Wednesday, October 20, 2010

Do-It-Yourself Estate Planning

Ask most estate planning attorneys about form mills and estate planning form websites and they'll tell you that they love it. That's because for one, it gets the public thinking about their wills and trusts, and second, those who partake will eventually end up in their office anyway to correct the mistakes made during the first go-around.

I had a client in my office a few months ago who had used the WillMaker computer program to create his estate plan. (You can also find form stores around town and the ever present LegalZoom to achieve a similar result.) I examined his documents and found that despite his best efforts they had not been properly executed. In all likelihood, they would not have been accepted at probate court. He pointed out that he had formed a trust so probate was unnecessary, but of course he had not actually funded the trust, so it wasn't worth anything more than the paper it was printed on. There were a host of other issues and we eventually scrapped it all in favor of a new, professionally-prepared estate plan.

I often use the metaphor of the off-the-rack vs. expertly tailored suit to emphasize that while the material may be similar between what you can find online and what an attorney will prepare for you, the actual fit of the material is what you're paying for. Like most other professions, you are paying for the expertise and experience to guarantee a superior result.

We live in a do-it-yourself culture where just about anything you want to know, you can find online. Often that provides just enough information to make someone dangerous. While I encourage people to learn all they can about planning their estates, I also encourage them to seek a professional for the actual drafting of the necessary documents. Why go through all the trouble of forming a homemade plan on their own that could very well fail, resulting in thousands paid by their heirs in attorney's fees for probate?  Much less can be spent on a competent attorney who will do it right the first time.

Monday, October 18, 2010

Another way Nevada makes it difficult to attack a Nevada asset protection trust

One of the most common strategies used by creditors to reach trust assets is applying the technique of veil piercing. Usually this involves proving the trust is merely the alter ego of the settlor. The creditor will argue that the settlor of the trust did not respect the trust as a distinct and separate entity, showing that the settlor, instead, used the trust as his or her personal piggy bank. Creditors use the same strategy to reach the business assets of a defendant sued individually by showing the defendant commingled personal and business funds or used the business to unjustifiably purchase personal use property.
While a business owner guilty of this type of irresponsibility may not have a leg to stand on, Nevada protects trust settlors who make similar mistakes. NRS 163.418 has effectively removed from consideration much of the evidence a creditor might use to attempt to establish a case of alter ego liability to attempt to pierce the trust veil. Under this statute, a creditor attempting to build an alter ego case cannot rely solely on the fact that a settlor has himself made distributions from the trust. Neither can they rely on proof that the settlor directed the trustee to hold, sell or transfer property from the trust. In other words, evidence that a settlor who foolishly writes a check from the trust account to pay his own credit card bill, will not on its own be available as evidence against him. Of course, such a practice should never be routine and the wall of separation between a settlor and his trust should always be respected, but it is comforting that it is unlikely Nevada would expose trust assets for occasional mistakes made by the settlor.

Friday, October 15, 2010

LLC S-Elections and Employment Tax Savings

LLCs are en vogue for new businesses because of their versatility and simplicity. They provide the liability protection of a corporation with far less organizational maintenance. Tax treatment can be changed, ownership interests can be owned by individuals, trusts or business entities, and charging order protection is afforded.

If you already have an LLC, you might have heard of S-elections and wonder whether an S-election makes sense for you. I’ll explain by outlining the benefits of making an S-election and then discuss the drawbacks. First, though, what is an S-election?

The S refers to Subchapter S of chapter 1 of the Internal Revenue Code. An LLC is a state-created business entity not formally recognized by the IRS. When an LLC is formed, its default taxation is based on the number of members (another word for owners). If it’s a single-member LLC, then it’s taxed as a sole proprietorship. If there is more than one member, it’s taxed as a partnership. Rather than accept the default tax classification, an owner can elect to be taxed as a C-corporation, which is the standard corporation, or an S-corporation. Hence the name: S-election. It’s important to note that an LLC taxed as an S-Corporation is not, itself, an S-corporation. The LLC is still managed and operated according to the LLC operating agreement. The LLC is only taxed as an S-corporation.

The key benefit of this election is employment tax savings. LLC owners do not receive compensation as employees of the company, but instead take owner distributions. All profits pass through from the company to the individual owner’s personal tax return. That owner is responsible for self-employment taxes (or SE taxes) on those profits at a rate of 15.3%. An S-corporation distinguishes between employee wages and owner distributions. In a single-member LLC, the owner who performs services for the company can be deemed an employee. The IRS assesses an employment tax on the wages earned by the owner-employee, but does not assess employment taxes on distributions taken by the owner.

Let’s look at an example. In 2009, Lisa ran a computer consulting business. After adding up all her revenue and subtracting her overhead expenses, she earned $50,000 in profits. That income passed through to her personal tax return and she was responsible for $7,650 in SE taxes (15.3% of $50,000). Enter the S-election.

Lisa made an S-election at the beginning of the year by filing form 2553. She earned the same $50,000 in profits. However, based on her part-time hours she determined that a reasonable annual wage for a computer consultant in her area also working part-time hours would be $25,000. She paid that to herself as wages and was taxed the same 15.3% rate in the form of payroll tax resulting in $3,825. However, the remaining $25,000 she took as a distribution employment tax-free. The result was an employment tax savings of $3,825!

So what’s the drawback? In the first scenario, Lisa could take distributions in any amount, at any time. Her tax payment wasn’t due with her personal income taxes until April 15 of the following year. As an employee in the second scenario, she was subject to the payroll tax, which required filing quite a bit of paperwork with the state and the IRS. She also needed to pay herself and the payroll tax at regular intervals throughout the year. Scenario two requires a lot more planning, paperwork and oversight. Much of that work can be delegated to a payroll company for a fee. Usually between $40 and $50 per month depending on the company size.

Finally, Lisa should not try to abuse the system by paying herself only a nominal wage and taking the rest as a tax-free distribution. The IRS requires the wage to be “reasonable.” Many accountants advise as a rule of thumb dipping no lower than a 50/50 split.

Making an S-election on your LLC can provide you the best of both worlds in flexibility and tax savings. It is wise to consult with your CPA before making the jump and even wiser to use a payroll company when the decision to elect has been made.

Thursday, October 14, 2010

What Makes Nevada Self-Settled Spendthrift Trusts So Special?

If you're reading this, you're probably already aware of the concept of a self-settled spendthrift trust. If not, it's simply an asset protection trust that enables the settlor to also be a beneficiary of the trust. Often the self-settled feature is not written into the trust at the outset due to its as yet unconfirmed acceptance by the courts.

Though the ability for the settlor to also be a beneficiary is unique to Nevada and a handful of other states, what makes Nevada a superior forum for spendthrift trusts is the statutory discretion given to the trustee.

In an asset protection trust, the settlor gives the trustee discretion to make distributions to the beneficiaries. While the settlor will provide a list of recommendations or suggestions, the trustee is not required to make these distributions. The benefit of this arrangement is that no beneficiary is unconditionally entitled to a distribution from the trust. That means if one of your beneficiaries is sued for money damages and loses, the resulting creditor cannot order payment from that beneficiaries’ interest in the trust. That beneficiary does not have any mandatory payouts due, so there's nothing for the creditor to acquire.

All states recognize some sort of spendthrift trust that limits the transferability of beneficiary interest, effectively keeping most creditors out. However, most states carve out certain exceptions in the form of “protected classes.” While a state will provide statutory support for their spendthrift trust, the state will also define certain groups that are not shielded from the assets of the trust. South Dakota protects personal injury claimants. Delaware leaves assets available for division in a divorce. Utah leaves trust assets open to a whole host of creditors.

By now, you can probably guess the answer to the title of this entry. What makes Nevada so special is that Nevada law does not leave trust assets open to any class of creditors. According to NRS 166.110 (1), discretionary power of the trustee is absolute. Nevada asset protection trust law is the best in the country and many commentators point to the lack of protected classes as the key reason.

While this is just one beneficial aspect of Nevada asset protection trust law, to many it is the most significant. While transfers still have to be timely and can’t be made with the purpose of defrauding creditors, Nevada residents (and out of state residents with a qualified Nevada trustee) who create a carefully-drafted Nevada asset protection trust enjoy a remarkable asset protection advantage thanks to absolute discretion granted to their trustees.