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Asset Protection Strategies

Robert J. Mintz, Esq.

Fear of lawsuits and the risk of personal financial loss is a predominant force shaping the practice of medicine today. In the previous article in this series on asset protection we discussed the fact that as a physician, you have a particular vulnerability to lawsuit exposure. Most other business owners are permitted to arrange their business activities in a structure which will legally shield themselves from personal liability—even from their own reckless or negligent conduct. The auto mechanic who fixes the brakes on your car can protect himself from liability, but, for physicians, no legal protection is available.  Whatever you own is available and exposed to a potential claim.

It’s fair to say that most doctors are not willing to bet everything on the hope that they will not get sued. Given the sheer number of cases filed and the potential for multimillion dollar jury awards, that particular risk is beyond what any individual can reasonably withstand.

Other than giving up the practice, the choices for controlling liability are limited to adequate insurance coverage and/or effective asset protection planning. With insurance premiums rising sharply and coverage often limited or unavailable, the Wall Street Journal reports that asset protection is increasingly used by physicians as a substitute or supplement to insurance.  In this article we present a brief introduction to some of the popular asset protection strategies and describe potential limitations on how these plans can be used.

Overview of Asset Protection Strategies

Family Limited Partnership

The Family Limited Partnership (FLP) has been a primary asset protection tool for many years. Originally designed as a tax savings strategy to shift income to lower bracket family members, the FLP is now widely used to reduce estate taxes and protect accumulated wealth from potential claims.

An FLP is a limited partnership with special features to accomplish tax savings and/or asset protection goals. You, or you and your spouse may be general partners each owning a small, one or two percent interest. “Safe Assets”–those not likely to produce liability– are generally transferred into the FLP. For example, bank and brokerage accounts as well as other passive investments (not real estate) are a good fit.

The FLP works well for asset protection because the law in every state does not permit a creditor to seize or collect against property held by the partnership. The property transferred to the FLP is generally safe from attack, but the creditor may attempt to reach your ownership interests in the partnership. To protect against collection activities such as “charging orders” and foreclosure, the limited partnership interests in the FLP are usually protected with a Family Savings Trust as discussed below. The combination of an FLP/ trust arrangement is diagrammed below.

Limited Liability Company

A Limited Liability Company (LLC) is a legal entity which provides the benefits of liability protection usually associated with corporations, but without corporate tax and without the strict formalities of corporate minutes, bylaws, directors and shareholders.

The LLC is good alternative to a corporation as the proper entity to conduct a going business (but not a medical practice). For asset protection, the LLC should hold “Dangerous Assets”—those which can generate liability-such as rental real estate or business interests. Safe Assets are placed in the FLP and Dangerous Assets in the LLC.

Personal Residence Trust

Most states protect some or even all of the equity in your residence with a “Homestead Exemption.” Depending upon where you live, a specified amount is sheltered from a creditor’s claim. In Florida, Texas and Kansas, the amount is unlimited. Almost any amount can be protected in the equity of the home. Other states range from $300,000 to $20,000. Depending upon the law in your state, you may have a need to protect equity over the homestead amount.

An FLP or LLC cannot be used to protect the family home.  The tax advantages you are permitted for your home, such as the mortgage interest deduction and the exclusion from tax of $250,000 in gains per spouse, will not be allowed in an FLP or LLC.

One alternative is a Personal Residence Trust (PRT). This is a grantor-type trust, specifically permitted under the Internal Revenue Code. Protection against claims is afforded while the tax benefits of ownership are preserved. A strong degree of control and enjoyment over your home can be maintained, depending upon the terms of the PRT which you establish.

Family Savings Trust

The Family Savings Trust (FST) describes a trust designed to hold almost any type of asset, including ownership of FLP or LLC interests. It can be flexible in form and should be crafted to accommodate your criteria for control and access to your savings. For instance, some individuals need current income from their assets to meet living expenses. Others, such as physicians with sufficient current income from their practice, can afford to “put away’ savings until retirement. The FST can usually accommodate either circumstance.

Offshore Trusts and Offshore LLC’s

Those in the high-risk medical specialties and those for whom insurance coverage is unavailable or inadequate often enhance their asset protection plan with an offshore trust or offshore LLC.  Although there are some technical and practical distinctions in the way each operates, the underlying premise of both is similar: Most prospective plaintiffs and their contingent fee attorneys will be discouraged from filing a case if collection of a judgment is difficult or impossible.  An Offshore Trust or LLC can force a plaintiff to litigate in an “unfriendly” foreign jurisdiction with laws designed to support common asset protection goals.  The ability to move funds out of the jurisdiction of the U.S court system may be a powerful weapon in litigation, but there are certainly risks and security issues which must be addressed and resolved.

Limitations on Asset Protection Planning

There are important limitations on the value and effectiveness of asset protection plans which should be considered.

Costs

Some asset protection plans are fairly easy and straightforward to implement. There are many permutations and variations which grow increasingly complex and sophisticated, depending upon the amount and type of property which is owned. Added complexity means greater initial expenses for establishing the plan, higher maintenance costs and additional paperwork burdens. The value of the property you wish to protect must be balanced against your liability risk and the expense of establishing the plan.

Timing

An asset protection plan must be created in advance of any claim or threatened litigation. The law in every state prohibits the transfer of property if the goal is to defeat the claim of an existing or anticipated creditor. If you know or have reason to believe there may be a case against you, the other party has the right to set-aside any transfers which you attempt.  Asset protection will not be effective against a pending claim.

Offshore Tax and Security Issues

A plan which involves an overseas account, such as an offshore trust or offshore LLC requires significant caution. Despite strong and tempting asset protection features, key issues must be resolved. How will the plan be treated by a U.S. court? How can you protect the security of the funds in an overseas bank? What is the tax treatment of the structure? Additionally, the degree of experience and competence of your advisor, the foreign trust company and overseas bank, should all figure prominently in your decision

Hospital Privileges, Damage Caps and Costs of Defense

If insurance coverage is available to you, dropping a costly policy to adopt an asset protection plan has certain ramifications.  Many hospitals require specified amounts of insurance coverage to enjoy hospital privileges. It may be necessary to negotiate an arrangement such as a security bond or other financial guarantee to maintain your privileges. Sometimes minimal coverage together with an asset protection plan to cover excess liability will be an acceptable solution.

Along the same lines, in several states which have adopted caps on non-economic damages, physicians without insurance are not entitled to the protection of the cap. By dropping your insurance coverage you may be trading a limited and insured liability for an uncapped damage award, to be collected from your future earnings.

The cost of defending a lawsuit, the legal fees and court costs will be carried by you, instead of your insurer if coverage is abandoned.  These amounts can be significant, ranging from $25,000 to $200,000 or more in a complex case. Most physicians, without coverage, attempt to self-insure by contributing regularly to build a reserve a sufficient amount to pay these costs. Whether this plan will be successful depends on luck and timing. If litigation arrives early, before you have had a chance to fully fund a reserve, the costs of defense will be financially painful.

Summary

There are many techniques available for asset protection and we have provided just a brief introduction. There are limitations on the planning with costs and timing our primary concerns. If asset protection is adopted as an alternative rather then a supplement to existing coverage, you will have potential issues with hospital privileges, damage caps and the costs of a lawsuit defense. Asset protection may provide an excellent solution to the liability and financial risk faced by many physicians. Because there are many variable factors to consider in each case it is important to discuss each of the key issues with your professional advisor to develop the strategy that accomplishes your important goals.

Full Original Article

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Asset Protection for Physicians and High-Risk Business Owners by Robert J. Mintz JD, LLM

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