Style versus substance

Editor's Note: The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action.

Too many physicians during the past decade have sought cookie-cutter asset protection plans to give them some piece of mind so that if they ever endure an outrageous malpractice case, they won't lose everything.

Although we admire these doctors' commitment to proactively managing their risks, we have to remind doctors with whom we speak that not all asset protection plans are created equal.

Just like tax planning

Although few physicians realize that crucial fact of asset protection planning, leading attorneys in the field know it quite well. Tax attorneys and certified public accountants (CPAs) also know that the adage is just as true when it comes to tax planning.

Simply put, when determining whether a particular transaction with significant tax benefits was a legitimate tax shelter, the Internal Revenue Service (IRS) or tax court typically uses a simple test: "Would a taxpayer have done the deal if not for the tax benefit?" The IRS or tax court is asking whether the transaction was done simply to save taxes or for another economic purpose. If there was such a purpose, the transaction stands; if the objective was only tax motivated, it fails.

Nearly every asset-protection attorney in the field agrees that the same test applies when evaluating whether a creditor protection tactic will be upheld if challenged down the road. Here, the question is: "Did this transaction have an economic purpose, or was it simply done for asset-protection purposes?"

Both authors are part of a collective of attorneys, CPAs, and other advisers called the Wealth Protection Alliance (WPA). In the WPA, we use a sliding-scale approach to evaluate asset-protection techniques. The lowest ranking (–5) denotes a completely vulnerable asset, and the highest (+5) designates a situation with an asset that cannot be taken by a creditor even in bankruptcy. This scale is important because every +5 asset protection technique-whether in a personal or practice implementation-has significant economic benefits to the client, regardless of asset protection.

Let's examine which +5 asset protection tools can be used in a practice.

Accounts receivable (AR) financing-A practice can effectively give a +5 shield to its AR by obtaining a third-party loan using the practice's AR balance as collateral. In the loan security agreements we have reviewed, the +5 protection will hold. The key to the economic transaction, however, is what happens with the loan proceeds. How are they protected? How are they invested to offset the cost of the loan interest? What if the interest rate increases and the investment returns decrease? Certainly, these are real economic concerns for a real economic transaction. Too often, unfortunately, we have seen physicians concentrate solely on the asset protection, disregarding the economic deal until too late-when they have lost significant wealth on this leverage technique.

Captive insurance companies (CICs)- Owners of a medical practice actually create their own licensed insurance company to insure 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). If the CIC is created properly, it is like any insurance company-established in a real economic arrangement with its insureds. Although it also is true that CIC assets are protected by statute, achieving the top +5 asset protection score, that is just one of the benefits of a CIC, certainly not the only one.