1 Asset Protection Planning John R. Humphrey, CPA, J.D. Taft Stettinius & Hollister LLP One Indiana Square, Suite 3500 Indianapolis, IN

2 What is Asset Protection Planning? State and Federal law prevents creditors from taking certain types of property and forcing its sale or other disposition. Asset protection concerns planning and structuring assets in consideration of these debtor protection laws. These “exemption laws” only apply to individuals and not to corporations, limited liability companies or other business entities. Also, it is possible for a debtor to mortgage property which would otherwise be exempt and such mortgages will be effective.

3 What is Asset Protection Planning? In Indiana, the primary state exemption laws only apply to individuals domiciled in Indiana. If your client has to file a bankruptcy, the “exempt” property is that property which the client will be able to keep after the bankruptcy debts are discharged. Outside of bankruptcy, a state or federal judge may not order this exempt property to be sold or otherwise disposed to pay a creditor’s claim. Bankruptcy and non-bankruptcy exemption laws are generally the same except where indicated below.

4 What is Asset Protection Planning? Another aspect of Asset Protection Planning deals with the transfer of property to a foreign country, particularly those nations that do not recognize judgments of the courts of the United States. There are several new hurdles to keeping such activities secret, including tax reporting of foreign bank accounts. Also, it is very common for persons who make such transfers to be held in contempt and jailed if they refuse to repatriate the money when they are pursued by creditors. I do not counsel clients to make such transfers as I don’t believe they are warranted in the vast majority of cases. Please contact me if you wish to investigate such services and I can refer you to appropriate persons.

5 What Property is Exempt? Retirement Plans According to I ND. C ODE § (c)(6), Retirement plans or funds are exempt to the extent of: 1. contributions, or portions of contributions, that were made to the retirement plan or fund by or on behalf of the debtor or the debtor’s spouse: (a) which were not subject to federal income taxation to the debtor at the time of the contribution; or (b) which are made to a ROTH IRA (Section 408A). 2. earnings on contributions made under clause (A) that are not subject to federal income taxation at the time of the levy; and 3. roll-overs of contributions made under clause (A) that are not subject to federal income taxation at the time of the levy.

6 What Property is Exempt? Retirement Plan Issues What is a “retirement plan” to which Indiana’s law would apply? I ND. C ODE § defines a “Retirement Plan” as: (1) a stock bonus, a pension, a profit sharing, an annuity, or a similar plan or arrangement, including a retirement plan for self-employed individuals or a simplified employee pension plan; (2) a government or church retirement plan or contract; or (3) an individual retirement annuity or individual retirement account; that is intended in good faith to qualify as a retirement plan under applicable provisions of the Internal Revenue Code of 1986, as amended.

7 What Property is Exempt? Inherited IRAs In 2014, the United States Supreme Court found that inherited IRAs were not exempt in bankruptcy. See Clark v. Rameker, 132 S. Ct (2014). However, we should note that if the person inheriting the plan is a spouse, and the spouse designates the inherited IRA as his or her own, Indiana’s state law exemption would likely apply and make those funds exempt. Clark concerned the creditors of beneficiaries other than the spouse of the IRA holder. Clients concerned about the creditors of their beneficiaries may wish to establish a spendthrift trust and make the trust the beneficiary of the retirement plan.

8 What Property is Exempt? Retirement Plan Issues, con’t Nondeductible contributions – Nondeductible IRA contributions and the earning thereon would likely not be exempt under Indiana’s statute because that law only exempts contributions which were not subject to tax at the time of contribution and ROTH IRAs and nondeductible contributions to a traditional IRA are not listed. However, they would be exempt in bankruptcy because of a statute that allows all Section 408 (traditional IRA) funds to be claimed as exempt. Distributed Funds - The Indiana Supreme Court has held that, once funds are out of the retirement plan, they are no longer exempt and remain subject to the claims of creditors. Brosamer v. Mark, 540 N.E.2d 652 (Ind. 1989). This would apply, for example, as in the case before the Supreme Court, to funds in a bank account that had formerly been in a retirement plan.

9 What Property is Exempt? Other Tax Exempt Accounts 529 Plans and Education Savings Accounts (accounts established pursuant to Section 530 of the Internal Revenue Code) are exempt pursuant to I ND. C ODE § (c)(9) and (10) except: 1) excess contributions and earnings on those contributions; 2) contributions made in the last year before bankruptcy or state court action and any earnings thereon and 3) any contribution of more than $5,000 for the same beneficiary (reduced by the amount of any contribution to the other type of account, i.e. only one $5,000 exemption may be taken for both the Section 529 Plan and the Education Savings Account), in the year prior to the last prior year. Health Savings Accounts established pursuant to Internal Revenue Code §223 by virtue of I ND. C ODE § (c)(8).

10 What Property is Exempt? Life Insurance Pursuant to I ND C ODE § , the death benefits, cash surrender value and other “proceeds and avails” of a life insurance policy are exempt from the claims of the insured person’s creditors or the creditors of the insured person’s spouse, as long as the beneficiary is a creditor, spouse, child or relative dependent of the policy owner. However, any premium paid within one year of the filing of a bankruptcy or made with intend to defraud the creditors of the policy owner is not exempt. The statute does not define what a “life insurance” policy is. At this point there are several different products that have some of the characteristics of life insurance. To qualify as “life insurance”, the contract may have to be issued by an entity authorized to write life policies in Indiana, however at this point that is unclear.

11 Life Insurance Indiana Constitutional Limitation There is no statutory limit to the amount of proceeds and avails of a life insurance policy that would be exempt under the specific exemption statute for life insurance. The Indiana Supreme Court has held that such an unlimited exemption is constitutionally suspect (because the Indiana Constitution only allows reasonable exemptions) and can only be allowed upon proof that the exemption is required to afford the necessities of life. The case is Citizens National Bank of Evansville, 668 N.E.2d 1236 (Ind. 1996). The Supreme Court sent the case back to the Bankruptcy Court, who had found that the policy was not exempt. The policy in that case was a single premium policy which had been purchased for $100, days prior to a bankruptcy filing. At that time, there was no statute that prohibited an exemption for premiums in the year prior to bankruptcy. Presumably, policies primarily weighted toward death benefits to support a family after the insured’s death acquired long before bankruptcy or other financial distress would be exempt if the death benefit is reasonably necessary to provide that support.

12 What is Exempt? - Real Estate Real Estate owned by two spouses is exempt from the creditors of a single spouse. I ND. C ODE § (c)(6). Such real estate will not be exempt from joint creditors of both spouses (including, for example, mortgages). However, spouses may still take $38,600 of exemption against joint creditors who do not have a mortgage. This would also apply to rental property or other real estate other than a residence. However, if one member of a couple files bankruptcy, and the couple owns a $10 million apartment building in their individual names, trying to exempt the $10 million will be constitutionally suspect and subject to avoidance as explained in the last slide dealing with life insurance. Single persons may claim $19,300 of their personal residence real estate equity as exempt.

13 What is Exempt? - Other Property Tangible personal property or real estate other than a residence – up to $10,750 in value or equity is exempt under I ND. C O de (c)(2). Intangible personal property up to $400 is exempt. I ND. C ODE (c)(3). Veterans Benefits are exempt under federal law. 38 USC 5301(a).

14 What is Exempt? - Other Property, con’t Social Security Benefits are not subject to creditor claims or loss in bankruptcy even after they have been deposited into a bank account. Limited Liability Company interests may not generally be sold without the consent of the other members of the limited liability company. A creditor of the member may usually only obtain a charging order from a court, which allows the creditor to obtain only that income that the debtor member is entitled to from the limited liability company. This limitation may not apply when the limited liability company has only one member, but that has not been decided in Indiana.

15 What is Exempt? Rules Differences in Bankruptcy Traditional IRA – If the bankruptcy debtor has more than $1,245,475 in a traditional IRA or Roth IRA (but not including rollovers), the amount of the excess will not be exempt if the debtor is forced into bankruptcy. As an aside, there are probably not many people who would have this amount in a traditional IRA that is not a rollover. Essentially, a person would have to have started investing the maximum in 1975 and continued until now while still remaining young enough to not age out of the contribution eligibility. A model shows that it might be possible for a person who was years old who contributed the maximum amount every year since 1975 and recovered at least the amount of the S & P 500 return every year. Such a person would be years by the time they accumulated this amount and such persons usually don’t find themselves in bankruptcy, however.

16 What is Exempt? Rules Differences in Bankruptcy con’t Residence Limitation – a debtor may not claim more than $155,675 in equity in a residence as exempt if the debtor acquired the residence within 3 and one half years (1215 days) of filing bankruptcy. 11 U.S.C. § 522(p). Self-Settled Trust - A bankruptcy trustee may avoid a transfer to a trust made within the last 10 years if the trust was established by a debtor with the intent to “hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.” 11 USC § 548(e).

17 Exemption Planning Converting Non-Exempt Property to Exempt Property. It is generally not a problem for a debtor to convert his or her property from a form which is not exempt to a form which is exempt, unless one of the following factors is present: (1) the debtor obtained credit in order to purchase exempt property; (2) that the conversion occurred after the entry of a l arge judgment against the debtor; (3) that the debtor had engaged in a pattern of sharp dealing prior to bankruptcy;... and [(4) ] that the conversion rendered the debtor insolvent. In re Smiley, 864 F.2d 562 (7 th Cir. 1989). Some states, most notably Florida, have fraudulent conversion statute, which nullifies an exemption on property has been converted from non- exempt to exempt form.

18 Exemption Planning, con’t Moving to a Different State: If a debtor is unhappy with the exemption laws in your current state, the debtor may move to a different state with more favorable laws. However, the exemption laws of the state of the debtor’s original domicile will be those which apply to your bankruptcy case for 2 years after the debtor’s move. Creditors may react to a move by forcing an involuntary bankruptcy within the 2 year period. Florida is a debtor-friendly state for married people while Texas is generally superior for unmarried persons. In deciding where, when and if to move, a debtor must consider whether the state has a fraudulent asset conversion statute (like Florida) and the effect of the $155,675 homestead limitation discussed above.

19 Exemption Planning, con’t Transfers of property: Debtors are often tempted to transfer property to a spouse, another family member or other friendly person to avoid a creditor obtaining the property. This should be avoided. First, if a person, conceals, encumbers, or transfers property with intent to defraud the person's creditor, such person has committed a Level 6 felony under Indiana law, and the person receiving the property may be an accessory and also subject to criminal prosecution. I ND. C ODE (8). Second, in many circumstances creditors will find out and simply sue the recipient of the property for recovery of the fraudulent transfer. Finally, if the transfer is made within one (1) year of bankruptcy, then the debtor may lose the bankruptcy discharge because of a provision of the Bankruptcy Code prohibiting the debtor from receiving the benefits of the bankruptcy when the debtor has made such a pre-bankruptcy transfer. 11 USC § 727(a)(2)(A).

20 Taxes: When your Creditor is the United States Indiana and other State Exemption laws do not prohibit the attachment of a federal tax lien and collection of the tax by IRS levy. For example, the fact that real property is held by two spouses as tenants by the entirety will not prohibit the IRS from foreclosing a federal tax lien and selling the real estate even though only one of the spouses owes the tax giving rise to the federal tax lien. See United States v. Craft, 122 S.Ct (2002). Ordinary creditors do not have that power and are prohibited by the exemption statute for tenants by the entireties.

21 Taxes: When your Creditor is the United States, con’t However, the IRS will not always use its full collection powers. For example, the Internal Revenue Manual instructs that revenue officers should not levy on a retirement account unless the taxpayer’s conduct has been flagrant. I.R.M Examples of flagrant conduct include: Making frivolous arguments, conviction for tax evasion, assisting others in evading tax, tax liabilities arising from illegal income, putting assets beyond the reach of the government by sending them outside of the country, concealing them, dissipating them or transferring them to other people, etc.

22 Conclusion Thankfully, the exemption laws track what many financial planners would suggest as prudent action from a financial and risk standpoint. In many cases, protecting $1 - $3 million from creditors may be relatively easy. Protection for amounts much greater than this, because of limitations on contributions to qualified plans and constitutional limitations on life insurance, may prove more difficult. Questions?