Tools of the Trade and Household Goods Exemptions

April 13, 2006

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"Tools of the trade" and "household goods" are asset exemption categories that provide good examples of the pigeon-hole concept, into which a particular item of property must somehow be fitted in order to be exempt in your overall asset exemption plan.

For example, individuals have successfully argued that valuable diamond rings are exempt as wearing apparel treated as protected household goods, rather than jewelry that would not be protected. Debtors in other courts have lost this same argument.

"Tools of the trade" are frequently exempt and can be widely interpreted to include any property reasonably necessary to carry out a business. Sometimes a vehicle can be qualified under this provision only if it is uniquely put to use in the business, such as a delivery van. If a vehicle were not qualified under this category, it would have to fit under a specific exemption for motor vehicles, which could offer less protection.

Keep in mind that the "tools of the trade" exemption will not ordinarily apply to the property owned by a business entity, such as a limited liability company (LLC) or a corporation, as exemptions are available only to natural persons. Thus, the exemption may not be as significant as first appears.

Work Smart

As advocated in our discussion of using operating and holding companies, a business owner should own assets personally or in a holding company, and lease them to the operating company, to shield the assets from the claims of the business's creditors.

When the assets to be leased fit under one of the exemptions, the owner should consider personally owning them so that he or she can rely on the exemption for the assets. This can be done with respect to tools of the trade, including office equipment and motor vehicles used in the business.

The one exception to this rule may be assets that carry a high risk of causing injury. Here, the owner ordinarily should contribute these assets to the operating company, because liability may run to the owner. An example would be motor vehicles used by other employees of the business.

When only the owner uses a motor vehicle, the risk is reduced, and the strategy of personally owning the asset becomes more attractive.

The same reasoning applies to the other tools of the trade. Manufacturing machinery may be too risky to personally own, while office equipment may be an ideal candidate for this strategy.

In either case, but especially when the owner personally owns the asset, the owner should ensure that there is more than adequate liability insurance coverage on the asset.

Finally, this strategy does not apply to nonexempt assets such as a commercial building. In the case of a commercial building, the risks would usually be too high to justify this strategy in any event. Nevertheless, in many cases, a lease of a commercial building makes sense. However, the lessor (and owner) should be the holding company.

The classification of exempt "household goods" usually involves various subcategories. States sometimes create separate categories for items that another state would include within the household goods category as a subcategory. As a result, the states vary widely in terms of what categories and subcategories they make available. Further, even with subcategories, the term "household goods" suffers from the same problem as the term "tools of the trade"--it is subject to court interpretation.

Subcategories are sometimes subject to caps, as are the controlling categories. For example, there is a federal bankruptcy exemption for household goods, but there is an overall cap of $9,850, and a separate cap of $475 per item. In some states, the categories have no caps. In others, the debtor has to prove certain items qualify as basic necessities.

In many cases, the dollar caps are relatively low. Nevertheless, all debtors will want to protect this type of property and, in particular, personal effects, many times simply for sentimental reasons.

For this reason, you should examine your state's particular exemptions (see the exemption list for your specific state information). In doing so, it is a good practice to conservatively include items within particular categories that indisputably fit there, while keeping in mind that it may be possible, if necessary, to stretch the definition of certain categories.