The current economic slowdown and the litigation explosion are forcing financial and estate planners to focus upon and address issues of wealth preservation, not only from the point of view of taxes, but also to protect clients' assets from creditors' claims, especially tort claims. Such claims include a wide range of legal activities, such as those relating to malpractice awards in excess of insurance coverage, uninsured claims, punitive damage awards, general creditor claims of defunct law and accounting firms, oil and gas, and real estate partnerships. The list is by no means complete. It keeps growing as plaintiffs devise and judges create new theories of liability and as juries award record verdicts.

A client's first reaction to asset preservation planning may be the statement that "I have no creditors." If that is the response or if the client does not understand the need for advance planning, it is the function of the planner to glean the information from the client that might expose the possibilities of a future financial calamity that could wipe out the client's wealth. The planner must then explain the dangers to the client and create a plan to minimize the exposure. The idea is to do the planning before the possible calamity becomes a reality at which time planning may be too late and bankruptcy may be the only choice.

If a client, such as a business owner, a partner in a partnership or a professional, has a need for estate planning, that client is a prime candidate for asset preservation planning, which is the subject of this month's article, "Asset Protection Planning: A Critical Part of Any Estate Plan," by Barry S. Engel, a principal in the Colorado law firm of Engel & Rudman, P.C.

As explained by Mr. Engel, asset protection planning should be a part of and integrated with the client's estate plan.

Mr. Engel's article provides detailed explanations of the need for asset protection planning and of the various planning techniques practitioners use to protect assets from future legal liability. These techniques include:

• the domestic family limited partnership;

• the domestic trust; and

• the foreign situs trust.

The author examines the advantages and disadvantages of the three structures and discusses various planning strategies, including strategies combining the family limited partnership and the foreign situs trust. The author details the advantages of the foreign trust over the domestic trust in terms of (1) benefit and control, (2) object of litigation, (3) practical barriers, and (4) degree of protection. Mr. Engel concludes that, although the domestic trust is an excellent planning device, in terms of asset protection the foreign situs trust is superior.

The author examines the factors that must be considered when selecting the foreign situs, including the existence of favorable asset protection trust (APT) legislation, political stability, the existence of language barriers, the effect of local tax laws, the quality of local professional services, communications and international banking facilities, and accessibility.



Asset Protection Planning: A Critical Part of Any Estate Plan

By Barry S. Engel, Esq., of Engel & Rudman, P.C., Denver, Colorado*

Anne Fasbee was a senior tax partner in the Los Angeles office of a national accounting firm. She was a proud professional who was thorough and ethical in her work. She was also extremely hard working and successful. By the time she was in her early forties, she was earning a hefty salary and had managed to accumulate a sizable net worth.

Anne was as diligent with her personal affairs as she was with her clients' affairs. Her and her spouse's estates were as planned as they could be (or at least so they thought), with pour-over wills, revocable living trusts, durable springing powers of attorney, living wills, a recently funded irrevocable insurance trust, a trust for each of their three children, burial instructions, and a charitable remainder unitrust. The Fasbee financial plan was also finely tuned, with net after tax returns for the previous several years averaging well into the upper reaches of ten something. Unfortunately, as well-planned as the Fasbees were, one very important form of planning soon became quite conspicuous by its absence.

The first of a series of lawsuits was served upon Anne's accounting firm in September of 1987, shortly after the Fasbee family returned from three weeks in Spain and Italy. This suit was a class-action suit alleging, among other things, that fraudulent and misleading financial statements were prepared by the firm's Houston office in connection with a public offering of subordinated debentures. The next two suits involved allegedly faulty tax opinion letters rendered by the firm through its offices in Denver and Chicago. Several other suits followed as well. After failing to have two adverse judgments reversed on appeal and following the tremendous drains on the firm's cash and other resources due to the strains and expenses of "fighting the battles," the partners voted to seek federal bankruptcy protection for the firm. As a consequence, many of the firm's partners had no choice but to do the same. This included Anne, and as a consequence her spouse as well, due to the Fasbees residing in a community property state wherein community assets were available to satisfy the separate debts of either spouse.

At last report, Anne was a single parent and solo practitioner sharing office space with a number of other professionals. By this most unfortunate personal experience, Anne learned that all of her sophisticated estate and financial planning was of little value to an estate that was itself of little value. Had the Fasbees included appropriate asset protection planning as part of their overall planning, the ultimate outcome of their misfortunes would more than likely have been much more favorable. It certainly would not have been any worse.

Definition of Asset Protection Planning
Asset protection planning may be simply described as the process of organizing one's assets and affairs in advance so as to guard them from loss by reason of some future fiscal calamity. The phrase "in advance" warrants strong emphasis, for one (including the planner) must be cautious and avoid the negative implications which may follow from planning to protect assets other than in advance, that is, when there are creditors who are entitled to remedies under applicable fraudulent conveyance and similar laws.

Asset protection planning concepts may be applied to protect every type of asset, whether cash, stocks, bonds, business interests, insurance proceeds, jewelry, art, antiques, real property, and so on. While asset protection planning is typically applied in the context of protecting individually accumulated wealth, a number of applications exist for the operating business or professional practice.

Why Asset Protection Planning
The idea of guarding in advance against the potential of a future legal liability is not a new one. Indeed, today an attorney who fails to advise a client to incorporate a business to protect the business owner against the personal risks of owning and operating a business would no doubt wish his or her own asset protection planning was in place. A number of factors have evolved through the course of the 1980's, however, that make persons with wealth not only more aware of the need to engage in some form of protective planning, but which in fact leave those who fail to plan more exposed than ever before. These factors are as follow:

  1. Expanding Theories of Liability—By definition, a system whose legal decisions are based on legal precedent will be subject to expansion of its theories of liability, for each decision in the chain will set the stage for the next step of expansion. This, coupled with the increasing willingness of judges and juries to expand a theory of liability, leave a tremendous amount of uncertainty and exposure for the person who has relied on traditional forms of planning.
For example, a recent Colorado case held that an accounting firm was liable to pay an employee's surviving spouse the employee's salary for the rest of the surviving spouse's lifetime, when the employee was attacked and killed as she left work one evening. The court stated that "[t]his death arose out of and was in the course of her employment," as if being brutalized was part of her duties, and totally ignoring the fact that the person who committed the crime was entirely to blame. Is the next step for a court to hold a company liable if the employee chokes on a sandwich in the lunchroom?
Ten years ago, the idea that a smoker who developed lung disease would sue a tobacco company seemed ludicrous, while today we have become familiar with this theory of legal liability. Is it possible that in 10 years we will become familiar with carnivores with heart disease suing the corner store where they had over the years purchased their red meat?

  2. Result-Oriented Judges and Juries—A recent survey conducted by the American Bar Association concludes that the personal opinions of judges often enter into the decisions rendered, to the (at least) partial exclusion of what the law provides the result should be. Furthermore, a "someone must pay" attitude seems prevalent in our society today.
Political reasons are another factor. To quote a justice of a state's highest court from his recent book: "As long as I am allowed to redistribute wealth from out-of-state companies to injured in-state plaintiffs, I shall continue to do so. Not only is my sleep enhanced when I give someone else's money away, but so is my job security, because in-state plaintiffs, their families and their friends will reelect me,"

  3. Outrageous Jury Awards—Consider the case of a man who was hit by a subway train and lost an arm after he fell drunk onto the tracks. A jury awarded him $9.3 million. The plaintiff, a Mexico citizen who had been in the United States for six months working as a dishwasher before the accident occurred, responded by exclaiming "God bless America."
Another example involves a $55.7 million jury award against Woodmen of the World Life Insurance Company whose representative "improperly persuaded" the plaintiff to invest her life's savings in insurance products.

  4. Concerns with Traditional Forms of Protection—The corporate veil is seemingly more piercable than ever before. Concerns with insurance coverage exist as well, whether it is with the solvency of the carrier, its continued willingness to write coverage, the existence of policy exclusions (e.g., punitive damages or damages which result from acts of gross negligence) or the like.

  5. Jury of One's Peers—Those of means who have ever considered the question generally feel that there would probably never be such a thing as a jury of their peers. Few litigators could claim lo have ever tried a case before a jury comprised of individuals the average net worth of whom even approached that of the wealthy defendant.

  6. Deep-Pocket Syndrome—An ongoing advertising campaign by an asset search firm shows two lawyers huddled over a table with one of the lawyers commenting to the other that "the defendant has assets, so let's proceed." The converse to this would be that "the defendant doesn't have much, so let's not bother."
The golden rule used lo be that "he with the gold, rules." The new golden rule may well be "he with the gold, pays."
Many good arguments may be advanced on behalf of the contingency fee system. At least as many good arguments may be advanced against such a system, including the manner in which it fuels litigation and otherwise often results in groundless or frivolous suits being brought by a plaintiff's counsel whose hope is to roll the settlement dice with the client rather than to proceed to a trial on the merits.

  7. Once You've Been Sued You've Lost—Imagine a scenario wherein a defendant is found not liable five years and hundreds of thousands of dollars in legal fees after the initial complaint was filed. In the interim, the defendant has had many sleepless nights and has suffered tremendously both in terms of anxiety and inconvenience. The business and marriage have also suffered from absences and distractions.  But ... he won!?!  Perhaps it would have been preferable to have either discouraged the suit in the first place, or to have been in a position to encourage an early and cheap settlement.
In his book, The Litigation Explosion, Walter Olson argues that "[a] litigator can come around, dump a pile of papers on your front lawn and you can go literally broke trying to respond to it." Speaking of which . . .

  8. The Litigation Explosion—It is unfortunate that efforts at tort reform have done little to curb the ever increasing spiral of lawsuits. It was reported by The Wall Street Journal on May 7, 1991. that "[nearly 100 million new cases were added to the dockets of the nation's state court system in 1989. with new filings of civil damage suits up sharply from the year before." This number does not include the numerous new cases that were added lo the federal dockets that same year.

Goals of Asset Protection Planning
Having defined asset protection planning, and having analyzed the reasons why this form of planning is increasingly becoming of interest to persons of means, the goals that are sought to be achieved through asset protection planning will be reviewed next.

  1. Create a User-Friendly Plan—Planners sometimes too easily forget that most clients are lay persons who must live within the confines of a plan of whatever nature that may be designed for them. Asset protection plans that consist of a myriad of entities designed to obfuscate and confuse third parties may also serve to confuse and frustrate the client. A properly designed structure that works because it is sound in legal theory and operation, rather than because it is complex, is not only better for the client but ultimately more protective as well.

  2. Deter Litigation—Avoiding the Deep Pocket Syndrome by reducing the size of the target may itself accomplish much in the asset protection context.

  3. Provide Incentive for an Early and Cheap Settlement—Economics drives the legal system. Personal experience proves that much can be achieved by knocking the "profit" out of the pursuit and by being able lo demonstrate to a suitor that being paid is not the given it was expected to be. Any seasoned litigator would confirm that it is one thing to win a judgment and another thing to collect a judgment.

  4. Level the Litigation Playing Field—A defendant who has no asset protection planning in place will have fewer strategies and defensive maneuvers available at critical points during the course of litigation. A properly designed asset protection plan will, by its nature, create numerous issues with which some future adversary would have to contend.

  5. Enhance One's Bargaining Position—Throughout the course of litigation, one who has a well designed plan in place will have the benefit of a vastly improved negotiating posture that will result from the mere fact that the planning was properly conceived and implemented.

  6. Provide Options as the Game Is Played—A well tailored plan will not tie the client's hands or lock the client into a course of action that must be followed regardless of what happens. Rather, it will provide a series of options that would not otherwise exist, whether the client's seas are calm or stormy.

  7. Win the Game—Proper planning will create a series of hurdles that the opponent must clear. Realizing that an angry, deep-pocket and emotional plaintiff may have the stamina and strength to clear the hurdles, the planning must ultimately work because it is legally sound. Therefore, a proper plan will build a brick wall on the other side of the last hurdle.

Finally, it is important to note that the plan should be designed to ultimately protect against any potential adversary. Life is more random and less lineal than we would like to think. Thus, a client may have some sort of free-floating anxiety over the possibility of a professional malpractice claim being filed at some point in the future. However, a problem of a completely different nature (e.g., a dispute resulting from a future business transaction) could certainly develop. By definilion, the proper plan must protect against future perils of whatever source or nature.

 What Asset Protection Planning Is Not
It is as important to know what asset protection planning is not as it is to know what it is. In this author's view, asset protection planning is:

  1. Not Based on Hiding Assets—Hiding assets can be dangerous and, therefore, an asset protection plan that is based on such an approach is dangerous. The dangers arise from the likelihood that the client will have to make a choice between protecting assets and committing perjury if the client becomes involved in litigation. Whether or not the client ever becomes embroiled in litigation, the client may face some difficult decisions each year when the client's Form 1040 is filed, for full disclosure on a tax return is certainly inconsistent with planning based on secreting assets. Further, depending on whom the creditor turns out to be, hiding assets may carry with it certain criminal implications. Finally, the tangled web that often results from such planning is inconsistent with the goal of creating a user-friendly plan.
While many clients appreciate the confidentiality that can be obtained through an asset protection plan, a properly devised plan will not rely on secrecy to be successful.

  2. Not an Excuse to Defraud Creditors—Uncertainty appears in the planning community as to when asset protection planning can be implemented, and the extent to which it can be implemented at a given point in time. The "while" cases are easy to identify as those that involve an individual with neither pending nor threatened claims nor any reason to believe that a legal problem will develop in the future, but who nevertheless wishes to protect against the "what if." The "black" cases are also easy to identify as those that involve an individual who is on the brink of bankruptcy (although pre-bankruptcy planning may offer some hope for such a person). In between are the many shades of gray.
Fraudulent conveyance law varies by slate. A statutory body of fraudulent conveyance law applicable to certain situations exists at the federal level as well. For the good of the client and the planner, an asset protection plan must be implemented within the bounds of propriety as defined by reference to applicable fraudulent conveyance law.
Our common law system favors the free alienability of property. As a result, one who is free from creditor concerns is absolutely free to dispose of his or her property as he or she sees fit. The person may see fit to make gifts to charities or to his or her children. Gifts to a spouse, whether outright or in trust, are also well within the realm of the ordinary as are gifts in trust for the benefit of members of the client's immediate family. Fraudulent conveyance laws tend to focus not on who is the transferee but rather on the intent of the transferor at the time of the transfer.
Fraudulent conveyance law generally protects present creditors and subsequent creditors from transfers made by a person who is or forseeably will become their debtor. The class known as subsequent creditors does not, however, include every person who becomes a creditor at some point in the future. Accordingly, another class of creditors exists that may be labeled "future potential" creditors. The distinctions are clarified rather simply in a recent Florida decision wherein it is stated that asset transfers are entirely permissible as to one's possible creditors, but not as to one's probable creditors.

  3. Not an Excuse for Evading Taxes—Some clients and some advisors are attracted to asset protection planning by tax advantages they hope to find. This is particularly true when the planning approach involves the use of foreign entities. As relatively few tax maneuvers involving foreign entities exist today for a global investor, a well designed asset protection plan will have no particular income, gift or estate tax advantage other than familiar estate tax advantages that can be accomplished through tax-oriented approaches found in inter vivos or testamentary trusts. Importantly, a well designed asset protection plan will have no particular income, gift, excise, or estate tax disadvantages, either domestically or abroad. Both the planner and the client should be aware on an ongoing basis that certain tax issues will exist, which tend to be no different or more involved than those associated with entities of the type with which clients and their planners tend to be familiar. Tax neutrality will, therefore, prevail for the proper plan.

Domestic Family Limited Partnerships
Family limited partnerships (FLPs) have become a popular tool for protecting accumulated wealth. Assets that would otherwise be attractive to a creditor are rendered unattractive by transferring them to an FLP in exchange for general and limited interests therein. Following the transfers, the transferor owns the partnership interest(s) rather than the transferred assets. Most state partnership laws provide that a creditor's remedy against a limited partnership is to obtain a "charging order," which is typically a rather limited remedy. Moreover, a creditor who has successfully obtained a charging order against interests in a limited partnership runs the risk of receiving phantom income from the partnership pursuant to Rev. Rul. 77-137.

FLPs are not only useful in rendering attractive assets unattractive, but are also useful in separating ownership from control. Even though substantial value can be gifted through transfers (either outright or in trust) of limited partner's interests, control over partnership assets as well as possession thereof can be retained by the client who retains the general partner's interest.

As useful as FLPs may be, they are not the panacea that some believe them to be. A number of disadvantages exist in the use of FLPs:

(1) The client remains subject to the whims of the domestic system by limiting the client's planning to domestic tools. FLPs arc most useful when the limited partnership interests are gifted to a foreign situs asset protection trust (APT), APT's are discussed in detail below.

(2) A client will be limited in his ability to freely access partnership assets if a charging order has been obtained by a creditor.

(3) Concern exists that a principal purpose for the creation and funding of a partnership other than protecting assets may be imposed by a court, and as such the charging order may not be the sole remedy of the creditor.

(4) Independent of the "principal purpose" concern is the issue of whether the charging order is in fact a creditor's "sole remedy." A recent California case (Centurion Corporation v. Crocker National Bank, 255 Cal.Rptr. 794 (Cal.App. I Dist. 1989)) held that a judgment creditor was not limited in its collection remedies to obtaining a charging order and was in fact able to attach and sell a limited partner's interest in an FLP towards satisfaction of the judgment the creditor had obtained some years earlier but which remained unsatisfied. Although the facts of this case are relatively narrow, the case can certainly serve as precedent for another court's adverse FLP decision in the future.

 Thus, although an FLP offers a number of asset protection planning benefits, a person of means who limits his or her planning to an FLP will be compromising both the degree of protection and the number of options that otherwise would be available if a legal problem were to develop.

Domestic Trusts
A trust is a vehicle by which legal and beneficial title are severed, with the trustee of a trust receiving legal title to the property settled in trust (its "res"), which property is to be held for the benefit of trust beneficiaries who receive beneficial (or "equitable") title. Trusts are an English common law principle. All English common law-based systems of law recognize the concept of a trust.

For purposes of this article, references to a "domestic trust" are to a trust settled by a person resident in the United States pursuant to the laws of one of the several states. References to "foreign trusts" are to a trust settled pursuant to the laws of a foreign country. At this juncture it should be noted that choice of law principles would allow a settlor who resides in one state to settle a trust to be governed by the laws of another state or another country, just as a business owner who resides in and operates a business in New York may incorporate the business in Delaware.

Domestic trusts are as old as our common law system, and their uses are many and diverse. In the asset protection planning context, however, domestic trusts suffer from a number of disadvantages when compared lo foreign trusts:

  1. Benefit and Control—Domestic trust law will generally restrict the nature and extent of benefit and/ or control that a settlor can retain through a trust. Domestic law generally provides that if a settlor docs not place property out of the settlor's own reach, the trust assets will not be placed out of the reach of a creditor of the settlor, whether present, subsequent or future potential.

Thus, a domestic trust that is settled at a time when there are absolutely no fraudulent conveyance issues may still be successfully attacked, even years after settlement, if the settlor has retained either benefit or control. By comparison, the level of both benefit and control over a foreign trust governed by the trust laws of certain foreign jurisdictions will represent a significant enhancement over the rights and powers that may safely be retained by grantors of domestic trusts. Properly drafted, an APT may result in little diminution of such attributes, and as such many more options and flexibilities exist in the course of drafting and designing an APT.

  2. Automatic Target—A domestic trust may be as much a target for litigation as its settlor, particularly if the trust holds assets of substantial value. A plaintiff's lawyer need not be particularly creative in order to craft a legal theory of liability against a domestic trust when the principal claim is against the settlor. Due to jurisdictional and other considerations, such as whether the judgments and orders of the domestic court will be recognized by the foreign court (comity), a foreign trust will not be such an "automatic" defendant.

  3. Lack of Practical Barriers—One of the advantages of foreign trusts over domestic trusts in the asset protection planning arena is that the foreign element will impact a creditor's decision as to how far the creditor is willing to go in the course of pursuing trust assets. Whether one considers the psychological barrier of dealing with foreigners and foreign systems, the cost of pursuing litigation overseas (particularly if the matter must be litigated anew in the foreign jurisdiction in the absence of comity), the added uncertainty of prevailing, or the increased time factor that results, the practical hurdles obtained simply through the use of foreign entities can prove to be formidable barriers.

  4. Not as Ultimately Protective—The trust law of some foreign jurisdictions is simply more protective than domestic trust law. In fact, the past few years have witnessed a number of offshore financial centers passing legislation designed to lend clarity to many APT issues, thus providing a substantial degree of certainty to a rapidly developing planning area. The leader in clarifying legislation is the Cook Islands, an offshore financial center located in the South Pacific. Its International Trusts Amendment Act of 1989 addresses not only fraudulent conveyance issues but issues relating to retained control and benefit, as well. Other jurisdictions that have recently adopted clarifying legislation include Gibraltar, the Bahamas, and the Cayman Islands. Clarifying legislation is presently being considered by the Isle of Man, the British Virgin Islands, and a number of other foreign jurisdictions.
Domestic trusts are a valuable planning tool; however. in the asset protection context and for the reasons set forth above they lend to offer substantially less protection than foreign situs trusts, and are otherwise not nearly as flexible as a planning tool.

Foreign Situs Trusts
A strategic advantage offered by APT’s is that differences in competing legal systems can be arbitraged to produce more favorable and protective results for the trust, its settlor and beneficiaries. This is an important planning consideration when it comes to matters such as the ability to force the legal battle over trust assets into the foreign court, and the ability to protect the settlor or others who may be in some position of control with respect to the trust against the awkward position of being forced to either repatriate trust assets or being held in contempt of court. These strategies are the foundation of the protection offered by an APT, and support the proposition that the trust instrument itself is merely a static part of a dynamic process. It is one thing to draft an APT, and yet another to have a full understanding of the options the APT creates and the manner in which the options may be implemented. Further, an APT may be rendered relatively useless unless there exist committed, dedicated and proven team members in the relevant jurisdictions.

A number of factors should be considered when analyzing whether a particular jurisdiction should be selected as the domicile for an APT. These factors include whether the jurisdiction has favorable APT legislation in place, and, if so, the particular provisions thereof; the jurisdiction's political stability; its economical and social environment; whether language barriers exist; the jurisdiction's tax laws; the availability and quality of professional services; whether modern telecommunications facilities exist; the jurisdiction's reputation in the global financial community; and its accessibility (or its inaccessibility to the extent such may be a factor).

An APT, when properly drafted and properly integrated with the client's estate plan, can accomplish everything a typical inter vivos living trust can accomplish, including avoiding probate, providing confidentiality, providing asset administration in the event of the settlor's disability, providing a smooth transition of property upon the settlor's death, and estate tax planning. Of course, the major goal that an APT can accomplish that a living trust does not accomplish is the protection of assets during the settlor's lifetime, which is, of course, when estate protection counts the most.

APTs and FLPs
The best of both worlds can be accomplished when APTs and FLPs are combined. The combination can be achieved merely by one or more gifts to the APT of limited partners' interests in the FLP. As a result of this combination, value (in the form of the limited partner interests) can be gifted away during a period when the client's legal seas are calm. The client, however, can retain control over the FLP's assets as the general partner of the FLP. Should the legal seas become choppy, a number of options are available that would otherwise not exist for the client, including the foreign trustee removing the domestic trustees and forcing a liquidation of the FLP. In such an event, FLP assets would flow to the APT based on the percentage of ownership the APT has in the FLP. Then, in the exercise of the foreign trustee's fiduciary duty to protect assets in the interests of the beneficiaries, the foreign trustee would likely reinvest the distributed assets out of the jurisdiction in which the settlor resides, which is the first step in forcing the battle over those assets into the foreign court.

A derivation of a typical APT/FLP structure involves the use of several underlying FLPs, each of which owns assets of a certain character or class. For example, FLP No. I might own cash and other liquid assets. FLP No. 2 might own an apartment building, and FLP No. 3 might own various works of art and antiques. In this fashion, assets and the risks of ownership associated with each of them can be segregated from each other. Accordingly, should some form of liability develop with respect to the apartment building, the liquid assets and art and antiques would not be owned by the same entity that owns the problem asset and as such would be safely isolated.

Other derivations include the use of underlying domestic corporations, foreign companies, or limited liability companies, typically in combination with one or more FLPs,

The typical APT/FLP structure is tax neutral in that it does not alter the federal income, gift or estate tax situations of most clients. For income tax purposes, all tax attributes of the trust flow through to the client's personal income tax return because the trust is a "grantor" trust for federal income tax purposes, pursuant to the 1986 Internal Revenue Code (Code) Sections 671 through 678, and because the FLP is also a pass-through entity.

Transfers can be made free of federal gift tax through the settlor of the trust retaining one or more powers of appointment, pursuant to Reg. §25.2511-2.

Incomplete gifts that are not otherwise "completed" prior to the settlor's death will be included in the settlor's estate for federal estate tax purposes, and typical estate tax oriented planning options remain available.

The Code imposes an excise tax on transfers of appreciated property to foreign trusts and other entities. The tax is imposed on the excess of the fair market value of the property transferred over its adjusted basis in the hands of the transferor. Although the line of distinction between domestic trusts and foreign trusts is unclear, careful draftsmanship should yield a trust that is a domestic trust for federal tax purposes and a foreign trust for purposes of its validity, interpretation, administration and matters of applicable law. An excise tax safety net is provided by Rev. Rul. 87-61, which states that the excise tax is inapplicable so long as the trust is treated as a grantor trust for federal income tax purposes.

Practical Applications of the APT/FLP Structure
With the foregoing in mind, in the experience of the author, the various practical applications of an APT/FLP structure may be summarized as follows:

(1) The structure has been used as a replacement or supplement to liability insurance, whether professional malpractice insurance, tail coverage, errors and omissions insurance, or directors and officers liability coverage. For example, a number of physicians who for various reasons were not required to carry coverage opted to go bare once the structure was in place. Other physicians as well as other high-profile professionals have found it advisable to reduce the amount of coverage otherwise in place, with the structure providing self-insurance in the event of a large judgment. Under this application, the insurance premium savings can be substantial.
Also, a number of people are of the view that a large insurance policy serves as a magnet for litigation. The structure has allowed individuals who are of this thinking to either go bare or to reduce their coverage to a lower level.

(2) The structure is useful in covering periods of time during which there is, for whatever reason, a lapse in insurance coverage.

(3) Recognizing that many insurance policies are quite porous, and recognizing that the insurance carrier could itself suffer economic reversals, the structure is useful in providing a means of backup insurance coverage.

(4) Many business people and professionals are often involved in business or investment activities that are outside the scope of their main area of work. The structure affords protection against risks that can arise from these other activities. For example, a CPA or surgeon who is a one percent partner in a general partnership may be unpleasantly surprised to learn that he is 100 percent liable (or all partnership debts, of whatever nature. This sort of a risk may pose a greater problem for this investor than his or her professional activities may pose.

(5) The structure has been used as a means to rebuild wealth that is free from the client's past or current financial problems. This is often referred to as a "business opportunities trust."

(6) Many people with wealth believe that their financial profile may encourage litigation against them. Statistics support this belief. The structure has accordingly been used as a means to reduce one's financial profile so as to discourage lawsuits.

(7) The structure has been used as an alternative or as a supplement to a prenuptial agreement. It is particularly attractive to a client who is facing a second (or so) marriage and does not wish to broach the issue of a marital agreement with his or her spouse-to-be.

(8) When an individual or a business signs for a loan or otherwise takes on a financial obligation, the individual or the business is, generally speaking, subjecting all owned assets to the loan or obligation. To avoid this problem, the structure has been used to segregate wealth into various pockets so that not all is at risk for one particular transaction.

(9) The degree of protection the law now affords retirement benefits is in a tremendous state of flux. Given the uncertainty of the legal protection, certain applications of the typical structure have been applied to protect retirement benefits.

(10) Asset protection planning is often done in connection with an overall estate plan for the client. As the structure's foreign trust accomplishes everything a typical living trust accomplishes (e.g., probate avoidance, privacy, estate tax planning) yet has the additional advantage of protecting assets while the client is alive, the foreign trust often serves as the main dispositive instrument under the client's estate plan.

(11)A person who is suffering creditor problems may be able to use the structure as a means to increase his or her strategic position with respect to creditor negotiations. This application must, however, be applied cautiously given the fraudulent conveyance considerations discussed earlier herein.

(12) When coordinated with the estate plans of other family members, the structure can be used lo protect inheritances that otherwise may be at risk when distributed to the beneficiary.

(13) A number of jurisdictions have "forced heirship" laws that dictate the percentage of an estate that certain heirs must receive, as well as perhaps the timing of the distributions to those heirs. The structure has proven quite useful for clients carrying out their wishes as to the ultimate disposition of their property, irrespective of local law requirements.

(14) It is not uncommon for a person who sells his or her business or professional practice to be concerned with protecting the proceeds of the sale. One concern often voiced is that the buyer may not be as successful with the business or practice as was the seller, and as such the buyer may reappear several years later only to claim, on whatever basis, that too much was paid by the buyer in the transaction. Protecting sales proceeds that result from transactions of this nature is, thus, another application of the structure.

(15) Increasingly, business and property owners are concerned with liability under the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as Superfund) and the Resource Conservation Recovery Act. Legislation of a similar nature also exists at many state levels. Businesses not usually thought of as generating or using hazardous substances fall within the reach of these laws. Moreover, under the liability net of these provisions, even persons who formerly had only an interest in the property are subject to liability exposure. The structure is useful in protecting against these forms of risks.

Potential clients and their advisers frequently ask whether planning of the nature discussed herein "works." The author believes that the word "works" must be defined by reference to where the client would have been had he or she not had the benefit of the planning. Although, in the opinion of the author, the ultimate goal of asset protection planning can be considered to have been achieved if the client weathers a legal storm at least moderately better than he or she otherwise would have had, the experiences of the author have to date far surpassed this standard.

Seminars & Events:

April, 2017 - CELESQ
“An Asset Protection Planning Primer for Estate Planning, Tax and Creditors Rights Lawyers”
Live Web Cast
May 31 – June 1, 2017 - 

SOUTHPAC TRUST OFFSHORE PLANNING INSTITUTE CONFERENCE 2017, “Asset Protection in a Changing World” (31 May 2017) and “Questions & Answer Panel on Industry Challenges to Asset Protection Structures” (1 June 2017)
Las Vegas, Nevada


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Contact Information

Barry S. Engel