Inaction by Congress has left the dying/inheritance process in chaos! Uncertainty reigns! No one knows what to do!
Although in 2010 ONLY there is no limit on the amount of money and other assets a person can leave to heirs without having to pay federal estate taxes, there are a number of critical caveats.
CAVEAT #1: The value of the assets in an estate is based on the ORIGINAL cost — not the market value at the time of death.
CAVEAT #2: This mean capital gains taxes are due when the house or other
asset is sold. If a house was purchased 30 years ago for $50,000 and sold
for $400,000, then capital gains taxes would be due on $350,000.
The cost of capital improvements can be added to the original purchase price,
which will reduce the amount on which capital gains taxes are due. For example,
a new kitchen, roof, furnace, air condition, windows can be added. A new deck
or finishing the basement also qualify.
CAVEAT #3: These capital improvement costs have to be documented by the
executor. The problem, of course, is that few people keep such records or
bills from work done sometimes decades ago.
CAVEAT #4: In 2010 only, the estate’s executor has what can be called a
discretionary basket of $1.3 million assignable dollars to cushion the impact
of the capital gains liability. In order to take advantage of this “money”
the executor must allocate an appropriate amount to a clearly specified
asset.
In the case of the house, $350,000 can be used to “erase” the gain when the
house is sold. This leaves $950,000 which can be used against the sale of
other assets.
THE 2010 RULES: Therefore, if death occurs in 2010 only, there is no
federal limit to the value of an estate and there is the availability of
discretionary assignable dollars to offset the capital gains liability.
CAVEAT #5: New Jersey still uses the old rules. There is a $675,000
exemption for assets going to linear heirs (children and grandchildren). In
addition, assets are valued on a stepped-up basis, which is market value at the
time of death.
THE PROBLEM: Thus executors are faced with a record tracking nightmare for
federal purposes and with two sets of basic rules.
WHAT’S AHEAD FOR 2011? The current law states that the exemption from
federal estate taxes goes down to $1,000,000 in 2011 and assets are market
valued at death. Taxes, as high as 55 percent, may be due on anything above
$1,000,000.
CAVEAT #6: Many wills use a formulata approach to set up marital trusts to
minimize taxes when the second spouse dies. Depending on how the will is
worded, the surviving spouse or other heir may not receive what the deceased
really wanted. This is too complicated to explain here.
CAVEAT #7: No one knows when or even if Congress will act. Because it is
an election year, Congress may not act at all. Whenever Congress does act,
the new law may be retroactive to January 1, 2010. This means estates may
remain in limbo indefinitely. In 2010, executors need to be very
conservative in distributing assets early on and closing an estate.
The federal estate tax, or “death tax” is in the news these days.
This year (2010) there is no federal estate tax. It was repealed, but only for one year. The federal estate tax will be reinstated in 2011, with a $1 million exemption and a maximum effective rate of 55%. In general, this means for persons with net worth of over $1 million, including life insurance they own, the amount over $1 million is taxable. In 2009 the exemption was $3,500,000, so not many people had estate tax exposure. Next year with a new law, and hopefully a rising economy, this may change.
During 2010, the federal gift tax remains in effect, but at a lower 35% rate. For gift tax, there will be a $1 million lifetime gift tax exemption and an annual gift tax exclusion of $13,000 per donee. Rates on gift tax also rise in 2011 to a maximum marginal rate of 55%.
Concerning capital gains on estate property, before this year (2010) the cost basis for assets held by a decedent would step up (or down) to the fair market value of the asset on the decedent’s date of death. This eliminated a capital gains tax on any pre-death appreciation.
Now, for one year, the “step-up” in cost basis at death for assets acquired from a decedent has been eliminated, and replaced with a modified “carryover basis” system. Assets generally will receive a cost basis equal to the basis of the property in the hands of the decedent under the carryover basis system. An executor can allocate up to $1.3 million of increased basis to the decedent’s assets in general, and an additional $3 million for assets passing to a surviving spouse. Under current law, the prior step up in cost basis will return in 2011.
The annual changes in estate taxes have been confusing to many. Congress may again make changes to the current law. At this time, though, many wills and trusts written in the past that contain plans to minimize estate taxes may not be effective under the current law. Having these reviewed would be a sound idea.
A power of attorney is a very important estate planning tool, but in fact there are several different kinds of powers of attorney that can be used for different purposes. Before executing this crucial document, it is important to understand what your options are.
A power of attorney allows a person you appoint — your “attorney-in-fact” or agent — to act in your place for financial or other purposes when and if you ever become incapacitated or if you can’t act on your own behalf. There are four main types of powers of attorney.
•Limited. A limited power of attorney gives someone else the power to act in your stead for a very limited purpose. For example, a limited power of attorney could give someone the right to sign a deed to property for you on a day when you are out of town. It usually ends at a time specified in the document.
•General. A general power of attorney is comprehensive and gives your attorney-in-fact all the powers and rights that you have yourself. For example, a general power of attorney may give your attorney-in-fact the right to sign documents for you, pay your bills, and conduct financial transactions on your behalf. You could use a general power of attorney if you were not incapacitated, but still needed someone to help you with financial matters. A general power of attorney ends on your death or incapacitation unless you rescind it before then.
•Durable. A durable power of attorney can be general or limited in scope, but it remains in effect after you become incapacitated. Without a durable power of attorney, if you become incapacitated, no one can represent you unless a court appoints a conservator or guardian. A durable power of attorney will remain in effect until your death unless you rescind it while you are not incapacitated.
•Springing. Like a durable power of attorney, a springing power of attorney can allow your attorney-in-fact to act for you if you become incapacitated, but it does not become effective until you are incapacitated. If you are using a springing power of attorney, it is very important that the standard for determining incapacity and triggering the power of attorney be clearly laid out in the document itself.
Regardless of what type of power of attorney you use, it is important to think carefully about who will be your attorney-in-fact. Your attorney-in-fact will have a lot of control over your finances, and it is crucial that you trust him or her completely.
While many pre-packaged do-it-yourself power of attorney forms are available, it is a good idea to have an attorney draft the form specifically for you. There are many issues to consider and one size does not fit all.
Few things get people madder at their estate planners than fights over who must pay taxes when someone dies. A big source of trouble: the patchwork of state rules that apply.
Most states say those who inherit have to share the tax burden for an estate. Many wills include provisions designed to take care of that problem, but these can sometimes produce unpleasant surprises. A recent Wisconsin Supreme Court decision shows the lack of coherence among states and the problems that can ensue.
Wisconsin says taxes must be paid from a single pot of money in an estate. (Georgia, Iowa and Arizona have similar laws.) But when James F. Sheppard died and left a goddaughter, Jessica Schleis, over $3.7 million, the estate sought to get her to pay taxes on her inheritance.
Sheppard, co-founder of a sandwich chain, was worth $12 million when he died in 2007, but had no will. He left the money to Schleis in two special accounts, one known as a “Payable on Death” account, and the other in a “Transfer on Death” account. A Wisconsin court held the estate, not Schleis, responsible for the tax and last week the state’s highest court affirmed that ruling after an appeal.
All of the trouble could have been avoided had Sheppard had a will — but only if such a will “did the right thing” in spelling out details.
A typical will contains an instruction that all debts, expenses and taxes be paid from what’s left of an estate after the heirs get the money or property bequeathed to them. Its called the “Dad-buys-dinner” provision, as when a father picks up the tab for the entire family at a restaurant.
This approach often creates problems, as it did in the Sheppard case. So most states have default laws that apportion taxes among all the beneficiaries, an approach Pennell calls “Dutch treat.”
As a general matter, a will can trump the state default rules on who gets what and who owes what taxes from an estate. More “estate meltdowns” spring from the “Dad-buys-dinner” provision than from any other.
The issue is only growing more acute as people transfer assets outside of wills through vehicles such as life insurance, leaving less in the estate to cover tax obligations and complicating the issue of who owes how much in taxes. Non-probate transfers have been on the upswing over the past decade.
If a person goes out and buys life insurance, for a child, a lover or a loyal employee, that has tax implications for everyone. To avoid trouble the resident of a state needs to know the default rule there and then decide whether he wants the will to adopt it or change it.
The key is to understand the issue and coordinate a proper response.
Otherwise, the estate could be on the hook for taxes on property, money or some other asset left to a secret beneficiary on the side. The story of television news personality Charles Kuralt is a case in point. Kuralt left property on the Big Hole River in Montana to his longtime lover, civil rights activist Pat Baker, touching off a court battle over whether his widow, Suzanna, should have to pay the taxes on it.
To pay for the hiring incentives in the recently enacted “Hiring Incentives to Restore Employment Act” (the 2010 HIRE Act), Congress passed several offsetting revenue raisers, including a comprehensive set of measures to reduce offshore noncompliance by giving IRS new administrative tools to detect, deter and discourage offshore tax abuses. Here is a brief overview of the new offshore anti-abuse provisions.
Increased disclosure of beneficial owners
Reporting on certain foreign bank accounts. The Act imposes a 30% withholding tax on certain income from U.S. financial assets held by a foreign institution unless the foreign financial institution agrees to disclose the identity of any U.S. individual with an account at the institution (or the institution’s affiliates) and to annually report on the account balance, gross receipts and gross withdrawals/payments from such account. Foreign financial institutions would also be required to agree to disclose and report on foreign entities that have substantial U.S. owners. Congress expects that foreign financial institutions will comply with these disclosure and reporting requirements in order to avoid paying this withholding tax. These provisions are effective generally for payments made after 2012.
Reporting on owners of foreign corporations, foreign partnerships and foreign trusts. The Act requires foreign entities to provide withholding agents with the name, address and tax identification number of any U.S. individual that is a substantial owner of the foreign entity. Withholding agents are to report this information to the U.S. Treasury Department. The Act exempts publicly-held and certain other foreign corporations from these reporting requirements and provides the Treasury Department with the regulatory authority to exclude other recipients that pose a low risk of tax evasion. Any withholding agent making a withholdable payment to a foreign entity that does not comply with these disclosure and reporting requirements is required to withhold tax at a rate of 30%. These provisions are effective generally for payments made after 2012.
Extending bearer bond tax sanction to bearer bonds designed for foreign markets. Bearer bonds (i.e., bonds that do not have an official record of ownership) allow individuals seeking to evade taxes with the ability to invest anonymously. Recognizing the potential for U.S. individuals to take advantage of bearer bonds to avoid U.S. taxes, Congress took a number of steps in the 1980’s to eliminate bearer bonds in the United States . First, they prevented the U.S. government from issuing bearer bonds that would be marketed to U.S. investors. Second, they imposed sanctions on issuers of bearer bonds that could be purchased by U.S. investors. The Act extends many of these sanctions to bearer bonds that are marketed to foreign investors and prevents the U.S. government from issuing any bearer bonds. These provisions apply to debt obligations issued after the date which is two years after the new law’s enactment date.
Foreign financial asset reporting
Disclosure of information with respect to foreign financial assets. The new law requires individuals to report offshore accounts and other foreign financial assets with values of $50,000 or more on their tax returns. Individuals who fail to make the required disclosures are subject to a penalty of $10,000 for the tax year; an additional penalty can apply if Treasury notifies an individual by mail of the failure to disclose and the failure to disclose continues. These provisions apply for tax years beginning after the new law’s enactment date.
Penalties for underpayments attributable to undisclosed foreign financial assets. For tax years beginning after the new law’s enactment date, the Act imposes a penalty equal to 40% of the amount of any understatement that is attributable to an undisclosed foreign financial asset (i.e., any foreign financial asset that a taxpayer is required to disclose and fails to disclose on an information return).
New 6-year limitations period. For returns filed after the new law’s enactment date as well as for any other return for which the assessment period has not yet expired as of the new law’s enactment date, the Act imposes a new six-year limitations period for omissions of items from a tax return that exceed $5,000 and are attributable to one or more reportable foreign assets. The Act also clarifies that the statute of limitations does not begin to run until the taxpayer files the information return disclosing the taxpayer’s reportable foreign assets.
Other disclosure provisions
New reporting rule for PFICs. Effective on the new law’s enactment date, activities with respect to passive foreign investment companies (PFICs) are subject to a new reporting rule. Unless otherwise provided by IRS, each U.S. person who is a shareholder of a PFIC must file an annual information return containing such information as IRS may require. A person that meets this new reporting requirement could, however, also have to meet the new reporting rule requiring disclosure of information with respect to foreign financial assets (see above). It is anticipated that IRS will exercise its regulatory authority to avoid duplicative reporting.
Electronic filing. For returns the due date for which (determined without regard to extensions) is after the new law’s enactment date, the Act creates an exception to the general annual 250 returns threshold for electronic filing: IRS will be permitted to issue regs requiring filing on magnetic media for any return filed by a financial institution with respect to any taxes withheld by it for which it is personally liable. Thus, IRS will be authorized to require a financial institution to electronically file returns with respect to any taxes withheld by the financial institution even though the financial institution files less than 250 returns during the year.
Provisions related to foreign trusts
Clarifications with respect to foreign trusts. Under present law, a U.S. person is treated as the owner of the property transferred to a foreign trust if the trust has a U.S. beneficiary. Under current Treasury regulations, a foreign trust is treated as having a U.S. beneficiary if any current, future or contingent beneficiary of the trust is a U.S. person. Notwithstanding this requirement, some taxpayers have taken positions that are contrary to this regulation. In order to enhance compliance with this regulation, the Act codifies this regulation into the statute. This provision is effective on the new law’s enactment date. The Act also clarifies that a foreign trust will be treated as having a U.S. beneficiary if (1) any person has discretion to determine the beneficiaries of the trust unless the terms of the trust specifically identify the class of beneficiaries and none of those beneficiaries are U.S. persons or (2) any written oral or other agreement could result in a beneficiary of the trust being a U.S. person. As a final clarification, the Act clarifies that the use of any trust property will be treated as a payment from the trust in the amount of the fair market value of such use.
Presumption with respect to transfers to foreign trusts. For transfers of property after the new law’s enactment date, the Act provides that if a U.S. person directly or indirectly transfers property to a foreign trust (other than a trust established for deferred compensation or a charitable trust) IRS may treat the trust as having a U.S. beneficiary unless such person can demonstrate to the satisfaction of IRS that under the terms of the trust, (1) no part of the trust may be paid or accumulated during the year for the benefit of a U.S. person, (2) that if the trust were terminated during the year, no part of the trust could be paid to a U.S. person (3) and that such person provides any additional information as IRS may require with respect to such transfer.
Minimum penalty with respect to failure to report on certain foreign trusts. Under pre-Act law, a taxpayer that fails to file an information return with respect to certain transactions involving foreign trusts (e.g., the creation of a foreign trust, the transfer of money or property to a foreign trust, or the death of a U.S. owner of a foreign trust) is subject to a penalty of 35% of the amount required to be disclosed on such return. If IRS uncovers the existence of an undisclosed foreign trust but is unable to determine the amount required to be disclose on such return, it is unable to impose a penalty. The Act strengthens this penalty by imposing a minimum penalty of $10,000 on any such failure to file. This provision applies to notices and returns required to be filed after Dec. 31, 2009. Notwithstanding this minimum penalty, in no event may the penalties imposed on taxpayers for failing to file an information return with respect to a foreign trust exceed the amount required to be disclosed on the return.
Dividend equivalent payments
Dividend equivalents treated as dividends. For payments made on or after the date that is 180 days after the new law’s enactment date, the Act treats a dividend equivalent as a dividend from U.S. sources for certain purposes, including the U.S. withholding tax rules applicable to foreign persons. A dividend equivalent is any substitute dividend made pursuant to a securities lending or a sale-repurchase transaction that (directly or indirectly) is contingent upon, or determined by reference to, the payment of a dividend from sources within the U.S. or any payment made under a specified notional principal contract that directly or indirectly is contingent upon, or determined by reference to, the payment of a dividend from sources within the U.S. A dividend equivalent also includes any other payment that IRS determines is substantially similar to a payment described in the preceding sentence. Under this rule, for example, IRS may conclude that payments under certain forward contracts or other financial contracts that reference stock of U.S. corporations are dividend equivalents.
Inheritance Tax, also referred to as the death duty, is the set of taxes which has to be paid by the heir on inheriting the estate of a deceased person. This tax is calculated after taking the total value of the property and money into consideration. The norms of inheritance tax can differ from nation to nation, as well as state to state. For instance, the due date for New Jersey inheritance tax is 8 months from death. Inheritance tax is not a prominent contributor to the treasury, and hence is not considered to be as important as income tax.
Inheritance Tax in the United States
In the United States, two things are taken into consideration when imposing inheritance tax – the sum value of the estate and the inheritor’s relationship to the deceased. In order to qualify for inheritance tax, generally, the sum value of the estate must exceed US $1.5 million. The immediate relatives of the person i.e. the spouse, children, parents and grandchildren, are classified as ‘Class A’ relatives, and hence are exempted from paying inheritance tax. The states which collect inheritance tax in the United States are Indiana, Kentucky, Pennsylvania, Iowa, Maryland, Nebraska and New Jersey.
Inheritance Tax in New Jersey
The inheritance tax in New Jersey is more often referred to as New Jersey inheritance tax. The sum value of the estate should be at least $500 or more in order to levy this tax. New Jersey inheritance tax, which is to be paid by the legal beneficiaries, and New Jersey estate tax, which is to be paid from the assets in the estate before distribution, are two different concepts. Assets such as stocks, bonds and security are subject to inheritance tax in New Jersey, only when the deceased person was a resident of New Jersey. Income from life insurance contract of the deceased person is directly payable to the beneficiaries and hence is not considered to be taxable as per the New Jersey inheritance tax laws. The beneficiaries/heirs of the estate are categorized into various classes depending on their relationship with the decedent. The exemption amount and the tax rate varies from one class to another. Generally, this tax is imposed at the graduate rate ranging between 11 to 16 percent. Some of the relatives, such as the spouse and the children of the decedent, are totally exempted from paying the inheritance tax in New Jersey. The second class of beneficiaries, which includes the brother, sister, son-in-law or the daughter-in-law of the deceased person, are granted an exemption of $25,000. But for the next $1,075,000, they are taxed at 11 percent and for the estate amounting to more than that 13 to 16 percent. Rest of the beneficiaries are taxed at 15 percent for the first $700,000 and 16 percent for estate amounting to more than that.
Filing and Payment of New Jersey Inheritance Tax
If the beneficiaries are subject to New Jersey inheritance tax, they have to file an inheritance tax return. If the decedent was a resident of New Jersey, Form IT-R should be used, and if the decedent was not a resident, then Form IT-NR should be used. If the beneficiaries, being the immediate relatives, are exempted from the inheritance tax, they don’t have to file an inheritance tax return. They will have to use Form L-8 in order to release bank accounts, stocks, bonds etc, and Form L-9 in order to release the State’s lien on real property. Before transferring the assets like real estate or stocks, the beneficiary has to obtain a written consent from the Director of the New Jersey Division of Taxation. This waiver, which doesn’t apply when Forms L-8 and L-9 are not applicable, is not granted until the beneficiary pays the inheritance tax. The due date to pay inheritance tax in New Jersey is 8 months after the death of the individual whose estate will be passed on to the heir. Tax debt, if any, after the due date will be subject to interest.
Even though, both inheritance tax as well as estate tax are based on the same principle, (i.e. when an individual is legally named the heir of the estate, he is liable to pay a particular sum to the administrative body), the state government is assigned with the responsibility to collect the inheritance tax, while the federal government collects the estate tax.
People who provide for their beneficiaries in their estate planning documents generally do a good job with their financial assets but are oftentimes remiss in providing detailed instructions regarding their tangible personal property (ie. household furnishings, jewelry, collections etc…). This is usually due to the erroneous belief that these assets don’t hold much value. However, as estate planners, we regularly see disputes among family members regarding the division of these assets after death, as their sentimental value is oftentimes under-appreciated when one does estate planning.
The holidays are an opportune time to take a sentimental tour with your children and grandchildren. Share stories and explain the significance of your jewelry, artwork, antiques, and other belongings. Sharing the significance behind each item gives the heirlooms meaning and value in the eyes of the recipient. Specifically, you may wish to:
- Identify specific items that you would like someone to have;
- Decide when you would like others to receive their something special;
- Express your wishes to a family member or the person named as executor of your estate; and
- Follow-up with language in your Will or other estate planning document to provide a roadmap for the ultimate distributions of these assets.
Your assets do not have to wait until your death to be distributed and enjoyed. However, in the event that you wish to retain your tangible personal property until your death, you should provide detailed instructions as to who you wish to receive your most prized possessions. An estate planning attorney can provide you with the best options as to how best to memorialize your wishes in writing.
If you live in New Jersey, then you’re lucky enough to live in one of the two states that collects both a separate state inheritance tax and estate tax (the other is Maryland). Currently the following rules apply with regard to the New Jersey inheritance tax:
•Charitable organizations are exempt from the tax.
•All other beneficiaries are broken down into three categories with regard to the tax:
•Class A beneficiaries. No tax is imposed on the following beneficiaries – spouses, civil union partners, domestic partners, parents, grandparents, and descendants (including those legally adopted).
•Class B beneficiaries. This class no longer exists.
•Class C beneficiaries. For the following beneficiaries – siblings, spouse or widow(er) of a child of the decedent, and civil union partner or surviving civil union partner of a child of the decedent – the first $25,000 is exempt and transfers above this amount are taxed at 11%–16%.
•Class D beneficiaries. For all other beneficiaires, the first $500 is exempt and transfers above this amount are taxed at 15%–16%.
•Life insurance paid to a named beneficiary is exempt from the tax.
•An inheritance tax return, Form IT-R for residents or Form IT-NR for nonresidents, must be filed and the tax paid within eight months after the decedent’s death.
•While no inheritance tax return is required to be filed for Class A beneficiaries, Form L-8 may be used to secure the release of bank accounts, stocks, bonds and brokerage accounts. If there was any real property in the name of the decedent, Form L-9, or Form L-9NR for a nonresident decedent, may be filed to release the State’s lien on the real property.
The bottom line – if you’re a New Jersey resident and your estate is passing to someone other than your immediate family, or if you’re a nonresident who owns real estate and/or tangible personal property located in New Jersey and it’s not passing to your immediate family, then your beneficiaries may owe a New Jersey transfer inheritance tax.
Physicians consider themselves targets, and they are, but their biggest predators are not personal injury lawyers. The average physician is not likely to be successfully sued in excess of their reasonable medical malpractice limits – such verdicts are actually very rare and nearly all could have been settled within the limits of the physician’s coverage.
Where physicians are most likely to lose wealth is through bad marriages, bad investments, bad tax planning, or a combination thereof. The average physician usually can’t name a colleague who got cleaned out in a medical malpractice lawsuit, but they can readily name a list of buddies who have lost money to ex-spouses, in various investment schemes, or they got burned in a tax shelter.
Indeed, physicians are stalked by a variety of promoters hawking all sorts of schemes, from tax shelters such as Irish/Barbados employee leasing schemes, to screwy and hyper-risky investments, to cookie-cutter offshore asset protection structures, and all sorts of other questionable schemes. Some groups even exist to market just to physicians, and offer them a veritable buffet of canned products and services that are advertised as meeting the specific needs of physicians but are simply mediocre or questionable solutions that have been repackaged with an MD logo.
Some of these groups adopt fancy names to try to sound respectable, such as “American Foundation for Physician Justice and Asset Protection”, and claim that they have been “endowed” by grants. Most of these scams are run from the Salt Lake City area, and they work by holding seminars enticing physicians to spend $2,000 or more on (worthless) kits that purport to allow them to form family limited partnerships and various special trusts. Usually, the seminars are loaded with paid shills who at the conclusion of the seminar will stand up and rush to the back, so that purportedly they won’t be the last and not get one of these kits, and thus trying to stampede the rest of the crowd to do the same. After the seminar, the checks of the shills are torn up of course, and the physician takes his kit home to self-create a nightmare of tax consequences for himself.
How good are these kits? Let’s put it this way: If you bought a kit with a laser pointer and a how-to videotape and a guide to performing laser surgery on your own eye, would you start pointing the laser pointer into your eye hoping that it would eliminate your need to wear glasses? That’s about the level of sophistication that these kits offer, and the structures they tell you to set up suffer from glaring defects, such as making the physician the general partner of his own family limited partnership. These kits also create tax nightmares.
This isn’t to say that physicians do not need asset protection, but that the asset protection they are getting usually isn’t what they need. But in attempting to satisfy those needs, a significant problem is that the average physician simply doesn’t have enough wealth to make the best planning cost-effective. The better solutions that are available to a small business owner making $5 million or more per year and having a net worth of $30 million or more, usually make no economic sense for a physician struggling to net a million or two per year after taxes. Thus, physicians tend to end up in one-size-fits-all legal or financial products than personalized planning for their unique needs. While the use of some product solutions is necessary to keep costs down, physicians still require a holistic and blended legal, financial and tax plan.
Strategies to Avoid
Foreign Asset Protection Trust – Although offshore trusts are mass-marketing to physicians as asset protection tools, they work very poorly for physicians. The reason is that the Anderson and Lawrence decisions have demonstrated that all a creditor needs to do is to ask the court to enter a repatriation order (“bring all the assets back to the U.S.”) against the settlor of an offshore trust, and if the settlor doesn’t bring the assets back to the U.S., then the court simply throws the settlor in jail until he does. This creates an important limitation on offshore trusts: They work only if you are prepared to flee the United States.
The problem for physicians is, of course, that their practices are in the U.S. and they probably couldn’t make anywhere near the revenue outside the country that they do in it. Thus, although lots of physicians have been sold offshore trusts, what happens in real life is that the physician doesn’t want to either flee the country or spend time in jail, so that when litigation arises they end up abandoning the offshore trust that they spent so much money for. In other words, when push comes to shove the offshore trust is worthless unless, again, you are willing to flee the country.
Before considering a Foreign Asset Protection Trust, better check out the collection of cases at http://www.assetprotectionbook.com/a2_a … fshore.htm first. A physician who has a Foreign Asset Protection Trust might even consider getting rid of it to avoid later possible problems.
Professional Leasing Companies – This is a tax scam whereby the physicians fires himself from his own professional practice, and then is re-hired by an employee leasing company situated usually in either Ireland or Barbados. The physician’s practice pays large employee leasing fees for the physician’s services to the Irish or Barbados company, which then pays the physician a small salary and drops the rest into a non-qualified deferred compensation account, known as a “Rabbi Trust”.
While all this sounds neat, the IRS considers it to be an abusive tax shelter, and the U.S. Department of Justice has started prosecuting those who have participated in these schemes. See http://www.quatloos.com/employee_leasing_shelters.htm
Basic Corporate Planning Strategies
Professional Corporation – A professional corporation will not, by statute, shield the physician from professional negligence claims. The professional corporation might, however, be useful in encapsulating within it the liability from other claims, such as employment practices claims made by staff, certain toxic materials claims, etc. Additionally, the use of a professional corporation may later give tax planners some options if the practice is later sold.
Equipment Leasing – Many physician practices require expensive medical equipment, such as CT scan or laser-vision machines. If these machines are owned by the practice, or worse by the physician individually, any equity in them is exposed to creditors. Even worse, a valuable opportunity is being missed to strip wealth from the practice by way of an equipment leasing entity. Basically this arrangement involves a new limited partnership or LLC that is set up for no other purpose than to hold the equipment used in the practice. The existing equipment is then either sold or contributed to the equipment leasing entity, which then leases it back to the practice. Every dollar paid to the equipment leasing entity for use of the equipment is a dollar that is removed from the potential reach of the practice’s creditors.
It is not just enough to set up a leasing company and call it a day. The ownership of the leasing company must be structured so that the company cannot be seized by creditors, or the creditors can convince a court that the arrangement is a sham.
Property Leasing – Many physicians own the building from where their practices do business. By separating the “dirt” from the practice, a physician creates an additional avenue to strip money from the practice and thus away from future unknown creditors. As with equipment leasing companies, it is not enough to simply put the dirt into a different entity. The entity must be structured so that a creditor cannot seize the entity or convince a court that the leasing arrangement is a sham.
Integrated Estate Planning Strategies
Family Limited Partnership or LLC – When properly done (which, by the way, is a rarity), a structure involving one or more Limited Partnerships or LLCs can provide substantial asset protection for a portion of the physician’s assets.
As with Foreign Asset Protection Trusts, the problem with these structures is that they are often sold as the only solution for the physician. While these structures can solve some problems – and should be used for the problems – they are unsuitable for solving many of the asset protection issues face by physicians.
Premium Financing – Traditionally a method of purchasing large amounts of life insurance, premium financing also can have the benefit of encumbering real estate, stock accounts, and other valuable assets, thus denying their benefit to creditors until the life insurance policy pays out. Because most creditors will probably not want to wait possibly decades to get at the assets, settlement is facilitated.
Insurance Strategies
Umbrella Insurance – Although umbrella insurance is not meant to act as a substitute for the physician’s medical malpractice insurance, umbrella insurance does play an important role in make the physician’s other asset protection better insofar as it can often be taken into account if a court attempts a “solvency analysis” to determine whether a fraudulent transfer has occurred. Also, if litigation does arise, a plaintiff’s attorney may well become fixated on hitting the umbrella insurance policy chasing the limits of the umbrella insurance policy, to the exclusion of the physician’s other personal assets.
Captive Insurance Company – Physicians always want to know whether a captive insurance company makes sense for them, and it almost never does. Typically, the insurance policies issued by a captive cannot be used for hospital privileges, the formation costs and ongoing expenses are too high, and frankly most physicians do not have enough wealth to capitalize an insurance company and spread the risk against a run of bad luck in underwriting.
Cell-Captive a/k/a Rent-A-Captive – Physicians are often scammed into participating into what is known as a “cell captive” whereby they pay premiums to an insurance company that segregates their premiums into a “cell”, and basically the only “reserves” they have available to pay claims is whatever they have collected in their own accounts. There are many problems with this, with the first problem being that either the hospital where they need privileges either will not accept the coverage or they are making misrepresentations to the hospital about the true nature of their coverage. The second problem is that the physician is taking a deduction for the premiums paid, but because there is no true risk shifting or risk sharing such arrangements probably will not pass IRS scrutiny if the arrangement is audited. Finally, a single claim can clean out their account and leave them exposed again.
Group Captive – Sometimes a group of physicians can group together to form a captive insurance company that they all own, and which underwrites various risks of their practice. While this arrangement makes tremendous sense, group captives for physicians are usually never successfully put together. There are several reasons for this, primarily that each physician is concerned that one or two significant claims by her colleagues will wipe out the company’s reserves and leave her own policies issued by the company worthless. Although these concerns can be mitigated in several ways, such captives rarely get past the discussion stage.
Risk Retention Group – Despite the problems with captives, there should be no doubts that risk retention groups (RRGs) make tremendous sense for physicians. Basically, a RRG is an insurance company that is licensed in one state (usually a state with “captive” legislation) and then qualifies under the federal risk retention statute for treatment as an RRG, meaning that it only has to notify other states that it is doing business there without affirmatively obtaining the other state’s approval. RRGs are regulated by the home state like any other insurance company, with the limitations that the policies it underwrites must be homogenous, its policyholders must by homogenous, the policyholders must own some portion of the company just like a mutual insurance company, and the RRG does not underwrite life insurance, workers compensation insurance, and several other types of policies.
The downsides to RRGs are that they usually have to have at least a few dozen members before they even start to make economic sense, and they function best when there are hundreds of members and can take advantage of the law of large numbers in underwriting. With the crisis in medical malpractice insurance that followed the investment markets decline of 2001-2002, new RRGs for physicians blossomed like wildflowers after a summer rain, with nearly 30 new RRGs for physicians being formed in 2003 alone. For the initial physician owners who start the RRG, there are tremendous money-making opportunities in addition to filling gaps in the availability of medical malpractice insurance. Another advantage of RRGs is that they have more latitude to “cherry pick” quality risks, i.e., not accept high-liability specialties like obstetrics.
Employee Benefit Strategies
Most physicians have IRAs and other pension plans, but depending on the states (or where they are sued) these plans may afford little or no protection against creditors – indeed, in some jurisdictions retirement plans are often attractive targets for creditors. From an asset protection perspective, a better type of planning involves certain advanced benefit plans, such as Section 419e Welfare Benefit Trusts or Section 412(i) Defined Benefit Plans.
The attractiveness of these plans is that since they are created for the benefit of the employees and not the owners, the assets in these plans should not be available to creditors of the business.
Because of these benefits, some form of ERISA planning usually makes sense for physicians, especially since they can simultaneously reduce their annual income tax paid since contributions to these plans are normally made pre-tax.
Collateralization Strategies
Accounts Receivable Factoring – Typically, one of the largest assets of the physician practice is also the asset which is most exposed to creditors: the accounts receivable. This is also a “non-working” asset, i.e., the value of the accounts receivable is not earning any investment income. By borrowing against the receivable, also known as “factoring”, they physician can effectively strip its value to creditors, while simultaneously leveraging the asset for investment purposes. During the last several years, major insurance companies and finance companies have developed sophisticated programs to facilitate the factoring of accounts receivables. These programs can and should be enhanced to provide significant protection for this valuable, and usually completed exposed, asset.