by: Begley Law Group

by Thomas D. Begley, Jr., Esquire, CELA, and Joellen C. Meckley, Esquire

This is the second of a two-part series (part one can be found here) designed to discuss various asset protection strategies for clients doing Estate Planning who are concerned about the possibility of future claims.  Typically, but not always, these clients are professionals OR business owners.

529 Plans

Contributions made more than two years prior to filing for bankruptcy are exempt from creditors.  NJBEST accounts are exempt from New Jersey bankruptcy.

UGMA Accounts

UGMA accounts are irrevocable accounts that belong to the beneficiary of the account and are, therefore, exempt from the claims of creditors.

Limited Liability Partnerships (LLP)

Creditors have a right to charge the debtor’s interest in the partnership.  Creditors only have the rights of an assignee of the partnership interest.  Creditors can only receive distributions the partner would have been entitled to receive.  The creditor has no say in the management of the partnership, nor does the creditor obtain any other rights associated with being a partner.

For federal income tax purposes, the creditor who has a charging order is subject to taxation on the debtor’s allocable share of partnership profits, even if the creditor does not receive any distributions. A charging order is a court-authorized lien imposed by a creditor on distributions made from the business entity.

Single Person Limited Liability Company (LLC)

  • The IRS disregards the LLC for tax purposes for employment taxes.The owner of the LLC is responsible for the employment taxes.
  • It is unclear in New Jersey whether the rights of the creditor are limited to a charging order.To date there are no New Jersey cases.  There are three rationales why a creditor of a member of a single member LLC should be able to assert a claim against the LLC.
  • Piercing the Veil. This is especially true if the LLC is undercapitalized.
  • Nominee Liability. Assets held by a nominee may be attached to satisfy claims against the true owner.  Factors include pervasive control by the entity owner and failure to observe business formalities.
  • Fraudulent Conveyance. This overrides the LLP Act and the LLC Act.

Self-Settled Special Needs Trust

Self-Settled Special Needs Trusts, which are trusts established by an individual for his or her own benefit, offer no protection from creditors in either New Jersey or Pennsylvania.

Self-Settled Asset Protection Trust

Nineteen states (excluding New Jersey and Pennsylvania) have Asset Protection Trust statutes.  Common issues in the formation of Asset Protection Trusts in these states include:

  • Time Period for Challenging Transfers to Trusts. these time periods range from 18 months to four years.  This means that transfer to the trust made during that time period may be set aside by a creditor.
  • Other Assets are Available to Satisfy a Marital Claim in a Divorce. These claims would include property settlement and alimony.  States go both ways on this issue.
  • Child Support. Are assets in a Self-Settled Asset Protection Trust subject to claims of child support?  States go both ways on this issue.
  • Tort Claims. Generally, Asset Protection Trusts cannot protect against preexisting tort claims.

Common features of Asset Protection Trusts include:

  • Independent trustee residing in the trust jurisdiction.
  • Trustee has absolute discretion.
  • No health, education, maintenance and support (“HEMS”) standard.
  • Spendthrift provisions.
  • Trust property must be located in the jurisdiction recognizing the Asset Protection Trust (i.e., for a Delaware Asset Protection Trust, the assets must be located in Delaware).Liquid assets of a New Jersey or Pennsylvania resident can be moved to Delaware, but real estate located in New Jersey or Pennsylvania cannot.
  • The trust grantor may retain a limited power of appointment to direct distributions during lifetime to someone other than the trust grantor.
  • The trust may provide for investment advisors, other than the trustee.

Third Party Spendthrift Trust (Bloodline Trust or Third Party Special Needs Trust)

A Spendthrift Trust for the benefit of a third party is recognized in every state.  There is no public policy rationale for finding that a trust estate should be made available to the beneficiary’s creditors.

The seminal case in New Jersey is Tannen v. Tannen[1] that arose out of a divorce.  In this case a husband sought to obtain alimony from the trust established by the parent for the benefit of the daughter.  The husband also wanted the income generated by the trust to be considered available to the wife for purposes of considering alimony.  The trust gave the trustee discretion over distributions and contains spendthrift provisions.  The court held that the beneficiary of a discretionary trust cannot compel payment to himself or application for his own benefit.  Therefore, the beneficial interest in the trust was not an asset to which he had access.  It was, therefore, improper to impute income from the trust in determining her alimony obligation.

The New Jersey Uniform Trust Code (3B:31-36) recognizes the validity of Spendthrift Trusts and their effect on creditors.  The spendthrift provision is valid, even though the beneficiary is named as sole trustee or co-trustee.  However, good practice would seem to dictate co-trustees.

A Third Party Special Needs Trust falls within the framework of a Third Party Spendthrift Trust.

In conclusion, there are a number of strategies available for asset protection, but careful thought needs to go into determining which option is best for each client’s unique facts and circumstances.

[1] 416 N.J. Super. 248 (App. Div. 2010), aff’d 208 N.J. 409 (2011)