin by talking about insurance. This seems a little abstract and boring to Lars, who had thought they would play a sort of board game with Bernie's assets. Duncan: "Who's your insurance agent, Bernie?" "Well, I've got several. I started with one guy but found I could do better by having my office gal check around each time we had a new project. She's gone now. I mean she didn't die, I just didn't need her any more, when I was through building."

Duncan doesn't seem to like this answer. In silence while the lawyer is formulating his next question, Lars takes a draw on the Starbucks dark roast he has brought.

Lawyer Duncan has told CPA Lars a little cryptically that, for them to meet with shared client Bernie and talk about protecting assets, Duncan needs to hire him specially for this engagement. Lars has some familiarity with this idea from tax cases he's worked on. A couple of times he's had clients audited by the IRS, in one case with heavy penalties assessed where the client's attorney mentioned an apparently well-known case called Kovel, and did an engagement letter making Lars his (the lawyer's) advisor rather than the client's.

For some reason Lars had just accepted the prior arrangements without thinking much about them. Now even though he's 55, he's finding himself more curious about the reasons for things rather than less. That Saturday night they and their wives are having drinks at Lars's before going out to dinner, and Duncan explains that his hiring Lars has to do with the attorney-client privilege.

Rich uncle Nils has a rich friend Bernie. Second-generation guy from Russia. Very successful real estate developer and builder. Wealthier than Nils, and that's saying something. Also a client of our CPA friend Lars.

Bernie has a longtime wife (Liza), and children and grandchildren, all unlike his newly-wed friend Nils. Now that he is old and rich, Bernie is thinking a lot about protecting what he has, and not so much about making more. His awake-in-the-night thoughts have featured vague possible lawsuits against him. In the light of day, there aren't any particular suits filed or even threatened right now. However, he's seen things like claims of faulty work made against condominium developers. Building and selling condos was one of Bernie's several modes of making money in real estate, a lot of it, and he's not ready to give a bunch of it back to lawyers.