Domestic Asset Protection Trusts - What You Need to Know
THE COUNSELOR
Volume 10 • Issue 6 • August 2020
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning and business planning issues. This month's issue will discuss one type of irrevocable trust used for asset protection planning - the Domestic Asset Protection Trust. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
In a recent YouTube video, we discussed the differences between revocable and irrevocable trusts. One of the reasons a person would choose to use an irrevocable trust is asset protection planning. Asset protection planning is not about hiding or concealing assets. It is about using the existing laws appropriately to obtain the best possible level of protection in the event of a lawsuit. Asset protection planning is the process of analyzing ownership of assets and re-arranging ownership of those assets as needed to ensure maximum protection, maximum use of exemptions and to minimize risk of loss in future litigation. Asset protection is not evasion of taxes or defrauding current creditors. To be effective, asset protection plans must be properly designed, drafted and implemented. An asset protection plan is never stronger than its weakest link.
While most of us like to have a high degree of certainty in the outcome of a particular planning strategy, asset protection tends to be more art than science. Asset protection can be time consuming, but worthwhile and the end result should be considerably better than if you had done no planning at all. An effective plan will discourage lawsuits from the outset. You cannot make it appear as if your assets do not exist, but you can create a structure that will make it much less attractive for a potential plaintiff to come after you as opposed to someone who has done no planning. One way to engage in asset protection planning is to establish an asset protection trust.
Domestic Asset Protection Trusts
Self-settled asset protection trusts are irrevocable trusts where the person creating the trust continues to have some access to the assets held by the trust. These come in two forms: domestic asset protection trusts (DAPTs) and foreign, or off-shore, asset protection trusts (FAPTs). DAPTs are trusts established under the laws of a particular state, whereas FAPTs are organized under the laws of a foreign country. The first state to enact a DAPT law was Alaska. Now there are 19 total states that have adopted DAPT statutes (Alaska, Connecticut, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming).
With a DAPT, you irrevocably transfer assets to the trust and name yourself as a beneficiary to receive distributions within the discretion of an independent trustee. You may retain certain rights, including the right to remove and replace the trustee with certain restrictions. This strategy becomes particularly powerful when coupled with entity planning. This is done when the DAPT is the owner of an LLC. DAPTs are only effective for future creditors, as the fraudulent transfer laws of all states prohibit transfers to avoid existing creditors. Also, the trust must be in existence for at least 10 years to protect you against creditors in bankruptcy.
The self-settled asset protection trust laws vary from state to state and some states have additional exemptions such as alimony and child support payments. Therefore, there may be advantages to selecting one state's laws over another in your particular circumstances. Fortunately, you can elect to have your trust governed by a particular state's statute as long as you meet the requirements of that statute. In addition to providing asset protection, a DAPT offers other benefits, including state income tax savings when the trust situs is a no-income tax state.
Like all trusts, a DAPT, to be effective, must be funded with assets. Some of the best assets for a DAPT include: cash, securities, LLC interests, real estate, and recreational assets such as aircraft and boats. An analysis of each asset should be undertaken to look at the consequences of transferring the asset to the DAPT, including tax and business consequences. Often, it is best to establish an LLC in the trust state to hold the assets and then have the DAPT own the LLC.
Why Not?
If there are so many benefits to a DAPT, is there any reason you would not do a DAPT? Probably the biggest concern is that the state where the lawsuit is taking place may not honor the DAPT, especially if DAPT assets are physically present in that state. Some commentators suggest what is referred to as a hybrid DAPT. In a hybrid DAPT, the original Settlor of the DAPT is not listed as a beneficiary, but could be added later. An additional problem, as with all irrevocable trusts, is there is a higher level of diligence required to maintain and operate the trust properly. Of the few cases that exist, those that have gone against the DAPT seem to involve ill conceived and ill executed DAPTs. One issue that permeates asset protection planning is that the more access you have to the assets, the less protection the asset will have. The required restrictions on access can be a non-starter for many people.
When to Plan
The best time to get your DAPT in place and funded is before a claim arises. There are different rules that apply for known creditors and unknown future creditors in each state. It is highly important to avoid fraudulent transfers, which are transfers of assets not necessarily occurring with intent to defraud but without full and adequate consideration. While no asset protection strategy is foolproof, proper use of DAPTs in conjunction with other legitimate asset protection strategies increases your chance of protecting your hard earned assets in our increasingly litigious society. So if you are interested in asset protection and a DAPT sounds like it could work for you, let’s get started.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.