Asset Protection - Trusts as a Tool

This is important because the cost of litigation and the potential risk of jury awards can literally steal all your hard earned assets, investments and wealth.  Insurance may not include the type of award and the insurance may not cover the amount of the award.

Who This Applies to - All of the persons listed below should consider assets protection:

1.  Anyone who has more than (US) $1,000,000 in assets, 

2. Any practicing professional, 

3. Anyone who is "high profile," such as those working in entertainment, sports, fashion, journalism, finance or medicine, 

4. Anyone that regularly engages in risky ventures, 

5. Anyone who personally guarantees obligations in the course of his or her business.

Asset Protection 

A. Introduction 

B. Importance of Asset Protection 

C. When to Engage Protection 

D. Asset Protection Trust 

Types of Trusts 

A. Introduction 

B. Spendthrift Trust 

C. Discretionary Trust 

D. Support Trust 

E. Blend Trust 

F. Shifting Interest Trust 

G. What Type of Trust to Use 

H. Self-Settled Trust 

VEBA Trust 

A. Learning Objectives for Lesson 3 

B. Insurance Held in a VEBA Trust 

C. Benefits of a VEBA 

D. Who Should Consider a VEBA 

Foreign Trusts & Certain States 

A. Learning Objectives for Lesson 4 

B. Effectiveness 

C. States That Compete 

D. Foreign vs. U.S. Trust 

Protection/Common Situations 

A. Learning Objectives for Lesson 5 

B. Common Situations 

C. Revocable Living Trust 

D. Trusts Created at Death 

E. Crummey Trusts 

Fraudulent Transfer Laws 

A. Learning Objectives for Lesson 6 

B. Too Late to Transfer Assets 

C. Types of Fraudulent Transfers 

D. Fraudulent Transfer Examples 

E. Consequences of Fraud 

F. Future Creditor 

G. Insolvency 

H. Constructive Fraud 

I. Fair Consideration 

J. Transfers 

Prebankruptcy Planning 

A. Learning Objectives for Lesson 7 

B. Exempt Assets 

C. Right to Convert 

D. Common Patterns of Planning 

E. Attorney-Client Privilege 

Foreign Trusts 

A. Learning Objectives for Lesson 8 

B. Foreign Trust Features 

C. Trust Structures 

D. Location Of Trust Assets 

E. Changing Location of Assets 

F. Foreign Law Not Recognized 

Foreign Trust Tax Compliance 

A. Learning Objectives for Lesson 9 

B. Foreign vs. Domestic Trust 

C. Tax Consequences 

D. Transfer of Appreciated Assets 

E. Foreign Trust Required Forms 

Practical Considerations 

A. Learning Objectives for Lesson 10 

B. Settlor's Control Over Assets 

C. Role of Trust Protector 

D. Assets To Be Transferred

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• Plain English Analysis - Your Answers
  • What it Does
  • Why or How it works
  • Alternatives
  • Cost v. Benefits Analysis

YOUR ANSWERS

What it does, Explanation of this topic and how it may affect you:

Asset Protection 

A. Introduction 

An asset protection trust contains special provisions that protects trust assets from the claims of the beneficiaries' creditors. These provisions protect mostly against the claims of commercial creditors. However, depending on the jurisdiction and the type of asset protection trust, the interest of a beneficiary will be shielded even from claims for alimony, child support and taxes.

B. Importance of Asset Protection 

C. When to Engage Protection 

D. Asset Protection Trust 

Types of Trusts 

A. Introduction 

There are many forms of trust.  Generally the options open to the person desiring to fund the trust are nearly limitless.   Some general types of trusts are:

1. Spendthrift Trust

2. Discretionary Trust

3. Support Trust

4. Blend Trust (Sprinkling Trust)

5. Shifting Interest Trust

6. Self-Settled Trust

7. Minor's Trust

8. Annual Exclusion Trust

9. Rabbi Trust

10. Charitable Remainder Trust

11. Living Trust

12. Life Insurance Trust

B. Spendthrift Trust 

The special clause added to make a trust a Spendthrift Trust can be used in nearly any Trust Instrument.  The clause prevents the beneficiary from hypothecating the trust assets, prevents commercial creditors from invading the Trust Corpus and prevent the beneficiary from "wasting" the corpus and income.  This provides no protection from spouses, children or taxes.

A shifting interest trust can be used where a spendthrift trust is initially employed. The shift could occur, for example, upon the insolvency of the beneficiary, and can either be to eliminate the beneficiary's interest, or provide a shift to a discretionary trust.

C. Discretionary Trust 

In a discretionary trust, the trustee has absolute and uncontrolled discretion to make distributions of trust income and principal to or for the benefit of beneficiaries, without regard to any ascertainable standard. For a trust to qualify as a discretionary trust, the trustee's discretion must be so complete that he can exclude a beneficiary from receiving any distributions or benefit from the trust. This rule, however, is subject to the requirement that the trustee not, among other things, abuse its discretion.

Since the trustee's powers are so broad, the beneficiary cannot force the trustee to pay or apply trust property to or for his benefit. Consequently, a creditor seizing a beneficiary's interest in a discretionary trust or attempting to purchase such an interest places the creditor in the shoes of the beneficiary; that is, the creditor has a mere hope that the trustee will exercise his discretion by making distributions, which is unlikely when a creditor is present. Further, the creditor cannot force the trustee to make distributions. The protection afforded a discretionary trust is so complete that generally it cannot be pierced to pay preferential claims such as tax claims. Similarly, claims for support cannot be collected against trust property until the trustee exercises the discretion to make a distribution.

D. Support Trust 

A support trust provides that the trustee will apply as much of the income and principal as is necessary for the education and support of the beneficiary. A beneficiary's interest in a support trust is not subject to creditors' claims. The protection afforded a beneficiary's interest in a support trust is separate from the protection afforded an interest in a spendthrift trust. It would be appropriate to use such trusts where a discretionary trust cannot be used because the settlor does not feel he can select a trustee that will exercise discretion in accordance with the settlor's wishes.

E. Blend Trust (Sprinkling Trusts)

A blend trust is a trust where the interests of two or more beneficiaries are blended in such a way that no beneficiary can claim any particular portion of the trust. (So called sprinkling trusts are often blend trusts.) For example, no beneficiary can claim a portion of the trust where the trustee has discretion to make distributions to some or all of a group of beneficiaries. The protection of a blend trust derives from the fact that the interest of the beneficiary cannot be defined. Generally, where a trust is created for a person and his family, it is a blend trust. A blend trust should provide as much protection as a discretionary trust, that is, it should protect against even claims for taxes.

Most of the time the settlor prefers each beneficiary to have his or her own separate trust, which for asset protection purposes should be a discretionary trust.

F. Shifting Interest Trust 

A trust that shifts from one generic kind of trust to another (e.g., from a spendthrift trust to a discretionary trust) or that has different beneficiaries on the occurrence of certain events is generally an effective protective trust. Most often the shift occurs on a change in the beneficiary's financial circumstances, e.g., a lawsuit, attempted attachment or bankruptcy.

A shifting interest trust can be used where a spendthrift trust is initially employed. The shift could occur, for example, upon the insolvency of the beneficiary, and can either be to eliminate the beneficiary's interest, or provide a shift to a discretionary trust.

G. What Type of Trust to Use 

H. Self-Settled Trust 

When a trust is self-settled, the settlor is the beneficiary. Most jurisdictions provide that self-settled trusts are not protected from the claims of the settlor/beneficiary's creditors on the grounds that such a result violates public policy.

VEBA Trust 

Voluntary Employees Beneficiary Associations (VEBAs) are tax- exempt organizations that are described in Section 501(c)(9) of the Internal Revenue Code of 1986. They require a letter of determination from the Internal Revenue Service stating that you have received tax exempt status to operate them. They usually provide for the payment of life, accident, sickness, and other benefits to members of the VEBA or their dependents or beneficiaries.

A. 

B. Insurance Held in a VEBA Trust 

C. Benefits of a VEBA 

Businesses and professionals are now allowed to join an existing multiple-employer VEBA as long as it has already received a letter of determination from the Internal Revenue Service (verifying the trust's tax-exempt status) and has an Independent trustee (usually a bank). An administrator handles all of the compliance filings. * A VEBA provides a number of significant business planning opportunities: * The program allows large, flexible and fully tax deductible contributions. * Assets accumulate and compound on a tax-deferred basis. * Assets are protected from creditors. Since all life insurance policies are owned by the multi-employer, VEBA trust any participating individuals have no "incidents of ownership" or control over the policies. This ownership arrangement puts the cash value out of reach of creditors. Although the plan can provide life, sickness, accident, long-term care, and educational benefits to its members, there is no vesting of benefits unless an event occurs that triggers the payment while an employee is a participant. A VEBA has a number of very specific design characteristics. There must be at least two participants in a plan (a spouse can be an employee). Benefits are based on annual compensation. Death benefits can be designed so that they will not be subject to income or estate taxes. This is because participants have no "Incidents of ownership" in the assets, including the life insurance contracts held by the VEBA trustee. To avoid the estate tax inclusion, a participant should make an irrevocable designation of beneficiary, like a trust, for the benefit of one's family.

D. Who Should Consider a VEBA 

Because of the numerous benefits of a VEBA Trust, the following types of businesses and business owners should consider joining a multiple-employer VEBA plan: 

Businesses and individuals who would like to protect their assets from creditors, especially those in high-liability businesses and professions.

Profitable businesses that want to reduce their tax liabilities.

Companies that can no longer make contributions to their qualified retirement plans because the plans are over-funded and/or the plans no longer favor the business owner. 

Individuals looking to reduce, eliminate or provide liquidity for estate taxes.  

Businesses looking to supplement or enhance their business- succession plans (for example, by using the death benefit in the VEBA as a more tax-efficient method of providing cash to beneficiaries and avoiding the disruption of the corporation's cash flow). 

Physicians, dentists, and other high-income professionals. 

There are trusts in the marketplace that may look like VEBAs or say they are VEBAs but don't comply with the VEBA rules. For instance, there are similar plans ("Welfare Benefit Trusts") designed under 419(A)(i)(6) by lawyers who believe they can avoid ERISA and nondiscrimination rules by not filing with the IRS. Perhaps they can, but advisors should know the differences and their implications of those differences. These differences may include no letter of determination from the IRS, lack of compliance with 505(b) nondiscrimination rules, including only a certain management group and ignoring the rank and file employees, and so on.

Foreign Trusts & Certain States 

The legal advantage that such foreign jurisdictions have is trust legislation that clearly authorizes self-settled asset protection trusts. A number of states have enacted similar legislation authorizing self-settled trusts. Generally, the settlor can select the jurisdiction whose laws will govern the trust. The settlor's ability to do so, however, is limited by public policy considerations. If the law designated by the settlor violates a strong public policy of the state that has the most significant relationship to the trust, then the law will not be recognized. The settlor's domicile (i.e., where the settlor resides and has the most important contacts) usually has the most significant relationship to the trust. In most states self-settled trusts violate public policy. Consequently, foreign self-settled asset protection trusts will not be upheld legally in U.S. courts. Several courts have so held. Notwithstanding this legal result, as a practical matter, if assets are not subject to the jurisdiction of U.S. courts, there is no practical way for a creditor to recover those assets.

A. 

B. Effectiveness 

C. States That Compete 

Several states now compete with foreign jurisdictions for self- settled asset protection trusts. Currently, states that have enacted such legislation are: Alaska, Delaware, Missouri, Nevada and Rhode Island. This legislation, however, has the same weakness of foreign jurisdictions that have enacted asset protection legislation, namely: if it violates the public policy of the settlor's domicile it will not be upheld.

D. Foreign vs. U.S. Trust 

In contrast, a foreign trust affords greater protection than a U.S. trust if trust assets are also outside of the U.S. Under those circumstances, any U.S. court, whether state or federal, would lack power over the assets.

United States courts could still attempt to exercise indirect power of foreign trust assets by attempting to hold that settlor/beneficiary in contempt as a way of coercing him to retrieve the assets. This was the case of Federal Trade Commission v. Affordable Media, LLC, (commonly known as the "Anderson" case) where the debtors were incarcerated for failure to retrieve assets from overseas. In that case, however, the debtors had broad powers over trust assets, so that they could not credibly assert that it was impossible to comply with the court's order. Impossibility is generally a defense to coercive contempt. Consequently, the possibility of contempt (with or without incarceration) can be eliminated by structuring the trust so as to enable the debtor to credibly assert the impossibility defense.

Protection/Common Situations 

A. Learning Objectives for Lesson 5 

B. Common Situations 

C. Revocable Living Trust 

Individuals often erroneously believe that their revocable living trusts provide some additional protection. A revocable living trust will not afford the settlor/beneficiary protection because the creditor can exercise the settlor's power to revoke. One way for a revocable living trust to provide at least cosmetic pro- tection is to name a person other than the settlor/beneficiary as the trustee. Since trust assets are normally titled in the name of the trustee, establishing a trust in this manner will allow the settlor/beneficiary to appear as if he or she does not own trust assets. This may be sufficient to prevent the interest of a plaintiff's lawyer and thereby avoid costly litigation.

D. Trusts Created at Death 

If the estate exceeds the exempt amount, then the balance is often allocated to a trust that qualifies for the unlimited marital deduction, i.e., a marital trust. Allocating property to the exemption trust and marital trust that are often formed on the decedent's death can also provide significant asset protection for the surviving spouse and other beneficiaries. To ensure protection, the trust must be an asset protection trust, i.e., contain a spendthrift clause or discretionary trust language.

E. Crummey Trusts 

Fraudulent Transfer Laws 

A. Learning Objectives for Lesson 6 

B. Too Late to Transfer Assets 

C. Types of Fraudulent Transfers 

D. Fraudulent Transfer Examples 

E. Consequences of Fraud 

F. Future Creditor 

G. Insolvency 

H. Constructive Fraud 

I. Fair Consideration 

J. Transfers 

Foreign Trusts 

Features That Make Foreign Trusts Suitable for Asset Protection

First, the law of the country in which the trust is established protects the settlor of the trust even if he or she is also the primary beneficiary. However, it is unlikely that this favorable foreign law will be recognized in the U.S. Therefore, it is important to transfer the assets to a foreign location as well. When both the trust and the assets are offshore, a U.S. court will not have jurisdiction or power over the trust assets.

Further, an investment advisor can be appointed to manage trust assets. The trustee and investment advisor can be replaced, and the trust can even be terminated under certain circumstances.

Selecting the Foreign Jurisdictions

Selecting Trustee

The trustee should have no contacts in the U.S., either directly or indirectly. Even if the trustee is a foreign corporation with U.S. branches or subsidiaries, case law indicates that a U.S. court can exercise jurisdiction or power over the bank. In the past this has taken the form of imposing penalties on the U.S. branch until U.S. court order is satisfied. The court order may request records or a return to the U.S. of the debtor's money.

In addition, in any long-term foreign trust it is advisable to select a "trust protector" or have a committee of protectors to act as a liaison between the settlor and the trustees.

Trust Structures

Living Trust Substitute 

All assets are transferred to a foreign trust.  If this transfer makes it necessary to draw on the trust of basic living needs, then there is a danger the structure is deemed that of an agency relationship.  If the courts find an agency relationship the assets are at risk.

Foreign Retirement Trust

One strategy is to set aside only a portion of one's assets, the kind of "nest egg." The disadvantage of this strategy is that only a portion of the assets will be protected. The advantage of the strategy is that assets that are under the management of a foreign trustee and that are not consistently drawn upon by the settlor will more likely be recognized as a valid trust, opposed to a mere agency.

Location of Trust Assets

Advantages of Foreign Location

The advantage of maintaining assets in a foreign location is that U.S. courts will not have jurisdiction over those assets. Unless the assets are held with a foreign trustee that has a presence in United States in the form of a branch or subsidiary or perhaps an affiliated corporation, U.S. courts will lack the ability to coerce the trustee to turnover to the U.S. court records and assets.

Domestic Location

Maintaining assets in United States clearly places those assets at risk for creditor attachment.

Use of Partnership to Change Location of Trust Assets

Partnerships can theoretically be used to effectively change the location of trust assets. For example, if the underlying assets, i.e., cash in securities, are transferred to a limited partnership and the limited partnership interests are transferred to the foreign trust, then the limited partnership interests are located in the foreign jurisdiction where the trustee resides. Under this scenario, the settlor often acts as general partner, thereby retaining investment control over the assets. Although there is a theoretical basis for the structure, U.S. courts have been exceedingly hostile to foreign asset protection trusts. Where the assets in fact remain in the United States, regardless of the legal technicalities, it is likely that a U.S. court will simply ignore the structure and treat the assets as owned directly by the settlor.

Recognition of Foreign Law in United States

It is crucial to structure the trust in a way that will prevent U.S. courts from exercising jurisdiction over either trust assets or the trustee of the foreign asset protection trust.  U.S. Courts will not recognize foreign law, therefore the neither the trustee nor the assets may have any U.S. nexis.

Foreign Trust Tax Compliance 

C. Tax Consequences 

One reason to ensure that the foreign asset protection trust is a grantor trust is the potential for triggering a gain on the transfer of appreciated property to a foreign trust. Under IRC  §684, the transfer of appreciated assets to a foreign trust is treated as a taxable sale or exchange of those assets for fair market value. This general rule does not apply if the foreign trust is treated as a grantor trust for U.S. income tax purposes. It has been suggested that IRC §684 may apply upon the death of the grantor, i.e., the trust will become a foreign trust since the exception for grantor trusts will no longer apply. No tax will occur since there is a step-up in tax basis at the time of death under IRC §1014 and Treas. Reg. §§1.014-2(b)(1) and 1.014-2(b)(2).

D. Transfer of Appreciated Assets 

E. Foreign Trust Required Forms 

A. On the initial funding of the trust, by the due date for the income tax return, plus any extensions, FORM 3520 (ANNUAL RETURN TO REPORT TRANSACTIONS WITH FOREIGN TRUSTS AND RECEIPT OF CERTAIN FOREIGN GIFTS).

B. Annually, by the 15th day of the 3rd month after the end of the trust's taxable year, subject to any granted extensions, FORM 3520-A (ANNUAL INFORMATION RETURN OF FOREIGN TRUST WITH A U.S. OWNER - UNDER SECTION 6048(B)).

C. Appointment of U.S. Agent for the foreign trust.

D. Any person who has financial interest in or authority over any financial accounts must file by June 30th TDF 90-22.1 (REPORT OF FOREIGN BANK AND FINANCIAL ACCOUNTS). Failure to comply or filing of a false return may result in criminal penalties.

E. FORM 1040, SCHEDULE B (must state whether taxpayer has interest in foreign accounts).

F. TRUST INCOME TAX RETURNS: (i) FORM 1041 (FILING FOR TRUSTEE) and (ii) FORM 56 (NOTICE CONCERNING FIDUCIARY RELATIONSHIP)

G. FORM 4790 (CURRENCY TRANSACTION REPORT), applicable.

H. FORM 8300 (REPORT OF CASH PAYMENTS OVER $10,000 RECEIVED IN A TRADE OR BUSINESS), if applicable.

I. FORM 709 (U.S. GIFT TAX RETURN)(Treas. Reg. §25.6019-3(a), transfer with a retained power of appointment must be disclosed).

J. IRS FORM 5471(INFORMATION RETURN OF US PERSONS WITH RESPECT TO CERTAIN FOREIGN CORPORATIONS). Foreign corporations are sometimes used to hold investments and conduct other business activities. The corporate stock is owned directly by the foreign trust.

K. IRS FORM 8288-A (STATEMENT OF WITHHOLDING OF DISPOSITIONS BY FOREIGN PERSONS OF U.S. REAL PROPERTY INTERESTS).

L. PENALTIES FOR FAILURE TO COMPLY REPORTING REQUIREMENTS The penalties for failure to file are confiscatory. 

1. Failure to report the initial transfer to the foreign trust results in a penalty of 35% of the value of the property transferred. Additional penalties can also be imposed. 

2. Failure to file the annual return results in a penalty of 5% of the assets, and additional penalties are possible.

Practical Considerations 

A. 

B. Settlor's Control Over Assets 

Creditors step into the shoes of their debtor. Under this general principle, a settlor's creditors can exercise any powers held by the settlor. Accordingly, it is important that a settlor not hold direct powers over trust assets. If a settlor does directly hold powers, the court may be able to cite the settlor for contempt for failure to return assets to the U.S., a procedure that could result in incarceration for a significant period of time.

C. Role of Trust Protector 

The problems created by the settlor holding powers over trust assets are avoided, by among other things, by appointing a trust protector (or a committee of protectors) to advise and direct the trustee with regard to matters such as: * The appointment of investment advisors; * The change of investment advisors; * Distributions and loans to be made to the settlor; * Termination of the trust; * Change of trustees; and * Change of the location of the trust administration. The Trust Protector should not be subject to U.S. jurisdiction, that is, the Trust Protector should be a resident and citizen of a foreign country.

D. Assets To Be Transferred

It is best to fund the foreign trust with liquid assets that should be transferred to trust. It is difficult to transfer title to U.S. real estate to a foreign location, since the real estate is located in the U.S.

I shall always strive to accomplish your goals, and to keep your planning in balance.  You will find no other adviser or groups of advisers that has your potential and your security more in focus than I. 

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Very truly yours,

by

       Bob Parrish CPA Engagement Manager