Many different situations drive people to do estate and asset protection planning. Sometimes, someone will suddenly get a bad diagnosis and realize they don’t even have a will. Sometimes, the probate hassles they’ve watched their friends’ families go through makes them see their lawyer to get a will, some powers of attorney, and a revocable living trust.
Other times, however, someone may see their friend and former partner, a doctor, get slapped with a $23.6 million dollar medical malpractice verdict. Soon, several other doctors in the area realized all their assets in excess of their mere multimillion dollar malpractice insurance policy were suddenly subject to being seized by their former patient’s survivors and they all got on their phones with their lawyers to make sure their asses and assets are both equally covered.
The lessons learned from such experiences teaches us that “fortunate” people, those who have worked hard to make or inherit their fortunes, should take all possible precautions to protect their assets against anyone who might try to take them away from them against their will.
Who might attempt to steal your family gold? Your:
- Disgruntled business partners or customers,
- Personal or business creditors,
- Angry soon-to-be-children-in-law,
- Victims of auto accidents those with better cars may or may not have caused, or
- Clients or patients who might sue accountants, lawyers, or doctors for malpractice.
These are but a few of the more common aggressors who may seek to plunder what others, including you, worked so hard to accumulate.
What can you to do to protect your assets? One good asset protection strategy is to transfer much of one’s assets into estate planning trusts and other asset protection trusts, which is also known by other descriptors such as a self-settled or self-created, irrevocable, investment, or spendthrift asset protection trust.
A Few Initial Definitions
Before we go too much farther, let’s define a few of our asset protection trust terms.
- A wealth owner who transfers assets into a trust becomes a “settlor” or “grantor” of such a trust. That transfer is sometimes referred to as a “disposition,” because the grantor is disposing of the assets to put them out of the grantor’s own unfettered future possession or use.
- “Irrevocable” means a grantor cannot get assets granted to a trust back without the action of a truly independent trustee who has not made a prior agreement to transfer the assets back to the grantor except in accordance with an ascertainable standard, such as for the grantor’s health, education, maintenance, and support.
- “Health, education, maintenance, and support” is defined by the IRS and courts to mean “just that” in contradistinction to “whatever the heck the grantor cum beneficiary then wants it to mean.”
The Cost vs. Benefits Analysis: Tax-Saving and Asset Protection Benefits vs. Loss of Control and Legal and Administrative Cost Conundrum
Every benefit in life has its costs. Creating and using asset protection trusts are no different than anything else in this regard.
Asset protection trusts (APTs), being irrevocable trusts, have two major advantages:
- Moving a wealth owner’s assets out of the reach of their future creditors and
- Moving those same assets out of an owner’s taxable estate before they eventually die.
On the other hand, however, being irrevocable trusts and requiring truly independent trustees, APTs have some disadvantages:
- Loss of wealth owner’s complete control over the wealth
that often scare wealth owners almost to a premature death. Why? Because wealth owners are usually Type A people who highly value maintaining, as completely as possible, control of all their entire domain.
Wealth owners cannot both protect their cake and eat it, too. They cannot protect their assets from undesired claims and retain unfettered access to those protected assets. But they can have a cake of protected assets and get rations from that protected cake when they really need it in the future. And here is the real bonus, anyone else that is a beneficiary of the grantor’s bounty defined in an asset protection trust can get a portion of protected asset cake whenever it is allowed under any circumstances defined in the asset protection trust.
Yes, a well-thought-out, well-understood, well-drafted, well-funded, and well-administered asset protection plan can achieve its goals of removing a wealth owner’s assets out of reach of the grantor’s future creditors and out of the grantor’s taxable estate prior to the grantor’s death, while maintaining a very feasible and acceptable level of future control over those transferred assets for both the grantor’s and the grantor’s loved ones’ benefit.
A few words of caution, however, before falling too far in love with asset protection trusts. First, being creatures of individual state statutes, mere mortals (including attorneys doing their first few APTs) should not try to D-I-Y these kinds of trusts, but rather they should hire or associate with attorneys schooled in the art of APTs to be sure all the I’s get dotted and all the T’s get crossed. If you don’t do your APT right, your future creditors or the IRS will certainly be apt undo them for you.
Second, each grantor’s actions being interpreted in conjunction with each state’s fraudulent transfers acts, a grantor should realize they cannot transfer all of their assets into an APT, nor can they transfer their assets for the cogent purpose of putting those assets out of reach of known present or probably potential future creditors. So, due diligence requires knowing all significant details about a grantor’s past, present, and foreseeable assets and liabilities and income and expenses. This does not mean, however, that a potential grantor with liabilities cannot move some of their assets into an APT. It just means the grantor should leave enough assets out of the trust to handle known current and foreseeable debts and anticipated future living expenses feasibly exceeding the grantor’s expected discretionary income.
Third, putting too large a portion of a grantor’s assets into an APT tends to lead the IRS and/or some judge deciding a creditor’s fraudulent transfer case to rule that the grantor had no care whatsoever of the grantor’s independent trustee not doing whatever the grantor wants done in the future. If the IRS or the judge finds there is an agreement between the independent trustee and the grantor, then the entire APT can be voided for asset protection and inheritance tax purposes. The TISA attempts to help prevent any court or the IRS from finding such an agreement by stating any such agreement or understanding shall be void. Not voidable, but simply, completely, and hopefully, absolutely void.
State Laws Creating Asset Protection Trusts
Because other countries used to have better laws to protect self-settled asset protection trusts, for a long time estate and asset protection planners located their clients’ self-settled trusts in foreign countries and they were called foreign asset protection trusts or FAPTs. In 1997, when Alaska became the first state to allow asset protection trusts to be created there, such trusts then became known as Domestic Asset Protection Trusts or DAPTs.
Whether they are FAPTs or DAPTs, asset protection trusts work substantially like other trusts. A grantor transfers property (“makes a disposition of assets”) to a trustee to hold, manage, and distribute according to the grantor’s instructions contained in the written trust agreement. Just like most other trusts, the grantor can still be a beneficiary of an asset protection trust, in limited circumstances.
The main difference between asset protection trusts and most other trusts, however, are:
- Asset protection trusts are irrevocable, which means once you put the assets in them, it is very difficult to get them out again except in accordance with the provisions of the trust; and
- Grantors must appoint an independent trustee, who cannot be the grantor, who is truly independent of the grantor, and who has absolute discretion to make distributions to the beneficiaries described in the trust in accordance with conditions described in the trust.
Since 1997, seventeen American states (Alaska, Colorado, Delaware, Hawaii, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming) have enacted statutes allowing some type of domestic asset protection trusts. Many other states and some of the 17 full-APT states have “kind-of / sort-of” (“ko-so”) allowed some less robust types of self-settled asset protection trusts.
Some “ko-so” states (Arizona, Arkansas Delaware, Florida, Kentucky, Maryland, Michigan, New Hampshire, North Carolina, Oregon, South Carolina, Tennessee, Texas, Virginia, and Wyoming) have also allowed partial DAPT trusts, called Inter Vivos QTIP (Qualified Terminal Interest in Property) Trusts. These IVQTIP trust laws say the settlor’s assets contributed to such a trust are no longer considered the assets of the donor spouse. Therefore, they cannot be reached by the donor’s creditors after the death of the donee spouse, even if the donor spouse is a remainder beneficiary of that trust.
Other “ko-so” states (Arizona, Florida, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Oregon, New York, and Texas) protect an irrevocable settlor trust from a creditor claim against the settlor even though the settlor can be reimbursed by the trust’s independent trustee for income taxes resulting from the trust’s assets. And still other “ko-so” states (Arizona, New Hampshire, and Tennessee) allow self-settled supplemental needs trusts to avoid claims of the settlor’s creditors.
Knowing what these “ko-so” states are doing allows their residents to better survive challenges with such “ko-so” state residents move assets to and create asset protection trusts in states that fully and free allow them. A “ko-so” state creditor of self-settled trust grantor may try to argue that state has a “strong public policy” against protection a settlor’s assets from legitimate creditors.
Now, that more than half of the United States allow some type of self-settled asset protection trust, it should be easier for residents of states that don’t allow full-on self-settled asset protection trusts to argue that doing so via interstate transfer of assets to states that allow such trusts is a right and proper thing to do.
Tennessee’s DAPT – The Tennessee Investment Services Trust
DAPTs in Tennessee exist as creatures of the “Tennessee Investment Services Act of 2007,” (TISA) which allows a person, regardless of where such a grantor or settlor may live, to create in Tennessee a self-settled, irrevocable, asset protection trust.
Before TISA was passed in Tennessee, a wealth owner could not protect his or her wealth from creditors and lawsuits while also retaining some control of his or her assets. Now, TISA allows an individual grantor to create that grantor’s own trust and maintain a certain level of control over the trust, while also protecting the grantor’s assets from creditors and lawsuits.
Like any other APT statute, the key favorable factor of TISA resides in its description of the grantor’s ability to retain a certain level of control over the trust. The grantor may retain the following rights, which include, but are not limited to, the rights to:
- veto distributions to any other permissible beneficiaries;
- appoint the assets by a written power of appointment to any person or entity other than the grantor, the grantor’s creditors, the grantor’s estate, or the creditors of the grantor’s estate;
- receive distributions of income or retained income at the discretion of the independent trustee;
- receive distributions of principal at the discretion of the independent trustee or distribution advisor in accordance with an ascertainable standard relating to health, education, maintenance, or support as defined by the IRS;
- remove the trustee and other trust advisors and appoint their successors under certain provisions
- live in a home owned by the trust using a qualified permanent residence trust;
- receive distributions of income or principal to pay income taxes incurred on trust assets
- direct the investment of the assets;
In order to meet the TISA’s requirements, the trust must be carefully drafted and administered. Specifically, the trust must:
- Expressly adopt Tennessee law to govern the validity, construction, and administration of the trust;
- Be irrevocable, meaning that the terms of the trust cannot be modified;
- Contain “spendthrift provisions” meaning the trust provides that the interest of the transferor or other beneficiary in the trust property or the income from the trust property may not be transferred, assigned, pledged or mortgaged, whether voluntarily or involuntarily, before the qualified trustee actually distributes or qualified trustees actually distribute the property or income from the property to the beneficiary;
- Receive from the grantor a signed qualified affidavit that states:
- The transferor has full right, title, and authority to transfer the assets to the trust;
- The transfer of the assets to the trust will not render the transferor insolvent;
- The transferor does not intend to defraud a creditor by transferring the assets to the trust;
- The transferor does not have any pending or threatened court actions against the transferor, except for those court actions identified by the transferor on an attachment to the affidavit;
- The transferor is not involved in any administrative proceedings, except for those administrative proceedings identified on an attachment to the affidavit;
- The transferor does not contemplate filing for relief under the federal bankruptcy code; and
- The assets being transferred to the trust were not derived from unlawful activities;
- Appoint a trustee of the trust who
- is either an individual Tennessee resident or a financial corporate fiduciary authorized to conduct business in Tennessee;
- maintains or arranges for custody at least some or all of the trust property in Tennessee;
- maintains records for the investment services trust on an exclusive or nonexclusive basis,
- prepares or arranges for the preparation of required income tax returns for the investment services trust, or
- otherwise materially participates in the administration of the investment services trust; and
- is not the transferor (grantor).
The TISA puts up several restrictions against creditors trying to bust a TISA trust.
- First, no creditor can successfully bring an action seeking to obtain property in a Tennessee investment services trust, unless such a creditor brings the action pursuant to the Tennessee Uniform Fraudulent Transfer Act, which has its own strict requirements.
- Second, a creditor must bring such an action within the statute of limitations contained in the TISA, which varies depending on whether or not the creditor became a creditor before or after the assets being attacked were transferred into the trust.
- If the creditor became a creditor before the assets being sought were transferred in to the Tennessee investment services trust, the creditor must file a lawsuit to make such a claim within the later of two (2) years after the assets were placed in the trust or six (6) months after the creditor discovers or reasonably should have discovered the transfer of the assets to the trust.
- If the creditor became a creditor after the assets being sought were transferred in to the Tennessee investment services trust, the creditor must file a lawsuit to make such a claim within the later of two (2) years after the assets were placed in the trust.
- Third, the TISA states a person is deemed to have discovered the existence of the transfer of the assets into an investment services trust at the time any public record is made of any such transfer, including but not limited to, the conveyance of real property that is recorded in the office of the county register of deeds of the county in which the property is located or the filing of a financing statement, or the equivalent recording or filing of either with the appropriate person or official under the laws of a jurisdiction other than this state.
- Fourth, the TISA states a creditor seeking to attack property transferred into a TISA trust must prove by clear and convincing evidence that the settlor’s transfer of such property was made with the intent to defraud that specific creditor.
Like most asset protection trust state laws, the TISA does NOT protect an asset protection trust’s assets against certain creditors, claims, or judgments, including those for past due child support, past due alimony or support of a spouse or former spouse or agreements setting forth division of marital property.
In summary, the Tennessee Investment Services Act of 2007 provides an asset protection opportunity for individuals who are concerned about the loss of their assets due to unforeseen creditors. The trust presents a unique solution to those who wish to protect their assets during their lifetime while still retaining the ability to manage those assets and benefit from them.