Domestic Asset Protection Trusts
 

DOMESTIC ASSET PROTECTION TRUSTS

 

What is a Domestic Asset Protection Trust?

A Domestic Asset Protection Trust ("APT") is an irrevocable trust designed to provide the client/grantor with protection from the claims of future unknown creditors.  Traditionally, a client could not set up a trust for his or her own benefit and have the trust assets protected from the client's creditors.  However, in a domestic APT, the grantor/client is permitted to retain a beneficial interest in the trust.  Numerous states have enacted laws that allow a client to create a Domestic APT, including Alaska, Delaware, Missouri, Nevada, Oklahoma, Rhode Island, and Tennessee.   

When Should You Consider A Domestic Asset Protection Trust?

Many people are concerned about the rise in litigation in our country and recognize that advanced planning is needed in order to protect the wealth that they have accumulated during their lifetime. 

Candidates for a Domestic APT vary and may include professionals who are exposed to litigation risk (doctors, lawyers, engineers, architects, actuaries and accountants), entrepreneurs, business owners, and those who serve as officers or on a board of directors of a company (including charitable organizations).  Domestic APTs are not appropriate for anyone trying to avoid the claims of current creditors.  The worst possible candidate for asset protection planning is a person who is currently involved in litigation or is about to incur a large obligation and wants to hide assets to avoid satisfying their debt.

What are the Benefits of a Domestic Asset Protection Trust?

A Domestic APT allows a client to place assets in an irrevocable trust beyond the reach of future creditors while still retaining certain interests in, and powers over, the trust. Each Domestic APT jurisdiction imposes certain limitations, such as a period of time (generally four years) during which creditors can challenge transfers to the trust as being fraudulent. Therefore, individuals transferring assets to a Domestic APT must be prepared to show that the transfer was not fraudulent.  In addition, claims such as alimony, child support and tort injuries incurred prior to the date of the trust are exempt from creditor protection for public policy reasons.

How the Domestic APT is Created and How It Works.

The mechanics of creating a Domestic APT are straightforward. The trust must be established in a state that has domestic asset protection trust legislation.  The trust must be irrevocable; appoint at least one qualified trustee (usually must be a resident of the Domestic APT jurisdiction or entity authorized to act as trustee within the state); contain a spendthrift clause (prohibits assignment and attachment of a beneficiary's interest in the trust); appoint additional beneficiaries other than the client (i.e. spouse, children and grandchildren); and be governed by law of the Domestic APT jurisdiction. The grantor/client cannot serve as the trustee of the Domestic APT.

The Domestic APT provides that the grantor/client and other beneficiaries named in the Domestic APT (typically family members) can receive as much of the income or principal from the Domestic APT's assets in the discretion of the trustee.  In some jurisdictions, (i.e. Delaware) the grantor/client can retain various powers over the Domestic APT's assets, such as the power to veto distributions to any other beneficiaries,  the power to change trustees, and the power to change the way the client is leaving assets upon their death through a limited power of appointment.

How is the Trust structured for tax purposes?

A Domestic APT can be structured in a number of ways for income, gift and estate tax purposes, depending on the client's goals. For example, the trust can be structured as a completed gift in an attempt to place the assets, and any growth of the assets, outside of the grantor's/clients taxable estate. Alternatively, the trust can be established with no gift tax consequences to preserve the grantor's lifetime gift tax exemption. This will cause the inclusion of the trust assets in the grantor's/client's estate for estate tax purposes. For income tax purposes, the trust may be a grantor trust or, depending on the distribution terms, the trust can be a separate tax entity and may be established to avoid state income tax. The ultimate makeup of the trust will depend upon the grantor's/client's overall wealth transfer, income and estate planning goals.

Can the Grantor/Client Serve as Trustee of the Domestic APT?

Many Domestic APT jurisdictions allow a client to separate the roles and responsibilities associated with a trust among various parties.  For example, the Domestic APT may appoint a "distribution trustee", "investment trustee", and "administrative trustee" in the Domestic APT with the authority to direct distributions to the beneficiaries, or the investment of trust assets, or the administrative functions of the trust, respectively.  This type of structure allows the client to appoint an "administrative trustee" in the Domestic APT state (to access the benefits of the Domestic APT state law) while appointing one or more separate trustees that may be located outside of the state.  The "administrative trustee" is responsible for filing any tax returns for the Domestic APT and maintaining the books and records of the Domestic APT in the Domestic APT state.  The "investment trustee" is given the sole authority to invest the Domestic APT's assets.  The grantor/client may serve as the investment trustee, or the client can appoint any other individual or professional advisor to serve as the investment trustee.  The client cannot however serve as the distribution trustee of the Domestic APT.


I do not want to lose control over my assets. How can I retain more control?

If the client/grantor wants to retain more control over their assets without compromising the level of their asset protection, a client can form a limited liability company ("LLC") or Family Limited Partnership ("FLP") to hold the family assets that the client wishes to protect. The client can be the manager (or general partner in the case of an FLP) of the LLC. The membership interest (ownership) of the LLC would be held by the Domestic APT. This structure allows the client to maintain management control of the assets while protecting the membership interest from a potential charging order or foreclosure. This structure is an excellent strategy that provides significant asset protection without diminishing the client's level of control over the assets.

Other Things to Consider.

To date, the Domestic APT, by itself (without the use of an LLC or FLP to hold the family assets) has not been tested in the U.S. courts, and a Domestic APT may be susceptible to being set aside pursuant to a judgment obtained outside of the Domestic APT jurisdiction. Despite this uncertainty, Domestic APTs continue to grow in popularity as the alternative to foreign asset protection trusts. Clients and their advisors must weigh the potential benefits of a Domestic APT against the outstanding issues regarding their effectiveness.

A Domestic APT should be evaluated as part of a client's overall financial and wealth transfer goals. A Domestic APT can be structured in a number of ways to facilitate income, gift and estate tax planning. For all of these reasons, it is essential that anyone considering a Domestic APT consult an attorney who specializes in this area.

The Kaiser Law Firm, P.C.
12231 Manchester Road, 1st Floor, St. Louis, MO  63131
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