New bankruptcy laws make old asset protection planning obsolete

What effect, if any, has the new bankruptcy act had on physician's asset protection plans? In short, the answer is "a significant one." In this article, we will explain exactly what this effect has been and why it is so important for all physicians to re-examine their planning because of it.

Background

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Act) was signed into law on April 20, 2005.

Much of asset protection planning comes from the bankruptcy laws, as bankruptcy is the forum where lawsuit debts can be eliminated (in Chapter 7). Thus, it is the ultimate test of what assets are shielded if "push comes to shove" in litigation.

Moreover, the threat of filing for bankruptcy is often crucial in negotiating settlements out of court. Therefore, even if you never plan, or even consider, bankruptcy as an option in an asset protection plan, you must understand how the new Act effects your planning - as many previously-protected assets may now be vulnerable in your plan.

The following are the key asset protection areas impacted by the Act:

1. Domicile: Where you can file for bankruptcy

Under pre-Act law, domicile was determined for state exemption purposes (i.e., which state's exempt assets you can use) by your domicile during the 180 days immediately preceding filing of the bankruptcy petition. The Act has now expanded this period to 730 days (two years). The most obvious effect of these new provisions will be to prevent a client from moving on the eve of bankruptcy in the hopes of taking advantage of more favorable state exemptions. In this way, there will be no more quick moves to states with generous protections (i.e. Florida) just before filing bankruptcy... it won't work anymore.

2. IRAs and Pensions

Between the Act and the April U.S. Supreme Court decision in Re: Rousey, we have mostly positive results for these asset classes. First, in Rousey, the court unanimously decided that IRAs had the same federal protections that ERISA-qualified pensions had previously enjoyed - total protection in bankruptcy. Thus, the answer to a common question we often hear from clients, "Is my IRA protected?", was given a definite answer for a few weeks in April - "Yes, to an unlimited extent."

This unlimited protection was slightly modified once the Act was signed into law less than a month later. Under the Act, the following rules apply:

Bottom line: With the proper planning (i.e., segregation of IRAs), nearly every client can enjoy almost unlimited protection of qualified plans and IRAs after the passage of the Act.

3. Homestead

Homestead protections were severely cut down by the Act. This will force many clients in states with significant homestead protections to have to re-consider how to shield their homes. States where clients lost the most: Florida, Texas, Kansas, Iowa and Massachusetts. In these states, the "enhanced debt shield" (EDS) will likely emerge as the best way to shield the home - as it already is for most of the remaining 45 states. Most importantly, the Act provides the following rules on homestead protection:

a. A client may only protect an interest in a residential homestead if the interest is to the extent allowed under his state's exemptions. Thus, the best a client could do in shielding the home after the Act, is what the state protection was before the act (i.e., $10,000 for New York, $0 for New Jersey, unlimited for Florida).