Any professional running a business with significant annual collections is susceptible to litigation from creditors, with the risk of the income stream being attached or at least targeted with a threatening lawsuit. This has been especially prevalent in the area of medical malpractice, although other professionals and small business owners can relate to the problem.
In today's environment, while most malpractice lawsuits are rarely tried to a successful conclusion against the physician, the mere filing of the complaint triggers an onslaught of expense and angst over the potential repercussions of a sympathetic jury turning into a John Grisham "Runaway Jury."
A primary objective of the business owner should be to place as many roadblocks as possible in the way of nuisance lawsuits. The goal is to avoid, or at least dramatically reduce, the possibility of being intimidated into an easy settlement.
With proper planning, a competent advisor can convert this vulnerable and underutilized asset into a protected and performing one. This is accomplished by first placing a lien against the business's annual collections and then using those collections to create wealth in a compounding, tax-deferred funding vehicle.
The first "layer" of asset protection is accomplished through the use of a UCC-1 lien on the business's income. The owner collaterally assigns the income stream to a friendly lender, who then perfects his security interest with a UCC-1 lien. The friendly lender now has priority over all other judgment creditors.
As a practical matter, nothing has changed for the business owner–he continues using the income to pay his overhead, himself and now the interest payment on the loan–except now there is a friendly lender standing between the owner's income and any adverse creditor seeking to attach the income.
The second "layer" of asset protection is achieved through the use of the loan proceeds themselves (which are taken out against the value of the income stream)–specifically, through the purchase of life insurance products. Life insurance products are excellent vehicles for asset protection because many states exempt both the cash value and proceeds of life insurance policies from attachment by creditors. State exemption laws do vary, however, so care must be taken to take full advantage of this extra layer of asset protection.
In addition to the benefits of asset protection, the business owner also now owns an income producing asset–a fixed life insurance product, which grows both (1) tax deferred, and (2) with a compounding crediting rate.
Note that the lender is further secured by the owner collaterally assigning the cash values of these insurance products. In turn, the owner retains the right to name the beneficiary in the event of death and receives all the other incidents of ownership on the products once the loan is repaid by now possessing a supercharged Roth-like accumulation asset, e.g., tax-free withdrawal of basis, tax-free loans from cash value.
This approach has numerous other benefits when compared to qualified plans. First, the investment is created by leveraging one's collections, rather than through the use of earnings. Distributions are tax-free, and the plan is not subject to ERISA. The program is also discriminatory–as many (or as few) of the eligible owners can participate in the program as desired, and there are no contribution limits.
Since the program is flexible, unlike qualified pension plans, participating owners can retire at any time without the typical restrictions and penalties (59 1/2 minimum age to withdraw and 70 1/2 required minimum distribution rules). Additionally, if the income stream is unpredictable and decreases, the loan can be amortized or the values in the insurance products can be used to collateralize fully the debt.
