As coauthors of For Doctors Only: A Guide to Working Less and Building More and advisors to physicians throughout the country, we are often asked to help doctors 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 incorrect assumptions and shed some light on opportunities for further asset protection.
Personal Versus Practice Protection
The first misconception most physicians have is that they should protect only their personal assets from potential lawsuits. 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 or employee claim (sexual harassment, wrongful termination) against any of the doctors threatens all assets of the practice. In other words, if you are in a group practice, you are underwriting the acts and omissions of all of your partners, to the extent of your practice assets.
What Are the Most Important Practice Assets?
Cash flow and income are the most important practice assets. The good news is that the tools that protect cash flow also typically help create savings on income taxes and build retirement wealth. These include qualified retirement plans (including defined benefit plans to 401[k]s to combination plans), nonqualified plans, and captive insurance arrangements.
Beyond cash flow, the practice's accounts receivable (AR) is typically an important asset. Your AR is what you, in fact, work for. What most physicians do not realize is that a lawsuit against the practice itself, created by a wrongful act of any of the partners, threatens all the AR in a typical practice setup. There have been cases where physicians had to work for free for several months because a lawsuit judgment resulting from the act of one physician created a loss of the AR for the entire practice.
Other important practice assets include the practice real estate, if any, and valuable equipment. If a 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, there are many methods 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 concerns their personal asset protection—shielding their personal assets from potential lawsuits. In this endeavor, asset protection attorneys approach a challenge much in the way that a physician approaches being a patient. Like physicians, 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 eating a poor diet. For our clients, bad habits might include owning property in their own names, owning property jointly with a spouse, or operating any medical practice with business assets exposed (see above).
We use an asset protection rating system for a client's overall situation from –5 (totally vulnerable) to +5 (superior protection). Exposing business assets and owning property in one's own name are examples of –5 situations.
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 your name or jointly with a spouse, you should talk to an asset protection advisor immediately. You do not want to linger too long in the –5 category.
Basic Asset Protection
Again, using the sick patient analogy, if you see a patient with a particular condition or 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 for more advanced tools, then you always need to 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, or gifting programs. In other words, you can own the exempt asset outright in your name, have access to any values, and still have it 100% protected from lawsuits against you.
Each state law has assets that are exempt from creditor claims, thereby achieving a +5 status. Many states provide exemptions for qualified retirement plans and individual retirement accounts, cash within life insurance policies, annuities, and primary homes. Make sure you consult an asset protection expert to find out the exemptions in your state.
Beyond exempt assets, basic asset protection tools like family limited partnerships (FLPs), limited liability companies (LLCs), and certain types of trusts should be used.
FLPs and LLCs 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.
There are also many types of trusts that provide significant protection for clients. These can range from life insurance trusts or charitable remainder trusts to grantor retained annuity trusts and domestic asset protection trusts. Each type has its pros and cons and costs and benefits.
For all of these legal tools, asset protection benefits are reliant upon proper drafting of the documentation, proper maintenance, respect for formalities, and proper ownership arrangements. If all these are in place, the physician can enjoy solid 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 they want. Other clients realize that the best protection comes from tools that can help 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 best medicine or most effective surgical procedure, asset protection consultants rely on several tools to provide maximal asset protection. These include nonqualified plans, which allow a physician to put funds away at the practice level and enjoy them in retirement. These types of plans 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.
Asset protection planning, like any sophisticated multidisciplinary effort, is a matter of degree. In your asset protection plan, make sure you understand the costs and benefits of the various tools you employ. This will help not only protect the wealth you have already built, but may assist you in building greater after-tax wealth for retirement and beyond.
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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. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently; accordingly, information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.
David B. Mandell, JD, MBA, is a former attorney and author of more than a dozen books for doctors, including For Doctors Only: A Guide to Working Less and Building More and Risk Management for the Practicing Physician. He is a principal of the financial consulting firm OJM Group (ojmgroup.com) 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.