Business owners and investors are constantly exposed to risks every single day. This is why a good protective asset protection strategy is critical to preserving your wealth.
If you own any assets or have savings, it is important that you make sure you are protected against future claims or lawsuits. A good tax strategy or wealth building plan must take into account asset protection.
When determining what structure to use for your business or investments, protection for your assets must also be considered along with the tax and legal implications.
This article gives a brief overview of the key considerations relating to asset protection and why it is imperative that entrepreneurs make sure they are fully protected against any potential claims or judgements against them in the future.
What is Asset Protection?
Aptly named, asset protection is protection for your assets against judgements or claims from creditors. When we talk about judgements in this sense, we are really referring to lawsuits where you lose and are required to pay the person suing you a lot of money. Claims from creditors refers to a lender’s ability to recover money you owe for outstanding debt. A good asset protection strategy should cover both of these types of risks.
- Protection against lawsuits
The classic example is you drive your car home from work and accidentally hit another car. You are deemed to be at fault for causing the accident, and unfortunately the other driver was badly injured. The other driver sues you for their injuries and wins the case. The jury awarded the other driver damages for all kinds of things you’ve never heard of and all of the sudden you find yourself on the hook for millions of dollars.
You might read this example and be thinking – “oh but my insurance would cover this.” Not so fast! We go into more detail below about why it is risky to rely on insurance alone.
- Protection against creditors for unpaid debt
Judgements can also mean claims from lenders for unpaid debt that you owe. A good example here is you buy a business and take out a business loan for $1M. The business fails and you can’t pay back the loan. Ideally, you want to set up your business and the loan in a way that the lender can’t come after your other assets that are completely unrelated to that business to satisfy the debt. The last thing you want is a situation where a bank can come in and take away your home because you made one bad business decision.
To the extent possible, you want to always limit the ability for lenders to come after other unrelated assets to satisfy any debt you owe.
Am I Really at Risk of Being Sued?
The sad reality is that there are a number of situations that could give rise to potential lawsuits. From driving a car or riding a bike to owning a home or rental property, we are all exposed in some form or another.
As a practical matter, we live in a litigious society and there are countless civil lawsuits filed each day. Business owners and investors are often at the most risk because of the nature of their dealings.
Lawyers are also quick to take cases where the client is suing someone that is likely to have the means to pay if the case is decided in their client’s favor. This means the more money you have, or the more money you are perceived as having, the higher the likelihood you will be an attractive candidate for a future lawsuit.
Many believe the risk of a large judgment against you is small; however, the reality is that these types of lawsuits are filed every day with increasing frequency. If you are a successful business owner or a high net worth individual, the chances of having a lawsuit filed against you during your lifetime are quite high.
There are 2 main ways you can be at risk from lawsuits.
Someone sues you for something that happened with respect to your business or investment
This involves a situation where you own a business and something happens involving your business and your business gets sued.
Most businesses have a lot of customers and those customers may sue you for something that goes wrong. You can even get sued for things you never imagined like someone coming into your store and tripping. You can also get sued by your employees or competitors. This happens all the time. Walmart for example gets sued on average over 20 times a day!
The same can apply even if you don’t have a storefront for your business where clients come into an office. Take my business for example, if I ever gave bad tax advice (which of course would never happen), a client could sue me if that bad advice caused them economic harm.
The same is true even if you are a passive investor. Something can happen with an investment that gives rise to a lawsuit. From investing in a business to owning rental properties, there are several different ways you are exposed to risk even if you aren’t involved in the day-to-day operations.
Someone sues you for something that happens and comes after all of your assets
This is the car accident example. You do something in your personal life that gives rise to a lawsuit and the next thing you know, someone is coming after all your assets, including your business or your brokerage account.
If you do not have a protective asset protection structure in place for your business and investments, everything can be at risk. This is the case regardless of what gave rise to the lawsuit in the first place.
Why Insurance Alone is Not Sufficient
It is always advisable to have insurance against any potential risks or exposures you may have with respect to your business and investments. Insurance is always the first line of defense against any damage to your property or business.
You should also have insurance to protect against and defend you in connection with any potential lawsuits or judgements against you. Nonetheless, insurance alone is not sufficient to protect you from the potential risks.
Most insurance policies have significant gaps or exclusions that could result in non-coverage. It is quite likely that your current insurance policies would not cover accidents that can occur from activities you engage in on a frequent basis.
Insurance companies are also notorious for finding every reason possible to deny payment for a claim. You may not even be aware that certain exclusions could apply as a result of minor details resulting in you being personally liable for judgements against you.
In some cases, it is not possible to obtain sufficient insurance. Umbrella policies above certain limits are frequently not available or cost prohibitive. If you have a net worth exceeding a few million, finding umbrella coverage for the full amount of all your assets above may not be possible or economical.
Individuals who engage in certain activities, such as boating, skydiving, or other higher risk activities, may find that their insurance policies do not cover them for accidents that occur while engaging in those activities. In these situations, protecting your assets is necessary to shield you against large claims that exceed the caps on your insurance policies or situations where your insurance policies do not apply.
There are also a number of situations where individuals in a given profession, such as lawyers, doctors, or other licensed professionals, may not easily be able to avoid having their personal assets at risk against malpractice claims. There is only so much malpractice insurance that is available. Traditional asset protection strategies, such as insurance or use of a Limited Liability Company (LLC), may not be available or may only provide limited protection. In these situations, it is critical that you ensure your other assets which are not connected to your business, including any real estate or stocks or bonds in your name, are fully protected against any potential malpractice claims in the future.
What is an Asset Protection Strategy?
The more assets you have, the more exposure you have to lawsuits. A good asset protection strategy takes into account your specific facts and circumstances. Moreover, you should develop a holistic approach which allows you to accomplish your business and investment objectives for building wealth in a safe manner that does not leave you exposed to the risk of future claims or judgements against you.
A strategic objective of an asset protection strategy will have the added benefit of making you a less attractive subject for potential lawsuits. Attorneys generally only want to take on easy cases where they know they are likely to get paid.
If an attorney sees that you have properly structured your affairs in a way that makes it less likely that your assets are available to satisfy any judgments against you, the attorney will be less inclined to take a case against you. This is a little known secret and trick that the uber wealthy use.
How to Develop an Approach to Asset Protection
The professionals at Winsmith Tax can help you design a comprehensive wealth and tax strategy for your business operations and investments which takes into account planning for protection of all your assets. Get in touch today to get started on developing your tax and wealth building strategy.
Every good asset protection plan should have these characteristics.
11 Protective Asset Protection Strategies
Buy sufficient insurance
As we mentioned before, you should always have insurance in place. An insurance agent is a key member of your wealth management team because as your wealth increases, so will your insurance needs. Remember that insurance is only your first line of defense, not your only line of defense!
Become an insurance expert
Insurance is boring. It isn’t something that most of us want to spend a lot of time learning about or studying. But as a business owner or investor, there are a few areas you can’t afford to delegate and insurance is unfortunately one of them.
Avoid the common practice of just trusting that your insurance agent has you covered. Finding a good insurance agent has been the most difficult part of building my own wealth building team. I still haven’t found an agent I am fully satisfied with.
The more I studied insurance, the more I realized agents either didn’t know or weren’t telling me. I was way underinsured in some areas and way over insured in others. A good example is that when I first started my business and was the only employee I had no business umbrella policy (underinsured) but for some reason did have coverage against an employee suing me for a terrorist attack (pretty sure I am not going to sue myself).
The reality is that there are a lot of different types of policies out there and you need to make sure you understand where your risks are. Not only do you need the right type of insurance, you need to make sure you have the right amount of coverage. As your net worth increases, your policy limits might also need to increase.
Understand your insurance gaps
Every policy has gaps and you need to have a complete understanding of what those gaps are. Common examples are that many umbrella policies don’t cover boating or flying. If you are going to learn to fly your own plane or drive a boat, you might not be covered for anything that goes wrong while you are doing these activities.
There is a good chance you might be surprised by some of the activities that aren’t covered. If there is an exclusion for an activity you do frequently, it might be worth seeing if you can get a rider to cover you in those cases for a slightly higher premium.
Use the appropriate legal entity for the business or investment
A good asset protection strategy involves ring fencing liability. The primary way to do this is to put your business or investment into a separate legal entity. Not only do you want to pick the right type of legal entity (e.g., LLC, corporation, trust), you also need to make sure you have the right number of entities in your structure.
Make sure you work with a good tax advisor or attorney who understands asset protection when setting up the right structure for your business and assets. We take into account protective asset protection strategies in all of our tax strategies we do for clients.
Always follow best practices for ensuring your legal entity is respected
Once you have the right legal entities in place, you need to make sure that entity will always be respected. It isn’t enough to just set up the entity. If you do not develop best practices around how to operate with respect to the entity, that entity is useless.
You should always operate as if the entity is a separate and distinct unit from yourself. If you don’t follow best practices, a court can disregard the entity and still go after the assets inside.
Don’t overuse LLCs
A common mistake I see is people overuse LLCs in situations where having a separate LLC is not appropriate. For example, putting your personal residence in an LLC doesn’t work or make sense. If someone tells you to do this, they likely don’t understand how asset protection laws work.
Having too many LLCs can be as bad as not having enough in some cases.
Separate out assets where it makes sense
In some cases, it may make sense to have more than one legal entity for different assets or businesses. There can also be situations where it is a good idea to carve out business lines and put those into separate entities. Don’t just assume everything you own should go into one legal entity.
Make yourself an unattractive defendant
Most plaintiff’s attorneys want easy cases they know they can win and get paid. You want to make it as hard as possible for a lawyer to come after you and your assets.
Your asset protection strategy should make it as difficult as possible to come after you. Examples of how you can make yourself an unattractive defendant are to use multiple legal entities where appropriate and to set up those legal entities in jurisdictions with favorable asset protection laws.
Limit avoidable high risk activities
There are always ways you can reduce your risk of lawsuits by avoiding unnecessary high risk activities. Certain high risk activities are also likely to be excluded from your insurance coverage.
Examples of these high risk activities include:
- Providing or paying for a car for your children to drive
- Letting anyone other than your spouse who is covered on your policies drive your car
- Flying an airplane
- Driving boats or other watercraft such as jet skis
- Hunting or using weapons for recreational purposes.
- Drug and heavy alcohol use.
Have the entity be the borrower
When you are going to take out debt for a business or investment, the best practice is to have the legal entity that owns that asset or business be listed as the borrower on the loan.
This may be difficult to do in practice unless you have a large business or sizable investment. However, whenever possible, let the entity be the borrower and not you in your personal capacity.
Try to avoid personal guarantees for debt
Providing a personal guarantee on a loan is the same thing as being the borrower on the loan. If you have a legal entity listed as the borrower, the lender can still come after your other assets if you provide a personal guarantee.
Please note that Winsmith Tax is not a law firm and is not otherwise authorized to provide legal advice. In connection with setting up your business and developing an approach to asset protection it is highly recommended that you consult with a licensed attorney. The content contained herein represents our opinions and is not intended to constitute legal advice.