How can I protect my personal assets from a failing family business?
Full Question:
Answer:
A person's personal assets are often protected from liabilities of a corporation, unless the person acted outside the authority of the position, breached a fiduciary duty, or the corporate entity is not truly separate from the person's personal dealings. When a corporation engages in wrongdoing, such as fraud, fails to pay taxes correctly, or fails to pay debts, the people behind the corporation generally are protected from liability. This protection results from the fact that the corporation takes on a legal identity of its own and becomes liable for its acts. However, courts will in some cases ignore this separate corporate identity and render the shareholders, officers, or directors personally liable for acts they have taken on the corporation's behalf. This assignment of liability is known as piercing the corporate veil. Courts will pierce the corporate veil if a shareholder, officer, or director has engaged in fraud, illegality, or misrepresentation. Courts also will pierce the corporate veil when the corporation has not followed the statutory requirements for incorporation or when corporate funds are commingled with the personal property of an individual or when a corporation is undercapitalized or lacks sufficient funding to operate.
Homestead laws allow an individual to register a portion of his real and personal property as "homestead," thereby making that portion of the individual's estate off-limits to most creditors. A trust can be used to perform many different functions, such as reducing or avoiding tax liability, easing lifetime financial management, protecting assets, preserving family wealth, ensuring continuity of a family business, donating to charities, voiding forced heirship laws, or create a pension scheme for employees or dependents. A properly structured and administered trust may produce substantial savings in income tax, capital gains tax and inheritance tax/estate taxes. By establishing a trust, probate delays, expenses, and requirements can be avoided. A trust allows a person to provide for those who may be unable to manage their own affairs such as infant children, the aged, or persons suffering from certain illnesses. Trusts provide flexibility in distributing its assets to beneficiaries according to the terms of the trust document. Rather than distributing shares to heirs, wealth may be retained in one fund and distributed in a specified manner, protecting trust beneficiaries from spending all their inherited property.
A trust can be created during a person's lifetime and survive the person's death. A trust can also be created by a will and formed after death. Once assets are put into the trust they belong to the trust itself, not the trustee, and remain subject to the rules and instructions of the trust document. Most basically, a trust is a right in property, which is held in a fiduciary relationship by one party for the benefit of another. The trustee is the one who holds title to the trust property, and the beneficiary is the person who receives the benefits of the trust. While there are a number of different types of trusts, the basic types are revocable and irrevocable.
A revocable living trust may be amended or revoked at any time by the person or persons who created it as long as he, she, or they are still competent. A living trust agreement gives the trustee the legal right to manage and control the assets held in the trust. It also instructs the trustee to manage the trust's assets for your benefit during your lifetime and names the beneficiaries (persons or charitable organizations) who are to receive your trust's assets when you die. Revocable trusts are extremely helpful in avoiding probate. If ownership of assets is transferred to a revocable trust during the lifetime of the trustmaker so that it is owned by the trust at the time of the trustmaker's death, the assets will not be subject to probate.
The trust document gives guidance and certain powers and authority to the trustee to manage and distribute your trust's assets. The trustee is a fiduciary, which means he or she holds a position of trust and confidence and is subject to strict responsibilities and very high standards. For example, the trustee cannot use your trust's assets for his or her own personal use or benefit without your explicit permission. Instead, the trustee must hold and use trust assets solely for the benefit of the trust's beneficiaries.
Irrevocable trusts are trusts that cannot be amended or revoked once they have been created. These are generally tax-sensitive documents. Some examples include irrevocable life insurance trusts, irrevocable trusts for children, and charitable trusts. With an irrevocable trust, all of the property in the trust, plus all future appreciation on the property, is out of your taxable estate. They may also be used to plan for Medicare eligibility if a parent enters a nursing home.
An asset protection trust is a type of trust that is designed to protect a person's assets from claims of future creditors. These types of trusts are often set up in countries outside of the United States, although the assets do not always need to be transferred to the foreign jurisdiction. The purpose of an asset protection trust is to protect assets from creditors.
These trusts are typically restricted by being irrevocable for a number of years and not allowing the trustmaker to benefit from the trust. Typically, any undistributed assets of the trust are returned to the trustmaker upon termination of the trust. The asset protection trust is basically a trust containing a spendthrift clause preventing a trust beneficiary from alienating his or her expected interest in favor of a creditor.
If a person could benefit from the trust being established, this could be a reason to challenge the asset protection trust. If the trust is created with knowledge of an impending claim, it is possible the trust could be challenged as a fraudulent conveyance. For example, creating a trust right before filing bankruptcy may throw up red flags for examination.
The elements of a fraudulent conveyance transfer are defined as follows by the Uniform Fraudulent Transfer Act:
(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:
(1) with actual intent to hinder, delay, or defraud any creditor of the debtor; or
(2) without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:
(i) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
(ii) intended to incur, or believed or reasonably should have believed that he [or she] would incur, debts beyond his [or her] ability to pay as they became due.
The following is an IN statute:
IC 34-55-10-2 (a) This section does not apply to judgments obtained....
(a) This section does not apply to judgments obtained before
October 1, 1977.
(b) The amount of each exemption under subsection (c) applies until a
rule is adopted by the department of financial institutions under
section 2.5 of this chapter.
(c) The following property of a debtor domiciled in Indiana is exempt:
(1) Real estate or personal property constituting the personal or family
residence of the debtor or a dependent of the debtor, or estates or rights
in that real estate or personal property, of not more than fifteen thousand
dollars ($15,000). The exemption under this subdivision is individually
available to joint debtors concerning property held by them as tenants by
the entireties.
(2) Other real estate or tangible personal property of eight thousand
dollars ($8,000).
(3) Intangible personal property, including choses in action, deposit
accounts, and cash (but excluding debts owing and income owing), of three
hundred dollars ($300).
(4) Professionally prescribed health aids for the debtor or a dependent
of the debtor.
(5) Any interest that the debtor has in real estate held as a tenant by
the entireties. The exemption under this subdivision does not apply to a
debt for which the debtor and the debtor's spouse are jointly liable.
(6) An interest, whether vested or not, that the debtor has in a
retirement plan or fund to the extent of:
(A) contributions, or portions of contributions, that were made to the
retirement plan or fund by or on behalf of the debtor or the debtor's
spouse:
(i) which were not subject to federal income taxation to the debtor at
the time of the contribution; or
(ii) which are made to an individual retirement account in the manner
prescribed by Section 408A of the Internal Revenue Code of 1986;
(B) earnings on contributions made under clause (A) that are not subject
to federal income taxation at the time of the levy;and
(C) roll-overs of contributions made under clause (A) that are not
subject to federal income taxation at the time of the levy.
(7) Money that is in a medical care savings account established under
IC 6-8-11.
(8) Money that is in a health savings account established under
Section 223 of the Internal Revenue Code of 1986.
(9) Any interest the debtor has in a qualified tuition program, as
defined in Section 529(b) of the Internal Revenue Code of 1986, but only to
the extent funds in the program are not attributable to:
(A) excess contributions, as described in Section 529(b)(6) of the
Internal Revenue Code of 1986, and earnings on the excess contributions;
(B) contributions made by the debtor within one (1) year before the date
of the levy or the date a bankruptcy petition is filed by or against the
debtor, and earnings on the contributions; or
(C) the excess over five thousand dollars ($5,000) of aggregate
contributions made by the debtor for all programs under this
subdivision and education savings accounts under subdivision (10) having the same
designated beneficiary:
(i) not later than one (1) year before; and
(ii) not earlier than two (2) years before;the date of the levy or the date a bankruptcy petition is filed by or
against the debtor, and earnings on the aggregate contributions.
(10) Any interest the debtor has in an education savings account, as
defined in Section 530(b) of the Internal Revenue Code of 1986, but only to
the extent funds in the account are not attributable to:
(A) excess contributions, as described in Section 4973(e) of the Internal
Revenue Code of 1986, and earnings on the excess contributions;
(B) contributions made by the debtor within one (1) year before the date
of the levy or the date a bankruptcy petition is filed by or against the
debtor, and earnings on the contributions; or
(C) the excess over five thousand dollars ($5,000) of aggregate
contributions made by the debtor for all accounts under this
subdivision and qualified tuition programs under subdivision (9) having the same
designated beneficiary:
(i) not later than one (1) year before; and
(ii) not earlier than two (2) years before;the date of the levy or the date a bankruptcy petition is filed by or
against the debtor, and earnings on the excess contributions.
(11) The debtor's interest in a refund or a credit received or to be
received under section 32 of the Internal Revenue Code of 1986.
(d) A bankruptcy proceeding that results in the ownership by the
bankruptcy estate of a debtor's interest in property held in a tenancy by
the entireties does not result in a severance of the tenancy by the
entireties.
(e) Real estate or personal property upon which a debtor has voluntarily
granted a lien is not, to the extent of the balance due on the debt secured
by the lien:
(1) subject to this chapter; or
(2) exempt from levy or sale on execution or any other final process from
a court.
