A primary goal of your estate plan is to transfer wealth to your family according to your wishes and at the lowest possible tax cost. However, if you have creditors, be aware of fraudulent transfer laws. In a nutshell, if your creditors challenge your gifts, trusts or other strategies as fraudulent transfers, they can quickly undo your estate plan.
Most states have adopted the Uniform Fraudulent Transfer Act (UFTA). Michigan has recently adopted the Uniform Voidable Transactions Act (UVTA) which has supplanted the Michigan Uniform Fraudulent Transfer Act.
Under MCL 566.34 of the UVTA,
. . ., a transfer made or obligation incurred by a debtor is voidable as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation in either of the following circumstances:
(a) With actual intent to hinder, delay, or defraud any creditor of the debtor.
(b) Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor did either of the following:
(i) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction.
(ii) Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they became due.
Note the inclusion in the statute of the language that refers to a creditor's claim [that] arose before or after the transfer was made or the obligation was incurred.
Just because you weren’t purposefully trying to defraud creditors doesn’t mean you’re safe from an actual fraud challenge. Because a court can’t read your mind, it will consider the surrounding facts and circumstances to determine whether a transfer involves fraudulent intent. So before you make gifts or place assets in a trust, consider how a court might view the transfer. The statute enumerates the factors to be considered as follows:
(2) In determining actual intent under subsection (1)(a) or (4), consideration may be given, among other factors, to whether 1 or more of the following occurred:
(a) The transfer or obligation was to an insider.
(b) The debtor retained possession or control of the property transferred after the transfer.
(c) The transfer or obligation was disclosed or concealed.
(d) Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit.
(e) The transfer was of substantially all of the debtor's assets.
(f) The debtor absconded.
(g) The debtor removed or concealed assets.
(h) The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred.
(i) The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred.
(j) The transfer occurred shortly before or shortly after a substantial debt was incurred.
(k) The debtor transferred the essential assets of the business to a lienor that transferred the assets to an insider of the debtor.
A transfer made or obligation incurred by a debtor is voidable as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation. MCL 566.35
“Insolvent” means that the sum of your debts is greater than the sum of the value of all of your assets, at a fair valuation. You’re presumed to be insolvent if you’re not paying your debts as they become due other than as a result of a bona fide dispute.
Know your net worth
By definition, when you make a gift — either outright or in trust — you don’t receive reasonably equivalent value in exchange. So if you’re insolvent at the time, or the gift renders you insolvent, you’ve made a constructively fraudulent transfer, which means a creditor could potentially undo the transfer.
To avoid this risk, analyze your net worth before making substantial gifts. Even if you’re not having trouble paying your debts, it’s possible to meet the technical definition of insolvency.
Fraudulent transfer laws vary from state to state, so consult an attorney about the law in your specific state.