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Business Asset Protection Planning

Business Asset Protection Planning

Owning a successful business can generate a lot of wealth for the owner(s). But great rewards usually come with high risks. One of the biggest risks a business owner faces is the risk of lawsuits that can drain the business of valuable resources. Businesses can be subject to large damage claims if they are felt negligent in their business practices. But even if a business successfully defend itself and “wins” a lawsuit, it still loses valuable time and money.
If you are a business owner then we don’t need to rehearse data and statistics to make you aware that you have a target on your back. People see you as having deep pockets and some people will look for opportunities to reallocate some of your wealth from your pocket to theirs! You already know this.

Who Is Most At-Risk?

Some businesses are more at risk than others due to the nature of their operations.
According to various legal experts there are five business categories that are sued most often:

1. Construction Contractors
2. Healthcare (hospitals and physician practices)

3. Hospitality (restaurants, casinos, entertainment)
4. Retail
5. Manufacturing

If you are in one of these highly targeted industries then it is imperative that you form a plan to protect yourself from the inevitable.

Bottom-Up Risk

There are two kinds of risk that a business owner needs to protect against. The first source is called bottom-up risk. This is the traditional risk that is inherent in the normal operations of running your business. An example would be a heavy equipment contracting company that seriously injures or kills a person in an accident. The injured person (or their surviving family) would file a lawsuit against the business that uses the equipment in its business. In this scenario the business owner could lose the entire value of the business that caused the injury. But what’s worse, the liability could spill over to the business owner’s other assets. There is nothing in place to limit the liability only to the business entity responsible for the injury.

If we were to see this graphically bottom-up liability would look like this:

Top-Down Risk

The second source of risk to a business owner comes from liabilities that did not originate from the operations of the business. An example would be if the business owner were driving under the influence of alcohol and caused a serious accident that resulted in significant injuries that require extensive and ongoing medical bills. The business owner would be sued personally and ALL of their assets are subject to seizure to pay for damages – including their ownership in the business entity that is protected by a limited liability entity structure.

Business Insurance To Limit Bottom-Up Liability

The #1 way to prevent a lawsuit from resulting in the surrender of your assets is to have the proper type and the proper amount of insurance! If you are engaged in a business, at a minimum you should have insurance that covers professional liability (business owner), general liability (property), and product liability.
This also applies to people who own rental properties. Disputes are common in the areas of the terms of the rental contract, condition of the property, repairs/service, etc. It’s also not uncommon for injuries to occur on the property that will eventually lead to lawsuits against the property owner. Insurance is a very effective way to cover these kinds of potential liabilities.

One of the greatest benefits of having proper insurance in place is that an insurance company can provide legal defense in court for items that are covered by the insurance policy!

Personal Insurance To Limit Top-Down

Insurance is also a very effective way to limit the liability resulting from personal activities. Car accidents are the most common source of personal injuries that lead to lawsuits and legal damages. Maintaining high limits for property, liability, and medical coverage on their personal home and autos is a wise choice that could save a lot of money in the long run. In addition, an umbrella policy will provide a great amount of additional coverage for things that are excluded from the home and auto policy such as libel or slander. According to Jury Verdict Research, 13% of personal injury liability awards and settlements exceed $1 Million. Would you rather pay that or have an insurance company step in for you? The insurance company is interested in settling claims for the least amount possible, even if it takes years to do so!

Basic Legal Entities For Business Owners

Another basic layer of asset protection is to form a limited liability entity and operate the business within that structure. The two most common entities used are the Limited Liability Company (LLC) and the Corporation. Any liabilities resulting from the business operation (bottom-up) would be contained within the entity structure and would not spill over to the business owner’s other assets. Graphically, it would look something like this: 
The one drawback to the limited liability entity is that it does not protect you from top-down liability resulting from personal activities.

The Family Limited Partnership – A Great Tool For Asset Protection

Families with substantial assets should consider entities that offer even greater asset protection benefits than a simple LLC or Corporation structure. One such entity is the Family Limited Partnerships (FLP). The reason the FLP offers stronger protection is two-fold.
First, a Limited Partnership by definition is a limited liability entity. The owners are classified as either a General Partner or Limited Partner. The limited partner can only lose only what was invested in the partnership, while the general partner has unlimited liability. To limit losses, multiple entities are used to create many different legal barriers to separate assets from potential intruders. The most valuable assets are segregated into protected sub-entities while the general partner has very few assets allocated to it. A typical Family Limited Partnership structure will look something like this:
Second, the FLP has a feature known as a “charging order protection” that allows the partnership to significantly delay the payment of legal claims. The payment can be put off for years, even decades, while partners in the partnership continue to receive certain kinds of payments. The partnership has the negotiating power in this dispute as the plaintiff will usually accept a smaller amount if payment is made in a shorter time frame.
In addition to asset protection benefits, the Family Limited Partnership is a great estate planning tool. The ownership units of the FLP can be gifted from the Family Trust to the 2nd generation (grandchildren) over time to reduce the size of the taxable estate. The structure also receives a “discount” on the valuation for estate tax purposes per IRS rules. The effect is a significant reduction of the estate tax upon death of the founding owners.

The Captive Insurance Company – A Superior Asset Protection Tool

Internal Revenue Code § 831(b) created a truly powerful tool for business owners to reduce their tax liability as well as shield their assets from potential creditors. This tax code allows business owners to establish a small insurance company known as a Captive Insurance Company and sell professionally underwritten insurance policies to the main operating company. The policies sold cover actual risks inherent in the operating business.
The operating business takes a tax deduction for the premiums paid to the Captive Insurance Company just as it does with any liability insurance premium. The Captive Insurance Company receives the premiums paid by the operating business as gross revenue. However, because it is impossible to know how much of that revenue will eventually be paid out as claims the insurance company does not pay income tax on its revenue.
Assuming the insurance company will pay out only small amounts on actual claims, it will eventually build up some large reserves of surplus capital. This excess capital must be invested in a conservative manner so that the insurance company can meet its potential obligations to pay future claims. The investment portfolio will generate interest and dividend income. The insurance company does pay income tax on this income.
You can see the potential for the business owner to potentially shift a lot of money from the operating business to the Captive Insurance Company and take large deductions. To prevent tax abuse, the IRS has placed a limit of $2.2. Million (adjusted for inflation) on the amount of premiums that the insurance company can receive annually. This is a high enough limit for successful businesses to do some serious tax planning!

The Captive Insurance Company – A Superior Asset Protection Tool

Internal Revenue Code § 831(b) created a truly powerful tool for business owners to reduce their tax liability as well as shield their assets from potential creditors. This tax code allows business owners to establish a small insurance company known as a Captive Insurance Company and sell professionally underwritten insurance policies to the main operating company. The policies sold cover actual risks inherent in the operating business.
The operating business takes a tax deduction for the premiums paid to the Captive Insurance Company just as it does with any liability insurance premium. The Captive Insurance Company receives the premiums paid by the operating business as gross revenue. However, because it is impossible to know how much of that revenue will eventually be paid out as claims the insurance company does not pay income tax on its revenue.
Assuming the insurance company will pay out only small amounts on actual claims, it will eventually build up some large reserves of surplus capital. This excess capital must be invested in a conservative manner so that the insurance company can meet its potential obligations to pay future claims. The investment portfolio will generate interest and dividend income. The insurance company does pay income tax on this income.
You can see the potential for the business owner to potentially shift a lot of money from the operating business to the Captive Insurance Company and take large deductions. To prevent tax abuse, the IRS has placed a limit of $2.2. Million (adjusted for inflation) on the amount of premiums that the insurance company can receive annually. This is a high enough limit for successful businesses to do some serious tax planning!

A Captive Insurance Company Structure Will Look Something Like This:

A Captive Insurance Company Structure Will Look Something Like This:

But What About The Asset Protection?

The Captive Insurance Company is regulated by the Department of Insurance of the state in which the entity is formed. The 18 states that allow Captive Insurance Companies to be formed provide a degree of statutory protection of the insurance company’s assets so that it can continue to provide the promised protection of its customers (the business owner).
In order to qualify for this statutory asset protection and to enjoy the tax benefits provided by the Internal Revenue Code, the Captive Insurance Company must meet some other guidelines. One requirement is that the Captive Insurance Company participate in a pooled-risk structure so it actually will share in some of the risks of other non-related captive insurance companies. This adds a bit of complexity to the overall structure but it is not something that negates the value of using such a powerful legal structure.
Finally, the Captive Insurance Company also provides a high-net-worth business owner with a superior estate planning tool. Because the Captive Insurance Company is a legal entity, it can be owned by the business owner’s trust or it can be owned jointly by several family members.
The Captive Insurance Company automatically passes large amount of liquid wealth to other family members as it accumulates large capital reserves over time.
Is your advisor helping you assess your asset protection plan? If they are not then our opinion is that they are doing you a disservice. Larson Wealth Management can help you determine to what degree your assets are at risk and what you can do to protect yourself from legal claims, reduce your lifetime taxes and pass your remaining estate to your heirs in an efficient manner.

ARE YOU READY TO WORK ON YOUR ASSET PROTECTION PLAN?

Getting started is easy. The first step is to let us know how we can help you. Just fill out the simple contact form below and we will be in touch with you right away – or just call us at 480-699-5540.

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