PLANNING TECHNIQUES FOR LARGE ESTATES PLANNING WITH DOMESTIC ASSET PROTECTION TRUSTS Richard W. Nenno, Esquire Managing Director and Trust Counsel Wilmington Trust Company Rodney Square North 1100 North Market Street Wilmington, Delaware 19890-0955 Tel: (302) 651-8113 Fax: (302) 651-1981 rnenno@wilmingtontrust.com April 30, 2004 2004 Wilmington Trust Corporation. Affiliates in California, Delaware, Florida, Georgia, Maryland, Nevada, New York, and Pennsylvania. This paper is not designed or intended to provide legal, investment, or other professional advice because such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional adviser should be sought. TABLE OF CONTENTS
I. INTRODUCTION... 1 II. PRELIMINARY MATTERS... 4 A. Reasons Against Recognizing Self-Settled Trusts... 4 1. One Should Pay One s Debts... 4 2. Preserve Liability System... 4 3. Self-Settled Trusts Always Are Fraudulent... 4 B. Reasons for Recognizing Self-Settled Trusts... 5 1. Authorities Do Not Support Professor Scott... 5 2. U.S. Is Unique... 5 3. Creditors Are Given More Rights Than Trustors... 6 4. Interests of Other Beneficiaries Are Ignored... 6 5. Continuing Control by Trustor Is Relevant... 6 6. Beneficiaries Are Punished for Failure of Benefactors to Plan... 6 7. Clients Who Accumulate Wealth Are Disfavored... 7 8. Other Self-Settled Vehicles Are Recognized... 7 9. Clients Want Self-Settled Trusts... 7 10. Preserve U.S. Business... 8 C. Fraudulent Transfer Rules... 8 1. Introduction... 8 2. Claims by Future Creditors... 10 3. Impact of Statutes of Limitations... 11 4. Recent Cases... 12 5. Applicable Law... 13 D. Ethical Principles... 14 E. Potential Liability for Attorneys... 16 III. DELAWARE QUALIFIED DISPOSITIONS IN TRUST ACT... 17 A. Introduction... 17 B. How to Take Advantage of the Delaware Act... 18 1. Qualified Trustee... 18 2. Trust Instrument... 19 C. Exceptions to the Delaware Act... 20 1. Introduction... 20 2. Creditors Who May Defeat Qualified Dispositions... 20 D. Consequences if Qualified Disposition Is Defeated... 21 E. Qualified Dispositions by Trustees... 22 F. Infrastructure... 22 IV. ALASKA ASSET PROTECTION TRUST ACT... 23 A. Introduction... 23 B. How to Take Advantage of the Alaska Act... 24 C. Exceptions to the Alaska Act... 24 D. Consequences if Transfer Is Defeated... 26 E. Moving Trusts to Alaska... 26
F. Infrastructure... 26 V. RHODE ISLAND QUALIFIED DISPOSITIONS IN TRUST ACT... 27 A. Introduction... 27 B. How to Take Advantage of the Rhode Island Act... 27 1. Trustee... 27 2. Trust Instrument... 27 C. Exceptions to the Rhode Island Act... 28 1. Introduction... 28 2. Creditors Who May Defeat Qualified Dispositions... 28 D. Consequences if Qualified Disposition Is Defeated... 29 E. Qualified Dispositions by Trustees... 30 F. Infrastructure... 30 VI. NEVADA ASSET PROTECTION TRUST ACT... 30 A. Introduction... 30 B. How to Take Advantage of the Nevada Act... 30 C. Exceptions to the Nevada Act... 30 D. Consequences if Transfer Is Defeated... 31 E. Moving Trusts to Nevada... 31 F. Infrastructure... 31 VII. UTAH ASSET PROTECTION TRUST ACT... 32 A. Introduction... 32 B. How to Take Advantage of the Utah Act... 32 C. Exceptions to the Utah Act... 32 D. Consequences if Transfer Is Defeated... 34 E. Moving Trusts to Utah... 34 F. Infrastructure... 35 VIII. OTHER STATUTES... 35 A. Missouri... 35 B. Colorado... 35 IX. FEDERAL INCOME TAX CONSEQUENCES... 36 X. FEDERAL TRANSFER TAX CONSEQUENCES... 37 A. Introduction... 37 B. Gift Tax... 37 C. Estate Tax... 37 1. I.R.C. 2038(a)(1)... 38 2. I.R.C. 2036(a)(1)... 38 3. I.R.C. 2036(a)(2)... D. Rights of Creditors... E. Domestic Asset Protection Trust Developments... 40
F. GST Tax... 41 XI. ASSET PROTECTION EFFECTIVENESS... 41 A. Introduction... 41 B. The Full Faith and Credit Clause... 42 1. Introduction... 42 2. Jurisdiction... 42 3. Choice of Law Principles... 46 4. Respect Due Statutes... 52 5. Respect Due Judgments... 56 6. Assessment... 58 C. Bankruptcy... 59 1. Introduction... 59 2. The Trust Exclusion... 60 3. Applicable Nonbankruptcy Law... 61 4. Implications for Offshore Trusts... 66 D. The Contract Clause... 66 E. The Federal Tax Lien... 67 1. The Lien... 67 2. Application to Trusts... 68 XII. POSSIBLE USES... 70 A. Employ Tax Benefits... 70 1. General... 70 2. Make Taxable Gifts to Reduce Federal Transfer Tax... 70 3. Make Taxable Gifts to Avoid State Death Tax... 70 A. Obtain Asset Protection... 70 1. General... 70 2. Protect Gifts and Inheritances... 70 3. Protect Young Adults Assets... 71 4. Protect Officers and Directors... 71 5. Protect Assets From Future Ventures... 71 6. Protect Vulnerable Persons... 71 7. Provide Premarital Planning... 72 8. Protect Personal Injury Awards... 72 B. Protect CRTs and Other Estate Planning Vehicles... 73 C. Avoid State Income or Intangible Tax... 73 D. Provide Preimmigration Planning... 74 E. Provide Protection for Trusts Moved From Offshore or Other Domestic Jurisdictions... 74 F. Enable Officers and Directors to Comply with Securities Laws... 74 XIII. A COMPARISON OF THE ALASKA AND DELAWARE ACTS... 74 A. Introduction... 74 B. Advantages of the Alaska Act... 74
1. No Recognition of Constructive Fraud... 74 2. Narrower Exception for Family Claims... 76 3. No Exception for Existing Tort Claims... 77 4. Limits Rights of Existing Creditors... 77 C. Advantages of the Delaware Act... 77 1. Much Longer Tradition of Trust Leadership... 77 2. Court System Superior... 77 3. Bars Judgments From Other States... 78 4. Harder to Prove Fraudulent Transfer... 78 5. Better Full-Faith-and-Credit Defense... 79 6. Counsel Fee Awards Less Creditor-Friendly... 80 7. More Distribution Options... 80 8. Surviving Spouse Cannot Reach Trust... 80 XIV. A COMPARISON OF THE NEVADA AND DELAWARE ACTS... 80 A. Introduction... 80 B. Advantages of the Nevada Act... 80 1. Might Have Shorter Claim Periods... 80 2. No Exception for Family Claims... 80 3. No Exception for Existing Tort Claims... 81 C. Advantages of the Delaware Act... 81 1. Much Longer Tradition of Trust Leadership... 81 2. Court System Superior... 81 3. Might Have Shorter Claim Periods... 81 4. Might Have Shorter Claim Periods for Enforcement of Foreign Judgments... 82 5. Better Full-Faith-and-Credit Defense... 83 6. Perpetual Trusts Possible... 83 7. Provides Protection to Advisers and Attorneys... 83 8. Addresses Consequences of Successful Attack... 83 9. More Distribution Options... 83 XV. A COMPARISON OF OFFSHORE AND DOMESTIC TRUSTS... 83 A. Introduction... 83 B. Advantages of Offshore Trusts... 84 1. Offer Protective Features... 84 2. Might Be Superior... 84 3. Full-Faith-and-Credit Not Due U.S. Judgments... 85 C. Advantages of Domestic Trusts... 85 1. Constitutional Issues Might Favor... 85 2. Less Financial Risk for Trustor... 85 3. Tax Treatment More Favorable... 85 4. Less Expensive... 86 5. Less Risk of Jail... 86
XVI. ESTABLISHING A DOMESTIC ASSET PROTECTION TRUST... 93 A. Introduction... 93 B. Due Diligence... 93 C. Involvement of Local Counsel... 94 D. Asset Selection... 94 E. Trustee Selection... 94 F. Drafting the Trust... 95 G. Funding and Administering the Trust... 95 H. Cost of Establishing the Trust... 96 XVII. PROPER DESIGN AND ADMINISTRATION OF A DOMESTIC ASSET PROTECTION TRUST... 96 A. Introduction... 96 B. The Finch Case... 96 C. Comments... 97 D. Wilmington Trust s Experience... 97 E. Recommendations... 97 1. Avoid Misunderstanding at Beginning... 98 2. Fund With Nest Egg... 98 3. Choose Proper Law... 98 4. Choose Proper Trustee... 98 5. Name Other Beneficiaries... 98 6. Create Domestic Trust... 99 Appendix A The Delaware Qualified Dispositions in Trust Act... 100 Appendix B The Alaska Asset Protection Trust Act... 108 Appendix C The Rhode Island Qualified Dispositions in Trust Act... 115 Appendix D The Spendthrift Trust Act of Nevada... 120 Appendix E The Utah Asset Protection Trust Act... 126 Appendix F A Comparison of the Domestic Asset Protection Trust Acts... 134 Appendix G Delaware Asset Protection Trust Case Studies... 141 Appendix H State Liability Systems Ranking... 144 Appendix I Solvency Letter... 146 Appendix J Delaware Asset Protection Trust Form... 150 PLANNING WITH DOMESTIC ASSET PROTECTION TRUSTS By Richard W. Nenno Wilmington Trust Company Wilmington, DE