Asset Protection – State Law Does Matter

State law does matter in the selection of a jurisdiction in which to create a domestic asset protection trust (APT). A brief (and incomplete) history of APTs may help the reader understand why.

Common law prevented an individual from establishing a trust to protect one’s assets from the claims of creditors where he or she is a beneficiary. Large jury verdicts and the escalating cost of insurance prompted advisers to look for a solution. Off-shore asset protection jurisdictions responded by amending their laws to permit APTs to protect one’s assets from creditors.  In response to the loss of trust and investment business, more than ten states have abolished the common law rule and permit a domestic APT to protect one’s assets from claims of creditors.   The factors listed below should be evaluated before selecting a jurisdiction for an APT.

First, state law should permit property to remain in trust in perpetuity in order to maintain the protection. Second, the trust should not be subject to state income tax in more than one state. Poor planning can cause a trust and beneficiaries to be subject to income tax in more than one state. There are several factors that may cause state income taxation of a trust. The law of the state of residence of the grantor, each trustee and each beneficiary must be analyzed. The analysis must also consider the place where trust assets are held and administered.

Third, law on fraudulent conveyances should be analyzed in order to determine the degree of protection against the claims of creditors.  Some states have special creditors, such as spouses and children, who may pierce the trust to collect on their claims. One should also analyze the state statute for protection against the claims of future creditors and the length of time before claims are barred.  Many foreign jurisdictions measure time from the date of transfer of assets to the APT rather than the date of the claim is discovered. Using the date of transfer provides greater certainty and protection.

Fourth, the decanting statute should be examined because it is conceivable that a trust may no longer function for its intended purpose. Decanting of the trust may permit its amendment or transfer to another jurisdiction.

Fifth, local law may authorize creation of a Directed Trust whereby trustee administration is separated from investment decisions. This allows the investments to be handled by an investment adviser or the business to be run by a manager without making the administrative trustee liable for their decisions. Sixth, consider the application of the Delaware tax trap to powers of appointment exercised under state law.

The Full Faith and Credit Clause of the Constitution requires that a judgment obtained in one state be enforced by the courts of another state. Enforcement of a foreign judgment against an APT in an asset protection state is a question yet to be decided.  Most off-shore jurisdictions will not enforce a judgment obtained outside its borders.