By DAVID B. MANDELL and JASON M. O’DELL
As advisors to physicians throughout the country, we are often asked to help doctors to protect assets against future lawsuits. From this experience, we often learn what misconceptions physicians have regarding how to protect their assets from potential lawsuits. In this article, we hope to dispel some of the incorrect assumptions that you may have, and shed some new light on opportunities for further asset protection.
Personal vs. Practice Protection
The first misconception that most physicians have is that they should only protect their personal assets from potential lawsuits. Nothing could be further from the truth. In fact, the practice’s most important assets are the usually most vulnerable to lawsuits, especially in a group practice. That is because any malpractice claim or employee claim (sexual harassment, wrongful termination, etc.) against any of the doctors threatens all of the assets of the practice. In other words, if you are in a group practice, you are underwriting all of the acts and omissions of all of your partners, to the extent of your practice assets.
What are the most important practice assets?
Certainly, your cash flow and income is most important. The good news is that the tools that protect your cash flow also typically help you save on income taxes and build retirement wealth. These include qualified retirements plans (including defined benefit plans to 401(k)s to combination plans and more), non-qualified plans, fringe benefit plans, captive insurance arrangements and more. While we have written extensively on these topics, we drill down on them a bit later in the article.
Beyond your cash flow, the practice’s accounts receivable (AR) are typically an important asset. Your AR is what you, in fact, work for. What most physicians don’t realize is that a lawsuit against the practice itself, created by a wrongful act of any of the partners, threatens all of the AR in a typical practice setup. Certainly, there have been cases where physicians had to work for free for a number of months because of the lawsuit judgment resulting from the act of one physician created a loss of the AR for the entire practice. Don’t let this be you.
Other important practice assets include the practice real estate, if any, and valuable equipment. If your practice has valuable real estate or equipment, it must separate these assets from the main practice. While the details of advanced strategies go beyond the scope of this article, suffice it to say here that there are a number of tactics we can use to protect real estate and valuable equipment from potential lawsuits against any of the physicians or the practice itself.
Personal Protection: A Matter of Degree
The most common asset protection misconception that physicians have regards their personal asset protection – shielding their personal assets from potential lawsuits. In this endeavor, asset protection attorneys approach a challenge much in the way a physician approaches being a patient. Like physicians, we asset protection professionals first will try to get a client to avoid “bad habits”. For a medical patient, bad habits might mean smoking, drinking too much or a poor diet. For a client of ours, bad habits might include owning property in their own name, owning it jointly with a spouse, or operating any medical practice with business assets exposed (see above).
In fact, we use an asset protection rating system for a client’s overall situation: from –5 (totally vulnerable) to +5 (superior protection). Exposing business assets, owning property in your own name, etc. – these are examples of –5 situation.
In this way, before we implement any sophisticated asset protection planning, we want to move the client from a -5 to at least a low negative or neutral number. This means eliminating any of the “bad habits” named above, and others. If you see yourself as a physician who has business assets exposed and owns personal assets in their name or jointly with a spouse, you should talk to an asset protection advisor immediately. You don’t want linger too long in the -5 category, as it’s only a matter of time until you get “sick.”
Basic Asset Protection
Again, using the sick patient analogy, if you see a patient with a particular condition/disease, you try to treat it. For us, we try to treat physicians to solve their lawsuit vulnerability. In this endeavor, we use particular structures to protect a physician’s assets.
If you are in such a situation, where you want good basic asset protection, but do not want to pay more advanced tools, then you need to always begin with exempt assets. We recommend exempt assets first because (1) they enjoy the highest +5 level of protection and (2) they involve no legal fees, state fees, accounting fees, gifting programs etc. In other words, you can own the exempt asset outright in your name, have access to any values and still have it 100% protected against lawsuits against you.
Each state law has assets that are absolutely exempt from creditor claims, thereby achieving a +5 status. Many states provide exemptions for qualified retirement plans and IRAs, cash within life insurance policies, annuities, and primary homes. Make sure you seek an expert on this to find out the exemptions in your state.
Beyond exempt assets, basic asset protection tools like family limited partnerships (FLPs) and limited liability companies (LLCs) should be used. Essentially, these tools will provide good asset protection against future lawsuits, allow for maintenance of control by you (the client), and can provide income and estate tax benefits in certain situations.
Specifically, these tools generally will keep a creditor outside the structure through “charging order” protections. These protections typically allow a physician to create enough of a hurdle against creditors to negotiate favorable settlements. For these reasons, we often call FLPs and LLCs the “building blocks” of a basic asset protection plan. We may also layer in domestic irrevocable trusts, such as life insurance trusts or charitable remainder trusts.
In essence, these tools will provide adequate asset protection relating to an asset protection score of +2. Obviously, their asset protection benefits are reliant upon proper drafting of the documentation, proper maintenance and respect for formalities, and proper ownership arrangements. If all these are in place, the physician can enjoy basic asset protection for a relatively low cost.
Ultimate Asset Protection: Advanced Strategies
For many physicians, a basic asset protection plan, which has some potential vulnerability, is not good enough. Perhaps their state has few exemptions and a +2 on their asset protection score is not enough to give them the psychological comfort that they want. Other clients realize that the best protection comes from tools that actually can help clients create wealth. For this reason, these clients use advanced structures to put themselves at a +4 or +5, the ultimate asset protection score. Like a physician giving the ultimate medicine or most effective surgical procedure, asset protection consultants rely on a number of tools to provide ultimate asset protection. These include:
- Fringe benefit plans. Fringe benefit plans allow a physician to put funds away at the practice level and enjoy them in retirement. Also, these types of plan can be used in addition to qualified plans. In many states, these can be funded by exempt (+5) asset classes. Even in the states where there is no (+5) exemption, a (+2) LLC can typically be used to provide a solid level of protection.
- Captive Insurance Companies (CICs): In this technique, the owners of a medical practice actually create their own properly-licensed insurance company – to insurance all types of risks of the practice. These can be economic risks (that reimbursements drop), business risks (that electronic medical records are destroyed), litigation risks (coverage for defense of harassment claims or HCFA audits) and even medical malpractice (keeping some risk in the captive and reinsuring the rest). To maximize the protection of the CIC, many physicians establish trusts to own the CIC.
Asset protection planning, like any sophisticated multi-disciplinary effort, is a matter of degree. Nothing in life is 100 percent certain (except perhaps death and taxes – subjects of other articles). For asset protection planning, this adage holds true. In your asset protection plan, make sure you understand the cost and benefits of the various tools you employ. It will help you not only protect the wealth you have already built, but may assist you in building greater after tax wealth for your retirement and beyond.
David B. Mandell, JD, MBA, is a former attorney and author of For Doctors Only: A Guide to Working Less & Building More. He is a principal of the financial consulting firm OJM Group along with Jason M. O’Dell, MS, CWM, who is also a principal and author. They can be reached at 877-656-4362 or firstname.lastname@example.org.
This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. You should seek professional tax and legal advice before implementing any strategy discussed herein. (Photo by 401(K) 2012 via Flickr)