There is simply a great deal of misinformation surrounding Asset Protection. Some of it is genuine misunderstanding about what really works as Asset Protection. And some of what is attempting to pass as legitimate asset protection are outright scams. In this article I will go over both categories:
Offshore Asset Protection Trust Will Not Reduce Your Taxes!
This is a SCAM plain and simple. Here is how the scam works. A “promoter” usually not an attorney or CPA with a license to protect, will sell the idea that “if you don’t have your money in the United States, then you don’t owe any taxes on it until you bring it back into the country.” While this sounds both reasonable and desirable, the fact is that the IRS taxes on WORLDWIDE INCOME. It doesn’t matter where you earn your money, if you are a U.S. taxpayer then you owe the tax. The real problem with this scam is that when the IRS does take a look at your plan it not only doesn’t protect your assets, but it also may leave you with a massive tax bill. The bottom line is that Asset Protection and tax planning do not go together. If someone tells you that they can accomplish both be very wary and get a second opinion.
Anyone promising to help you “legally” evade paying taxes using an offshore entity is almost certainly flat out lying! If you get involved in such a scheme, it’s only a matter of time. You will get burned! If you have established any type of Asset Management Company or Constitutional, Business, Equipment, Service, Family Residence, or Offshore Tax Trust designed to evade or decrease taxes, be aware, the IRS has created a Task Force specifically to track you down! I recommend you stay far away from this SCAM.
Revocable Living Trust Do Not Protect Your Assets
This is just plain MISUNDERSTANDING of how the law works. More times than I can count I have had someone tell me that they are already protected since they have a Living Trust and everything is in it. And in one sense they are correct, they are “protected” from probate and estate taxes, to the extent that their RLT was set up to avoid or reduce both. But when it comes to lawsuits, creditors and claims against you and your Trust, a Revocable Living Trust has NO (and I mean Zero) Asset Protection. The Revocable Living Trust is an important part of an overall plan, just don’t make the mistake of thinking it will protect your assets.
Titling Assets in the name of your Spouse or Children Does Not Protect You
This is what I call the “Doctor’s Special.” Somewhere along the line someone said to a doctor (or other high-risk professional), “why don’t you just put all your assets in your wife (or husband’s) name?” The theory was that since the doctor was the high-risk spouse it would be safer to put all of the assets into the name of the other spouse, or better yet, the children. There is only one problem with that approach – IT DOESN’T WORK!
This is really the ultimate in bad planning and totally misunderstands the reach of a judge to ‘recast’ almost anything to fit his or her desire. First, I will point out the most obvious flaw in this approach. It creates a nightmare if there is a divorce or other issue that requires the division of family assets! Second, it is worthless to protect against the liabilities of the spouse (or kids). It is simply a “poor man’s” version of asset protection and doesn’t work!
These two obvious reasons alone should be enough to completely erase the idea that somehow this is good planning. Not to mention many possible negative estate planning and tax consequences. However, if this is not enough, then consider the fact that a judge has the power to simply ‘reallocate’ or ‘recast’ family assets under a legal theory known as a “constructive Trust”. Basically what this means is that if all of the family assets are in the wife’s name, and the husband is sued the judge can simply say that it is not reasonable to believe that the husband has no assets and in reality the wife is holding the family assets in a constructive trust for the benefit of the husband. This being done the judge can then reach in and take what they deems appropriate. Voilla – No asset protection there.
The Corporate Shield Does Not Protect You
The ‘corporate shield’ is one of the most misunderstood concepts in all of law. It is easy to understand why, since the concept is actually a real legal concept. It applies in cases of a corporation, like GM or Microsoft with respect to their shareholders. What the corporate shield does is provide a barrier from liability to those shareholders. So if GM gets sued for a defective auto claim, the corporate shield will protect the shareholders from also getting included in that lawsuit. The shareholders might lose their investment if the share price goes down, but they will not be at risk for any excess liability the company might incur. That is the corporate shield and it does work, as long as we are talking about shareholders in a public corporation.
But what about the doctor who has a ‘corporation’ for his medical practice. Or the businesswoman who has several corporations for her various investments and businesses. Does the corporate shield work the same way for them? NO it doesn’t! The difference is that when the corporation is run or managed by the same person or people who are also the shareholders, then the ‘corporate shield’ virtually disappears. This is called “piercing the corporate veil,” and this has become the absolute rule of thumb for any personally held corporation.
What that means is that if your company gets sued for any reason, you are almost certainly going to be just as liable as the company! That is true for a doctor, lawyer, CPA, business owner, real estate investor or virtually any other type of business you can think of. And guess what else? If you DO happen to serve on the Board of GM, or better yet are the CEO, CFO, COO or any other executive, for any company, then the corporate shield doesn’t work for you either! Just ask Enron CEO, Ken Lay (before his demise) or WorldCom CEO, Bernie Ebbers how well the corporate shield worked for them! In fact, if you do happen to hold a senior position at any company (big or small), then the real asset protection tools that do work will become all that much more important to you.
So where does that leave the corporate shield as an asset protection tool? Well it is not totally dead, but it is very limited! The corporate shield concept does almost nothing to protect you from liability in your own company. But as long as you understand this and don’t see the corporation as some catch all liability protection, then the Corporation, and its cousins the Limited Liability Company and Limited Partnership, can and are very useful in an overall plan when used as appropriate.
Nevada Corporations
If you thought the corporate shield was misunderstood, then you can’t even imagine the confusion around the infamous “Nevada Corporation!” What is all the hullabaloo? We just busted the myth around the corporate shield, so how is a Nevada Corporation any different?
We are now crossing over from the simply misunderstood to the scam. And there is no better place to start than the Nevada Corp. Here is the real story. The Nevada Corporation Scheme is NOT about asset protection. It is about tax avoidance and tax evasion! This is why there has been such a buzz, because anything that promises lower or NO taxes gets some serious attention! Remember our rule from Scam #1 – Tax Planning and Asset Protection NEVER go together! That’s it! NEVER, and I mean NEVER! So the minute you hear anyone tell you they have an asset protection program that will create more deductions or where you won’t have to pay any taxes until you ‘take the money out.’ RUN and fast!
The Nevada Corp is just like any other corporation. There is NOTHING SPECIAL about it. It is just a corporation registered in Nevada—that’s all! Why it has gotten so much attention is because some unethical promoters decided to use it in an unethical way! Here is their scam. Let’s say you have a business with $200,000 of net income. Thus you pay taxes on that $200K at the net personal tax rate of, let’s say 35%, leaving you with $70,000 in taxes! Their scheme says, create 4 Nevada Corporations. Charge off your $200K in profits to these 4 (phony) consulting companies and pay only the Corporate Tax rate (which is only 15% up to the first $50K of income, which is why you need 4 phony Nevada Corps).
By doing this you will have 4 Nevada Corps, each with $50K of income, taxed at a rate of 15% for a total tax of $30,000! That is a $40K tax savings each year!! And by the way we will only charge you one year of saving ($40K) to set this all up for you. Sounds good right? WRONG again!
The problem with this little scheme is that it relies on YOU lying! That’s right—lying! First of all you need to lie about what the 4 companies do, and make up phony companies to shift income (definitely not allowed by the IRS). Second you need to lie about the fact that you own all of these companies, because if you don’t then the IRS rules would require you to consolidate the earning of all 4 companies and your tax rate would be HIGHER not lower than your personal rate! Finally, in their plan you are then encouraged to lie about the deductions that these 4 companies have so that you can still get the money out for you to spend without triggering a double tax!
You see, even if you followed their plan, and even if you actually did have 4 separate jobs you could really have those 4 companies do, they are C-corporations, and that means there are 2 taxes, Corporate and Personal! What that means is that AFTER you pay your 15% corporate tax, then the balance is distributable to you as a dividend and STILL INCLUDED on your personal return and thus you are pay MORE TAX – NOT LESS (unless you lie!). Now, I am not sure about you, but I do not advise clients to enter into planning that is based on them needing to lie for it to work! And the ONLY reason these promoters chose Nevada, is because Nevada allows the formation of corporations which does not require you to list the shareholders, which makes it easier to LIE. And that is ALL that the Nevada Corp Scam is all about!
So what is the lesson? Simply stay away! There is no reason you need to do a Nevada Corp, unless you live and work in Nevada, and even then there is no special benefit to you. You can be sure that anyone pitching these to you is only putting you at risk by doing so, because when you are eventually found out it is not the promoter who will be responsible for the back taxes, penalties and fees, OR the possible jail time – It will be YOU!
Numbered Bank Accounts and Bank Secrecy Will Not Protect You
This is a holdover from the James Bond days of tax evasion and money laundering. There is almost nothing to say except it doesn’t exist and doesn’t work. This is more true than ever after 9/11 and the international banking reforms. There is NOTHING WRONG with having your money in a Swiss bank, or German bank or French bank or anywhere in the world you choose. Absolutely nothing. But the IRS must know about it and you must pay taxes on the money you earn. That’s it!
If anyone tells you that you can set up a “numbered account” and earn money without the IRS knowing it and pay no tax – they are lying! Not only is it virtually impossible to do nowadays! But even if you could, you are still responsible to pay the tax, and if you don’t it is tax evasion and it is illegal!
And I am not kidding about it being impossible to do. All foreign banks are required to identify who the beneficial owner of the account is, AND if that person is a U.S. taxpayer, the bank is required to issue a 1099 for any interest or dividends earned – just like a U.S. Bank! You will absolutely NOT get into trouble if you choose to use a foreign bank. And hundreds of thousands of U.S. people do it every year for many reason such as bank stability, access to investments, access to currency, diversification of risk, asset protection, and many other legitimate reasons. Just know that you will also absolutely be reporting it! As long as you are clear on that, then you can have as many Swiss accounts as you like and give yourself all the reason in the world to take a European vacation to visit your money. Just don’t cheat the taxman!
Giving Your Assets Away, Moving to a better Homestead state, and Other Last Minutes Plans
I am going to throw everything that involves an “after the fact” scenario together. This includes moving to Texas or Florida at the last minute to try and take advantage of the unlimited homestead exemption, giving your assets away to a friend, spouse or relative, “selling” your assets at less than fair market value, hiding your assets so that a judge or court cannot find them, or anything other planning that is done in a reactive way after an issue arises. The bottom line here is that all of these transfers can simply be reversed or negated by a judge and the money brought back. I think by now it should be obvious that you do not want to have to lie for your planning to work. This can get you in far more trouble than just losing your assets. If you think you can just wait and do something about your asset protection after you have a problem I would suggest that this is perhaps the ultimate in poor advice. It is a little like saying that you will quickly put on your seat belt if you see yourself having an accident.
It is TOO LATE! If you are not going to plan, then just be honest with yourself and choose not to do any planning. But don’t lie to yourself and think that you can do it later. Almost certainly you cannot. If you really want asset protection you should do it now, and the sooner the better.
What is the difference, if any, between your Asset Management Limited Partnership and the normal LLC?
Great question! What’s the difference between an FLP and an LLC? Like any other complicated area, it is easy to get confused. Of late there is much discussion of how an FLP is different from the relative newcomer, the LLC. While these legal entities are similar in structure, there are significant and important differences, particularly if the purpose of the structure is related to the increasingly more important goal of Asset Protection.
This article will help you understand the two tools, how they are different, and when they should each be used. Both are valuable and, if used properly, are often complimentary to an overall Asset Protection and business structure.
THE FLP
An FLP is a legal entity known as a Limited Partnership. While the Limited Partnership has been around for over 100 years, they became popular in the 1980s when many real estate developers and investors began using this structure to assemble groups of unrelated investors. The primary defining feature of a Limited Partnership is the distinction between the two classes of partner, the General Partner (GP) and the Limited Partner (LP). It is this distinction that makes the LP so useful in business applications in which some partners will be managers and others will only be investors.
In the LP structure, the GP interest is also the management interest. The GP is 100% responsible for the management of the partnership assets and there is no input whatsoever required, or for that matter even allowed, by the Limited Partners. The GP in most cases is also responsible for any liabilities of the partnership.
The Limited Partners, on the other hand, are in the reverse position. They have no management responsibility and in fact are not permitted to. They have no say whatsoever in the operation of the partnership and do not have any control over the amount or timing of any distributions of partnership income or assets. They are much more like beneficiaries of a discretionary trust than shareholders of a corporation. However, other than the investment itself, they also have no liability or risk associated with the partnership. They are completely insulated from the acts of the partnership and the General Partner. It is for this reason that this structure is so popular with investment groups.
The designation simply stands for Family, hence a Family Limited Partnership. All Limited Partnerships are governed under the statutes of the state in which they were created. While these state laws are for the most part similar, there are some important differences when it comes to creditor protection. For example in Arizona and Nevada, there is greater protection in the form of a Charging Order which is statutorily the exclusive remedy to creditors as opposed to states like California, New York or Florida, where judicial discretion remains.
An LP will also have its own tax ID and file a 1065 partnership tax return, and are most commonly treated as a pass-through entity for tax purposes. This means no double tax, as all income is accounted for via a K-1 on the individual partners return.
THE LLC
The LLC is the relative newcomer to the field. They first began in Wyoming and Florida in the 1970s. The purpose was to create a corporate structure, which had the benefits of a corporation without the downside of double taxation. Prior to the LLC this was accomplished by using an S-corporation; however, S-Corps have significant restrictions and are therefore difficult to use. With the introduction of the LLC came a true hybrid with essentially all of the benefits of the Corporation with none of the S-Corp restrictions.
The LLC has the exact same tax options as the FLP above. The LLC does not use the term shareholders, but rather ‘members.’ In the standard LLC structure there is only one class of member. This was meant to mirror the corporate stock ownership and creates a majority rule type of management. While this can be changed through careful drafting, it is this distinction that becomes important when comparing it to the Limited Partnership for use in Asset Protection Planning.
There is much confusion today about which structure is most desirable when it comes to the area of Asset Protection. While both are useful, there are significant differences which should not be overlooked. In particular, there is a distinct advantage to the Limited Partnership structure when it comes to designing a truly effective Asset Protection Plan. For example under the laws of Arizona, which is considered one of the very best jurisdictions for the purpose of Asset Protection, there are the following critical differences between an FLP and an LLC:
1. An FLP requires “unanimous consent” for dissolution as opposed to a majority in interest (51%) for an LLC. This restriction is advantageous in both a creditor situation and a discount valuation scenario.
2. It is much easier to obtain an “Administrative Dissolution” in an LLC. This is a significant disadvantage with respect to Asset Protection. Among the grounds for administrative dissolution in an LLC are:
1.
1. Failure to make required amendments to the articles of organization.
2. Failure to make required publication.
3. No statutory agent or registered office for a period of 60 days.
4. Failure to notify the corporation commission of a change in statutory agent or registered office within 60 days.
While these seem minor, they are often overlooked and may be used by a judge to justify dissolving an LLC. There is no corresponding statute for an FLP, which is much more likely to remain intact in a creditor crisis.
3. A majority of LLC members can require a distribution in an LLC.
4. There is no right to distribution in an FLP until winding up.
5. An FLP can allocate income, gain, loss, deductions or credit items in any manner it deems appropriate.
For all of the above reasons, the use of an FLP as the primary consolidating entity is preferable when structuring the most effective Asset Protection Plan possible. This is particularly true if the planning combines the use of the International Asset Protection Trust. (https://www.lodmell.com/asset-protection-bridge-to-another-world). Since the IAPT would typically hold a majority of the FLP interest, using a Limited Partnership share is ideal as opposed to attempting to draft around the LLC rules with a membership interest.
The LLC is, nevertheless, extremely useful. Most often an LLC will be used to hold and shield individual ‘risky’ assets, such as real estate, boats, airplanes and other potentially liability generating assets. These may be held by a multi- or single-member LLC, which in turn may be held by the master FLP. The clients may directly hold the General Partnership interest of the FLP with the IAPT serving as the majority Limited Partner. The net effect is that the majority of the client’s assets would be ultimately held in the FLP with the wrap around protection of the IAPT.
This structure is the ultimate in ease of use, protection and lawsuit deterrence, while maintaining the level of comfort and control most clients require. The mere existence of this level of planning is often enough of a deterrent to dissuaded potential plaintiffs’ and their aggressive attorneys.
Douglass S. Lodmell, J.D., LL.M.