Risk Management Terms Glossary
Often, stringent risk management techniques are some of the most useful asset protection strategies. Setting up a domestic asset protection trust is important, but so are the basics such as buying insurance and other forms of risk management you will read about below. This is meant as a short glossary for informational purposes.
Internal Fraud Prevention & Deterrence – Internal fraud is fraud or embezzlement by your advisors or other persons close to you. We assist you with oversight services, including periodic review of portfolio and financial records, etc. These services are designed not only to catch fraud that has already occurred, but also to prevent and deter future fraud by making it known that the review will occur.
Oversight services are not meant to interfere with the activities of any existing advisors or employees, but instead quietly review their activities to identity and deter possible fraud. Services should enhance your relationship with your agents and advisors by eliminating questions of trust.
External Fraud Prevention & Deterrence – External fraud is fraud that outside third parties attempt to perpetrate on you. The best example of this is investment fraud, i.e., inducing you to invest in bogus business opportunities. To prevent external fraud, we provide investigation and due diligence services to discern the background of the promoters of investments, and then we also will assist in reviewing the proposed investment to determine the level of risk involved and whether the investment has a reasonable chance of achieving the promised returns.
Tax Risk Management
Excessive taxation poses a serious risk to the business and its owners, who will typically lose more to taxation than to any other risk the business faces. This is due in part to the fact that taxes are a threat that has already materialized — the business and its owners know they will be paying some amount of taxes each year.
Tax Risk Management primarily seeks to reduce the risks that a business or its owners will conduct business in a tax-inefficient fashion, as well as mitigate the tax consequences of specific transactions.
Solutions include: Restructuring of “C” corporations and “S” corporations into more tax efficient business entities. Use of tax efficient forms of corporate ownership and wealth transfer to children. More efficient treatment of intangible assets, such as copyrights, trademarks, patent rights and royalties. Utilization of Closely Held Insurance Companies. Specific, targeted tax planning for significant business transactions.
The primary tax risk a business and its owners face is that of income taxation. Learn more about LLC taxes here.
Since income tax is paid at least annually, if not more frequently via estimated taxes or withholding, not only is this money lost, but also is the opportunity to generate investment income on this money.
Additionally, there is a disparity between federal income tax rates and capital gains tax rates that should be maximized whenever possible. Where it is possible to defer the payment of income tax within a structure until the structure is sold or liquidated, the net result will have been to convert ordinary income that is taxable up to 36% into capitalgains taxable as low as 18%.
Highly Appreciated Assets
There are a variety of strategies available that legally defer — sometimes perpetually — the gains on highly appreciated assets, such as stock or real estate.
Private Annuity transactions are a recognized form of tax and succession planning. Some have enhanced the Private Annuity structure to make it even more tax efficient, and to add some benefits not found in traditional Private Annuity planning.
VUL policies are a respected and popular means of growing assets within a tax-free environment and providing cash for heirs. An additional feature is that the owner of the policy may borrow against the policy “tax free”, and in many states both the VUL policy and its cash value are protected from creditors.
Asset Protection Terminology
Below are a list of asset protection terms and their definitions:
A type of Defined Benefit Plan that requires the use of insurance for funding, and which may provide certain inherent asset protection advantages because of the ERISA anti-alienation provisions.
A Welfare Benefit Trust formed pursuant to Section 419A(f)(6) of the Internal Revenue Code, and which may have asset protection benefits because of the ERISA anti-alienation provisions.
A civil law entity that is somewhat similar to a U.K. Unit Trust and can carry on commercial business.
The process of getting assets to the children or the children's trust, so that the assets and their future growth are not exposed to the parent's creditors. This is the asset protection variant of the Estate Freeze.
Asset Protection Consultant
A multi-level marketing scam involving franchisees who pay $10,000 to become "consultants" in the area of asset protection and who, though they have no education or training in the area, solicit clients to participate in Nevada bearer share structures that have highly questionable advantages, and many tax disadvantages. The scam operates on two levels: first, against the franchisees who are suckered into buying into the program, and, second, the clients who are duped into buying services from the franchisees.
Asset Protection Kits
Do-it-yourself packages that purport to allow purchasers to create one-size-fits-all asset protection plans. Suffice it to say that the quality of these plans is highly suspect, which is compounded by the fact that the purchasers almost never implement the plans correctly anyhow, often leading to very negative tax consequences.
A method for creating an apparent high sale value to defeat fraudulent transfer purposes, with a later reduction in price when the limitations period has passed.
Badges of Fraud
In the fraudulent transfer context, a historically recognized non-exclusive list of circumstances that tend to show that the debtor intended to make a transfer in derogation of the rights of creditors.
Bankruptcy Remote Entity (BRE)
An entity that acts to contain and resolve litigation away from valuable assets, and which can file for bankruptcy without subjecting the valuable assets to the bankruptcy proceeding.
Shares which are owned by and give all their rights to the holder (the "bearer"), which ownership is not recorded on the company's books. Because of their primary uses for money laundering and tax evasion, nearly all jurisdictions have abolished bearer shares in favor of registered shares, the ownership of which are recorded on the company's books so that physical issuance of the shares is in many ways superfluous.
One for whose benefits assets are held in trust.
Captive Insurance Company ("Captive")
Slang for an insurance company used predominantly to underwrite the business risk of other subsidiaries of the parent company or owner. The term "captive" is not used in any insurance statutes or in the Internal Revenue Code, but is rather a practice term used to describe an insurance company fulfilling the described role.
The process of selecting forms of structures and transfers based upon what creditors know about those structures and transfers, and the level of efforts being made by creditors to penetrate them and set them aside.
An order issued by a court to a judgment creditor which essentially compels an entity of which the debtor is a partner or member to direct to the creditor until the judgment is satisfied any distributions that would otherwise have been made to the debtor.
Charging Order Protected Entities (COPEs)
Entities that restrict the remedies of a creditor of an owner to a "charging order" that entitles the creditor to distributions made in respect of that ownership interest, but do not allow-at least initially-the creditor to actually take the ownership interest. From an asset protection standpoint, the advantage is obvious: The creditor has no immediate means of getting at the assets in the entity even though the creditor holds a judgment against one of the owners.
Charging Order Protection
This prevents a creditor of an owner of particular types of business interests from reaching the assets of the business and from gaining voting control over the business interest. Rather, the creditor can only get a court order charging the debtor's interest with the debt, meaning that the creditor will receive any distributions made in respect of the debtor's interest. If the person in charge of making such distributions never makes one, the creditor may be out of luck. Originally, this protection arose to protect nondebtor partners from the debts of other partners of a business enterprise. Typically, the availability of charging order protection is limited to partnerships and limited liability companies, which is why Family Limited Partnerships are a popular asset protection tool.
Regulations promulgated by the Secretary of the Treasury in 1996 which allow an LLC simply to choose whether to be taxed as a partnership or a corporation.
Closely Held Insurance Company (CHIC)
A privately-held insurance company that is typically owned either by the owner's children or an domestic asset protection trust formed for the owner's children, to provide additional tax and succession benefits in addition to those of the captive arrangement.
A widely-marketed cookie-cutter asset protection structure involving an FLP with the limited partnership interests owned by a FAPT. The strategy is that if a creditor attacks the FLP, the FLP is liquidated into the FAPT and all assets moved offshore.
Companies Limited by Guarantee
A company that has not been capitalized by cash, but rather by the promises of the shareholders to provide a specified amount of cash if required by the company to satisfy liabilities. A similar example is the traditional Lloyds of London syndicates were essentially companies that were capitalized by the unlimited guarantees of their members (the "Names") to stand behind the syndicates' underwritings.
An asset that is capable of being broken into component parts.
Controlled Foreign Corporation (CFC)
In very general terms, the U.S. Internal Revenue Code term used to describe a foreign corporation that is owned in substantial part or controlled by U.S. persons. For example, an International Business Company formed in the Cayman Islands and owned and controlled in majority party by three U.S. shareholders would likely be treated as a CFC. A CFC has very extensive reporting requirements, and the failure to disclose the existence, operation or revenues of a CFC may be a felony in some instances.
Cook Islands Trust
See Foreign Asset Protection Trust, below.
A plan of a one-size-fits-all nature sold by promoters, who make enormous profits from selling such plans because their costs to implement the plan are nominal. The effectiveness of such plans is highly questionable, since typically if a creditor is able to defeat one plan then all similar plans can be likewise defeated.
Corporate Shell (a/k/a Corporate Veil)
Slang for the liability limiting advantage of a corporation, which limits the liability of shareholders to the equity they have contributed.
A fictitious legal entity authorized by statute, created by the filing of Articles of Incorporation with the relevant jurisdiction, and capitalized by issuing shares of stock. A corporation can provide protection to the shareholders against the liabilities created by the corporation in excess of the corporation's capital.
The financing of an entity by borrowing or by issuing bonds or promissory notes, etc. From an asset protection standpoint, the advantage of debt financing to equity financing is that in the event of a bankruptcy the debtholders should have priority over general creditors of the entity in the distribution of the entity's assets.
A strategy whereby multiple layers of defenses are created with the idea that even though the creditor might ultimately be able to break through each layer, the creditor will eventually be worn down and settlement will be facilitated.
Deferred Private Annuity (DPA)
A Private Annuity arrangement that is deferred until the Obligee reaches some age, usually around 70. From the asset protection viewpoint, the hoped-for advantage is that the creditor will not be able to garnish payments until the deferral period ceases and the annuity payments begin.
A method of setting a low value for an asset by repeated sales to third-parties at successively lower prices, and which may include dissembling an asset with the idea of later reassembling it with the target purchaser.
A method of decreasing a creditor's share or interest in an entity by issuing additional shares or interests to non-creditor shareholders or members.
Directors' and Officers' Liability (a/k/a D&O Liability)
The direct, personal liability of directors' and officers' of corporations for their acts that adversely affect the corporation (and thus giving rise to a shareholders' derivative action) and for the corporation's acts which adversely affect others (as in the case of employment discrimination claims).
A trust that allows the trustee the discretion to make or not make distributions of benefits to the beneficiary, and to make unequal distributions among all beneficiaries.
An entity for which the tax consequences are attributed to its owner as if it did not exist. Note that this does not mean that the entity is "tax exempt", which is a common and false claim made by tax scam artists.
Doctrine of Disbelief
This doctrine holds that since no sane person would transfer all of their assets to a foreign trustee and risk the assets disappearing, it then stands to reason that they still retain some hidden control over the assets whether they admit to such control or not.
Domestic Asset Protection Trust (DAPT)
A self-settled spendthrift trust formed in a U.S. state that permits such forms of trust.
Domestic/Offshore Trust – See “Killer Rabbit Trust”
A trust formed in a jurisdiction that has either abolished the Rule Against Perpetuities (which limits the duration of trusts) or has statutorily expanded the Rule Against Perpetuities for a period in excess of 100 years.
Those strategies identified as asset protection strategies (typically in the marketing materials of asset protection promoters), but about which the law is not yet settled.
Those strategies that are readily identifiable and either do or do not work according to established law.
Employee Stock Ownership Plan (ESOP)
A plan formed to benefit and incentivize the employees of a business, and which can qualify for advantageous tax treatment.
The process of borrowing against an asset so as to reduce the debtor's equity in the asset.
ERISA Anti-Alienation Provision
A provision found in the Employee Retirement Security Act (ERISA) that prohibits a participant in an ERISA-qualified trust from transferring his or her interest in the plan to others, and which effectively prevents a creditor from attacking the assets of the plan while they are in the trust.
The process of transferring assets to either the children or a trust for the benefit of the children now, so that the future growth of those assets is with the children or their trust, and not within the parent's estate. The asset protection equivalent is known as an "asset freeze".
See Xtreme LLC, below.
Family Limited Partnership (FLP)
A limited partnership which holds the family's business or investments, with the idea that the parents will gift interests in the partnership to their children at a discount, thus potentially saving federal gift and estate taxes. The term is planner's slang, since there is no entity called a "family limited partnership" that is referenced by any statute, nor is any such entity referenced in the Internal Revenue Code.
Father of Asset Protection
(or sometimes, "Grandfather of Asset Protection")
A self-annointed title shamelessly used by some cookie-cutter promoters in their sales materials in an attempt to falsely give the impression that they were the one who created the field of asset protection planning. There have been no claims to be the "Mother of Asset Protection" yet, but as women enter the field of asset protection planning it is inevitable that such a title will eventually be claimed.
Fleeing Trust – See “Killer Rabbit Trust”
Flight Trust – See “Killer Rabbit Trust”
Foreign Asset Protection Trust (FAPT)
A self-settled spendthrift trust formed in a foreign debtor haven jurisdiction.
A charitable organization typically created in a tax and debtor haven jurisdiction, most often on the model of the Stiftung.
Fraudulent Transfer (a/k/a "Fraudulent Conveyance")
A transfer in derogation of the rights of a creditor to satisfy his judgment against the assets of the debtor.
General Partnership (GP)
A partnership that consist only of general partners, all of who are jointly liable for the liabilities of the partnership, and all of whom have management rights to the partnership. In asset protection planning, general partnerships are usually to be avoided.
A defensive arrangement whereby if a hostile party attempts to seize control of the corporation by changing the corporation's officers, the officers are given large severance benefits, thus increasing the costs to the hostile party.
Relationships or transfers linking persons or entities that cannot be undone. For instance, a gift is "hard wired" because it cannot be undone. A Protector who cannot be changed or removed is said to be "hard wired". Contrast with "Soft Wiring".
Homestead Exemption (a/k/a "Homestead Protection")
A statutory exemption against collection given to certain interests in real property being used as the primary residence of the debtor.
An entity that does not have a classic form, such as a corporation or partnership, but instead exists as a combination of entities, such as a combination of trust and corporation. Even as late as the early 1990s the LLC was considered to be a hybrid of a corporation and a partnership, for example, but it has since become a classic form of business entity.