Trusts Used For Asset Protection
We have seen that trusts to avoid probate have very modest requirements because avoiding a court process at death producing an actual cost saving for the state by reducing the use of valuable court resources. Tax Trusts, on the other hand cost the government revenue so the restrictions on various tax saving techniques are generally tightly prescribed.
What about trusts used for asset protection? Are the rules very restrictive for these types of trusts? In general, the answer is that we are now permitted considerable flexibility in structuring asset protection trusts. There is much greater freedom in our design than is available for Tax Trusts.
Unlike Tax Trusts the government is not an adverse party in the asset protection arena. It has no direct stake in the outcome of litigation between two private parties. The government does have a legitimate interest in promoting the flow of commerce. It is pretty well agreed that encouraging the flow of business and commerce is an important role of government.
To this end, public policy has developed over the years which favors limiting personal liability from business activities but does not permit one to avoid legitimate debts and obligations. In other words, operating your business and personal affairs to minimize the risk of unexpected loss is sound financial management. Each state sanctions the use of trusts, corporations, Limited Liability Companies and Limited Partnerships in order to control personal liability for unanticipated obligations. What is not permitted is for individuals or businesses to abandon existing obligations or refuse to pay the debts they incur. The Fraudulent Transfer rules of every state prohibit attempts to defraud creditors by hiding or transferring property.
As long as we act within the boundaries of the Fraudulent Transfer rules, we have considerable latitude in preparing a trust to accomplish asset protection goals. If we attempt to combine asset protection with tax savings we are handicapped by the stricter rules limiting the administration of Tax Trusts. When our primary purpose is asset protection, rather than tax saving, we will make the trust a Grantor Trust – ignored for tax purposes – allowing us the most possible freedom in designing the features of the trust. Unlike the Tax Trust, asset protection laws generally allow us to design effective trusts which maintain the important benefits of property ownership without compromising the quality of the asset protection. There are certainly rules to be followed and traps to be avoided, but as long as we do not violate the Fraudulent Transfer prohibitions we can exercise broad discretion in choosing the terms and features appropriate for any individual circumstances.
The level of government scrutiny and regulation which applies to the formation of trusts for business and personal planning depends upon the level of government interest in the particular activity. The use of trusts to avoid probate is favored because that reduces the cost and burden on the court system. Trusts for tax saving directly reduce revenue so permissible uses and features are more restricted. Asset protection trusts are revenue neutral and are generally permitted as consistent with public policy and proper regard for the rights of creditors.