The following article was contributed by our friends at the trusts and estates law firm, The Law Offices of Ernest J. Kim
In the current economic climate, many employers are no longer able to generate the same
amount of income they did just a couple years ago. This has resulted in furloughs, pay cuts, and massive layoffs for employees. In addition to losing their main source of income – their paychecks – employees have had to suffer additional financial hits due to bad investments in real estate and stocks. These losses have forced many to file for bankruptcy or resort to other drastic means. It should come as no surprise that our law firm has seen an increase in the number of calls from employees requesting information on how to protect their assets from creditors trying to collect on debts.
Asset protection devices can provide effective protection against creditors for employees and their families who are facing bankruptcy, foreclosure, lawsuits, etc.
Tip 1: Professionals Watch Out
Those engaged in professional occupations in particular, such as doctors, lawyers, dentists, engineers, and accountants, should engage asset protection devices, as they are more vulnerable to being sued. In California, professionals are personally responsible for liability arising out of the practice of their professions.
Tip 2: Living Trusts Don’t Protect against Creditors
A common misconception is that a living trust will provide creditor protection. Living trusts do provide important benefits after the owner’s death, such as avoiding probate and reduction of estate taxes. However, living trusts do not provide creditor protection. If you are interested in asset protection, there are other trusts and methods available, considered to be “advanced” planning techniques, which will provide creditor protection if used and maintained properly.
Tip 3: A Qualified Personal Residence Trust Can Save Your Home
Some time ago, our law firm was contacted by a client who was a long-time employee at a successful retail business. Due to the financial crisis, however, the business lost money and was forced to close. Some of the suppliers who were owed money by the retail business sued the employee, arguing that he was personally liable for the contracts. The employee was aware that nothing could be done to avoid the lawsuit, so his main concern became protecting his home from the business creditors.
One option would have been to defend against the lawsuit and prevail. However, as any lawyer will tell you, victory in a lawsuit is never guaranteed, even when you are not at fault. A lawsuit can also be costly and could put you even further in debt.
A better option would have been to have set up a Qualified Personal Residence Trust (“QPRT”) to shield his home from creditors before the lawsuit was filed.
The QPRT is a trust technique that permanently transfers either a principal residence or a vacation home to your children while you are still living. Because you have already given your home to your children irrevocably in the trust, and it no longer belongs to you, your creditors cannot go after the house – technically you no longer own the house.
Caution: a QPRT is irrevocable and cannot be changed once it is set up. You cannot later choose to give your home to other people.
On the bright side, even after you set up a QPRT, you can sell your current home and replace it with a new home, and many of the tax advantages of home ownership remain available to you.
Another advantage is that, unlike an outright gift directly to your children, a QPRT gives you the legal right to continue living in the home. The QPRT will set a number of years for which you have the right to occupy the house and retain all income-tax benefits of home ownership (the “term”). After the term expires, you still have the right to continue occupying the house in exchange for rent paid to your children.
For example, you can set up the QPRT term for ten years. After ten years, if you want to continue to live in the house, you can pay reasonable rent to your children.
The QPRT is also one of the few methods available which can provide some protection for licensed professionals such as doctors, lawyers, dentists, architects, engineers, etc. This is important because professionals are normally unable to use most asset protection methods to avoid professional liability.
The QPRT also provides additional tax benefits. Transfers made during your lifetime are subject to gift taxes, and transfers made after you die are subject to estate taxes. With a QPRT, your children will be able to get a substantial discount on gift taxes owed. In addition, all future appreciation will be excluded from your estate, and it will not be subject to estate tax upon your passing.
Tip 4: Act Now BEFORE Problems Arise
A key point to remember is that most of these asset protection techniques must be put into place before the possibility of a creditor claim or lawsuit occurs. For example, the client mentioned above was already facing a lawsuit, and so it was too late for him to set up a QPRT. If he had set up the QPRT earlier, he could have protected his home. It is very important that the QPRT planning is done before problems arise.
There are many additional techniques that can provide creditor protection, as well as tax benefits. Please contact our offices if you wish to get a more detailed review of your assets and the techniques that would allow greater creditor protection for those assets. The QPRT is an advanced estate planning technique, and there are many other factors to consider before creating one. If you have questions about the QPRT or other techniques, please call our office.
The Law Offices of Ernest J. Kim has offices in Irvine, San Francisco’s Financial District, and Los Angeles. The law firm focuses on estate planning law, including preparation of living trusts, powers of attorney, marital property declarations, wills, irrevocable life insurance trusts, family limited partnerships, charitable gifts, private foundations, and other irrevocable trusts. Tax analysis is also provided for those with estates in excess of the exemption limits. After-service includes trust administration services, estate tax returns, probate filings and probate administration. You can visit their law firm website or call them at 1-800-793-5633.