Appendices Sample domestic asset protection trust clauses Sample irrevocable trust clauses Sample solvency letter State liability systems rankings Sta
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1 PLANNING WITH DOMESTIC AND FOREIGN ASSET PR0TECTION TRUSTS Robert G. Alexander, JD, LL.M., EPLS, AEP Copyright 2009 Our Two Study Goals To Understand the Dynamics of Assets Protection Planning To Examine Specific Planning Issues and Techniques Using Domestic and Foreign Situs Trusts 2 Index of the Subject Matter Overview of Asset Protection Planning Fraudulent Conveyances, Bankruptcy and Other Issues Overview of Domestic Trusts Domestic Asset Protection Trusts Foreign Asset Protection Trusts Ethical and Practical Considerations 3 1
2 Appendices Sample domestic asset protection trust clauses Sample irrevocable trust clauses Sample solvency letter State liability systems rankings State third party spendthrift statutes State self-settled settled spendthrift statutes 4 Appendices - Cont. Uniform Trust Code statutes State income tax provisions for non-grantor trusts Rev. Rul A comparison of six (6) DAPT statutes Synopsis of State asset protection and exemption planning 5 Appendices - Cont. Delaware Act Alaska Act Nevada Act South Dakota Act Synopsis of Cook Island Law Synopsis of Cayman Island Law Planning flow charts 6 2
3 PART ONE OVERVIEW OF ASSET PROTECTION PLANNING Increasingly sophisticated financial, business, tax and litigation environment Asset protection planning historically is a part of comprehensive, integrated wealth planning 7 Overview - Cont. Asset protection two general topics Insuring against loss Planning to place assets our of the reach of creditors Exemption planning Business entities Trusts Domestic Foreign 8 Overview - Cont. Current litigation environment creates greater exposure to loss Expanding and new theories of liability Higher damage awards deep pockets Government causes of action New statutes and regulations High cost of litigation Loss of business, reputation, credit, etc. 9 3
4 Traditional Asset Protection Strategies Transfers to a spouse Joint ownership Entities by the entireties Business entities Traditional estate planning entities ILIT GRAT IDIT Dynasty trusts 10 Traditional Asset Protection Strategies - Cont. - Exemption and pre-bankruptcy planning Domestic asset protection trusts DAPTs Foreign asset protection trusts - FAPTs 11 Traditional Forms of Asset Protection Have Become Inadequate Insurance Exclusions Policy limits Solvency of the insurer Premium costs Multiple policy issues Multiple party issues 12 4
5 Traditional Forms of Asset Protection - Cont. - Business Entities Piercing the entity veil Owner liability Manager liability Fines and penalties 13 PART TWO Fraudulent Conveyance Issues Bankruptcy Issues Other Statutory and Legal Issues 14 Fraudulent Conveyance Issues Statues to set aside fraudulent transfers Three categories of creditors Present creditors Subsequent creditors Potential future creditors Uniform Fraudulent Transfer Act UFTA Utah has adopted the UFTA. Utah Code Ann et seq. 15 5
6 Four Possible Classes of UFTA Violations Present actual fraud claim or debt occurs before the transfer Just pay the debt Present constructive fraud present, foreseeable link between the transfer and the loss Just plan ahead Stay solvent Future constructive fraud no present notice or knowledge Same planning Future actual fraud very hard to prove 16 UFTA QUICK ANALYSIS Actual Fraud Intent only Solvency is irrelevant SOL 4 years/1 year Constructive Fraud Transfer before the claim arises Insolvency 4 year SOL 17 UFTA QUICK ANALYSIS - Cont. - Constructive Fraud Claim arises after the transfer Lack of adequate consideration, and Insolvency Foreseeable claim Causal connection 4 year SOL 18 6
7 Remedy for Fraudulent Transfers Transfer is set aside Assets are recovered by the creditor Identity of the original transferee is essentially irrelevant Statute of Limitations UFTA Four years after the transfer was made One year after the transfer could reasonably have been discovered by the claimant. 19 Choice of Applicable Law Courts should apply the Fraudulent Transfer law of the statute governing the Asset Protection Trust The Real Issue: is the creation of the trust a fraudulent transfer? If so, it can be set aside Even if the trust otherwise is valid in the state of creation. Is the transfer itself a fraudulent conveyance? 20 Bankruptcy Issues Old Law Set aside a transfer if made within one (1) year of filing a petition The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 BAPCPA Set aside a transfer if made within two (2) years of filing a petition Set aside a transfer to a self-settled settled trust if made within ten (10) years 21 7
8 Other Statutory and Legal Issues Many categories of statutory violations and remedies RICO IRS Money Laundering Patriot Act Many categories of civil remedies Constructive trust, etc. 22 PART THREE AN OVERVIEW OF DOMESTIC TRUSTS DEFINITIONS APT asset protection trust DAPT domestic asset protection trust FAPT foreign asset protection trust Grantor tax term Settlor - person who establishes a trust UTC Uniform Trust Code 23 Drafting Trusts For Asset Protection Spendthrift Clauses - generally recognized Except for self-settled settled trusts Restatement Second of Trusts RST Asset protection for beneficiaries of domestic trusts depends on three factors: Settlor s retention of control over the trust Powers of appointment available to the beneficiaries Withdrawal/invasion rights available to beneficiaries 24 8
9 Summary of Trust Characteristics Types of common estate planning trusts All have asset protection features to some extent Generally, creditors only can reach trust assets and income to the maximum extent that the trustee can distribute the assets/income to the Settlor or beneficiary Review the distribution requirements Review applicable state law Review fraudulent transfer issues 25 The Key Factor Distribution Standards Income Principal State law considerations What are the document s distribution standards The Uniform Trust Code Restatement of Trusts 3rd 26 The Three Basic Types of Distribution Standards Discretionary Absolution discretion Discretionary with standards Support trust What are the standards Mandatory What are the standards 27 9
10 Drafting For Maximum Protection For Beneficiaries Independent trustees Rights to receive income and principal are determined in the trustee s sole discretion Trustee is given power to make payments on behalf of beneficiaries rather than directly to them Trustee is authorized to acquire assets for the use of the beneficiaries 28 Drafting For Maximum Protection - Cont. - Trustee is given power to hold back distributions if they are not in a beneficiary s best interest Beneficiaries are only given limited powers of appointment Trustee is given power to sprinkle distributions among multiple beneficiaries Trust includes a spendthrift provision 29 Drafting For Maximum Protection - Cont. - The trust is sitused in a state that recognizes and enforces spendthrift provisions Assets that may create liability exposure are isolated in: Business entities Separate trusts 30 10
11 Generally Recognized Exceptions to Spendthrift Protection Internal Revenue Service Existing tort creditors Child support Spouse support Reciprocal trusts Self-settled trusts Review specific state statutes carefully 31 Summary of Trust Characteristics Types of common estate planning trusts All have asset protection features to some extent Generally, creditors can only reach the trust assets and income to the maximum extent that the trustee can distribute the assets/income to the Settlor or beneficiary Review the distribution requirements Review applicable state law Review fraudulent transfer issues 32 Asset Protection Trusts - APTs - States that have no Rule Against Perpetuities Now over twenty (20) states and counting States with no state income tax such as Alaska Arizona Delaware Florida Nevada South Dakota Wyoming 33 11
12 Asset Protection Trusts Cont. Foreign jurisdictions offshore trusts States that have expanded asset protection features of domestic trusts Delaware Alaska Nevada South Dakota Tennessee Utah Others 34 Advanced Planning Considerations Retain control Transfer assets to a FLP/FLLC Transfer entity interests to the APT Creditors remedies limited to a charging order Specific state statutes Create the entity in a state that maximizes the entity asset protection features Also helps establish contact in that state 35 PART FOUR DOMESTIC ASSET PROTECTION TRUSTS DAPTs Most states do not extent protection of spendthrift trust laws to self-settled settled trusts Trusts where Settlor retains too much control or benefits Uniform Trust Code Third Restatement of Trusts 36 12
13 Ten States Have Extended Spendthrift Protection to Self-Settled Settled Trusts Alaska Delaware Missouri Nevada Oklahoma 37 Self-Settled Settled Spendthrift Trusts -Continued- Rhode Island South Dakota Utah Tennessee Wyoming The extent of asset protection varies dramatically from state to state 38 Key Tax Considerations Is the trust a Grantor trust IRC Secs Trust income taxed to Settlor Are transfers to the trust completed gifts for gift tax purposes Does the trust allow the trustee to reimburse the Settlor for income taxes attributable to the trust 39 13
14 Key Tax Considerations - Cont. - DAPTs can be used to avoid state and local income taxes Structure the trust so that transfers to the trust are completed gifts for gift tax purposes and excluded from the Settlor s gross estate Even though Settlor retains powers Even though Settlor retains discretionary rights to receive distributions 40 Key Tax Considerations - Cont. - Gift Taxes incomplete gift Settlor retains a LPOA over the DAPT Settlor retains the power to veto distributions Estate Taxes IRC Sec and 2038 Too much Settlor control Too much Settlor retained rights Can Settlor s creditors enforce rights because of Settlor s retained control or rights? 41 Protecting Against Challenges to DAPTs Constitutional issues Full faith and credit clause Due process clause Supremacy clause When are Constitutional issues important Actions and judgments in a non-dapt state and enforcement in a DAPT state Judgment against a DAPT or DAPT trustee in a non- DAPT court 42 14
15 Domestic vs. Offshore APTs Important legal distinctions More substantial legal barriers to creditors with FAPTs Selected foreign jurisdictions will not honor judgments rendered in the U.S. Creditors may have to re-litigate in the foreign jurisdiction Shorter statute of limitations in foreign jurisdictions Much stricter standards of proof for fraudulent transfers Beyond a reasonable doubt Duress clauses to protect trustees 43 Domestic vs. Foreign APTs - Cont. - Difficult for U.S. creditors to engage local counsel U.S. courts have no jurisdiction over the trust or the trustee But U.S. Constitutional issues may intervene Risks of U.S. fines and/or imprisonment Planner s risk professional discipline 44 Factors in Favor of DAPTs U.S. grantor trust tax rules Discretionary flee clauses to move trusts offshore Economic stability Political stability U.S. courts are not offended by what is perceived to be illegitimate planning Costs of creations and administration Convenience 45 15
16 THE BENEFICIARY DEFECTIVE INHERITOR S TRUST Finessing the Pipe Dream The Ultimate Trust A Beneficiary Defective Inheritor s Trust Combining: A third-party settled trust with Grantor trust income tax status for the beneficiary Finessing the pipe dream 47 So What Is A BDIT? A dynasty trust set up for my descendants which avoids their Transfer taxes Creditors, including divorcing spouses A beneficiary controlled trust Allows gifts and sales to a trust that is income tax defective as to the beneficiary Crummey power of withdrawal 678 Wealth transfer leveraging with discounted entities 48 16
17 So What is a BDIT - Cont. Combines the planning opportunities of: Chapter 13 GSTT rules IRC 678 beneficiary income tax status Rev. Rul non-recognition of sales to IDITs Rev. Rul no family attribution rules for purposes of discounting Rev. Rul no additional gift on payment of income tax 49 BDIT Design Established and initially funded by a third party Fully discretionary distribution standards Controlled trusteeship Family trustee Independent trustee The use concept Broad SPA a re-write power Perpetual Beneficiary has the functional equivalence of outright ownership of the trust assets 50 BDIT Tax Results Estate freeze Installment notes in the estate Post-transfer transfer appreciation shifted Estate squeeze Discounted assets removed from the transfer tax system Income tax burn the beneficiary pays the tax on the income generate by the trust Section 678 Crummey power of withdrawal 51 17
18 BDIT Non-tax Results The client/beneficiary is in control of the BDIT Assets are creditor protected for the client/beneficiary and his/her family Assets are available after the tax burn Client/beneficiary has a re-write power with a SPA Protects against potential family conflicts Protects against inadvertent gifts to the trust 52 BDIT Non-tax Results - Cont. Opportunity shifting Business and investment opportunities Giving free advice or managing trust assets Quintessential life insurance trust Life insurance on a beneficiary who is also a trustee Decision must be made by an independent trustee Beneficiary cannot have a SPA over life insurance 53 Seeding the Trusts Gifts to Trust $5,000 $5,000 $5,000 Trust A Trust B Trust C FBO Client and Katie FBO Client and Bob FBO Client and Sue Client Power of Withdrawal $15,
19 Who is the Grantor? Owner for Income Tax Purposes - IRC 678(a) Transfer Tax Creditor rights Caveat: Client has a Power of Withdrawal over all gifts to BDIT Caveat: Client never makes a gratuitous transfer to BDIT Tax-Free Sale to BDIT BDITs Assets Installment Notes Trust A Trust B Trust C Wealthy client sells discountable income producing assets for an Installment Note Contact Information Robert G. Alexander, Esq Alexander & Klemmer, S.C. 933 N. Mayfair Road, Suite 301 Milwaukee, Wisconsin Tel: bob@alexander-klemmer.com 57 19
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