Asset Protection – What Does That Mean and How Has It Changed?

What does the term “asset protection” mean? Most people think of asset protection as a shield from death taxes, income taxes, lawsuits and divorce actions. Historically, the technique most commonly used to protect one’s assets has been to transfer money to offshore legal structures in jurisdictions such as the Caribbean / Island nations. However, over the past several years, a number of states in the U.S., including Delaware, Nevada, Missouri, Alaska, Rhode Island, Utah and Oklahoma, have enacted asset protection trust rules to compete with offshore alternatives.

In the early 1990s, the first big push with asset protection was really for the purpose of tax avoidance. People would move assets offshore in the attempt to “hide” them from the IRS. However, “as a U.S. taxpayer, you are responsible to report on your worldwide income and failure to do so is fraud and potentially a criminal offense,” according to Jim Tombor, CPA for Bartlett, Pringle & Wolf, LLP. “The IRS has really been cracking down on those who try this ploy.”

Through the 1990s, the term “asset protection” morphed from income tax “savings” to a focus on creditor protection. Though virtually impossible to shield oneself from a creditor’s claims, the idea behind the use of domestic and foreign asset protection techniques has been to make the lawsuit process and pursuit of claims so difficult and expensive that it tilts the settlement process toward the debtor.

“To assist in any settlement process, it is always a good option when you can use someone else’s money [to defend yourself],” says Chris Hill, president of Riviera Insurance Services. “Regardless of the structures put into place, a useful and cost effective way to handle negotiations [with a creditor] is to have the proper liability coverage and limits to pay for the cost of defense and settlement.”

More recently, the topic of “asset protection” has changed again to focus increasingly on estate/inheritance planning, especially in states such as California, where rules prohibit the endless growth of estates through perpetuity limitations.

“California law essentially limits the term of a trust to the longer of ninety years or the date occurring twenty-one years after the death of the youngest beneficiary alive at the time the grantor passes,” says Steve Jung, an attorney at Hatch & Parent and a certified estate planning specialist. “For the needs and wishes of the majority of our clients, these rules do not present a problem. However, for larger estates in which dynasty planning is appropriate, we find it necessary to go outside of California to states such as Delaware to maximize the tax benefits for our clients and their children, which can be substantial over time.”

How substantial? The chart above shows the difference between what a “dynasty trust” can accomplish versus other trusts that are subject to hypothetical estate taxes at every generational passing. For those wishing to establish long-term “family legacies,” the amount actually preserved for inheritances is usually multiple times larger through a “dynasty trust” than through other kinds of trust vehicles.

Asset protection trusts – whether domestic or foreign – are making a big splash today. While not appropriate for everyone in Montecito and Santa Barbara, there are clear areas where they may make enormous sense. Quite frankly, no one cares about asset protection or strategic tax planning until something bad or unfortunate happens. Future beneficiaries may ultimately be generations down the road; the creator may not physically get a chance to see the benefits of the work that went into setting up his or her trust. However, for people who have amassed wealth, making wise use of asset protection techniques and structures may help protect an estate and its inheritors for generations to come.

Who will you need to help you structure (or re-structure) the most appropriate trust for your family? We recommend that you consult with your CPA, your wealth manager, and an attorney who specializes in asset protection. It’s important that your advisors be well-versed in all of the various nuances of asset protection, because it’s a complicated area of law, the laws change frequently, and you will want to make sure you get the best advice available.