Asset protection in California is in high demand as the state has earned a reputation for being the most litigious in the United States. Divorce rates in California are over 60%. Those in high-risk professions, such as physicians, lawyers and other business owners, may be even more likely to fall victim to predatory lawsuits. Asset-hungry creditors feel emboldened by laws slanted in their favor. For these reasons, a solid asset protection strategy is an essential tool for any California resident looking to protect his or her wealth.
What is Asset Protection?
The main goal of asset protection is to keep assets out of the reach of creditors without engaging in concealment or tax evasion. Properly implemented asset protection planning is both ethical and legal. For people of substantial means, asset protection planning is an absolute necessity. Many of the structures people use in well-crafted asset protection plans are ones people commonly use in business and estate planning. These structures include limited liability companies, corporations, and trusts, among other tools.
Effectiveness of Asset Protection Vehicles in California
California does not have a strong reputation for asset protection. Domestic Asset Protection Trusts (DAPT), are domestic legal vehicles for asset protection. Unfortunately, there is no such thing as a California asset protection trust, in this context, as they are not available in California. The legal tools for asset protection that are available in California have varying degrees of effectiveness. We discuss the most popular vehicles below.
A trust does the following. A person with assets assigns a person as caretaker of assets for the benefit of another person. We call the person who hands over the assets the settlor of the trust. The term for the person who takes care of the assets is the trustee. Finally, we call the person receives the benefits from the assets that the trusts the beneficiary. Trustees are to follow the instructions the settlor give with regards to the management of the trust. Frequently, these instructions will include how and when the beneficiary may use the assets held in the trust.
Experts consider trusts as the favorite tools for asset protection because they separate the beneficial interest of trust assets from their legal ownership. The most commonly used trusts in California are revocable inter vivos trusts. Frequently referred to as living trusts or family trusts, they provide very little protection from creditors for the beneficiaries of the trust. If the debtor is the settlor and beneficiary of the trust, they do not provide the settlor/ debtor with any significant degree of asset protection. Irrevocable trusts in California, where the settlor and beneficiary differ, in contrast, can provide protection for the settlor/ debtor because the settlor is permanently removed from the legal ownership of the assets in the trust.
Types of Trusts
As mentioned previously, Domestic Asset Protection Trusts (DAPT) are not available in California. Californians who wish to avail themselves of the protection provided by Domestic Asset Protection Trusts must do so in a state where they are available. Even if a Californian does use an asset protection trust established under the laws of a state that does recognize them, we have seen California courts penetrate them.
People commonly use qualified personal residence trusts, spendthrift trusts, and discretionary trusts for asset protection in California. Qualified personal residence trusts are irrevocable trusts that homeowners use to transfer the settlor’s residence out of their estate as a low-tax gift. The settlor retains a term-of-years right to live in the residence rent-free. The remaining interest goes to the beneficiaries.
Spendthrift trusts are trusts that limit or remove the ability of beneficiaries to assign or transfer their interest in the trusts. Traditionally, people use spendthrift trusts to provide for beneficiaries who cannot manage their own financial affairs. Spendthrift trusts can provide some asset protection for beneficiaries. However, California law prohibits self-settled spendthrift trusts. As a result, spendthrift trusts in California do not provide asset protection for the settlors who contribute to them.
We refer to a trust as a discretionary trust when the trustee has discretion over making distributions. This discretion applies to the timing and amount of the distribution, as well as the identity of the beneficiary. The lack of control on behalf of the beneficiary works in their favor with regards to asset protection. That is, because the beneficiary has no property right, there is nothing for their creditors to pursue. In states such as California the trust may not be self-settled if it is to provide asset protection. So, in California, this protection applies to beneficiary and does not apply to the settlor. Like other California trusts, discretionary trusts are not immune to child support and alimony claims.
Business owners often use limited liability companies and corporations for lawsuit protection in California. Limited liability companies protect the personal assets of shareholders or partners by limiting their liability for the business’ debts and obligations. The statutes of these entities can limit owner liability to the amount they have invested in the business. Corporations also have the ability to act as separate legal entities from their owners or shareholders when someone sues the business.
While limited liability entities protect the assets of an individual from creditor claims of the business, the reverse is not true. In California, creditors of individual partners and shareholders have the ability to make claims against a debtor’s interest in a business. Additionally, with regards to limited liability companies and corporations, it is possible for creditors to enact the alter ego doctrine. We also call the alter ego doctrine piercing the corporate veil. The doctrine asserts that the law only considers limited liability companies and corporations as separate legal entities from their owners and shareholders when they treat them as such. If a shareholder commingles personal and business assets, they run the risk of their company or corporation losing its status as a separate legal entity from the shareholder.
California Homestead Exemption
A homestead exemption means that a creditor cannot force the sale of a debtor’s home when the equity qualifies for the exemption. Let’s say the debtor chooses to sell his or her primary home. The exemption protects the proceeds of that sale up to the amount of the exemption.
The state legislature has revised the California homestead exemption. Previously, it was $75,000 for singles, $100,000 for married couples, or $175,000 for elderly or disabled.
As of January 1, 2021, Cal. Civ. Proc. Code §704.730 allows for a minimum homestead exemption of $300,000. Plus it has a maximum of the median sale price for a single-family home in the prior calendar year in the county in question to a maximum of $600,000. Furthermore, the amounts are to be indexed annually with inflation starting January 1, 2022, based on the California Consumer Price Index published by the Dept. of Industrial Relations. Therefore exemption amounts will be automatically updated by county without the need for another act of legislature. (So, for example if the median home price in San Francisco County is $1.4 million, the maximum homestead exemption in that county is $600,000. If the median home price in Modoc county is $134,854, the maximum homestead exemption in that county is $300,000.)
While this exemption is higher than the exemption available in some states, so are the housing prices. For example, Florida and Texas offer exemptions that are unlimited in terms of financial value, depending on the size of the land. With the high cost of housing, home equity in California often far exceeds the amount of the exemption. Thus, the place they call home represents a juicy carrot dangling before the noses of hungry trial lawyers.
It is essential to note that certain creditors are not impacted by the California homestead exemption. These creditors include International Revenue Service, state government for tax claims, and those with alimony and child support claims. Likewise, the exemption does not impact purchase money creditors with a secured interest in the homestead and debts related to the improvement of the homestead property.
Life Insurance Exemption
California law also allows for an exemption for life insurance. The state does not provide any limitation on the face amount of the insurance protected. It does, however, place a $9,700 limitation on cash surrender value. Several other states offer no limitation on the protection afforded to cash surrender value. This is the case so long as a resident of that state owns the policy.
Retirement plans offer the one of the commonly used asset protection planning tools available in California. With regards to asset protection, we break retirement plans down into two categories. These categories are qualified retirement plans and non-qualified retirement plans.
The Employee Retirement Income Security Act of 1974 (ERISA) says that qualified retirement plans must include anti-alienation provisions. As a result, the law excludes qualified retirement plans from a debtor’s bankruptcy estate. Protected plans under ERISA include pension plans, defined contribution plans, and 401K plans. The protections afforded by ERISA apply only to employees. Employers and sole proprietors are not covered by the Act. Qualified retirement plans are not protected from alimony and child support claims.
Non-qualified retirement plans are retirement plans that are generally not protected by ERISA. These plans may, however, be protected by state laws which exempt retirement plans from the claims of creditors. Under California asset protection laws, private retirement plans are protected are protected from creditors. This protection applies both before and after distribution to the debtor. Private retirement plans are defined as including profit sharing plans, IRAs (theoretically), and self-employment plans. As with qualified retirement plans, non-qualified retirement plans are not protected from child support claims. Moreover, California courts routinely penetrate IRAs. If a judge feels like the debtor can support himself or herself in retirement without use of the IRA, the judge can order its seizure. We have seen this time and time gain.
California vs. DAPT States vs. Offshore
As described above, California law leaves much to be desired with regards to asset protection. As a result, many California residents choose to look out of state or offshore for jurisdictions with more favorable laws.
One option that many Californians look into is states that offer domestic asset protection trusts (DAPT). Domestic asset protection trusts are irrevocable self-settled trusts in which the grantor is named as a beneficiary. The grantor is also allowed access to the funds held within the trust. While DAPT’s may be preferable to many of the local options available to California residents, they are not without pitfalls. DAPT’s are subject to intense scrutiny with regard to claims of fraudulent transfer. They are also subject to the claims of exemption creditors including child support, alimony, and government agencies regarding taxes.
Strongest Asset Protection for California Residents
The most effective way for a California to protect their assets is to keep them as far out of reach of creditors as possible. For this reason, many people prefer to seek an offshore asset protection trust. The offshore trusts provide the strongest available asset protection for the California resident. There is a wealth of information on this website in support of the offshore asset protection trust. So click on the link in this paragraph for detailed information.