Asset protection has emerged as a fundamental in financial planning for individuals with high net worth. Estate planning attorneys who fail to address this aspect do their clients a disservice. Even the most elegant estate planning documents are rendered meaningless if a surgeon has been sued and lost all of his or her estate assets prior to death.
Orthopaedic surgeons should carry sufficient insurance and conduct their affairs in a manner that minimizes risk; they should also have both business and personal asset protection plans. To overlook one area could jeopardize the other.
Operating as a sole proprietor or in a general partnership with another surgeon exposes the owner to unlimited liability for all claims against the business. Corporate law exists, and has continued to evolve, to ensure that those who run businesses can separate their business liability from their personal affairs and assets. Entities that provide this insulation are called limited liability entities.
Among the company forms that allow for the isolation of business liabilities are the following:
- C corporations
- S corporations
- limited partnerships
- limited liability partnerships
- limited liability companies
Each has its own merits and unique tax treatment, but all provide the same key benefit: preventing a company’s creditors from attacking the owner’s personal assets in the event of a lawsuit. Properly formed and implemented, the limited liability entity creates a “veil” between the business and the owner, so that if the assets of the business are insufficient to settle the claims of creditors, the business simply goes bankrupt.
In addition, as the business succeeds, a single entity may not be the optimal solution. The larger the asset base of the entity, or the greater the risk of the activity, the more of a target it may become. Therefore, to minimize potential loss, it is often advisable to use multiple entities to own separate assets or lines of the business.
For example, substantial real estate, intellectual property, or equipment is usually placed into its own dedicated entity and leased, licensed, or otherwise contracted for the benefit of the primary operating company. In this manner, a lawsuit against the operating company should not adversely affect the property that has been stripped out. The operations can simply be bankrupted, a new operating company formed, and the assets redirected to the new company. Once the overall asset base of the operations reaches an uncomfortable critical mass level, the idea of setting up additional companies should be explored.
As business assets (profits) are converted to personal assets (income), the protective shield of the business becomes meaningless. To ensure that such assets are actually preserved, orthopaedic surgeons must develop a personal asset protection structure to properly receive such assets.
Personal asset protection planning breaks down into two steps: maximizing exempt assets and transferring nonexempt assets to asset protection vehicles.
Exempt asset planning
Exempt asset planning is based entirely on the laws of the state in which the surgeon resides. Each state has a basket of identified assets that are exempt from creditor attachment in the event of a personal bankruptcy. Depending on the state, exempt assets may include the following:
- the homestead (residence and land)
- property owned in “tenancy by the entirety”
- qualified retirement plans (ERISA plans)
- nonqualified retirement plans (IRAs)
- life insurance cash value and/or death proceeds
- annuity cash value and/or payout
- other select personal property exemptions
Because these exemptions are created under a state’s bankruptcy act, the treatment of each varies widely between states. In one state, a particular asset’s value may be fully exempt; in another state, the asset is afforded no protection whatsoever; in a third state, a portion of the asset’s value may be exempt.
Thus, the first step should be to review the exempt asset laws of the surgeon’s home state and determine which, if any, of the existing assets benefit from some form of exempt status. In addition, if exemptions exist under the state law for assets which the surgeon does not own, it may be prudent to convert nonexempt property into exempt property. For example, in a state where annuities are protected, a surgeon may be better off converting unprotected cash or securities into an annuity for retirement purposes.
The general goal is to maximize exempt asset holdings to the extent it is possible and financially prudent. It may not be prudent, for example, to pay off real estate simply because it is exempt, if doing so creates too much concentration risk to the asset class or the geographic region. The main benefit to exempt assets is that they are inherently protected; although there are costs to the assets, legal fees are avoided.
Protecting non-exempt assets
After exempt assets have been maximized, orthopaedic surgeons should consider transferring any nonexempt assets into an asset protection vehicle. This require the assistance of a lawyer, and essentially two options are available: the limited liability company (LLC), or the asset protection trust (APT). LLCs and APTs may be within or outside the United States.
LLCs—Assets held by an LLC are protected under what is known as the “charging order,” a statutory remedy dictated by the legislation under which the LLC is formed. Properly applied by a court, the charging order prevents creditors from attaching any of the LLC’s assets. The creditor will only receive payment if and only if the LLC’s manager makes a distribution of profits to the members. Because the manager is usually the surgeon or a select family member, such a distribution is unlikely to be made, nor can it be compelled by the creditor.
With a properly structured LLC, the holder of the charging order (the creditor) must pay all of the taxes associated with the charged interest, whether profit distributions are made or not. The prospect of never receiving a distribution but paying taxes along the way is usually a strong incentive for creditors to go away or settle for a more reasonable sum.
APTs—Protection with an APT stems from the trust’s “spendthrift clause,” which states that the trustee of the trust is prohibited from using trust assets to pay for any claims of a beneficiary’s creditors. The spendthrift clause was initially limited to trusts established for the benefit of a third party (such as a gift trust for a child), but are now permitted in trusts established for the benefit of oneself (referred to as a self-settled spendthrift trust). Self-settled spendthrift trust statutes have been passed in 15 states, and that number is growing.
The APT structure may be more beneficial than the LLC because a properly structured APT simply provides no remedy to the creditor whatsoever. The creditor is barred from trying to collect on the trust or impair its assets. The main drawback to the APT is that it is an irrevocable trust that requires an independent trustee, and thus is not under the surgeon’s control. An assessment of the trade-offs is necessary to determine the optimal application.
The effectiveness of either an LLC or an APT depends on thoughtful consideration of jurisdiction selection and careful drafting of the documents. To implement either of these options and protect nonexempt assets, surgeons should seek experienced counsel.
Now is the time…
Lastly, the time to seek counsel for this type of planning is always now. Surgeons who wait until they are sued may find that they have committed a fraudulent conveyance. Given the “clawback” rules found in state and federal laws, it is important that any structure established be “old (4 to 10 years) and cold” to withstand scrutiny and avoid the unwinding of any transfers. Acting when not under duress is certainly the preferred path to protection.
James M. Duggan, MBA, JD, is a partner at Duggan Bertsch, LLC, in Chicago. He can be reached at firstname.lastname@example.org
© 2013 James M. Duggan
Editor’s Note: This article is for general information purposes and should not be construed as providing financial advice. Individuals who need tax or legal advice should contact a duly licensed professional.