Volume XIII, Number 1 – May 2004
© Donlevy-Rosen & Rosen, P.A.
STATE EXEMPTION LAWS:
Pitfalls To be Avoided – Part 1
INTRODUCTION. All states provide some degree of “asset protection” through state exemption laws which shield certain types of assets, such as homestead, wages, annuities, life insurance and retirement funds (“exempt assets”). This issue of the APN is the first of two parts addressing the most frequent failings of individuals attempting to implement asset protection on their own by using (or failing to properly use) state exemption laws.
BACKGROUND. Many individuals attempt to implement asset protection on their own, and, as a result, often invest in assets that provide neither the maximum return, nor optimum asset protection. In addition, investments in exempt assets are often made without proper estate tax considerations. Individuals should proceed with caution and utilize experienced counsel before attempting to utilize state exemption laws.
PITFALL #1: NOT GETTING ADVICE OF EXPERIENCED COUNSEL BEFORE USING STATE EXEMPTION LAWS. This is one of the biggest mistakes made. Often an individual attempts to use creditor exemption laws provided by the state in which he/she resides, but goes about it in a way which does not always obtain the desired exemption. As a result, one may expose assets to more liabilities than anticipated, and may receive no or less protection from third party claims than could otherwise be obtained. In addition, sometimes using state exemptions causes one to forego other investment opportunities with greater appreciation potential. Obtaining competent legal counsel will result in greater protection of assets with less exposure to liabilities and headaches, as well as provide flexible estate planning.
PITFALL #2: NOT CONSIDERING WHAT THE EXEMPTION LAWS OFFER. Almost as foolish as not getting competent advice is not even knowing what exemption laws apply to the state in which one currently resides. Individuals often hear or read something, and take it as gospel. Speakers and articles tout, for example, the protection afforded by putting assets in a spouse’s name, or titling assets jointly with a spouse. The state in which an individual resides (or the state in which an individual’s real property is located) may not afford the same protection as another state may afford. An individual needs to know which state is his primary residence for purposes of litigation (which may not be the same as the one where the individual works or has a business), and what exemptions are available for residents of the state, and to what extent they are available to the individual given the specific circumstances of the individual. For example, Massachusetts provides more generous homestead protection to someone over a certain age or with a disability. Since real property is governed by the laws of the state in which it is located, if an individual owns property outside his state of residence, the individual will need to know what, if any, protections are available in that state for the real property. However, one must also keep in mind that when real property is owned by an entity – such as a trust, limited partnership, limited liability company or corporation, other laws may come into play, and homestead exemptions will likely not be available. Individuals need to have a qualified professional periodically review their assets to insure that they are held in the manner providing the best protection.
PITFALL #3: CHANGING ONE’S STATE OF RESIDENCE. People move across state lines. When they do so, they often forget to have their wills redone, and to have their asset holdings reviewed in light of the laws of their new state of residence. For example, an individual moving to Florida from Delaware (which has no homestead protection) may fail to take advantage of the generous homestead (unlimited value) protection afforded by Florida for an individual’s primary residence. Conversely, moving may cause the loss of protection. For example, Florida provides a 100% wage exemption for the head of a family, whereas Georgia limits it to 75%. Thus, an individual who is the head of a family who moves from north Florida across the border into Georgia may not realize that a substantial portion of his wages are no longer protected. Another example where primary residence matters is in the case of IRAs and SEP/IRAs and 509 Plans. Plans which are not “ERISA-qualified plans” (such as the aforementioned) are protected in some states, such as Florida, Kansas, New York, and Wisconsin by statute, but not in others. Whether and to what extent an individual’s non-ERISA plan is protected must be determined by reviewing the applicable state law. If the individual moves from a state that protects IRAs to one that does not, the individual loses the protection for the individual’s IRA. One should seek competent counsel before one moves residence to another state, from an attorney familiar with the exemption laws of the intended state of residence.
PITFALL #4: CONVERTING NON-EXEMPT ASSETS INTO EXEMPT ASSETS AT THE WRONG TIME! Another problem we often see is when one attempts to protect assets after there is some threat of a claim by converting non-exempt assets into exempt assets. An exemption from attachment, garnishment, or legal process provided by a state’s statute will likely not be effective if the individual fraudulently transferred or converted the asset. Any conversion that results in the proceeds of the asset becoming exempt under state law from the claims of one’s creditor may be a fraudulent asset conversion as to the creditor, whether the creditor’s claim arose before or after the conversion of the asset, if the debtor made the conversion with the intent to hinder, delay, or defeat the claim of the creditor. In other words, a court can order the transfer/conversion to be undone, and thus make the asset available to the creditor. This problem will be avoided if one undertakes and completes asset protection planning before there is any claim against one. (See APN, Vol. I, No. 5).
PITFALL #5: TITLING THE ASSET IMPROPERLY. Just because one owns an asset otherwise eligible for exemption under state law doesn’t make it automatically exempt. The asset must be titled in the specific manner which will allow the individual to claim the exemption. For example, state law may provide a homestead exemption that makes all or part of an individual’s primary residence in the state exempt from the individual’s creditors. Generally only a natural person (i.e., a human being) may claim homestead protection, and that natural person must have legal title to the property. Thus, if the individual’s principal residence is owned by a limited liability company, a limited partnership, a corporation or a trust, the individual may lose the exemption. For example, an individual’s home in Florida would be 100% exempt from the claims of his/her creditors. Were the individual to place the home in a family limited partnership – the homestead protection would be lost, and a creditor may have a way to reach the otherwise exempt asset. Yet another reason one should have the manner in which ones assets are titled reviewed by competent counsel.
CONCLUSION. Use experienced, qualified counsel – and stay tuned for the rest of our series on pitfalls to be avoided in using state exemption laws!