Asset Protection & Charitable Giving Guide
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Step Four: Determine Which Entities Are Right For Your Use STEP FOUR: DETERMINE WHICH ENTITIES ARE RIGHT FOR YOUR USE The information listed below is merely an overview of some of the more common asset protection entities. Some may not work in your particular situation. One of our estate planning lawyers can analyze your situation and determine the appropriate entity or entities for you. FAMILY LIMITED LIABILITY COMPANY A limited liability company is a statutory legal entity which provides each of the participants, known as members, from liability. A Family Limited Liability Company (FLLC) is a limited liability company involving only you and your family members, such as children, grandchildren, or those with whom you wish to share your estate. A FLLC closely parallels the Family Limited Partnership (FLP) described below. The major advantage to the FLLC is that the manager of the FLLC, occupying the same position as the general partner of the FLP, has NO personal liability for the business of the FLLC. As a result, many people are selecting the FLLC as their choice for an asset protection document. You will be the Manager of the FLLC so that you can control the FLLC assets. You will also be a member. Your other family members will also be members. You can use the FLLC to reduce the size of your estate by making gifts to the other members of interests in the FLLC. You do this by signing simple assignments of interests to them. By law, you can make gifts of up to $10,000 per year per person without triggering a gift tax. You will only make gifts of your interest as a member and you can let your total ownership interest dwindle down to as little as one percent and STILL maintain full control as long as you are the Manager. Take, for example, a situation where you own a vacation home. Since it is not your primary residence, it is not exempt from creditor claims. Next, assume you suffer a judgment against you for $100,000.00. The reason for the judgment doesn't matter. It can be from a bad investment, a bad car wreck, professional liability or anything else. The judgment creditor can take your vacation home and sell it if you don't pay the judgment. Even if the creditor does not sell it, YOU cannot sell or mortgage your vacation home until you pay the judgment and obtain a release from the creditor. Now, assume you place the vacation home into a FLLC prior to the liability which led to the judgment. The vacation home was not owned by you individually -- It is owned by the FLLC. The judgment against you has NO EFFECT on the FLLC because the judgment is against you individually, NOT AGAINST THE LIMITED LIABILITY COMPANY. Therefore, you can still transact business through your FLLC (sell or mortgage the real estate) without interference from your judgment creditor. The law does grant the creditor certain rights in the FLLC, however. The creditor can get what is known as a charging order against a manager or member who has suffered a judgment. The charging order gives the creditor the right to receive any income actually distributed to the member. However, as the Manager, you can retain the right to NOT distribute income and, therefore, the creditor can be denied any recovery from the FLLC. Also, the law does not allow the creditor to take and sell the FLLC interest without the consent of the Manager. Obviously, you can protect the member's interest by refusing to allow the sale. Thus, a creditor cannot obtain any right to influence the operation of the FLLC. The FLLC allows you and your family to take advantage of some "discount" planning. For estate and gift tax purposes, as well as for creditor purposes, the value of an interest in a FLLC is considered to be the "market value" of the interest. "Market value" means what a willing buyer will pay to purchase the interest from a willing seller. With a FLLC, there is usually a lack of marketability, since there are numerous restrictions placed on the ability to sell or encumber the interest. The Internal Revenue Service has even recognized this lack of marketability and has allow taxpayers to discount interest in a FLLC. Therefore, a 1% interest in a $200,000 FLLC may only be worth $1,500 or $1,800 instead of $2,000. In any event, this is just another benefit to the use of a FLLC in estate planning. You must keep in mind that creating and establishing a FLLC is more than just filing the entity. There are other documents and actions that must surround these entities in order to create sufficient proof that the entity is valid and justified. We can discuss these actions with you, should you consider a FLLC as a part of your estate plan. As the result of changes in the law in 1997, you can now have a one-person FLLC. This provides an additional advantage, since you cannot have a one-person partnership. This entity, commonly referred to as "the Tax Nothing" can protect you from liability associated with risky investments, such as real estate, and also protect those investments from your individual creditors. FAMILY LIMITED PARTNERSHIP A limited partnership is a written agreement between at least two people. One is the general partner who manages the business of the partnership and the other is the limited partner. The limited partner cannot manage the business of the partnership. The general partner is WHOLLY liable for any losses caused to the partnership. The limited partner is, much like a passenger on a bus, simply "along for the ride". He or she cannot participate in the management, but he or she can receive distribution of profits and losses from the partnership. A person can be both a general and a limited partner and any number of individuals or entities can be a part of a limited partnership. A limited partner of a limited partnership is in much the same position as a member of a limited liability company. Both have limited liability and their interests are protected from creditors. Some planners prefer to use the limited partnership entity instead of the limited liability company entity because of the many years of court and tax decisions upholding the use of the limited partnership. The limited liability company is a much more recent entity with not as much legal history. However, due to its similarity to the limited partnership, we believe legal decisions will uphold the use of the limited liability company in the same manner as they support the limited partnership. THE IRREVOCABLE LIFE INSURANCE TRUST It is true, as insurance agents say, that life insurance proceeds are not subject to income taxes. However, those same insurance proceeds can be subject to estate taxes at the time of your death. If you own a policy of insurance on your life, the proceeds are taxable in your estate at the time of your death. In fact, life insurance accounts for 75% of all federal estate tax dollars assessed! If you name your spouse as the beneficiary of your policy, there is no tax on the proceeds since you have an unlimited marital deduction. However, what happens if your spouse dies shortly after you? The proceeds are taxable in your spouse's estate! Furthermore, what if one or more of your beneficiaries are minor children? Legally, they are entitled to their share of the proceeds (after your death) when they reach age eighteen. Do you want to give an 18-year old $500,000? You can avoid these problems with an irrevocable life insurance trust. Such a trust, commonly referred to as an ILIT, is one you create and in which you place your life insurance. You designate a close friend, advisor or bank as trustee, and designate your spouse and children as beneficiaries. Upon your death, the proceeds from the life insurance policy are paid to your trustee of the ILIT. Since you did not own the policy in your individual capacity, but rather in an irrevocable trust, the proceeds are not taxable in your estate. If your spouse survives you, the trustee can pay the income and as much of the principal as is necessary to your spouse for his or her care. When your spouse dies, the proceeds are then paid to your children, if they are at the age you want them to be when they receive the proceeds. Such a trust allows you to withhold the money from your heirs for as long as you wish and even skip over a generation and provide that the proceeds are eventually distributed to grandchildren or great-grandchildren or other heirs. With appropriate language, you can protect the policy proceeds from creditors of your heirs as well. The only real disadvantages to this sort of trust are that the trust is irrevocable and the insured person cannot be the trustee or beneficiary of the trust. Please also be advised that any existing life insurance that you transfer to your ILIT is still included in your estate for estate tax purposes if you die within three (3) years of the date the policy is transferred into the trust. Therefore, it is wise to create your ILIT before applying for life insurance that the trust, not you personally, can take title to any new policies. How do you know if you need an irrevocable life insurance trust? Obviously, it depends upon the amount of life insurance you own. Since the trust will cost at least $800 to create, you want to be in a position where the savings derived from the trust will cover the cost of preparing it. If the total value of your taxable estate, including life insurance proceeds, does not exceed $1 million, you will not pay federal estate taxes on your life insurance. However, if your taxable estate exceeds $1 million, the initial marginal tax rate is 41%. That means $41.00 of each $100 over $1 million is paid to the IRS. Using some math, the tax on a $1,001,951.22 estate is $800.00. (Assuming the proceeds are paid to lineal heirs, the Oklahoma estate tax is an additional $9,726.83!) Therefore, if the total value of your estate exceeds these amounts, you may want to consider an irrevocable life insurance trust. Such a trust can be beneficial to your estate if your total life insurance exceeds $100,000. CHILDREN'S TRUST This is a form of a trust that can allow you to continue control of assets after allocation to your children or grandchildren, or can allow you to protect certain assets from your children's creditors, spouses and others. Many times, instead of making a child a limited partner of a FLP or a member of a FLLC, individuals will use a trust for the benefit of that child. The parent can be the trustee of the trust. However, all beneficial ownership is in the name of the child. The Trust can set forth various parameters for the distribution of income and principal from the trust to the child and can even provide for the distribution of the trust assets after the child dies, thereby avoiding redirection of the trust assets by the child's will or trust and avoiding loss of the trust assets in the event of divorce. WHY NOT USE A CORPORATION? Many people ask why a corporation seems to be used so infrequently. They know that the corporate form of business has been around for many years and has worked to protect individuals from the liability of their business. This is true and a corporation still provides that liability protection. However, if you are sued personally, your creditor can take the stock that you own in your corporation. When you use corporate stock to reduce your estate by making gifts to children and other beneficiaries, if you give away more than 50% of the stock, you lose control of your corporation. For these reasons and others, a corporation, although still a good form of business entity, is not necessarily the best form to use. |
