Financial Snake Oil: Asset Protection Scams

Here's a typical ad for asset protection services:

Shelter your home, auto, savings, and everything else you own from creditors!

Divorce-proof your assets!

Block the IRS from levying your wages or seizing your property!

Gain total financial privacy!

Open a bank or brokerage account without providing your Social Security number!

The litigation explosion, Why you should have a corporation - even if you don't own a business!

Sounds great, right?  Google "bullet proof asset protection" (in quotes) and almost 14 thousand websites show up.  

Here's the problem: bullet proof asset protection is a lie.  Oh, and that "ad" above?  It's from Bill Reed, and according to Webwire, "A federal judge in St. Louis has permanently barred William S.Reed, the founder of a so-called “asset protection” business, from preparing fraudulent liens for customers and helping customers conceal their funds by having shell corporations own their bank accounts, the Justice Department announced today."

Certainly, there are legitimate things one can do to better protect assets.  However, 1) nothing is 100% effective, 2) nothing will allow you to completely avoid your tax obligations, 3) nothing will allow you to commit fraud and crime unimpeded.

I am writing this article because from time to time I see high-pressure "planners" pitch expensive "trusts" to unsuspecting people here in Cobb County, Georgia.  They claim that the trusts will avoid creditors, taxes, and medicaid recovery.  Typically, these are just revocable trusts.  Since they are revocable, they don't protect against anything and are really just for avoiding the probate process.  In Georgia, revocable trusts are subject to the creditors of one's estate at death if there are insufficient assets in the probate estate.  As such, they are NOT asset protection tools.  Moreover, these trusts tend to be written by attorneys in other states.  What a terrible situation to have to deal with: a trust or a Will that has a different state's law apply for no legitimate reason.  Remember: attorneys make a lot more money from bad Wills and trusts going to court then they do from planning.  Probate litigation can easily cost tens of thousands of dollars.  It is important therefore to make sure that the attorney you hire is very experienced, even if you have a small estate.  The process here in Georgia to probate is generally the same regardless of the size of the estate, and I have seen plenty of $20,000 estates end up having $20,000 of attorneys fees due to poorly drafted documents.  I have pretty much never seen a non-attorney completely and properly draft their own Will (but again just going to some random attorney won't fix the problem....attorneys need to be licensed in your state and experienced at drafting Wills.  Even better if they have probate court experience defending their documents).

Now, back to the problems with "bullet proof asset protection".

Problem #1: Judges: Judges dislike defendants telling them they can't do something.  Many of the asset protection planners have no courtroom experience.  A judge isn't going to listen to the idea that a defendant cannot bring back assets that they embezzled because of some fancy Cook Island trust.  As has been shown in some famous cases, such as the Lawrence case, the judge will simply incarcerate the defendant standing right in front of them for contempt, until such time as the assets are repatriated.  The worst part about this is that this defendant may very well be unable to bring the assets back, yet the judge won't care.  Why?  Because the defendant is responsible for the problem, as the defendant put the assets in the trust.  

I had a law professor once tell me, "If you cannot explain something to a judge on a 4th grade level, then you are going to lose."  Although this may be a bit of an exaggeration, it is not much of one. Judges like short and simple explanations (and explanations that respect the judges power).  Therefore, weaving a complex web of corporations, trusts, secret bank accounts, etc. will simply look like deception to a judge.

Silly arguments don't go over too well.  Several years ago snake oil salesmen pitched Nevada corporations as "bullet proof asset protection" due to this made up idea of "bearer shares".  The idea was that you set up a Nevada corporation, and had shares which state that whoever holds the shares owns the corporation.  You then give the shares away to a person, who gives them away to another person.  Then, if called into court, you could "truthfully" state that you do not know who actually owns the corporation.  The problem with this?  Each transfer of the corporation would be a taxable event, and would be reportable on tax returns.  Failure to so report could mean either 1) this whole bearer share thing is a sham that should be ignored by the court, or 2) that the parties are committing tax fraud.  If tax returns are filed, then they can easily be obtained by a Plaintiff.  Nevada has since amended their laws to specifically disallow bearer shares, since this scam was giving Nevada a bad reputation. 

Problem #2: Divorce, particularly with minor children:  Judges have taken a dim view of the use of asset protection trusts to avoid child support obligations, and have not hesitated to incarcerate those who defy repatriation orders (even when it truly has been impossible to bring back assets).

Problem #3: Fraudulent transfers: Court can look back several years and undo transfers of assets that were for less than full value.  

Problem #4: Bankruptcy:  Bankruptcy judges have a great deal of power to bring assets back into the bankruptcy estate.  Moreover, failure to list assets can be a reason to deny a discharge and dismiss a bankruptcy (which would make a debtor continue to be liable to creditors).  Don't forget, these bankruptcy courts can use the same fraudulent laws to undo transfers for less than value.  I saw this happen to investors who bought distressed real estate a few years ago from desperate people who then declared bankruptcy.  The bankruptcy trustees argued that the real estate was bought for less than reasonably equivalent value and that therefore the sales of the property should be undone (and notice that there does not actually have to be any bad intent, just that it was for less than reasonably equivalent value).

Problem #5: The very determined creditor: Many of the asset protection plans are more like deterrents to litigation than they are "bullet proof".  A determined creditor could sue anywhere, and could even utilize tools such as involuntary bankruptcies (which may expand the types of assets that could be available to creditors, in addition to being able to utilize the powers of the bankruptcy trustee).  Contrary to much of what is written on the internet, it is often much cheaper to initiate litigation than it is to conduct extensive background checks, and then to develop what assets and entities there are through the discovery process.

Problem #6: The IRS:  Don't cheat them.  Bad idea.  There is extensive reporting now for US citizens and tax residents (see some of my other blog posts).  The consequences for failure to file can be dire, including criminal penalties.  A department at the Treasury Department that looks into failure to file foreign bank account reports is titled "Global Financial Crimes".

Problem #7: Scams:  I had clients be pitched by Stanford Group before Stanford Group was seized by the government (the clients fortunately did not invest with them). Part of their pitch was that by holding your money offshore it was asset protected.  The problem? The government claims the entire operation was a Ponzi scheme.  Don't forget, you can get judgments against wrongdoers, but that doesn't bring the money back if it has already been spent, and the con artist is insolvent.

Problem #8: Loss of control over assets:  This problem exists even in legitimate plans.  If you have complete control over an asset so can your creditors generally.  Most of the assets protection structures will have at least some restrictions over your control of an asset, which may be unattractive.

Problem #9: Medicaid Recovery:  Like fraudulent transfers, medicaid has a lookback period for transfer that are for less than equivilent value.  Also, if you continue to use an asset, such as a house, it may not be considered transferred.

The solution?:  Make sure that you do your planning before there are any lawsuits and while you are solvent. Be especially careful if you are thinking you will need nursing home medicaid in the next few years (and use a good elder care planner).  Obviously, don't commit fraud and crimes.  Have legitimate non-asset protection reasons for whatever structure you set up.  Don't try to just hide assets as you could be forced to answer discovery questions anyway, and committing perjury is not a wise asset protection plan.  Use counsel that is experienced in asset protection and is familiar with the court process, possible IRS challenges, etc.  There aren't too many solutions to the loss of control problem mentioned above, and there will simply have to be cost/benefit/risk analysis done of any proposed structure.

 

 

Do you have foreign assets or accounts? Then read this post.....

US citizens and residents who have assets and/or accounts in foreign countries, beware.  You have reporting requirements with harsh penalties for failure to comply.

According to the IRS:

United States persons are required to file an FBAR if:

1. The United States person had a financial interest in or signature authority over at least one financial account located outside of the United States; and
2. The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

An FBAR is required for "financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account."  The FBAR filing requirement exists "to help the United States government identify persons who may be using foreign financial accounts to circumvent United States law. Investigators use FBARs to help identify or trace funds used for illicit purposes or to identify unreported income maintained or generated abroad."

Moreover, and interest, gains, etc. from these accounts must be reported on the tax return.  US Citizens and US residents should file tax returns every year, even if all of their income is earned in a foreign country. 

According to the IRS:

Depending on a taxpayer’s particular facts and circumstances, the following penalties could apply: A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation. A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048.This return also reports the receipt of gifts from foreign entities under section 6039F.The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift. A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b).The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the United States person. A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046.The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency. A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional. A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit. Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax. A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent. A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent. An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

Therefore, it is imperative that one keep up with all of the proper filings.

If this wasn't enough, there are now additional filings under FATCA:

You must file the new Form 8938 if:

• You are a US Citizen or Tax resident; and
• You have "[a]ny financial account maintained by a foreign financial institution," "[s]tock or securities issued by someone other than a U.S. person," "[a]ny interest in a foreign entity," and/or "[a]ny financial instrument or contract that has as an issuer or counterparty that is other than a U.S. person."  The types of assets that may be ensnared by this provison is quite broad, so it is strongly recommended to consult a tax professional; and
• "The aggregate value of your specified foreign financial assets is more than the reporting thresholds that applies to you: Unmarried taxpayers living in the US: The total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.  Married taxpayers filing a joint income tax return and living in the US: The total value of your specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.  Married taxpayers filing separate income tax returns and living in the US: The total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year." 
• "For Taxpayers living abroad (You are a U.S. citizen whose tax home is in a foreign country and you are either a bona fide resident of a foreign country or countries for an uninterrupted period that includes the entire tax year, or [y]ou are a US citizen or resident, who during a period of 12 consecutive months ending in the tax year is physically present in a foreign country or countries at least 330 days.) If you are a taxpayer living abroad you must file if . . . [y]ou are filing a return other than a joint return and the total value of your specified foreign assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year; or [y]ou are filing a joint return and the value of your specified foreign asset is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year."

This form will need to be filed with the 2011 tax return (generally filed in 2012 for most people).  Therefore, this is a new form, released November 2011.

So what are the penalties for failing to file this new form you might ask?  It's at least $10,000, and up to $50,000 for a continued failure to file after the IRS notifies you of your failure to report. For most taxpayers this will be filed with the 2011 tax return they file during the 2012 tax filing season.  Worse,  "underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent."  40%!!!!

Just in case I have failed to emphasize how serious the US government is taking this reporting, remember that it can be a crime not to report and US government agencies such as the Financial Crimes Enforcement Network have issued warnings to dissuade people from failure to file.

Oh, and there is nowhere to hide: "FATCA will also require foreign financial institutions . . . to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest."

Sources:IRS.gov, fincen.gov