Protecting Your Assets

Presented By Thomas J. Murphy
March 29 & 30, 2011



Arizona Revised Statute 33-1101 exempts the first $150,000 of equity (not market value) in your residence. Includes a condo or mobile home. Only one exemption per married couple. Homestead protection is automatic – no longer any need to record the exemption.

Retirement plans

In Arizona, any retirement plan has unlimited protection. ARS 11-1126(b).   This includes IRAs, 401(k)s, 403(b)s and deferred compensation plans. Applies to plan participant (ie, owner) and beneficiaries of the plan.

As a matter of federal law, any ERISA plan (typically 401(k)s and pensions) also have unlimited protection. The United States Supreme Court has so ruled several times, most notably in Patterson v. Shumate, 504 US 753 (1992)

In a bankruptcy setting, section 522(b)(3)(C) of the Bankruptcy Code upholds the ERISA protection. Bankruptcy Code Section 541(b)(7) also provides for unlimited protection for all deferred compensation plans and all tax-deferred annuities under IRC section 403(b). The precise amount of bankruptcy protection for IRAs is not entirely clear. No doubt that at least $1 million is protected. Most commentators believe that all funds rolled over from an ERISA account into an IRA are also protected, in addition to the $1M. The United States Supreme Court has also that more than $1M can be protected if the additional funds were “reasonably necessary for the support of the debtor or his dependents”. Rousey v. Jacoway, 125 SCt 1561 (2005)

The only creditor who can reach retirement assets is the IRS. To the surprise of many practitioners, ERISA and other retirement plans are not listed as exempt assets in section 6334 of the Internal Revenue Code. Because of this, the IRS has always taken the position they can seize retirement assets. But section of the Internal Revenue Manual limits when an IRS agent can proceed with collection – only in flagrant cases and only after obtaining supervisory approval.

Life insurance and annuities

Unlimited protection from decedent’s creditors for the death benefit payable from a life insurance policy or annuity contract. ARS 20-1131. There may be an issue when the spouse is named as beneficiary but this can be resolved through the use of a trust discussed below.

Provides bankruptcy protection for the cash surrender value of a life insurance policy and the net investment amount in an annuity if the contracts have been in force for at least two years and a spouse, parent or child has named as beneficiary for that two year period. ARS 33-1121(a)(6)&(7) & 20-1131(d)

Irrevocable, stand-alone trusts

An irrevocable trust can be a marvelous asset protection tool as long as the person creating the trust is not a trustee or beneficiary. This works very well for setting up an account for children. The funds held by the trust are protected from the creditors of the person creating it and is also protected from the beneficiaries’ creditors, spouses or soon-to-be ex-spouses.   Funds that are distributed to a beneficiary are reachable but, as long as the funds stay within the trust or are used for other purposes, they are beyond the reach of creditors. ARS 14-10501 & -10502. Only a party seeking child support can pierce the trust. ARS 14-10503.

Family limited partnerships and limited liability companies

Family limited partnerships (“FLPs”) and limited liability companies (“LLCs”) function much like trusts but are used if the property is generating significant amounts of income. This is because trusts are in very high, compressed tax brackets with the 35% bracket hitting at $11,200 of income for 2010, compared with $373,650 for married couples.

FLPs and LLCs are “pass-through” entities that do not pay tax. The partners and members pay their allocated share of any profits that are reported on their personal form 1040 and will be taxed at their individual rate.

In Arizona, FLPs and LLCs also have creditor protection. The “exclusive remedy” of a creditor is a charging order. ARS 29-341 & -655. A charging order is essentially an assignment of the rights to future profits of the FLP or LLC but confers no management rights.

The tax consequences of a charging order has generated a great deal of controversy with no definitive ruling. The theory is that a creditor holding a charging order is treated as an assignee of the debtor/partner, thereby attributing taxable income to the creditor despite the fact that the creditor never received an actual distribution from the FLP. This “phantom income” concept is based on Rev. Rul. 77-137 and Evans v. Commissioner, 447 F2d 547 (7th Cir., 1971). One commentator has referred to this as “getting KO’d by the K-1”.

529 college savings plans

Section 529 of the Internal Revenue Code allows any taxpayer, regardless of income level, to establish college savings accounts that allow for tax free growth if the funds are eventually used for tuition, room and board and the like for any post-high school education. There is no specific creditor protection in Arizona but the bankruptcy code affords a great deal of protection. Sections 541(b) & (c) of the Code protects 529 plans as well as Coverdell education accounts. Any of these accounts that name a child, grandchild, stepchild or stepgrandchild as a beneficiary will be protected. Any contributions made prior to two years of a bankruptcy filing are protected as long as they did not exceed the amounts that are tax-qualified under the IRC. This will be in the $250,000 range for most 529 plans and, for Coverdell accounts, will be the accumulation of the $3,000 maximum annual contributions. For contributions made within one to two years of filing, only $5,000 per account will be protected. Contributions made within one year of filing will not be protected in any amount.

Other personal property exemption.

Arizona Revised Statute 33-1121 exempts payments received for child support and spousal maintenance as well as proceeds from health, accident, disability and property and casualty insurance.

Other creditor protection issues

  1. Fraudulent conveyance
    You cannot give away all your assets once you have been sued or know that you are about to be sued. A fraudulent transaction will occur with any transaction where you receive less than the fair market value and the transaction has the effect of hinder, delay or defraud” a creditor. ARS 44-1004. This means not only will the transfer be voided but that you will have your children or other transferee dragged into the litigation as well.   The statutes specifically authorize garnishment against any transferee. ARS 44-1007.
  2. Be wary of offshore asset protection planning.
    Before you place assets in the Cook Islands, Belize, Nevis, the Cayman Islands or similar haven, read the case of FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999) (a/k/a “Anderson case”),. In that case, a couple were incarcerated for six months on a contempt of court charge when they claimed they were unable to have the funds repatriated from the Cook Island trustee that held the assets sought by the FTC. For a more recent case, see SEC v. Jamie Solow, ____ F.Supp.2d ____, 2010 WL 303959 (S.D.Fla., Jan. 22, 2010) in which Mr Solow, while on trial for securities fraud resulting in a $3.4M judgment against him, transferred $5.2M to a Cook Islands trust. He was found in contempt and jailed when the funds could not be returned. See, also, “Basking in Islands of Legalisms”, by Floyd Norris in the January 21, 2010 edition of the New York Times discussing the Solow case.
  3. Probate creditors.
    Your debts do not die with you but collecting debts post-mortem can create problems for creditors. A deceased person cannot be sued – the Personal Representative of his probate estate must be sued instead. ARS 14-3104 This means opening a probate proceeding which a creditor will almost never do.

    But once a probate is opened, there are strict rules that a creditor must comply with. Notice of the probate must be mailed to all known creditors or those that are reasonably ascertainable who are notified that there is a four month period in which to submit a creditor claim ARS 14-3803; Estate of Travers, 192 Ariz 333, 335 (CA1, 1998). If a probate is not opened, there is a two-year time period to assert claims beginning on the date of death.