Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)
Download Free 646 Page E-book: The Biggest Legal Mistakes Physicians Make and How to Avoid Them
The goal of asset protection planning is to protect and preserve assets from being adversely affected by events such as a lawsuit, divorce, illness, death, business failure, or even a change in taxation or other government action. Physicians, who rely heavily on their practice income and who have significant professional exposure, should be acutely aware of asset protection and preservation issues, yet they often fail to plan. With proper planning, physicians can take many steps to protect and preserve their assets, which they have accumulated through their efforts.
Mistake 1 Failing to Consult with Legal and Financial Professionals
Physicians must understand that their practices expose them to many legal, business, and financial risks, which must be thoroughly planned for. Before a practice is established and while it is on going, physicians should consult with counsel and financial advisers to properly address these planning issues. This consultation should be continuous as personal assets are accumulated. Physicians should not be intimidated and must make the time to consult with the appropriate professionals in order to take the necessary steps to minimize their risks and protect and preserve their wealth.
Action Step Physicians should not hesitate to consult with professionals to identify and address these protection concerns. This consultation should be continuous as assets are accumulated or as new ventures are contemplated. A team approach, among professionals, should be established.
Mistake 2 Failing to Be Properly Insured
One of the most basic steps physicians can take to protect their assets is to practice risk management in the form of risk shifting. The first step physicians should take toward asset protection is to make certain that they carry adequate liability insurance, including not only professional liability and other business insurance, but adequate automobile and homeowners coverage as well. Physicians should consult with their commercial brokers regarding appropriate coverage limits and deductibles. Also, they should consider having the policies reviewed by an attorney who specializes in insurance law. If the physician has accumulated assets in excess of limits, then an increase in the limits might be in order. It may also make sense to purchase an umbrella policy if additional coverage is needed.
Action Step Physicians should consult with a commercial insurance agent who can clearly discuss with them options and strategies that meet their insurance needs.
Mistake 3 Failing to Properly Insure for Death or Disability
Like many individuals, physicians often fail to protect against some of life’s curve balls, such as premature death or disability. No discussion of asset protection planning would be complete without mentioning the protection of the physician’s most valuable asset: the physician himself or herself. Physicians need to make certain they carry adequate life insurance and disability insurance coverage. They should also consider purchasing long-term care insurance to preserve their assets in the event that they or their spouse require this type of care. There are many misconceptions regarding long-term care insurance, so physicians need to educate themselves about this type of insurance protection. They should consult with professionals about appropriate coverage and tax consequences. Without appropriate coverage, the physician and his or her family could be forced to spend down their life’s savings.
Action Step Physicians should consult with advisers and professionals about appropriate insurance to meet their needs. Coordination with a tax adviser is also important.
Mistake 4 Failing to Consider How Assets Are Titled
Physicians should pay attention to how their assets are titled, especially if they are married. Married physicians may own assets in their name only (as may their spouses) or the physicians and their spouses may own assets jointly. In some instances, the law protects jointly owned property of a husband and wife from creditors of either spouse. As with any rule, however, there are always exceptions. Physicians also need to think about protection from divorce. In addition, owning assets jointly is not a bulletproof solution because husband and wife may have joint obligations or the judgment-less spouse may die first and thus a judgment creditor could then seize assets of the spouse whom it had obtained the judgment against.
Action Step Physicians should consult with counsel about how their various accounts should be titled. As additional assets are accumulated or as new ventures are considered, they should be sure to continue to consult with their advisers.
Mistake 5 Failing to Consider Placing More Assets into Protected Classes of Assets
Certain assets enjoy enhanced protection under the law. This enhanced protection can vary from state to state. As a result of the Enron tragedy, many people have become aware that one’s principal residence may be a protected asset in certain states and lavish homes are often built in those states. In most states, life insurance and pension plan assets are protected asset categories. It is not unusual for physicians to own large whole life policies and enhanced pension and profit sharing plans.
Action Step Consulting with legal and financial advisers regarding these issues is a critical part of insulating and protecting personal assets. Building value and separate “nest eggs” is always a smart approach to protecting and preserving assets. Therefore, physicians should consult with professionals about planning issues and about creating diversified pools of assets, some of which have enhanced protection under the law.
Mistake 6 Failing to Check Social Security Statements
The Social Security Administration has begun sending statements containing earnings records to everyone who has ever paid Social Security taxes. A physician may not recall what he or she earned 10 or 15 years ago, but if the earnings for a particular year do not make sense (perhaps they were very low, or even zero), then it is worth an inquiry. One’s earnings records will determine the Social Security benefits that he or she may receive. Unreported earnings could result in a decrease in benefits, which means having to spend more of one’s own assets (another form of asset erosion that is worth protecting against). The Social Security statement also contains instructions on how to keep one’s earnings record accurate.
Action Step Physicians should check their Social Security statements for accuracy. If they don’t understand the statements, they should consult with their financial adviser.
Mistake 7 Failing to Implement Sophisticated Planning Strategies on a Timely Basis
Generally, the goals of the more sophisticated strategies—that is, those dealing with off-shore trusts and other legal entities specifically created to provide asset protection—are to deter litigation and provide incentives for early and cost-effective settlements by enhancing one’s bargaining position. These strategies are not a means to defraud creditors or hide assets. Candidates for asset protection include physicians who wish to shelter personal assets from liability and who wish to diversify their investment portfolios into direct overseas investments. Before one enters into any of these strategies, one must be familiar with the structure of asset protection (by being able to afford to lock up assets), and be in a financial position that lends itself to asset protection planning.
One of these strategies, family limited partnerships (FLPs), is attractive as an asset protection tool because of the limited remedies available to creditors when attempting to reach assets transferred to an FLP. In forming an FLP, one transfers ownership of a particular asset or assets to the FLP in return for an ownership interest in the FLP itself. So, instead of owning 100 shares of a stock or a piece of real estate, one owns (as a “partner”) an interest in an FLP that owns the stock or real estate.
Generally, a judgment creditor may obtain only a “charging order” against distributions received by the debtor partner from the FLP. The creditor is treated as an assignee of the FLP interest. As an assignee of an FLP partnership interest, the creditor may be treated as the owner of the interest for federal income tax purposes and be subject to tax on the pro rata undistributed income of the FLP. Creditors do not like reporting income without receiving cash distributions to pay the associated tax. This, therefore, discourages creditors from looking to FLP interests to satisfy a debt. However, it is still possible that creditors in egregious circumstances could argue that fraudulent conveyances should result in remedies other than merely a charging order, such as a sale of the debtor’s FLP interest or even liquidation of the FLP. This may be a particular danger if the creation of the FLP lacks any apparent purpose other than asset protection. Often, the impetus for discussing an FLP is triggered by an event or circumstance that raises liability exposure and the client is hoping that establishing an FLP will provide some defense against an anticipated onslaught of creditors. This is obviously a dangerous perspective, as it immediately raises fraudulent conveyance issues (i.e., transfers made in order to defraud creditors). Clients must be cognizant of the limits of what can and cannot be accomplished in this area, and the compromises a client must be willing to accept to achieve his or her goals and objectives. Transferring assets to an FLP will result in a shield, although not an invulnerable shield, to protect assets from creditors.
When asset protection planning is a paramount concern of the client, the safest structure from an asset protection perspective is to have the limited partner of the FLP be an offshore trust and to have substantially all the assets of the partnership located outside the jurisdiction of the U.S. courts. By moving both the limited partner as well as the partnership’s assets outside the jurisdiction of the U.S. courts, the client has forced the potential creditor to physically go to the foreign jurisdiction where the trust has its situs and attempt to persuade a local court that the creation of the trust and the original transfer were fraudulent. Obviously, this structure exponentially increases the complexity and cost of planning, as well as increases the filing requirements.
Domestic Delaware and Alaska trusts have become more popular as an asset protection tool, but these trusts are relatively new and thus not yet as tested as a planning tool.
Action Step Physicians should consult with counsel to determine if more sophisticated planning techniques are required to meet their needs, which may be because of the size of their estate or their enhanced exposure.
Mistake 8 Failing to Conduct Estate Planning Properly
By far the biggest and most widespread mistake that physicians make is simply failing to plan their estates properly. Some may not be aware of the existence or magnitude of death taxes. Others may just assume that their estates are not large enough to be taxed, or that the taxes won’t exist when they die. Others still are just too busy to focus on the process and get it done. As the old saying goes: “You can only be certain of two things—death and taxes.” Failing to plan properly for the occurrence of the two can be financially catastrophic for a physician’s family.
Action Step Consultation with professionals regarding estate planning is imperative, no matter what the size of the estate.
Mistake 9 Failing to Properly Consider Whether to Form an Entity and What Type
The initial consideration a physician faces is whether to form a legal entity to conduct the medical practice and if so, the type of entity to form. The choices include partnerships, limited liability companies, and corporations (S corporations, C corporations, and professional corporations). Each has different legal characteristics, tax attributes, and asset protection features.
The unique features of a corporation are its perpetual existence (i.e., the death of an individual does not terminate the existence of the corporation) and its ability to provide limited liability to its officers, directors, and shareholders (whereas physicians who participate as sole proprietorships or general partnerships have unlimited personal liability).
The problem for physicians is that personal liability for malpractice cannot be limited by using a corporation. Although a corporation won’t shield them from claims brought by patients they treat, it can be used to defend against the negligence of a physician partner. If the practice is structured as a general partnership, the physician is legally responsible for any injury caused by the other partners. Moreover, a partner could bind other partners and the practice to other contractual obligations, which also might create liability exposure.
Except for professional malpractice cases, when the source of the claim arises outside of the physician-patient relationship, the corporation can be an effective device to shield the physician from liability. Thus, with respect to the other injuries that occur at the practice location, employee-related issues, or issues with landlords or other customers or suppliers, the corporation will provide a useful shield against personal liability, thus protecting the physician’s personal assets.
Action Step Physicians should consult with professionals to determine the type of legal entity that best suits their medical practice.
Mistake 10 Failing to Use Multiple Corporations
If the practice or corporation can be divided into separate businesses, assets can be further protected by the use of multiple entities. For example, a single corporation may own and operate five medical clinics in different locations. If something happens at one of these clinics that gives rise to liability or business failure, the assets of the other successful clinics must be isolated from these claims. A logical approach would be for each office location to be separately incorporated, thus if one location falters, it would not have an effect on the others. A judgment creditor of one corporation would not be able to reach the assets of the other successful companies. Also, consideration should be given as to the legal structure of any new ventures.
Action Step As a physician’s practice grows and as he or she enters new ventures, consideration of the structure and ownership of business assets and operations is critical in any attempt to protect and preserve the physician’s assets. Physicians should consult with their advisers to develop a proper plan.
Physicians face many challenges and potential risks. With proper planning, these risks can be minimized and assets can be protected and preserved. Consultation with a team of advisers who specialize in these matters is critical.
Philip A. Goldblum, Esq.
Peer reviewed by:
Scott M. Hare, Esq.