Domestic Asset Protection Trusts

Domestic Asset Protection Trusts

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As a general rule, self settled trusts are not protected from creditors. However, recently the States of Alaska, Delaware, Nevada, Rhode Island, Colorado, Missouri, Utah and South Dakota have provided various degrees of asset protection legislation in a self settled trust. The Colorado, Missouri and Utah asset protection statutes are only marginally effective, and, as such, not worthy of further discussion. The Alaska, Delaware, Nevada, Rhode Island and South Dakota legislation allowing for domestic asset protection trusts ("DAPTs") is similar in many respects to the asset protection trust legislation found in several foreign jurisdictions. It should be noted, however, that the courts have not had an opportunity to pass muster on the DAPT legislation because of their recent enactment and because the statute of limitations in most cases has not expired.

The Nevada, Delaware and Alaska DAPTs are generally considered to be the most debtor favorable. Generally, the required procedures for setting up a DAPT are similar, although they vary from state to state with the requirement that the trustee be a resident of the DAPT state. Delaware, Nevada and Alaska also allow for a non resident co-trustee. It would seem, however, that the employment of the non resident trustee would more likely subject the trust to the jurisdiction of the courts outside of the relevant domiciliary state. In this regard, it appears that the trustee must at least conduct some minimal level of activity in the domiciliary state on behalf of the trust. In addition, the trust has to provide for spendthrift provisions and be irrevocable. For the most part, the Trustor cannot have an automatic right to distributions which must be discretionary. In Delaware, however, the statute allows the Trustor to be the sole beneficiary with the right to receive the income and principal in the trustee's discretion.

With respect to the statute of limitations, which is an integral part of the legislation of Nevada, a person may not bring an action with respect to a transfer of property to a spendthrift trust if he is a creditor when the transfer is made, unless the action is commenced within two years of the day of transfer or six months after the transfer could have been reasonably discovered, whichever is later. For future creditors the statute is two years after the transfer is made. There are some exceptions including spousal and child support.

Analysis of Legal Efficacy of DAPTs: Full Faith and Credit Clause of the Constitution Pursuant to the Full Faith and Credit Clause of the Constitution, each state is required to recognize and enforce the judicial acts of other states. Although the general rule is that the domicile of the trust determines the applicable law and, accordingly, the degree to which the trust affords protection against creditors, the courts may refuse to do so when there is some critical state policy at issue. In this regard, a California court may reject the application of the DAPT legislation of the trust situs and instead rule under California law that the creditor is able to reach the assets of the DAPT. If this occurs, the creditor will still have the necessity of enforcing the judgment against the out of state trustee and the DAPT domiciliary state may then refuse to enforce the California judgment because California did not apply the domiciliary law. Similarly, a federal bankruptcy court may elect not to apply the law of the domiciliary DAPT legislation. However, under Section 541(2) of the U.S. Bankruptcy Code, it would appear that the bankruptcy court should give full faith and credit because a bankrupt's interest in a trust that is subject to restrictions is exempt to the extent that such restrictions are enforceable under state law.

The issue of whether the DAPT state court must recognize and enforce a contrary decision by the court of another state may have to be litigated on appeal, perhaps, even all the way to the U.S. Supreme Court. In this regard, litigation costs would be substantial. Moreover, it may be that resident trustees of DAPTs have sufficient nexus or contacts with other states so that the non DAPT states can obtain personal jurisdiction over the resident trustee of the DAPT. Many of the DAPT professional trustees are actively involved by mail, telephone and personal contacts, i.e., seminars, etc., in all the states so that sufficient contacts or nexus may be established.

Expanded Interpretations of Fraudulent Conveyance Statute: The Trustor of a DAPT will normally have the burden of proving that the transfer to the trust was not a fraudulent conveyance. This burden may be difficult to up hold.

Application of Statute of Limitations: As was previously discussed, most DAPT legislation allows a plaintiff to bring a claim based on the latter of two separate time periods, e.g., when the transfer to the trust occurs or when the creditor finds out or reasonably could have found out about the existence of the transfer to the DAPT. Accordingly, the Statute of Limitations that is based on the creditor's knowledge of the transfer may continue to run for years into a lawsuit.

In REM Jurisdiction: A court in a non DAPT state may hold that a creditor may reach the assets of a DAPT on the basis of in rem jurisdiction with regard to real estate. In rem jurisdiction may also extend to bank accounts, stock accounts, bonds and intangible property and personal property.

Estate and Gift Tax Consequences: Many times proponents of DAPTs recommend that the DAPT be designed as a completed gift for tax purposes. However, many trustors are not prepared to pay significant sums in gift taxes in order to establish and set up their asset protection plan. The gift tax credit equivalent for 2002 and thereafter is $1,000,000. The generation skipping transfer tax exemption is $1,000,000 (adjusted for cost of living). If the GST tax exemption amount is utilized, a current federal gift tax could be imposed on the cost of living adjusted amount.


Copyright (c) 2011 Jeffrey Matsen

About the Author:
Jeffrey R. Matsen of Wealth Strategies Counsel helps people structure their personal and business assets in the best way possible to protect, preserve and transfer them in the most efficient and tax saving manner. For more information go to http://www.WealthStrategiesCounsel.com



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