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Bankruptcy rules could affect asset protection plans

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By Katherine Vogtcovered hospital and personal finance issues, physician/hospital relations, and ancillary health facilities for us during 2003-06. Posted July 10, 2006.

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As the dust settles from last year's sweeping bankruptcy reform legislation, it is becoming clearer that the changes could affect some asset protection strategies.

The law, which took effect in October 2005, generally made it more difficult for middle- and higher-income individuals to eliminate their debts through bankruptcy proceedings. But experts say the law also made significant changes to rules -- which haven't been tested in courts -- regarding debtor protections available in bankruptcy. The changes affect homesteads, IRAs and certain types of trusts.

Accordingly, they say asset protection plans should be reviewed with an adviser to ensure that they would stand up to the new rules. And they say any review or changes to asset protection plans should be done well in advance of a threat from creditors.

For physicians, the need for attack-proof asset protection is significant because of the threat of medical liability claims and judgments that drain professional and personal accounts. Bradley Shraiberg, a bankruptcy attorney with Kluger Peretz Kaplan & Berlin in Boca Raton, Fla., said that for the most part, the new bankruptcy code still allows for some protections, as long as they are established well before any bankruptcy filing.

"The new code abolished a lot of the tricks that asset protection attorneys were able to implement once a threat occurred. [Therefore] it is imperative that a person plans for a rainy day when there isn't a cloud in sky," Shraiberg said.

Certainly, advanced preparation will be needed under the new law to take advantage of state homestead exemption laws, which vary by state and could allow individuals to protect their homes in bankruptcy proceedings. The rules changed regarding qualifications for these exemptions.

Previously, there was no limit on how much of an exemption could be claimed, assuming your state hadn't set a limit. So states such as Texas and Florida, which have offered virtually limitless protections, would allow bankruptcy filers to exempt the full value of their homes from the estate assets that were being targeted by creditors. Also, it was possible to simply move to a state with liberal homestead exemption rules and soon thereafter file for bankruptcy, while still being able to take advantage of the exemption.

But the new law said bankruptcy filers have to be in a state for at least two years to take advantage of a state exemption, said Randy Williams, a bankruptcy attorney with Thompson & Knight in Houston. Also, he said filers must own a home for at least 1,215 days (three years and three months) to take full advantage of the exemption. Otherwise, the exemption would be capped at $125,000. "I really think the changes that have been made apply more to timing than anything," he said.

The good news is that other state exemptions that could protect your home in bankruptcy, such as "tenants by the entirety" provisions, which afford protections to homes jointly owned by spouses, were not affected by the reform legislation, said Martin Press, a tax attorney and estate planner with Gunster Yoakley, in Fort Lauderdale, Fla.

The reform legislation also affected rules regarding how retirement plans might be protected during bankruptcy proceedings. Traditionally, in most jurisdictions, qualified ERISA retirement plans have been protected from creditors. But there was some confusion as to whether IRAs fell into this category.

The new law seems to have resolved that confusion and made it clear that IRAs could qualify for the same protections, said Mark Ralston, a bankruptcy attorney in Dallas with Munsch Hardt Kopf & Harr. "It does not appear to me to be a material change in the law, but it is better defined under the amendments than it had been," he said.

Williams said the new law caps that IRA protection at $1 million. And though IRA contributions often are limited to smaller amounts under tax rules, making it unlikely that an account would grow to surpass $1 million on its own, the cap could affect decisions about rolling over other, larger accounts into IRAs.

"It might require physicians to reconsider where they keep their retirement funds and how they title various retirement accounts," Shraiberg said.

The reform law also addressed certain types of trusts that have been used to shelter assets from creditors. Specifically, there may now be more scrutiny of self-settled trusts -- those that benefit the person who established them.

Under the new law, self-settled trusts established up to 10 years before a bankruptcy filing might be scrutinized to determine whether they were created to avoid paying a creditor. If that determination is made, the trust could lose any protections it had from creditors. Williams said that previously the "look back" period for undoing those trusts was about two to four years.

Press said the law could make asset protection planning in regard to certain trusts a little more tricky. "It makes it very murky and it could become a booby trap for the unwary," he said.

Attorneys say it's still too early to know exactly what all of the changes mean, because the language in the new code is confusing and the theories have not been challenged in courts.

But Ralston believes that at least one sure thing has come out of the new law: Bankruptcy just got harder, especially for the individual debtor. With that in mind, he said that if someone is assuming the bankruptcy process is going to be a way to gain asset protection, "they are now in for a shocking surprise."

Katherine Vogt covered hospital and personal finance issues, physician/hospital relations, and ancillary health facilities for us during 2003-06.

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