Income Tax Liability In Bankruptcy For Appreciated Property

by Zach Haris

People avoid filing Chapter 7 bankruptcy if they have the nonexempt property with significant equity. Yet, consider a debtor who owns real estate that has appreciated and therefore has a built in liability for capital gain. If that debtor files bankruptcy could the IRS hold him personally liable after bankruptcy for the income tax liability associated with the gain on the property?

When a person files bankruptcy all of his property interest is transferred to the Chapter 7 trustee and the property constitutes the bankruptcy estate. The trustee acquires the debtor’s property with its tax characteristics including gain and character. The trustee controls the sale of the property, and the trustee receives the sales proceeds for the benefit of creditors.

The trustee and the bankruptcy estate is liable to pay the tax liability created by the sale of the debtor’s property. The tax is an administrative expense. The debtor is not liable for tax on the sale of property he had conveyed to the bankruptcy estate upon filing bankruptcy. A trustee may avoid tax liability by abandoning the property instead of selling it.

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Asset Protection Planning

by Junita Jackson

Now that you are familiar with the most important asset protection and estate planning concepts how do you create the best plan? Protecting what you have from liability and preserving your estate for your family involves many new concepts for you and it’s not always easy deciding where to begin.

In this section, we will present a summary of the issues and options available-techniques to think about to frame the building of your overall plan. This is the approach we use with our clients to analyze their particular needs and to build an efficient program for asset protection, estate planning, and tax savings.

“Asset Protection and Estate Planning with the Family Savings Trust“

An increasingly popular tool used for asset protection and estate planning is known as The Family Savings Trust.  The term is broadly descriptive of a trust designed specifically to hold and protect a variety of assets against lawsuits and business risks.  It can be very flexible in form and allows for the accomplishment of most important asset protection and estate planning goals. 

“What is the Best Asset Protection Plan for Physicians?“

In our initial discussions with a client, these questions always come up “What’s the best asset protection plan?”  “Are there any plans which are completely bulletproof?”

Like any well-trained professional, I usually duck those kinds of direct and unconditional questions. After all, this is the legal system we’re talking about and when we compound the mixture of judges, jurors, and lawyers,  the results can be unexpected, to say the least.    Law is probably a lot like medicine in that respect.  So while we can’t honestly guarantee that the particular plan we design will produce the exact outcome we want, we do know what has happened before in similar situations.  If existing case law and legislation are clear and well developed then an asset protection plan that falls within the pre-set boundaries will have favorable and predictable results.

“Answers to Key Asset Protection Questions“

When I sit with clients to prepare or review their estate planning and asset protection goals a wide variety of questions and issues arise: What plan is most efficient? How are tax savings created?  How do we protect against the lawsuit and business risk?  Although I have addressed many these topics in detail in previous columns, here are a few starter questions which often arise and which may open the door for further thought and discussion. 

“Asset Protection: Needs Change Over Time“

The type of asset protection planning you need depends on where you are in your career. Because the amount and form of your investments and the particular risks you face will vary over time, your initial planning should be appropriately flexible and capable of adjusting to meet these changing needs. 

“When Is It Too Late For Asset Protection?”

One of the life’s ironies is that the worst time for asset protection planning is when you really feel like you need it the most. Although the law favors and encourages asset protection in most circumstances, there comes a point in financial transactions and legal proceedings when it is no longer permitted. In some cases, this boundary is clearly defined, but often the question of when the remedy of asset protection is still permissible is fuzzy. Experienced planners can follow several guidelines and make some educated guesses about where the line should be drawn in situations that physicians may encounter in their practice. 

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Beware Of Domestic Asset Protection Trusts

by Jason Kelley

The Domestic Asset Protection Trust ("DAPT") is an irrevocable trust that allows the settlor (or creator) of a trust to be a discretionary beneficiary.  While this trust has some advantages, it should not be used for Asset Protection as recent litigation has highlighted concerns about the DAPT, as it is often an inadequate entity to protect assets.  The DAPT is often referred to as a "self-settled trust" because the settlor is one of the beneficiaries.  Self-settled trusts allow the trustee to have the discretion of whether to make distributions to the settlor, while simultaneously protecting the assets from the settlor's creditors.The primary goal of the DAPT is to protect the assets of the settlor from their creditors.  The DAPT may also allow a settlor to transfer assets to a trust, preventing these assets from being included in the settlor's gross estate.

The major disadvantages of using the DAPT as a personal asset protector are as follows:

  • In creating a DAPT, you are more susceptible to litigation on your trust (fraudulent transfer claim) as Creditor's use this argument often to break through DAPT trusts to get to debtor assets.
  • The laws of the state where the DAPT is formed will not necessarily apply where the settlor, beneficiaries, or the trust's assets are not subject to the jurisdiction of the state.  In other words, a DAPT is only valid if the settlor and beneficiaries, as well as the trust assets, are all in the DAPT state.  Further, only twelve jurisdictions recognize the DAPT – so there is little uniformity across the United States.
  • State law pursuant to the Supremacy Clause of the US Constitution does not always bind federal courts.  Therefore, DAPT statutes may not protect the settlor against judgments in federal courts or by federal administrative agencies.
  • DAPT, as self-settled trusts, have a longer statute of limitations for creditors to sue on than most other Asset Protection Tools.

On the other hand, the limited liability company (LLC) and limited partnership (LP) are far more adequate entities for Asset Protection planning.

See more on these entities at the following links:

  • Limited liability companies
  • Limited partnerships

If you have any more questions regarding DAPT's or any other Asset Protection Planning tools, feel free to contact our Attorneys.

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Asset Protection for Patients

by Zach Haris

In light of the proposed appeal of The Affordable Care Act, we are re-issuing this Article about the importance of protecting your assets from unexpected medical bills and claims:

 

Asset Protection for Patients

 

In a new and ironic twist, a growing number of individuals are now legally protecting themselves from their doctors. The idea may be surprising, but with rapidly disappearing health coverage, medical expenses are now a realistic and high probability threat to the lifetime savings of millions of Americans.  Just as physicians have been diligent about planning to minimize their malpractice liability risks, now patients are anticipating and protecting themselves against the serious financial consequences of unforeseen medical expenses.

No one doubts that there’s a monumental crisis in health care coverage. Forty-five million Americans have no medical insurance and even those with group or private policies are sometimes stuck with unexpected and un-payable bills. Higher deductibles and co-pays can easily balloon out-of-pocket costs beyond anything anticipated. Even those who think they have solid insurance, in a good plan, may find out, when it’s too late, that their coverage means a lot less than they thought.  Every day we hear stories from clients and the news about insurers refusing payment during or after treatment.  In a recent CBS News report about one of the nation’s largest insurers, Richard Blumenthal, Connecticut Attorney General, declared that “The company [Assurant Health] offers the illusion of coverage while challenging any large claim.” In the report, a former claims adjuster revealed that it was company policy to scrutinize any significant claim, often manufacturing excuses to avoid payment. Unfortunately, despite a few notable fines and lawsuit settlements, these hardball tactics appear to be the normal course of business for at least some insurers.

When Patients Can’t Pay

What happens when a large medical bill can’t be paid?  Usually the outcome is a lawsuit filed by the hospital or collection agency with a judgment and a lien filed against the patient’s home and accounts. In most states, a percentage of the debtor’s employment earnings can be garnished. Generally, before this point is reached, the patient files a personal bankruptcy to stop the wage garnishment and wipe out the medical bills and other accumulated debts. But that requires that he give up all of his assets including savings accounts, real estate and equity in his home.  These assets, except those that are specifically exempt, are turned over to the Court and divided among the creditors.

According to a 2005 study by Harvard University, about half of the 1.5 million annual bankruptcy filings are caused by illness and medical bills. And surprisingly, three fourths of those had health insurance at the start of the illness which triggered the filing. “Unless you’re Bill Gates, you’re just one serious illness away from bankruptcy”, said Dr. David Himmelstein, the study’s lead author and an associate professor of medicine. “Most of the medically bankrupt were average Americans who happened to get sick.”

How Patients Protect Themselves

The high level of financial risk posed by an unpredictable medical event is now leading patients to take steps to protect their savings from this threat. For instance, I met with Mr. and Mrs. X last week, a couple in their early 50s. They have about $300,000 of equity in their home and $200,000 in savings. Mr. X is self-employed and Mrs. X works for a small company. Both are covered under her group plan, but, with rising costs, the company might cut back or terminate the plan sometime soon. Individual policies may be available at that point but the cost and extent of the coverage is unknown.  The goal of their planning is to protect their savings from large, unexpected bills at any point in the future.  Asset protection, using techniques such as a Family Savings Trust can effectively shield savings from these events, but the planning must be completed before the fact. If bills have been incurred, or expenses loom, planning is too late at that point.

Conclusion

Of course the real solution to the problem is for everyone to have affordable insurance which covers any health care costs. However, it’s almost impossible to imagine a scenario in which competing financial and political interests are able to agree and implement a worthwhile plan, at least for the foreseeable future. For now, many believe that their only reasonable choice is asset protection to minimize these risks.  Early planning and advice from a knowledgeable local attorney are essential to the success of these measures.

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