Part Three | Asset Protection Planning from A-Z: 26 Things to Think About Before Jumping In

Prepared by Jeffrey Zaluda and Shannon B. Miloch

GRAT, GRIT, GRUT, CRAT, CRUT, CLAT, CLUT, QPRT, IDIT, ETC.

How we estate planners love our acronyms! As well we should. We used to charge by the number of Latin words and phrases in our documents. Now, we charge by the number of incomprehensible concepts that we present to our clients. But, incomprehensible or not, they can be very effective asset protection tools.

• A client utilizing the Acronym Toolbox is doing so because of the wonderful estate planning benefits associated with those tools. That is, of course, the best defense of any asset protection plan.
• There is little, if any, case law as to whether the annuity interest received back from a GRAT, CRAT or similar vehicle is protected under state law exemption statutes that protect annuities generally, but in any event the underlying principal should be protected since the grantor retained no rights to that property and in fact filed gift tax returns (hopefully and presumably) showing his clear intent to retain no dominion or control over the transferred assets.
• This may be especially true for a CRAT or other charitable vehicle since courts may be loathe to deprive a charity of the benefit of the planning.
• A sale of assets, whether to a grantor trust (an IDIT, or IDGT, if you prefer) or non-grantor trust, will also protect the underlying asset sold to the trust, even if the payment stream or note is available to the creditor.
• If the client can afford it, the planner should use interest only notes with a balloon payment at the end of the term, as that may be a deterrent to a creditor who wants to be paid up front.
• It is important to obtain a third-party valuation of the asset being sold in order to avoid an unintended gift or fraudulent conveyance. An adjustment clause in a Note is often advisable in the event the IRS adjusts the value of the sold asset upon audit.
• At a minimum, by using these techniques, the client is freezing the value of his estate at the present value of the transferred asset (plus a small interest factor tied to the AFR) so that the future appreciation on those assets should be sheltered from the client’s creditors.

Home and Hearth

For many clients, no issue is more emotionally charged than ensuring the protection of the home from the reach of creditors. Protecting the home can be harder than protecting liquid assets for one reason in particular: you can’t lift the home up and move it out of its jurisdiction. A sheriff will be able to place a lien against the home almost no matter what planning steps have been taken. But, as with other areas of planning, that doesn’t necessarily mean that the client can’t place all sorts of obstacles in the way of the sheriff who may want to foreclose on the lien. Four actions are commonly taken that can protect the home from a creditor’s immediate reach: give it away, borrow against it to the max, use a tenancy by the entireties, or use a QPRT.

• The best way to protect an asset from a client’s creditors is to not own the asset at all when the creditor comes calling. Accordingly, it is common to see a professional such as a lawyer, doctor, architect, or accountant, among others, place title to the family home in the name of their spouse. This works as long as the spouse doesn’t also have an out of the ordinary risk profile. Also, the transferring client must balance the benefits of giving the home away against the need to maintain assets in their own name for estate tax exemption purposes or borrowing net worth covenants.
• Illinois provides a $15,000 home equity exemption to each debtor. That isn’t much. So a client who cannot utilize their spouse as owner for some reason may consider borrowing against the home to the maximum extent possible, and then placing the loan proceeds in a protected environment, such as an asset protection trust. Certain lenders, including offshore banks, may agree to lend against the home and place the loan proceeds into a CD or other savings vehicle at the bank under which interest earned can be used to cover all or a portion of the debt service.
• For a married couple in Illinois, tenancy by the entireties is by far and away the most common form of home ownership. The beauty of T-by-E is that as long as the couple stays married the creditor of one spouse or the other cannot force a sale of the home to satisfy that one spouse’s debt. The danger is that upon death, divorce, or even just a sale of the home, the tenancy is broken and the creditor may then be able to be immediately satisfied. Note that there is an argument to be made under Illinois law, though untested, that a spouse can transfer her interest in the house held by T-by-E to the other spouse without consideration even during the pendency of a claim against that debtor spouse, without fraudulent conveyance concerns. This argument is based on the theory that a lien against only one spouse cannot attach to property held in T-by-E since no divided interest in the property attaches to the debtor. Courts have supported this argument in Ohio, Indiana, and Maryland, which have similar statutes and common law to Illinois on this issue.

1. In Sawada v. Endo, 57 Haw. 608, both husband and wife transferred property held in T-by-E to their children pending a claim against the husband. The Supreme Court of Hawai’i held that the conveyance could not be fraudulent because the husband had no separate interest in the property but held that a property owned in tenancy by the entirety is not immune from the process of only one creditor if there was ‘joint action’ by the spouses with respect to the property. Later case law regarding property in Hawai’i since the Sawada decision has held that when spouses agree to joint and several liability for a property, Sawada’s joint action requirement is satisfied, and the property is not protected from the creditors of only one spouse. DiStefano v. Endurance American Insurance Company, 620 B.R. 687.
2. In contrast, a joint tenancy is rarely effective as a creditor protection devise. Joint tenancies provide protection for only 50% of an asset’s value during the debtor spouse’s lifetime.
3. A ruling from the U.S. Supreme Court does allow a federal tax lien to attach to one spouse’s interest in tenancy by the entireties property due to the broad language under IRC section 6321. Since a federal tax lien attaches “to all property and rights to property,” the Court concluded that the limited rights that one spouse has under state law, such as the right to sell property with the other spouse’s consent, were sufficient rights to which an IRS lien could attach. Although the decision authorizes the IRS to administratively seize and sell a taxpayer’s interest in real and personal property held in entireties form, the IRS recognizes the limited value of the property right to a potential purchaser (i.e., the right to enjoyment of the property only following divorce, sale of the property, or death of the non-debtor spouse).

• The use of a QPRT as an asset protection device remained untested in the courts until In re Yerushalmi, 2012 WL 5839938, in 2012. The bankruptcy court refused to pierce a QPRT that was settled in 1995 and funded in 1996. It held that the QPRT was to be recognized as the owner of certain residential property and that it was not part of the debtor’s bankruptcy filed in July of 2007.

1. The Husband (debtor) became embroiled in a partnership dispute in 1998 and divorced the wife in 2002. He was ordered to pay all expenses of the residence, including mortgage payments, taxes, utilities, and insurance. In 2007, debtor filed for Chapter 11 bankruptcy, and the Bankruptcy Trustee sought declaratory judgment that the QPRT was the alter ego of the husband and thus, part of the bankruptcy estate.
2. The court noted that generally under New York law, estate planning trusts are susceptible to attack if used for fraudulent purpose. However, the residence was transferred into the QPRT in 1996 when the debtor had significant assets and disposable income, thereby not finding any fraudulent purpose or improper use.

• Nonetheless, if one combines the idea that the client has retained no interest in the property other than the right to the use of the property (and most creditors are not going to want to share a bedroom with their debtor!) along with the notion that Illinois law protects annuities generally from a creditor’s reach, then the QPRT should work or, at a minimum, provide a pretty good negotiating position.

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