Occasionally, clients who are interested in asset protection will ask me what type of structure provides the best protection: a trust, a Family Limited Liability Company (FLLC), or a Family Limited Partnership (FLP)?
Let’s start by analyzing what each of these different structures has to offer.
An Asset Protection Trust
An asset protection trust typically establishes terms for how the beneficiary of the trust is allowed to receive funds from the trust. The more restrictive the trust is, then the more asset protection it provides. A trust that allows a beneficiary to broadly invade a trust is not a trust that can protect the assets. A trust that provides that only a neutral third party may distribute to a group of beneficiaries in the sole discretion of that neutral trustee provides much more protection for the beneficiaries. Additionally, a trust can provide for unequal distributions to beneficiaries.
There is also a major difference depending upon whether you create a trust for yourself or if another person creates and funds the trust for you. It is very easy to create a trust for your spouse, descendant, or other loved ones with asset protection features. While more and more states are allowing self settled spendthrift trusts (an asset protection trust that you create for yourself), it is usually more costly to create, and one must be very careful in terms of funding it and using the assets in the trust. If the settlor retains too much control or uses the assets in the trust too much for personal living, the trust is less likely to be respected by the courts in the event there is litigation.
For those who value extreme asset protection, it may be worthwhile using the services of an offshore trust company. The benefit of creating an offshore asset protection trust is that anyone suing the trust would need to sue in the jurisdiction where the trust is located.
Is creating an asset protection trust worthwhile?
When considering if an asset protection trust is worth creating, ask yourself:
- Am I providing asset protection for myself, for others, or both?
- What types of risks am I trying to prevent against?
- Are those risks able to be covered by insurance?
- How great is the risk?
- Is it more important that the beneficiaries of the trust have unfettered access to the funds or is it more important to protect the funds?
Many clients tell me that they wish to have asset protection. Typically though, when I ask them the questions above, the risk is usually small and more theoretical in nature. Moreover, other than divorce, the risk can usually be covered by insurance. The importance of this analysis is that it affects what type of trust we create. If the answers to the above questions are that the client is trying to protect himself/herself from creditors that won’t be covered by insurance, that they are engaged in lawful activities but at high risk for being sued, and that the client doesn’t really need access to the funds, then a self settled asset protection trust may be appropriate.
If the goal is to provide funds to the client’s children and protect the children from divorce (but currently in a good marital situation), then it is more likely a traditional trust can be created for the child that gives the child some access to the trust funds without the need for an expensive neutral trustee. Something as simple as a traditional ILIT can make a great asset protection trust, especially if funded with whole life insurance.
An asset protection trust can be costly to create and maintain (high annual fees for an independent trustee). Additionally, better protection is achieved by ceding control. So to answer the question of whether an asset protection trust is worthwhile, the more money you have and the more at risk you are for a lawsuit, the more you want to set up a trust.
Other benefits of a trust structure
It should be noted that one of the major benefits of all trusts, including asset protection trusts, is that it can act like a Will and dictate where the assets should go upon the death of a beneficiary. This is not a feature of most business entities.
Family Limited Liability Company (FLLC)
Single-Person FLLC
A single-person FLLC offers some asset protection. However, for a variety of reasons, it is not the most secure. First, for tax reasons, the IRS considers a single-person LLC a “disregarded entity”. Legally, what this means is that all the income earned by the LLC is taxed to the person individually. As a practical matter, it confuses people into thinking that the LLC and the person are the same, so why bother with formalities? However, keeping up with the formalities (such as having things titled in the name of the LLC, telling third parties that they are doing business with the LLC rather than the person individually, and not using the business as your personal account) is what provides the asset protection!
Additionally, and most importantly, an LLC by its nature is designed to provide protection one way. Specifically, it provides protection for your personal assets if there is a lawsuit against the LLC. It doesn’t necessarily provide protection against the LLC assets if you are sued personally.
Multi-Member FLLC
As with a single-member FLLC, a multi-member FLLC without an operating agreement offers decent protection for the members’ personal assets from any lawsuit arising from business conducted by the FLLC. However, it offers little protection for misdeeds done outside the FLLC as a Court can impose a charging order against the FLLC.
That being said, a multi-member FLLC with a strong operating agreement limiting distributions can provide much more protection. This is why there is more of a setup cost. This structure is good for people who don’t want to part with their assets and/or think they will need it in the future. By simply shutting down the FLLC, with the agreement of the other members of course, you can relatively easily get your assets back.
Big Difference Between Trusts and FLLC
One big difference between a trust and an FLLC is that the trustee can distribute to beneficiaries of a trust unequally. With an FLLC, typically the manager MUST distribute to the members equally. (However, if a person is serving as a manager or providing other services to the FLLC, the person can be compensated for that.)
Family Limited Partnership (FLP)
A Family Limited Partnership is very similar in purpose and style to a FLLC. The one big benefit to the FLP is that it provides a very clear automatic distinction between full control partners and limited partners. A Limited Partnership, by definition, must have at least one general partner who has control. Accordingly, if you know that you wish to have family members with an economic interest, but no control, this is usually the way to go.
When setting up an FLP, it is also very important to create a limited partnership agreement clarifying the level of control and who will be the general partner. The biggest hurdle in creating a Limited Partnership is that the General Partner has unlimited liability. This hurdle is easy to overcome though by simply making the General Partner another FLLC.
Because of the ease of creating these structures, the clear asset protection for limited partners, and the ability to achieve favorable tax results, it is a favorite amongst most practitioners for providing asset protection.
Maximum Protection Can Best Be Achieved By Using a Combination of Asset Protection Trusts and Business Entities.
You can achieve your asset protection goals by using either trusts or business entities. However, it is usually best to use multiple structures and obtain proper insurance in order to achieve maximum protection. For example, let’s say that you and your spouse have $60M in real estate, you most likely would not want to own that outright. Perhaps it would be wise to have a multi-tiered structure in which you have an FLP where the General Partnership is an LLC owned by you and your spouse, in a revocable trust, and the Limited Partnership interests are owned partially by your revocable trust and partially by an irrevocable trust for your minor children. The appropriate entities should obviously still have insurance on the properties.
Usually, an arrangement like this can be structured in a way to minimize estate taxes as well since the transfer of limited partnership interests (which lack control and marketability) would be made at a discount for estate tax purposes. This topic deserves its own blog post though.
Conclusion
There are many ways to provide asset protection. The attorneys at The Pollock Firm LLC start by getting to know you and your family, determining your risk, and then understanding your goals. We then work with you based on these goals to provide a complete asset protection solution.
Please note:
- Asset protection entities and trusts are under constant scrutiny by the IRS. So it is best to meet with your legal team frequently to ensure that your structure continues to minimize taxes in the manner that you anticipate.
- We do NOT assist clients in fraudulent transfers. Please do not ask.
