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Assets Exempt From Creditors’ Claims

By: C. Randolph Coleman 2004, All Rights Reserved[*]
Asset protection – assets exempt from creditors’ claims by statute or otherwise. Each state has various statutory provisions that protect specified assets exempt from creditors’ claims. Florida statutes provide for substantial protection from creditor claims for a number of different assets. In addition, Florida’s constitution provides one of the most significant protections from creditors’ claims by exemption from forced sale for a homestead in Florida. There are many questions and nuances associated with these constitutional and statutory exemptions. All exemptions must be evaluated in light of the impact of the Federal Bankruptcy Act, which may supersede certain of the state statutory exemptions. Proper planning through the use of these exempt assets is central to any asset protection plan. If you have questions regarding the extent or applicability of a statutory exemption, state or federal, or how the bankruptcy law may impact the validity of a state exemption, you are encouraged to consult with an experienced Florida asset protection attorney or lawyer.

Florida Homestead Exemption

The Florida Constitution, Article X, §4, provides as follows: There shall be exempt from forced sale under process of any court, and no judgment, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon, obligations contracted for the purchase, improvement, or repair thereof, or obligations contracted for house, field or other labor performed on the realty, the following property owned by a natural person: (i) a homestead, if located outside a municipality, to the extent of 160 acres of contiguous land and improvements thereon, which shall not be reduced without the owner’s consent by reason of subsequent inclusion in a municipality; or if located within a municipality, to the extent of one-half acre of contiguous land, upon which the exemption shall be limited to the residence of the owner or his family . . . . (ii) These exemptions shall inure to the surviving spouse or heirs of the owner. Accordingly, in Florida, there is no dollar limitation for the homestead exemption. The Florida Constitution provides only three exceptions whereby the homestead may be subject to a forced sale: (1) payment of taxes and assessments thereon; (2) obligations contracted for the purchase, improvement or repair thereof; or (3) obligations contracted for house, field or other labor performed on the realty. The purpose of the homestead exemption law is to promote the stability and welfare of the state by securing to the householder a home, so that the homeowner may live beyond the reach of financial misfortune. Another court has stated the purpose of the homestead exemption law is to benefit the debtor by securing his or her homestead beyond all liability from forced sale under process of any court. The cases uniformly have held that the homestead exemption laws are to be liberally applied to the end that the family shall have shelter and shall not be reduced to absolute destitution. Florida’s constitutional homestead protection applies only to property located in the state of Florida. There are three significant limitations to the homestead exemption; acreage limitation, an ownership limitation and a residency limitation. Acreage Limitation The constitution provides protection to the extent of 160 acres of contiguous land and improvements for a homestead located outside a municipality, and one-half acre within a municipality. The U.S. Supreme Court denied cert in a case where the 11th Circuit Court of Appeals affirmed a decision of the bankruptcy court to order the sale of homestead property and apportionment of the proceeds, where the property at issue exceeded the area restrictions and could not be practically or legally subdivided.

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The debtor in Englander owned a home on approximately one acre within a municipality. The debtors had not only delayed the disclosure procedures of the court, but also provided an inaccurate size of the homestead to the court. After the debtors finally admitted the actual size of the parcel, the debtors sought to claim a homestead exemption for a portion of the property that surrounded the nonexempt portion, eliminating any reasonable access to the nonexempt portion, and rendering it valueless. The court found that the debtors acted in bad faith, holding that the homestead designation was improper and requiring the sale of the property with an allocation of the proceeds.The Englander opinion tells that even with the generous Florida homestead exemption from creditors’ claims, it remains necessary to carefully plan to protect the homestead property where it exceeds the acreage limitations provided by the Florida Constitution and Florida Statutes.

Residency requirement: A number of cases examine the residency requirements of the homestead exemption. Specifically, these cases address (i) Whether the person claiming the exemption must have legal immigration status, (ii) At what point in time does a person have the requisite intent to have a home qualify as his or her homestead, (iii) Whether the person claiming homestead exemption must live in the residence or if use of the residence by family of the owner is sufficient to qualify the residence for the homestead exemption, and (iv) Abandonment of a homestead.

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One court has found that the following do not necessarily constitute abandonment: (i) Mere absence from the homestead for financial reasons, (ii) Posting a “for sale” sign or offering the property for sale, (iii) Leaving the property for years and weeds growing on the property. The court stated that abandonment occurs when debtors state the intention to abandon the property and have an intention not to return to it. From an analysis of all the cases, there appears to be a general rule that if the debtor leaves his home due to financial, health or family reasons it is not considered abandoned. Furthermore, the party seeking to avoid the homestead exemption has the burden of showing that property is not entitled to homestead protection.

Ownership requirement: The form of legal title ownership of a residence can affect whether the residence qualifies for the homestead exemption. While the general rule is that a person must have legal title to a residence to claim the homestead exemption, a person who holds only an undivided one-half interest is entitled to the homestead exemption protection. Similarly, occupancy pursuant to a long-term land lease on property used as a residence is entitled to the protection. A cooperative apartment can qualify as an exempt homestead.

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However, the homestead does not lose its protected status when conveyed to a revocable living trust. The Florida courts have found that if a residence retains its homestead status for property tax exemption, then it retains is creditor protection as well.

Proceeds from the sale of the homestead: The proceeds from the sale of a homestead residence can retain the protection of the homestead exemption if properly maintained. To ensure proceeds from the voluntary sale of a homestead maintain assets exempt from creditor’s status until a replacement residence is purchased:

  1. The debtor must show a good faith intention prior to and at the time of the sale of the homestead to reinvest the proceeds thereof in another homestead within a reasonable time.
  2. Only so much of the proceeds of the sale as are intended to be reinvested in the new homestead are exempt; any surplus above the amount to be reinvested will be treated as general assets of the debtor and will not be assets exempt from creditors’ claims.
  3. The funds must not be commingled with other funds of the debtor, but must be kept separate and apart for the sole purpose of acquiring a new home.
  4. The funds will lose exempt status if not reinvested in a new homestead within a reasonable period of time, or if the debtor continues to hold the funds for general purposes. Limitations on the use of homestead exemption. The courts continuously scrutinize the facts involved in homestead exemption cases in an effort to prevent the use of the exemption to defraud creditors. In particular, the courts do not allow the exemption to avoid the application of tax liens by the Internal Revenue Service. Notwithstanding the ability of the IRS to enforce tax liens against homestead property in Florida, a taxpayer’s residence can only be seized to satisfy a taxpayer’s tax liability as a last resort and it is otherwise exempt from levy unless a judge or magistrate of a U.S. district court approves of the levy in writing. However, and most significantly, when otherwise nonexempt funds were intentionally used to acquire a homestead, with the specific intent to convert those funds to exempt homestead for the very purpose of removing the funds from the reach of creditors, the Florida Supreme Court ruled the homestead exemption continued to apply.

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    The federal courts have ruled that the federal forfeiture statutes preempt Florida’s homestead exemption. Corporations are not entitled to homestead exempt status, even if the homestead is owned through a corporation electing to be taxed under Chapter S of the Internal Revenue Code and the only asset of the S-corporation is the residence of the sole shareholder of the S-corporation. On the other hand, a qualified personal residence trust (QPRT) qualifies for the homestead exemption. The homestead is protected from claims of creditors in the debtor’s estate, even if the “heirs” are merely individuals categorized in the intestacy statutes. Whenever you are involved in a situation that requires consideration of the state or federal forfeiture statutes, you should consult with a qualified Florida asset protection lawyer. If you would like to schedule a consultation regarding asset protection, please call us at 904-448-1969, or toll-free at (866) 510-9099, or email us at [email protected].

    Planning considerations: In light of the Havaco ruling, advisers should be aware that the investment of funds into a homestead in Florida is virtually creditor proof, with the exception of the IRS and U.S. Bankruptcy Court. Based on Havaco, it also appears that utilizing available funds to pay down an existing mortgage on the homestead, even if for the express purpose of avoiding creditors, can be reasonably safely accomplished, without violating the fraudulent conversion statute or constituting a fraudulent transfer.

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    A person residing in Florida should file an affidavit declaring that the real property on which he lives is the homestead of such person under Fla. Stat., §222.01. This may be especially true if the homestead is within a municipality and is located on more than one half acre. Consider whether there may be an advantage of having the homestead surveyed and designating the precise one-half acre to which the owner wishes to have the exemption apply, before creditor problems arise. If possible, the resident should consider fencing the some portion of the adjoining property so that it is easily distinguishable from the one-half acre on which the homestead is situated. The Englander decision dictates that advisers make their clients aware that having a homestead on more than one-half acre (160 acres outside a municipality) could result in the harsh result of selling the homestead and apportioning the proceeds. Anyone purchasing a home in a municipality after its incorporation will be subject to the one-half acre limitation. Advisers should counsel their clients of the implications of Englander. For residents who may be at risk of lawsuits, owning property in a municipality on one-half acre or less, or a condominium may be preferable to owning a residence on more than one-half acre. Even though the Florida homestead exemption is nearly absolute, to ensure that your homestead remains among your assets exempt from creditors’ claims, there may be actions that you can and should take.

    Statutory exemptions: There are various assets exempt from creditors’ claims under current Florida law. The exemption statute allows you the opportunity to take advantage of various estate planning techniques while protecting assets from the claims of creditors. For example, there are different types of life insurance products that provide for large cash values to be accumulated very early in the life of the policy which are assets exempt from creditors’ claim under the exemption statute.

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    Such value would be part of the gross estate of a decedent, regardless of whether held in a revocable trust or directly, and thus, would be available to utilize the unified credit in the decedent’s estate. While the individual is alive, Florida statutes would provide protection as we will see below. In addition, other exempt assets may also be held to utilize the unified credit, i.e., homestead property, annuities, retirement plan accounts, etc. The statutory exemptions are not effective against the Internal Revenue Service. They also are not effective if they result from a fraudulent transfer, or if they constitute a fraudulent conversion.

    Pension funds and IRAs: Section 206(d)(1) of Title I of the Employee Retirement Income Security Act (“ERISA”) provides that each pension plan shall provide that benefits under the plan may not be assigned or alienated. This is often called the anti-alienation provision. Section 206(d)(1) generally protects pension funds in an ERISA qualified plan from the claims of individual participant’s creditors.

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    In bankruptcy court, the U.S. Supreme Court has said that assets in an “ERISA-qualified” plan are excluded from the bankruptcy estate and are assets exempt from creditors’ claims. The basis for the ruling is Bankruptcy Code §541(C)(2), which excludes from the bankruptcy estate a beneficial interest of the debtor in a trust where the trust contains a restriction on the transfer of the beneficial interest which is “enforceable under applicable nonbankruptcy law.” The plan involved in Patterson was also tax qualified. Accordingly, some courts, including those in Florida, also require that the plan be tax qualified under IRC §401(a)(13), in order to receive the Patterson protection. Plans that are not subject to Title 1 of ERISA, and therefore are not subject to the anti-alienation provision, do not have the protections of Patterson. These types of plans typically include excess benefit plans, governmental plans, most church plans, most IRAs, SIMPLE IRAs and some SEP/IRAs. Florida statutory law provides protection for retirement funds that are not protected by PattersonFla. Stat., §222.21 (2015), provides protection for IRAs, SIMPLE IRAs, and SEP/IRAs. Such protection is not preempted by ERISA. However, ERISA’s anti-alienation provision does not shield against federal tax liens and judgments. Nor does a statutory exemption for IRAs protect those accounts from tax liens. While Florida includes IRAs as assets exempt from creditors’ claims, that protection does not apply to the Internal Revenue Service. In 1998, the Florida legislature amended the Florida statutory exemption from creditors for Roth IRAs, medical savings accounts, the Florida Prepaid College Program and other tax advantaged college savings programs, such as 529 plans.

    Life Insurance Fla. Stat., §222.13(1) (2015) provides: Whenever any person residing in the state shall die leaving insurance on his or her life, the said insurance shall inure exclusively to the benefit of the person for whose use and benefit such insurance is designated in the policy, and the proceeds thereof shall be exempt from the claims of creditors of the insured unless the insurance policy or a valid assignment thereof provides otherwise. Notwithstanding the foregoing, whenever the insurance, by designation or otherwise, is payable to the insured or to the insured’s estate or to his or her executors, administrators, or assigns, the insurance proceeds shall become a part of the insured’s estate for all purposes and shall be administered by the personal representative of the estate of the insured in accordance with the probate laws of the state in like manner as other assets of the insured’s estate. Accordingly, the life insurance proceeds pass to the beneficiary as assets exempt from creditors claims for creditors of the insured. The benefits of §222.13 do not extend to bar claims from the creditors of the beneficiary. If the designated beneficiary of the life insurance policy could have creditor problems, the use of a spendthrift trust for the beneficiary can be an advantageous asset protection measure, as well as provide additional estate and generation-skipping tax planning.

    Cash Surrender Value of Life Insurance Policies and Annuity Contracts Fla. Stat., §222.14 (2015) provides: The cash surrender values of life insurance policies issued upon the lives of citizens or residents of the state and the proceeds of annuity contracts issued to citizens or residents of the state, upon whatever form, shall not in any case be liable to attachment, garnishment or legal process in favor of any creditor of the person whose life is so insured or of any creditor of the person who is the beneficiary of such annuity contract, unless the insurance policy or annuity contract was effected for the benefit of such creditor. The cash surrender value of a life insurance policy is exempt only when the insured is the debtor. When the person whose life is insured is not the debtor, another person may not claim exemption from creditors’ claims for the cash value. This is an important issue where life insurance is held in a split dollar or split ownership arrangement. Only claims of the insured’s creditors are barred. The cash value in a policy, or presumably a portion of a policy, owned by someone other than the insured is not an asset exempt from creditors’ claims of the owner. Thus, cash value in the hands of the insured’s spouse would not be assets exempt from creditors’ claims of the spouse.

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    The cash value of an annuity, however, is protected from the claims of the creditors of both the annuitant and the beneficiary of the annuity. This exemption must be liberally construed in favor of debtors. This exemption is not limited to commercial annuities, but is also applied to private annuities. A single premium annuity, in which interest accrues until maturity, which does have a surrender value, but for which an early surrender will result in a surrender penalty, is protected by the statute from claims of the insured’s creditors, as well as the creditors of the beneficiaries. Either the owner or the issuer of the annuity contract has the right to raise the exemption. The proceeds of an annuity furnished pursuant to a “structured settlement agreement” representing the settlement of a personal injury lawsuit are exempt from the claims of creditors of the beneficiaries. However, where annuities are paid directly by the state to a lottery winner, the annuity is not protected, because the state is the obligor to the winner regardless of the performance of the annuity, and there is no privity between the lottery winner and the insurance company. At least one court has also found that there is no requirement that the annuity be issued to a resident of Florida, but that the proceeds of the annuity contract be paid to a resident of Florida. This same court further held that the annuity proceeds retain their exempt character even after they were deposited into the spouse’s bank account. The court concluded that so long as the funds can be properly traced into the account and are readily accessible to the debtor, the funds retain their exempt status. A Florida court has held that the cash surrender value of a life insurance policy is exempt from garnishment even when converted to purchase a certificate of deposit. There have been cases where the purchase of annuities was held to be a fraudulent conversion, and the exemption was denied. However, where a physician who engaged in “a pattern of asset protection over the years, converted assets, some of which were exempt and some that were not exempt, into cash value life insurance after an accident occurred, but before the liability for the accident was determined, the court found that the investment of the proceeds from the sale of his Jaguar automobile into a life insurance policy could not be avoided by the trustee in bankruptcy as a fraudulent transfer.

    Planning considerations: Obviously, the use of life insurance, cash value in life insurance and annuities offer significant asset protection for individuals. In particular, practitioners should consider the use of private annuities in intra-family transactions to provide asset protection as well as income and estate tax benefit. This planning can be initiated through intentionally defective grantor trusts for income tax purposes that are also effective for estate tax purposes. Such planning allows one to minimize income tax consequences typically resulting from private annuity transactions.

    Disability insurance: The proceeds or benefits for disability income under an insurance policy are exempt from creditors’ claims, except where the policy is procured for the benefit of a creditor. Additionally, worker’s compensation settlement proceeds have been held to represent a debtor’s right to receive a disability benefit within the meaning of 11 U.S.C. §522(d)(10)(C), and therefore are exempt assets, even where the proceeds are invested in a certificate of deposit.

    Wages Exemption Fla. Stat., §222.11 (2015) provides: (2)(a) All the disposable earnings of a head of family whose disposable earnings are less than or equal to $500 a week are exempt from attachment or garnishment. (b) Disposable earnings of a head of a family, which are greater than $500 a week, may not be attached or garnished unless such person has agreed otherwise in writing. In no event shall the amount attached or garnished exceed the amount allowed under the Consumer Credit Protection Act, 15 U.S.C. § 1673. (c) Disposable earnings of a person other than a head of family may not be attached or garnished in excess of the amount allowed under the Consumer Credit Protection Act, 15 U.S.C. § 1673. (3) Earnings that are exempt under subsection (2) and are credited or deposited in any financial institution are exempt from attachment or garnishment for 6 months after the earnings are received by the financial institution if the funds can be traced and properly identified as earnings. Commingling of earnings with other funds does not by itself defeat the ability of a head of family to trace earnings.

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    Generally, this statute exempts the wages of a head of a family from claims of creditors. The limit of the exemption is $500 per week. However, even the excess over $500 per week may not be attached unless the debtor agrees in writing. From a practical standpoint, it appears that this statute applies to an unlimited amount of wages unless creditors require the debtor to waive the exemption in writing in consideration for the extension of credit. The exempt portion of wages retains the exempt status even when placed into a bank account, for a period of time up to six months. However, where other funds are deposited into the same bank account, making it impossible to trace the exempt wages, the account will not be exempt. The issue of most concern with respect to this statute is whether it applies to earnings of an independent contractor. Certain courts have found that fees owed for personal labor and services are exempt, and that commissions and bonuses earned by a debtor are exempt earnings, even though the debtor was labeled an independent contractor. Most courts have held that money due for personal labor or services can only be earned by an employee and consequently that the payment of wages to an employee is exempt, whereas compensation to an independent contractor is not. Where the debtor is a professional or a business owner of a sole proprietorship, cash in bank accounts and accounts receivable are not exempt earnings. The courts require that the debtor must receive regular compensation dictated by the terms of an arm’s length employment agreement to perform services that are much like a job. The courts have also held that insurance renewal commissions earned by an independent contractor are not exempt under Fla. Stat., §222.11 (2011). Similarly, the exemption is not available for fees paid to a private investigator. However, where the debtor’s distributions from a corporation are not considered regular wages, then the distributions are not subject to garnishment. The wages should be deposited into a “financial institution” to obtain the exemption. Funds deposited into a cash management account at a brokerage firm are not protected. The exemption is available only for the head of a family, i.e., someone who provides more than one-half the support for a child or other dependent.

    Planning considerations: To effectively use this statutory exemption, it is necessary for small business owners and professionals to have a legal entity as the employer and enter into “an arm’s length” written employment agreement. The employment agreement should provide for regular wages to be received on a regular basis, and the wages should be reasonable based upon the nature of the work, the qualifications of the individual, and the range of competitive salaries negotiated in the community for arm’s length employment agreements. The person seeking protection of wages, should avoid the temptation to take compensation as funds become available, even if it is necessary to use a line of credit to provide the cash flow. It may be desirable to establish a “wage account” in an appropriate financial institution that is used exclusively for “wages.” Based on the statute, up to 6 months of wages can be protected in such an account.

    [*] This document was originally written in 2004 for presentation to a continuing legal education seminar for attorneys, lawyers, certified public accountants and financial advisers. The footnote references to various case citations and other legal support for the statements made have been removed. The information presented was current as of the date of its original publication in 2004. The laws dealing with asset protection planning, including statutory and constitutional exemptions from creditors’ claims are constantly evolving through statutory changes and case law decisions. You should not rely on any of the information contained herein without consulting with an experienced asset protection attorney or lawyer to determine whether the law has changed.