Picture this- You put twenty years into growing your business. Twenty years’ worth of money, hard work, and dedication. Come the twenty-first year when the business is a fully-functioning, profit-making machine, you get a knock on your door; you’ve been sued.
Business owners, especially dealer owners, don’t want an adverse settlement to gobble up all of their assets. Additionally, if their business fails they don’t want creditors wielding claims on those possessions. The big question is this:
How can I cover my assets?
There are many ways to take proactive steps to protect what’s yours. Consider the options listed below:
- A Crummey trust
Another vehicle to consider is a Crummey trust. If you gift assets to someone else, such as your children or other family members, generally, the assets will no longer be vulnerable to your creditor claims. But you may not want to gift assets outright. Instead, you could transfer those assets to trusts for your family members. This allows you to retain a degree of control over their access to the funds and provide a measure of protection against their creditors.
Normally gifts to trusts are not eligible for the $14,000 (per recipient) annual gift tax exclusion because transfers must be of a “present interest,” meaning, the recipient has immediate access to the funds, to qualify. But in a Crummey trust, after each gift to the trust is made the beneficiaries are allowed to withdraw the funds for a limited time.
This withdrawal right allows the gift to qualify for the annual exclusion. You don’t have to use up any of your lifetime gift tax exemption, or pay gift taxes on the transfers. Plus, the assets, along with any future appreciation on them, are removed from your taxable estate.
However, once transferred you won’t have access to the assets. There is also a risk that the beneficiary will take out the funds during the withdrawal period.
- A family limited partnership
One asset-protecting vehicle worth exploring is a family limited partnership (“FLP”). In a typical scenario you transfer assets to the FLP, and as its General Partner you have discretion over how the assets and income are distributed. You then gift or sell limited partnership interests to your children or other family members. A common application is to transfer assets, such as marketable securities, and the real estate on which your dealership is located to an FLP.
The agreements are typically written with asset protection in mind for the purpose of keeping the underlying assets safe from creditors. Also, if the FLP is properly structured and administered, the assets gifted or sold will be removed from your taxable estate. And transfers of FLP interests might be eligible for minority interest and other discounts.
There are some drawbacks. Your franchise agreement may restrict transferring ownership interests in your dealership operations. You need to be cautious when signing bank or creditor guarantees — they could undo the FLP’s protective quality.
- An offshore trust
You can set up a trust in a foreign country with more favorable asset protection laws than in the United States. Offshore trusts are typically funded with cash or readily movable securities, rather than real estate. Bear in mind, that even if the assets are offshore you are liable for paying taxes on the trust’s income. It is also good to know that trust assets can still be subject to gift or estate taxes.
Offshore trusts offer protection from U.S. legal judgments and discourage litigation because of the expense and difficulty in pursuing a case under foreign jurisdiction.
There is a downside. The costs to set up and administer offshore trusts can be high, making them a sensible choice only for individuals with sufficient net worth and risks of claims and lawsuits to warrant the expense. Since these trusts often face IRS challenges, be sure to get solid legal and tax advice.
No business owner thinks a life’s work of asset-building could be destroyed by a legal settlement or creditor payments. But things like that do happen. Make sure you are prepared if such events come your way. One of LGT’s tax professionals can help you get started.
Interested in learning more? Contact one of our professionals today.