Volume XVI, Number 2 – June/July 2007
© Donlevy-Rosen & Rosen, P.A.
Pitfalls To Be Avoided – Part I
BACKGROUND. Many individuals attempt to implement asset protection on their own (See, APN, Vol. III, No. 3). Among the “do-it-yourself” methods commonly utilized is titling and re-titling assets among a spouse, children and others (friends & family members). Instead of accomplishing the desired protection, such “strategy” often exposes the assets to additional creditors, causes family conflicts, and raises gift and estate tax issues. Therefore, individuals should proceed with caution and utilize experienced counsel when titling new assets or transferring title to existing assets. This issue of the APN is the first of two parts addressing the most frequent failings of individuals attempting to implement do-it-yourself asset protection by titling/retitling assets.
PITFALL #1: NOT GETTING ADVICE OF EXPERIENCED COUNSEL. Without first conferring with legal counsel, an individual (transferor) transfers assets in an attempt to protect them. As a result, the transferor exposes assets to more liabilities than anticipated (creditors of the transferee), and receives less protection from third party claims than would be obtained with proper planning. In addition, titling assets among spouse, children and others often has gift and estate tax ramifications that are problematic to undo later. Competent legal counsel will assist an individual in obtaining the maximum protection of assets with the minimum exposure to liabilities and headaches.
PITFALL #2: MAKING FRAUDULENT TRANSFERS. An individual who becomes aware of a possible claim often rushes to gift or sell assets to try to protect them from creditors. In most states, a creditor who is unable to collect on a judgment will be able to challenge gifts and other transfers made within 4 years of the time the action on which the judgment is made arose, and, if successful, a court will undo the transfer (that is, put the property back in the transferor’s hands – available to the transferor’s creditors). Any gift, or sale made for less than fair market value, including (particularly) to family or friends, within the period provided by the state’s fraudulent transfer laws, would likely result in a court setting aside the transfer.
PITFALL #3: ASSUMING THAT TRANSFER OF TITLE TO A SPOUSE WILL PROTECT THE ASSET. An individual transfers assets to his spouse believing that the assets will be protected from claims against him. This assumes that the spouse does not work, or have an interest, in the individual’s business affairs. More importantly, this also assumes that the spouse will never be liable to anyone for any reason (not have creditors of her own) – such as credit card debts, medical bills, intentional torts, accidents, etc., that she will never divorce him, or die before him and leave the assets to him in her will (or by state law). When an individual titles assets in the name of his spouse (without professional advice), there may be estate tax ramifications which will cause more estate taxes to be paid on the second death than would be paid with proper planning. Although the Internal Revenue Code permits U.S. citizen spouses to transfer title back and forth between themselves with no immediate gift tax consequence, if a recipient spouse is a not a U.S. citizen, there will be gift taxes on transfers in excess of $112,000 per year. Finally, and most importantly, an individual’s creditor may be able to undo the transfer to the spouse, if a court finds it to be a fraudulent transfer (4 year “window”).
PITFALL #4: ASSUMING THAT TENANCY BY THE ENTIRETY PROVIDES ADEQUATE PROTECTION. Tenancy by the Entirety (TBE) is a form of ownership recognized under common law, which can be created and exist only during marriage. Traditionally, one spouse cannot transfer or mortgage TBE property without the other spouse’s written consent (although statutes have changed this in certain states). Married individuals living in states that continue to recognize traditional TBE (such as Delaware, D.C., Florida, Pennsylvania, Michigan and Rhode Island) may believe that their assets are completely protected if they are held as TBE. Although a creditor of one spouse generally cannot reach traditional TBE property in states recognizing TBE, bankruptcy courts have been known to find ways to reach the debtor spouse’s interest, by partition or foreclosure, or otherwise. There are no gift tax concerns in creating the TBE, if the donee spouse is a US citizen. Finally, death or divorce ends any TBE protection.
PITFALL #5: GIVING UP OWNERSHIP OR CONTROL. An individual (“original owner”) sometimes retitles solely owned property with another (“added owner”) as tenants in common (TIC) or as joint tenants with right of survivorship (JTWROS). A TIC is a form of ownership where the interests are unilaterally severable (that is, one owner can transfer his interest without the consent of the other). Since either owner may transfer his/her interest without the other’s consent, the creditor of either owner may reach that debtor’s interest in the property. The death of the added owner would not, absent a provision in the that person’s will (or under state intestate succession law), return the property interest to the original owner. Creditors (including spouses) of the estate of the deceased added owner would be able to reach the deceased’s interest in the property held as TIC. Thus, the surviving original owner could end up with an unwanted and uncooperative “partner” (creditor or spouse of the added owner). A JTWROS is similar to a TIC in that it is also unilaterally severable; one owner may transfer his/her interest without the other’s consent. Thus, while the transferee is alive, his/her creditors (including spouses) may reach the his/her interest in the property. The JTWROS differs from a TIC only upon the death of one of the co-owners. Should the original owner die first, the original owner’s creditors would be out of luck, as the entire property interest would belong to the added owner. Conversely, should the added owner die first, the entire property interest would vest back in the original owner, providing no protection from the original owner’s creditors. The creation of a TIC or a JTWROS is subject to fraudulent transfer scrutiny and to partition/severance by a court, and neither should be considered an effective protective strategy.
CONCLUSION. Use experienced, qualified counsel – and stay tuned for the rest of our series on pitfalls to be avoided in titling assets.