Domestic Asset Protection Trusts
An increasing number of states have now enacted laws permitting residents to legally shield their homes, savings and other assets from potential claims of creditors. In 1997 Alaska and Delaware became the first states to allow Domestic Asset Protection Trusts.
In 2017 Michigan became the 17th state to allow property and savings to be sheltered from lawsuits and creditor collection actions. These states and others which will follow provide significant planning tools through Domestic Asset Protection Trusts for individuals and businesses owners who wish to protect assets and limit potential exposure to liability risks.
Prohibition on Self- Settled Trusts
Let’s understand the goals of these trusts – what they are intended to accomplish. Many people want asset protection for their nest egg while continuing to use the income and maybe the principal, to pay for their personal living expenses. For example, a retired client wants to protect his savings of $5 million from general lawsuit risks. The problem is that he needs the income to live on each year. These types of trusts are called “Self-Settled” trusts and for centuries, English and American laws have held that an individual cannot protect savings from creditors with a trust while reserving a right to use the income and/or principal for his or her own benefit. This rule certainly makes sense (at least to creditors) and reflects the dominant public policy that one should not be able to maintain full enjoyment of his property without meeting his legitimate obligations.
For those individuals who don’t need the income from their savings to live on because they have an independent source of income from a business or professional practice, there are many asset protection strategies that will be successful. Business owners who live on the income from their businesses or professional practices and not on the income from their savings are usually in a good position to implement these strategies. But for those without an independent source of income, until fairly recently, the asset protection choice was often an Offshore Asset Protection Trust, organized under the laws of a country that legally sanctioned trusts for these asset protection purposes ( See “Is Offshore the Right Asset Protection Choice?” )
Demand for Asset Protection Trusts
As these Offshore Asset Protection Trusts gained in popularity, due to the “litigation explosion” some U.S states viewed the demand for asset protection trusts as a ripe business opportunity to provide a lucrative financial service for clients in a local setting without the uncertainty and inconvenience of foreign banking. Delaware and Alaska led the charge and subsequently fifteen other states adopted laws which essentially duplicated the rules in the offshore jurisdictions by creating a category of Domestic Asset Protection Trusts (DAPT’s). Simply put, under these new laws, Self Settled trusts were permitted. Asset protection could be accomplished even for trusts reserving to the Settlor a right to the income or principal, if the appropriate rules are followed.
Features of Domestic Asset Protection Trusts
Each of these states has some differences in their laws but generally DAPT’s must have at least one independent trustee located in the state of choice and any distributions to the Settlor must be approved by that trustee.
Although states differ popular features of the DAPT legislation are as follows:
- A trust can be created in which the Settlor is also the beneficiary.
- At least one trustee must be a licensed in state financial institution or an individual who resides in the state.
- This trustee must have some responsibility for trust tax returns and administration;
- The Settlor may have the right to veto any distributions by the trustees;
- Some portion of the assets of the trust must be in a bank or other financial institution in the state;
- The power to make distributions to the Settlor must be held by a trustee who is independent of the Settlor;
- The assets of the trust are protected from any claims against the Settlor except:
- Fraudulent Transfers;
- Claims for spousal support, alimony and child support;
- Claims for personal injury or property damage which occurred before the transfer to the trust; and
- Claims by creditors who relied upon an express written statement by the Settlor that the assets of the trust were available to satisfy the debt to such creditor.
Effectiveness of DAPT’s for Asset Protection
Are these DAPT’s effective for asset protection? There has been a surprising lack of case law on this issue but it’s probably true that if you live in a DAPT state then the legal asset protection should be strong. if you set up a trust in that state or even another DAPT state. In the case of a bankruptcy, The Bankruptcy Reform Act of 2006 states that “Asset Protection Trusts” can be set aside by the Bankruptcy Trustee if formed within the previous 10 years with an actual intent to hinder, delay or defraud a creditor. What constitutes such prohibited “intent” is a fairly large and debatable issue but it seems likely that the intent of that language is that DAPT’s created prior to the 10 year period, will be respected under Federal Bankruptcy Law, even if formed with an “evil” intent. For those living in non-DAPT states and attempting to use a DAPT, we don’t yet know whether assets in these trusts can be protected from a legal judgment and a collection action in your home state.
Planning with Domestic Asset Protection Trusts
Based on the current status of the DAPT law we consider the following issues for our clients:Those who need to reserve the current income from their savings, should consider a DAPT if they live in a state with DAPT legislation. If they live in another state then the outcome of the DAPT is less certain and an Offshore Asset Protection Trust or other planning techniques should be explored. For a U.S. bankruptcy filing, regardless of the home state, and especially if it is formed more than 10 years from the filing, the DAPT may be worthwhile consideration.
If a client has a secure source of income from a professional practice or business and wishes to protect a retirement nest-egg, the DAPT and all of the traditional asset protection strategies can be very successful and should be considered in developing a comprehensive asset protection plan.