There are two questions that estate planners commonly ask when they have a client in financial distress:
(1) If the Debtor has a history of tithing or making other charitable contributions, can the Debtor continue giving to charity?
(2) If the Debtor has a history of making annual gifts to his children, can the Debtor continue making those gifts?
The answers can never be better than a "maybe, it depends". Mostly, it depends on whether the Debtor is in bankruptcy, or (if not) whether the Debtor is "insolvent" -- the latter which may be established by the fact that the Debtor is not paying bills as they come due.
First, as to tithing and charitable gifts, those are usually treated differently inside and outside of bankruptcy. Section 548 of the Bankruptcy Code deals with fraudulent transfers, and subsection (a)(2) of 548 provides a limited exception for tithing and charitable gifts:
(2) A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a transfer covered under paragraph (1)(B) in any case in which—
(A) the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made; or
(B) the contribution made by a debtor exceeded the percentage amount of gross annual income specified in subparagraph (A), if the transfer was consistent with the practices of the debtor in making charitable contributions.
So, if the Debtor had a habit of giving to charity, the Debtor can do so right up until the time of the bankruptcy filing in the same amounts without it being a fraudulent transfer.
Outside of bankruptcy, the fraudulent transfer laws of most states provide no such exception (although a few states have amended their UFTA to create a similar exception), meaning that even if the Debtor had a habit of giving to charity, that provides no defense against a fraudulent transfer action.
As to annual gifts to children or trusts, neither the Bankruptcy Code nor the fraudulent transfer laws provide any exception. This does not mean that such gifts will ipso facto be fraudulent transfers -- here, we must make a distinction as to whether the Debtor was solvent or not.
If the Debtor was insolvent, then any gifts made to children or trusts will fraudulent transfers per se under the constructive fraudulent transfer test. This test only has two elements: (1) the Debtor was insolvent, and (2) the recipient did not provide any "reasonably equivalent value" in exchange for the transfer. Since a gift, by definition, lacks "reasonably equivalent value", any gift made while the Debtor is insolvent will always be a fraudulent transfer per se.
If the Debtor is solvent such that the constructive fraudulent transfer test does not apply, the instead the Court will look to determine the Debtor's intent in making the gifts. If the Court concludes that the Debtor made the gifts to defeat the rights of creditors, then the gifts will be a fraudulent transfer. If the Court find that the Debtor had no such intent, then the gifts will not constitute a fraudulent transfer. It is simply a crapshoot as to what the Court may or may not believe, and the Court may look past the Debtor's stated intentions and past history of gifting to other circumstances that might infer such intent.
Consider the Debtor who is deeply underwater, but makes small Christmas gifts to her children. In that case, it would be unlikely (but not impossible) for a Court to find that the Debtor had the intent to defeat the rights of creditors. Conversely, the same Debtor who makes annual gifts of $10,000 to each of her four children at a time when creditors are knocking on the door, might well see those transfers avoided as fraudulent transfers. This seems to be a good place for the application of the old rule: "pigs get fat, hogs get slaughtered".
For some reason, estate planners seem to think that there is some exception to the fraudulent transfer laws for the client who has made regular gifts each year to her children's trusts, such that even if the client can't pay her creditors, the client can still keep making those gifts -- but there is no so exception; it's just a myth.
Note that trying to justify these transfers as "estate planning" may be ridiculous under the circumstances -- the insolvent or bankrupt debtor no longer has an estate to plan for!
These results might seem harsh, but they reflect a conscious decision by Congress and the state legislatures that between the debtor being able to make gifts, and the creditor being paid on its judgment, the creditor should be paid on its judgment. Which is another way of saying that a debtor shouldn't be making any gifts until all creditors are paid up.
Would this apply to very small gifts, such as the father who gives his toddler son a $20 teddy bear? Theoretically, yes, but practically, no. Most states have "wildcard" exemptions from collection that give debtor some small amount, $7,500 or something, of general assets that can be protected from creditors. Since an exempt asset is not an "asset" for purposes of the fraudulent transfer laws, it cannot be fraudulently transferred. However, from a strictly technical standpoint, if the father is insolvent, then any even small gift that he gives his son might be a constructive fraudulent transfer -- again, it is a harsh test. This is why small gifts are rarely challenged as fraudulent transfers, but significant gifts can often be easily voided on those grounds.
Another situation that causes difficulty is where the debtor has purchased a whole life insurance policy for the benefit of his wife, and the policy was to be purchased in five equal payments of $20,000 over five years. In the fifth year, the debtor gets into financial difficulties and becomes insolvent. Can the debtor make the final $20,000 payment into the policy without it being a fraudulent transfer?
No, the transfer of the $20,000 to the life insurance company would be a fraudulent transfer, and a creditor could recover it. This is true even if life insurance is exempt in the state where the debtor resides -- that an asset becomes exempt after a transfer does not in any way insulate the transfer itself from challenge as a fraudulent transfer. Ditto for 529 college savings plans, although those sometimes have shortened Statutes of Limitation by when particular contributions can be challenged by creditors.
The hard truth is that a debtor who is insolvent can safely do little more than pay creditors. Doing anything more than making very small gifts, or as allowed by Bankruptcy Code 548(a)(2) requires careful technical analysis to determine of the debtor is making a fraudulent transfer, and thus risking the done being dragged into the debtor-creditor controversy.
This article at http://onforb.es/10cHfNE and http://goo.gl/saQD9e
