PORTFOLIO

Domestic Asset Protection Trusts (Portfolio 868)

Tax Management Portfolio, Domestic Asset Protection Trusts*, No. 868, discusses various aspects of domestic asset protection trusts (APTs), including the reasons for and against recognizing such trusts, the benefits of such trusts, and the potential application of the fraudulent transfer rules.

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DESCRIPTION

Tax Management Portfolio, Domestic Asset Protection Trusts*, No. 868, discusses various aspects of domestic asset protection trusts (APTs), including the reasons for and against recognizing such trusts, the benefits of such trusts, and the potential application of the fraudulent transfer rules. An APT is an irrevocable trust in which the settlor retains some benefits that cannot be reached by his or her creditors. The portfolio gives particular attention to defending APTs against creditor attacks, noting, where appropriate, matters addressed by the Uniform Trust Code or the Restatement (Second) Conflict of Laws. The portfolio also discusses the ethical and liability concerns of attorneys involved in domestic APT planning.
In addition, the portfolio covers the income and transfer tax ramifications of domestic APTs. The ability of a creditor to reach trust assets often impacts whether a transfer to a domestic APT is a completed gift and whether a domestic APT will be included in the settlor's estate.
After reviewing various state statutes governing domestic APTs, the portfolio compares Delaware APTs to Alaska and Nevada APTs. The portfolio then compares domestic APTs to foreign APTs.
The portfolio concludes by describing the designing, drafting, and funding of domestic APTs and various issues related to trust distributions. To avoid distribution problems, the portfolio recommends, among other things, that the attorney and trustee make it clear to the APT's settlor at the beginning that the settlor will receive distributions only in accordance with the trust terms.
This portfolio is not designed or intended to provide financial, tax, legal, accounting, or other professional advice because such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional adviser should be sought. This portfolio is for informational purposes only; it is not intended as a recommendation, offer, or solicitation with respect to the purchase or sale of any security.
This portfolio may be cited as Nenno & Sullivan, 868 T.M., Domestic Asset Protection Trusts.


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AUTHORS

RICHARD W. NENNO, ESQ.
Richard W. Nenno, Esq., Princeton University (A.B., cum laude, Woodrow Wilson School of Public and International Affairs), Harvard Law School (J.D.); Managing Director and Trust Counsel in Wealth Advisory Services, Wilmington Trust Company, Wilmington, Delaware (1982–present); former associate in Estates Department, Ballard, Spahr, Andrews & Ingersoll, Philadelphia, Pennsylvania; admitted to practice of law, Delaware and Pennsylvania; Distinguished Accredited Estate Planner; member, Delaware State Bar Association (Past Chair: Estates and Trusts Section), Estate Planning Council of Delaware, Inc. (Past President), American Bar Association, Section of Real Property, Trust & Estate Law (Chair: Non-Tax Estate Planning Considerations Group) and Section of Taxation, and Philadelphia Bar Association; over three decades of estate planning experience; recognized national speaker and published authority on estate planning issues.

JOHN E. SULLIVAN, III, ESQ.
John E. Sullivan, III, Esq., Boston College (1980), University of Texas School of Law (1984); founding member, law firm of Sullivan & Sullivan, Ltd., Beachwood (Cleveland), Ohio; admitted to practice, Ohio, Massachusetts, Illinois, and numerous federal courts, including U.S. Supreme Court and Tax Court; named as one of “Top 100 Attorneys” in United States by Robb Report's Worth Magazine (Dec. 2005); quoted or cited in Bloomberg Wealth Manager, Wall Street Journal, and Forbes.com; practice includes asset protection, asset recovery, and estate and business planning; frequent lecturer on debtor-creditor and asset protection matters; author of numerous articles on these matters, including one that was favorably cited and quoted by federal bankruptcy court in In re Bergman, 293 Bankr. 580 (Bankr. W.D. N.Y. 2003); editor and contributing author, International Trust Laws and Analysis, most recently published by Kluwer Law Publishing in The Hague (1998–2007); former contributing editor, Tax Havens of the World, then-published by Lexis/Nexis; guest lecturer, International Business Organizations Course at Case Western Reserve University Law School, Cleveland, Ohio; peer reviewer, Oxford University Press, in connection with proposed academic text on anti-money laundering issues; participant, American Enterprise Institute's 2007 Roundtable on Regulatory Competition and Offshore Financial Centers; member, International Tax Planning Association, Offshore Institute, Cleveland Estate Planning Council, Ohio State Bar Association (OSBA), Creditor Access to IRA Committee (part of OSBA's Estate Planning, Trust, and Probate Law Section), OSBA's Banking, Commercial & Bankruptcy Law Committee and Bankruptcy Law Sub-Committee, and Greater Cleveland International Lawyers Group.

TABLE OF CONTENTS

Portfolio 868-1st: Domestic Asset Protection Trusts

Portfolio Description

Authors

Technical Advisors

Description

Detailed Analysis

I. Introduction

A. Traditional Rule

B. Effect of Traditional Rule

C. Domestic APT Option

D. Reasons Against Recognizing Domestic APTs

1. One Should Pay One's Debts

2. Preserve Liability System

3. Domestic APTs “Always” Are Fraudulent

E. Reasons for Recognizing Domestic APTs

1. Authorities Do Not Support the Scott Treatise

2. United States Is Unique (Although Less so with Each Domestic APT Law)

3. Creditors Are Given More Rights than Settlors

4. Interests of Other Beneficiaries Are Ignored

5. Settlor's Continuing Control (or Lack Thereof) Is Relevant, as Is Governing Statute

6. Domestic APTs Create Economic Incentives and Encourage Entrepreneurship

7. Other Self-Settled Vehicles Are Recognized (Even Unlimited Ones)

8. Congress Impliedly but Clearly Blesses Domestic APTs

9. Clients Want APTs

10. Domestic APTs Preserve U.S. Business

11. Domestic APTs Preserve U.S. Oversight (the “Safe-Situs” Doctrine)

12. Domestic APTs Can Even Benefit Tort Victims (Dissolute or Otherwise)

13. Outright Gifts Are Hurtful to Creditors at Least as Much but Outright Gifts Are Allowed

F. Scope

II. Benefits of Domestic APTs

A. Introduction

B. Employ Tax Benefits

1. General

2. Make Taxable Gifts to Reduce Federal Transfer Tax

3. Make Taxable Gifts to Avoid State Death Tax

4. Assure Favorable Tax Treatment for Grantor Trusts

a. No Taxable Gift and Estate Exclusion: Discretionary Tax Payments for Grantor Trusts

b. Possible Estate Inclusion: Relegation of Creditors Doctrine and Exception Creditors

C. Obtain Asset Protection

1. General

2. Protect Gifts and Inheritances

3. Protect Young Adults' Assets

4. Protect Officers and Directors

5. Protect Assets from Future Ventures

6. Protect Vulnerable Persons

7. Provide Premarital Planning

8. Protect Personal Injury Awards

D. Protect CRTs and Other Estate Planning Vehicles

E. Avoid State Income Tax

F. Provide Options for NRAs

G. Provide Protection for Trusts Moved from Offshore or Other Domestic Jurisdictions

III. Fraudulent Transfer Rules

A. Introduction

B. Claims by Future Creditors — Cases

C. Claims by Future Creditors — Commentary

D. Impact of Statutes of Limitations

E. Applicable Law

IV. Defenses to Creditor Attacks on Domestic APTs

A. Introduction

B. Obstacle 1: Judgments Against Settlors Are Not Enough

C. Obstacle 2: Non-DAPT Court Might Lack Jurisdiction

1. Introduction

2. In Rem Jurisdiction

3. Personal Jurisdiction — General Principles

4. Personal Jurisdiction — Trustee Concerns

5. Personal Jurisdiction — Federal Courts

6. Implications

D. Obstacle 3: Non-DAPT Court Should/Must Decline Jurisdiction

1. Restatement Approach — Movables

2. Restatement Approach — Land

3. UTC Approach

4. Federal District Court

E. Obstacle 4: Venue Might Be Bad

F. Obstacle 5: Non-DAPT Court Should Apply Domestic APT State Law

1. Restatement Approach — Introduction

a. Background

b. Type of Asset

c. Type of Trust

d. Type of Question — Definitions

(1) Validity

(2) Administration

(3) Construction

(4) Restraints on Alienation of Beneficiaries' Interests

(5) Implications

e. Type of Question — Effectiveness of Designation

(1) Validity

(a) Trust of Movables Created Inter Vivos

(b) Substantial Relation to the Trust

(c) Strong Public Policies

(d) Most Significant Relationship

(e) Trust of Land Created Inter Vivos

(2) Restraints on Alienation of Beneficiaries' Interests

(a) Trust of Movables Created Inter Vivos

(b) Trust of Land Created Inter Vivos

2. Restatement Approach — Application

a. Restatement Approach — Movables

(1) Introduction

(2) Validity

(a) Introduction

(b) Questions of Validity

(c) Substantial Relation to the Trust

(d) Strong Public Policy

(e) Most Significant Relationship to the Matter at Issue

(3) Restatement (Second) of Conflict of Laws § 273 — Restraints on Alienation of Beneficiaries' Interests

b. Restatement Approach — Land

3. UTC Approach — Introduction

4. UTC Approach — Application

a. Introduction

b. Specifics

(1) Place of Trust's Creation

(2) Location of Trust Property

(3) Trustee's Domicile

(4) Settlor's Domicile

(5) Beneficiaries' Domiciles

(6) Policies of Forum State — Domestic APT State Not the Forum

(7) Policies of Forum State — Domestic APT State as the Forum

(8) Policies of Non-Forum State

(9) Justified Expectations, Certainty, Predictability, and Uniformity of Results

5. Rules for Foreign APTs

6. Why the Rules Are Different

7. Judicial Hostility to Domestic APTs Will Only Promote Foreign APTs

8. Rules in Federal Court

G. Obstacle 6: Domestic APT Court Might Not Have to Give Full Faith and Credit to Judgment of Non-DAPT Court

1. Respect Due Statutes

2. Implications

3. Statutory Safeguard: Statutory Auto-Removal Rules and Related Tactics

4. Respect Due Judgments — Collateral Attack and Important Domestic APT Interests

5. The Role of Strong Public Policy

H. Obstacle 7: Domestic APT States May and Do Limit the Remedies Available for Judgments Given Full Faith and Credit

1. The Right to Limit Remedies

2. The Restrictive Domestic APT Remedy — Fraudulent Transfers and Related Issues

3. APTs Are Not Inherently Fraudulent

a. Introduction

b. Implications

(1) Post-Transfer Solvency (Present and Future Creditors)

(2) Disclosed Transfers (Future Creditors)

4. APTs and Sham Trusts, Alter Egos, and Related Issues

a. Introduction: Sham Trust and Alter Ego Concerns

b. Background: Trusts Are Relationships, Not Entities

c. Trusts Cannot Be Alter Egos Because Trusts Are Not Persons

d. Trustees Can Be Alter Egos, But That Is Often Hard to Prove

e. Sham Trust Theory: The Proper Creditor Alternative to Alter Ego

f. Sham Trust Theory: Limited Tax Holdings

g. Sham Trust Theory: Unrevealing State Law Holdings

h. In re Baum: A Federal Attempt to Divine State Law

i. The English and Common Law Approach to Sham Trusts: Introduction

j. The English Approach to Sham Trusts: Five Principles

k. The “Common Intent” Rule: No Sham Trust Unless Settlor and Trustee Both Intend One

l. Complexity or Unusualness Do Not a Sham Trust Make

m. Distributions or Other Friendly Relations Are Hardly Proof of an Alter Ego or a Sham Trust, Especially Because Trustees May Be Obligated to Distribute

n. Retained Powers and Interests Do Not a Sham Trust Make

o. Concluding Thoughts on Sham Trusts and Alter Egos

I. Obstacle 8: Domestic APTs Should Survive Bankruptcy

1. Introduction

2. The Limited Nature of Bankruptcy Concerns

a. Challenging an Involuntary Petition

b. Pre-Trial Motion Practice and Discovery

c. Certain Creditors Do Not Count

d. Certain Claims Do Not Count Pre-BAPCPA Rules

e. BAPCPA's Revised Rules — Damages Disputes Can Prevent Involuntaries

f. “Generally” Failing to Pay Debts when Due

g. Sanctions for Unsuccessful Involuntaries: Damages, Fees, Expenses

3. Bankruptcy Code § 541's Trust Exclusion

a. Introduction

b. Bankruptcy Code § 541(c)(2) and Applicable Nonbankruptcy Law: A Three-Pronged Test and Two Key Questions

c. Bankruptcy Code § 541(c)(2) and Applicable Nonbankruptcy Law: Does the Law of the Debtor's Domicile Apply?

d. Implications for Foreign APTs

4. BAPCPA and Bankruptcy Code § 548(e)’s 10-Year Look-Back Rule

5. Post-Petition Distributions

J. Status of Domestic APTs

V. Concerns for Attorneys

A. Ethical Principles

B. Potential Liability to Third Parties

C. Potential Liability to the Client

VI. Federal Tax Consequences of Domestic APTs

A. Income Tax

B. Transfer Taxes

C. Gift Tax

D. Estate Tax

1. Section 2038(a)(1)

2. Section 2036(a)(1)

3. Section 2036(a)(2)

E. Rights of Creditors

F. Domestic APT Developments

G. GST Tax

VII. Delaware Qualified Dispositions in Trust Act

A. Introduction

B. How to Create a Delaware APT

C. Who May Defeat a Delaware APT

1. Introduction

2. Creditors Who May Defeat a Delaware APT

a. Pre-Transfer Claims

b. Post-Transfer Claims

c. Family Claims

d. Tort Claims

D. Consequences if a Delaware APT Is Defeated

E. Moving Trusts to Delaware

F. Infrastructure

G. Additional Protection for Trust Distributions

VIII. Alaska APT Act

A. Introduction

B. How to Create an Alaska APT

C. Who May Defeat an Alaska APT

D. Consequences if an Alaska APT Is Defeated

E. Moving Trusts to Alaska

F. Infrastructure

IX. Nevada APT Act

A. Introduction

B. How to Create a Nevada APT

C. Who May Defeat a Nevada APT

D. Consequences if a Nevada APT Is Defeated

E. Moving Trusts to Nevada

F. Infrastructure

X. Other Statutes

A. Rhode Island

B. Utah

C. South Dakota

1. Limitations

2. “Defraud” Versus “Hinder and Delay”

3. Prevailing Party Attorney Fees

D. Wyoming

E. Tennessee

F. New Hampshire

G. Oklahoma

1. Introduction

2. How to Create an Oklahoma APT

3. Who May Defeat an Oklahoma APT

4. Other Matters

H. Missouri

I. Colorado

J. Hawaii

XI. A Comparison of Alaska and Delaware APTs

A. Introduction

B. Advantages of Alaska APTs

1. No Recognition of Constructive Fraud

2. Narrower Exception for Family Claims

3. No Exception for Existing Tort Claims

4. Limits Rights of Existing Creditors

5. Counsel Fee Awards Less Creditor Friendly

C. Advantages of Delaware APTs

1. Much Longer Tradition of Trust Leadership

2. Infrastructure Superior

3. Harder to Prove Fraudulent Transfer

4. Better Full Faith and Credit Defense

5. Additional Distribution Options

6. Surviving Spouse May Not Reach Trust

7. Additional Protection for Trust Distributions

8. Less Risk of Offending Public Policy

XII. A Comparison of Nevada and Delaware APTs

A. Introduction

B. Advantages of Nevada APTs

1. Shorter Limitations Periods

2. No Exception for Family Claims

3. No Blanket Exception for Existing Tort Claims

C. Advantages of Delaware APTs

1. Much Longer Tradition of Trust Leadership

2. Court System Superior

3. Might Have Shorter Claim Periods for Enforcement of Foreign Judgments

4. Better Full Faith and Credit Defense

5. Provides Protection to Trustees

6. Addresses Consequences of Successful Attack

7. More Distribution Options

8. Additional Protection for Trust Distributions

9. Less Risk of Offending Public Policy

XIII. A Comparison of Foreign and Domestic APTs

A. Introduction

B. Advantages of Foreign APTs

1. Offer Protective Features

2. Might Be Superior

3. Full Faith and Credit Not Due U.S. Judgments

C. Advantages of Domestic APTs

1. Constitutional Issues Might Favor

2. Less Financial Risk for Settlor and Beneficiaries

3. Tax Treatment More Favorable (Although This Can Be Planned Around)

4. Less Expensive

5. Less Risk of Fine or Imprisonment

a. Introduction

b. Some General Principles Regarding Civil Contempt Law

c. The Cases

(1) The Anderson Case

(2) The Lawrence Case

(3) The Bilzerian Case

(4) The Eulich Case

(5) The Solow Case

(6) The Grant Case

d. Implications

XIV. Designing, Drafting, and Funding a Domestic APT

A. Introduction

B. Due Diligence

C. Involvement of Domestic APT Counsel

D. Drafting the Domestic APT

E. Trustee Selection

F. Funding the Domestic APT: An Overview

G. Asset Selection: Amount to Entrust (a Quantitative Issue)

H. Asset Selection: What to Entrust (a Qualitative Issue)

I. Cost of Establishing and Administering the Domestic APT

J. Basic Administration Concepts: Procedures and Distributions

XV. Distributions from Domestic APTs: Who Is in Charge and Other Issues

A. Introduction

B. Recommendations

1. Avoid Misunderstanding at Beginning

2. Fund with Nest Egg

3. Choose Proper Law

4. Choose Proper Trustee and Follow Proper Request Procedures

5. Name Other Beneficiaries

6. Domestic APTs Make It Easier for Other Beneficiaries to Sue (Which the Client May or May Not Consider Good and What to Do if He or She Does Not)

7. Settlor May Expressly Reserve Certain Rights to Income

C. Another Problem: Confused Distribution Standards

1. The Nature of the Problem: Contradictory Terms

2. The Consequences: Unwanted Demands and/or Bankruptcy Problems

3. Why Spendthrift Clauses Alone Are Not Enough in Bankruptcy


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 State Self-Settled Trust Statutes*

Worksheet 2 A Comparison of the Domestic Asset Protection Trust Acts*

Worksheet 3 Delaware Asset Protection Trust Case Studies*

Worksheet 4 A Practitioner-Friendly Guide to the Delaware Asset Protection Trust*

Worksheet 5 Client Letter Summarizing Delaware Asset Protection Trusts*

Worksheet 6 Solvency Letter*

Worksheet 7 Delaware Asset Protection Trust Form*

Worksheet 8 Foreign and Electronic Sources*

Bibliography

OFFICIAL

Federal Statutes:

Treasury Regulations:

Treasury Rulings:

Committee Reports/Public Laws:

Cases:

UNOFFICIAL

Books and Treatises:

Periodicals:

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2000

2002

2003

2004

2005

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2007

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