By Edward D. Brown, Esq.
One may ask, why spend money on legal advice and planning structures to protect assets when all I need to do is place all my assets in my spouse’s name? In fact, this has been proposed by some as free legal advice. Just remember though, you get what you pay for.
Nevertheless, this strategy is seen in cases in which a married person who is in a riskier profession than his/her spouse places the ownership (or title) of the assets in the name of the less risky spouse. One risk to consider was illustrated in a litigated matter some years ago in which a husband was concerned with a $2 million claim against him for “profits” he had obtained through a Ponzi scheme. The husband, in effect, using a post-nuptial agreement, gave his wife several million. To his chagrin, she filed for divorce very soon after, and left him while keeping those millions as her own separate property. This action, of course, led to a lawsuit between the two (now ex) spouses in his attempt to have the post-nuptial agreement declared void. The wife, asserting her defense through her attorney, was successful in having the court uphold the martial agreement as valid.
This type of spousal gifting planning can backfire for other reasons as well. For example, if a husband places the residence in his wife’s name because the husband is in the riskier profession, his creditor may still argue that his wife is holding the residence in a “constructive” or “resulting” trust (which is a legal fiction) for his benefit. As such, the fictitious trust could be viewed as a “self-settled trust” (meaning a trust he created as the “settlor” and under which he is also a beneficiary).
In most states (other than those states that passed asset protection trust laws), self-settled trusts provide no protection of the trust assets against that settlor’s creditors. People living in those non-asset protection law states therefore may turn to using offshore trusts so that a court in the U.S. is not applying one state’s non-asset protection laws to a trust created under another state law that allows asset protection trusts, and deciding which state law will apply.
Another drawback of gifting is that if the gifted assets were community property, you lose any double step-up in basis benefits that state law may otherwise provide. This means that when the asset is sold someday after the donor spouse’s death, the donee spouse could pay significantly more capital gains taxes than if the donor spouse had, for example, placed the assets into a protective South Dakota-created asset protection trust that treats the property as community property, and then had the assets sold after the donor-spouse’s death. The community property nature of the assets enjoy a “double step up in tax basis” that in effect wipes out any inherent taxable gains. Tennessee and Alaska have somewhat similar laws.
Gifting strategies are certainly not limited to married persons or gifts to a spouse. A gift of assets for asset protection purposes carries with it other shortcomings, such as the persons (donees) to whom you gifted the assets having their own creditor problems, spending temptations, bankruptcy, or divorce risks. Also, such a gift can be “clawed back” as a fraudulent transfer if motives were to avoid existing or perceived creditors.
Furthermore, once you make the gift, legally you cut all ties and give up all control over those assets. Given these tradeoffs, perhaps spending some funds for proper legal advice on creating more effective asset protection planning structures, such as domestic trusts (or often times more protective offshore trusts), saves money in the long run.
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