Asset protection trusts promise their settlors the best of many worlds. They allow a grantor to give away assets to a trust and remove them (and any future appreciation in the trust assets) from their taxable estate. However, the grantor can remain as a discretionary beneficiary, and thus can have access to the assets if needed (if the trustee cooperates). Lastly, the assets are placed beyond the reach of the grantor’s creditors, subject to fraudulent conveyance and other local law limitations.
The foregoing only works for trusts established in jurisdictions that override common law rules and exempt the reach of the grantor’s creditors from the trust assets. This can be accomplished in many offshore jurisdictions. For those that do not want to go offshore, 14 states now have some version of domestic asset protection trust (DAPT) laws that provide the requisite exemption. However, the recent case of in In re Huber, 493 BR 798 (Bkrptcy. DC Wash., 2013) has raised significant concerns about the ability of non-DAPT state residents to set up a trust in a DAPT state and enjoy the benefits of the DAPT. Since there is little other law on this question, Huber has been closely scrutinized by planners.
Huber turned on whether the state of the trust (Alaska) had a substantial relation to the trust, and looked at 3 factors: the domicile of the grantor or trustee, the location of the assets, and the domicile of the beneficiaries. Based on the minimal connections of the trust with Alaska, the court did not find such a connection and applied Washington law instead which voided the benefits of Alaska’s DAPT laws.
In a recent article, Sean R. Weissbart has the following suggestions to maximize the likelihood that a court will respect and apply the law of the DAPT state even when the grantor does not reside there,based on the Huber analysis. These suggestions are:
- Create the trust as early as possible. This minimizes the risk of the court being influenced by fraudulent intent. It also starts the 10 year period that exists under federal bankruptcy law for a creditor to overcome a domestic asset protection trust if the trust was established with bad intent.
- Use a trustee in the DAPT state, and minimize the use, or powers of, co-trustees located outside of that state.
- Acquire assets in the DAPT state well in advance of creating the trust.
- Name beneficiaries that reside in the DAPT state. As a practical matter, this one may be hard to accomplish.
- Dilute trust contacts with the grantor’s home state.
Weissbart, Sean R., Estate Planning Strategies for the Young and Wealthy, Estate Planning Journal, Feb 2014