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U.S. v. Kimball Case Supports the Use of a 541 Trust – Even Against IRS Lien

One of the simplest planning techniques to protect against claims from creditors, even the IRS, is to use a properly drafted irrevocable non self-settled trust. For generations, courts have found that these types of trusts will not be accessible by the creditors of the individual creating the trust.

In U.S. v. Kimball, Jr., 117 AFTR 2d 2016-811, (DC ME), 06/24/2016, the United States District Court District of Maine addressed two separate counts. The first count was granted on summary judgment, resulting in a judgment of $1,090,700.05 in unpaid taxes and penalties against Mr. Kimball as an individual. The second count was an attempt to have the tax lien attach to a trust that Mr. Kimball created. The Court denied the second count on summary judgment. In other words, the assets in the trust were safely protected from the tax lien.

The Court found that the trust was not the property of Mr. Kimball and the tax lien should not attach to the trust property. Mr. Kimball created the trust naming his children as beneficiaries and himself as trustee. The trust included flexible provisions, but the trust restricted any changes that would cause Mr. Kimball to become a beneficiary of the trust. In the event of changes to the trust, the relevant property would go to the beneficiaries of the trust, and not to Mr. Kimball.

The type of trust used by Mr. Kimball was a non-self-settled trust. This type of trust is a trust that does not name the settlor as a beneficiary, but instead the trust names a third party as the beneficiary of the trust (i.e. naming the settlor’s spouse or children as beneficiaries). Because the trust is not “self-settled” the creditors of the settlor cannot reach into the trust, so long as there are no fraudulent transfers into the trust.

A powerful asset protection solution is to combine the asset protection benefits from using a non-self-settled trust with the flexibility provided by the grantor retaining a special power of appointment. A special power of appointment is a tool that provides the settlor with a lot of flexibility while still protecting the trust from creditors’ claims. Court cases and statutes going back over 200 years have consistently held that a special power of appointment is not subject to creditors. We have created such a trust with these unique characteristics. We call our unique trust a 541 Trust®.

A non-self-settled trust has provided an elegant and powerful solution for solid asset protection. Asset protection does not need to be complicated and does not need to use a new and untested planning technique. When properly funded and operated correctly, a 541 Trust® is one of the most efficient, flexible, and effective creditor protection strategies available.

We have perfected the 541 Trust® to obtain the best in asset protection with the flexibility to adjust for changing circumstances. There are generations of court cases demonstrating that it is extremely unlikely that a creditor will be able to access the assets in a 541 Trust®.

Want to get the best in asset protection or learn more about the 541 Trust® and why the Kimball Court, on summary judgement, denied the IRS’ attempt to attach a tax lien to the trust, please call us at 801-765-0279.

Best Asset Protection Trust isnt an Asset Protection Trust

Could it be true that the best trust for asset protection isn’t even an asset protection trust? It may sound strange, but the legal precedent proves it to be true.

Whenever you hear the term “asset protection trust” it almost exclusively refers to a self-settled spendthrift trust. This where the settlor establishes and funds an irrevocable trust naming themself as a beneficiary. The trustee is an independent party who can make distributions from the trust to the settlor. So what does this mean? It means that the settlor can give money or assets to the independent trustee of an “asset protection trust” so future creditors can’t touch those assets. It also promises that the trustee can give the assets back to you at any time. This sounds pretty awesome right!

The problem is that self-settled trusts have historically provided zero asset protection in the United States. Generations of US laws have made it clear that your creditors can reach into a trust that you create if you are also the beneficiary.

This includes dozens of US court cases successfully attacking the assets of offshore asset protection trusts and none to the contrary.

Likewise, domestic self-settled asset protection trusts have failed in the only court cases to date.

So if quote Asset Protection Trusts have a dismal record in protecting assets, what is the solution?

The solution lies right in front of us. Generations of US legal precedent has made it perfectly clear that a non self-settled trust has ALWAYS worked. As opposed to creating a trust and naming yourself as the beneficiary, this trust names a third part as the beneficiary, such as the settlor’s spouse or children. Because the trust is not “self-settled” the creditors of the settlor cannot reach into the trust, so long as there are no fraudulent transfers into it.

We’ve also learned that a special power of appointment is a tool that provides infinite flexibility without subjecting a trust to creditors. Court cases and statutes going back over 200 years have consistently held that a special power of appointment is not subject to creditors, without exception.

We call this a 541 Trust because it is canonized in Section 541(b)(1) of the US Bankruptcy Code, as well as multiple other statutes and court cases nationwide dating back generations. The 541 Trust is superior to what are traditionally called Asset Protection Trusts because:

1. It works in all 50 states and in bankruptcy courts and has for over 200 years.
2. It works for any asset in any location.
3. It is proven by court cases for generations. We can actually show you court cases and other examples where our trusts were upheld.
4. It’s simple to understand, implement, and operate unlike the extremely complex structures associated with offshore trusts
5. It is infinitely flexible and can be modified at any time.
6. It is a fraction of the cost of an offshore trust structure and doesn’t have high annual maintenance charges or complex IRS reporting.

Nobody prepares this trust as well as we do. We pioneered it, we perfected it, and we have seen it succeed in every challenge. Some have criticized the 541 Trust but the legal precedent and the continued court support remains. It doesn’t matter what we say or what others say. The only thing that matters is what the courts say. The courts have spoken in favor of the 541 Trust over and over again.

So technically speaking, a 541 Trust isn’t an asset protection trust. It just happens to protect assets better than the types of trusts referred to as asset protection trusts.

CALL 801-765-0279 for more information

What is a 541 Trust®?

We use the 541 Trust® name to refer to an irrevocable asset protection trust built upon a foundation of generations of proven legal precedent. A 541 Trust® is a domestic, irrevocable, non-self-settled trust carefully designed to provide the best asset protection while at the same time affording maximum flexibility. The 541 Trust® is not a new school of thought nor is it based on foreign laws. We have carefully researched generations of legal precedent right here in the U.S. to find strategies that have always worked and design our trusts in compliance.

Assets owned by you are within reach of your creditors. Likewise, absent a fraudulent transfer, assets not owned by you cannot be reached by your creditors. If asset protection is a key goal in your estate planning, you must somehow remove the assets from your personal ownership. The best way to remove assets from your ownership is through the use of a properly crafted irrevocable trust. Because our trusts are drafted in compliance with U.S. laws, and are supported by generations of legal precedent, they provide the best possible protection.

Public policy and generations of legal precedent are clear: you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. Offshore Trusts and Domestic Self-Settled Asset Protection trusts (DAPTs) are self-settled, which is a fatal chink in the supposed armor of these types of trusts. Even though some states and offshore jurisdictions purport to allow self-settled asset protection trusts, it is important to see what the courts have made clear–the only court cases dealing with Offshore Trusts or DAPTs have shown that they fail to protect the assets.[i] Despite an abundance of promotion and marketing, self-settled trusts (DAPTs and Offshore Trusts) have zero wins when challenged in court. The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[ii] In other words, if a settlor who is also a beneficiary has access to trust cash, property, vehicles, etc., so does a creditor. It is hard to argue that an Offshore Trust or a DAPT is the best solution based on their dismal record when challenged in court.

Generations of legal precedent have made clear that the only type of trust which has withstood the test of time as a proven method of asset protection is a non-self-settled trust (a.k.a. a third party trust or our 541 Trust®). This means that the settlor of the trust creates the trust for beneficiaries other than him/herself.[iii] 

Our 541 Trust® protects assets from a person’s potential future liabilities by removing the assets from the person’s legal and personal ownership. Rather than employing new strategies which have not been tested or strategies which rely on the laws of foreign jurisdictions, the 541 Trust® is designed using methods which have been successfully tested in lawsuits, bankruptcy, and IRS audits in the U.S. legal system. The 541 Trust® has been proven to work better than offshore trusts and other asset protection strategies. Frankly, the name of the trust is of little importance. The important part of the 541 Trust® is its craftsmanship. Our years of experience and dedication to building trusts upon a tried and tested legal foundation is the key value to our asset protection trusts. After all, what good is a trust if it fails when challenged? The legal precedent speaks for itself.

 [i] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011), Waldron v. Huber (In re Huber), 2013 WL 2154218 (Bk.W.D.Wa., Slip Copy, May 17, 2013), Dexia Credit Local v. Rogan 624 F. Supp 2d 970 (N.D.Ill. 2009), 11 U.S.C. 548(e), More offshore self-settled trust cases HERE.

[ii] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[iii] “By establishing an irrevocable trust in favor of another, a settlor, in effect, gives her assets to the third party as a gift. Once conveyed, the assets no longer belong to the settlor and are no more subject to the claims of her creditors than if the settlor had directly transferred title to the third party.” In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

IRS Approved NING Trust provides Substantial Tax Savings

For many years, we have helped clients reduce income taxes by using a Nevada trust often referred to as a “NING Trust” (Nevada Incomplete Gift Non-Grantor Trust). In PLR 20131002, the IRS approved this concept by ruling that the trust qualified as a complex trust for income tax purposes and that gifts to the trust were incomplete for federal gift tax purposes. In other words, a person can transfer assets of unlimited value to a NING Trust without gift tax consequences. The income of the NING Trust is taxed at the trust level and does not flow through to the grantor. Because Nevada has no state income tax there is huge potential for income tax savings. Here are three examples of how a NING trust can save taxes:

A California resident can avoid the 13.3% California tax on investment assets or capital gains. For example, assume a California resident establishes a properly structured [NING] trust and contributes a $20 million stock portfolio that produces 8% taxable income per year. Over a period of 10 years, the California income tax saved could be $2,500,000. Over 20 years, the compounded savings from not paying California income tax could be $8,500,000. (See Gordon Schaller & The 13.3% Solution: of DINGs, NINGs, WINGs and Other ThINGs, LISI Estate Planning Newsletter #2191 (February 5, 2014)).

As another example, we have a client who placed his stock into a NING trust prior to a sale of his company. When the stock was sold by the NING trust, the client saved over $5,000,000 in state capital gains taxes. Later, when the trustee terminated the trust and distributed the assets back to the client, the client was not required to pay state capital gains tax on the distribution because the state does not tax capital gains distributed from a nonresident trust.

As a third example, a professional athlete transferred the majority of his investment portfolio to a NING trust. The athlete pays federal and state tax on his W-2 earnings and on the investments he holds outside of the NING trust. The athlete is not required to pay state tax on the investment income earned by the trust, and this allows the trust to grow free of state income tax.

Call 801-765-0279 for more information or click HERE to email us.

The information and examples above are provided as general information and may not be used as tax advice for any particular situation. Each person should seek individualized tax advice for their own situation.

Why Self-Settled Asset Protection Trusts Don’t Protect Assets

Don’t Self-Settle for Inadequate Asset Protection

Why Self-Settled Asset Protection Trusts Don’t Protect Assets

By: Randall Sparks, JD LL.M. and Lee S. McCullough, III, JD MAcc

Click HERE for pdf verison

Self-Settled Asset Protection Trusts are all the rage. They come in two main flavors: (1) The Domestic Asset Protection Trust (“DAPT”) and (2) the Offshore Trust, aka Foreign Asset Protection Trust (“FAPT”). To boost in-state trust business, about a dozen states have passed or are actively improving their self-settled asset protection trust statutes … and that number is growing. Although self-settled trusts are heavily promoted by asset protection attorneys across the county, all of the relevant court cases indicate that if asset protection is your goal, you should find a more viable option.

If self-settled trusts are inadequate for asset protection, why do attorneys go to such lengths to sell them? The answer is simple: Money. Asset protection promoters market them heavily promising maximum protection and make big profits in the process. They do this despite zero court authority in existence that upholds self-settled asset protection trusts. Promoters also ignore the many court cases showing that self-settled trusts simply don’t afford the promised asset protection benefits.

What is a Self-Settled Asset Protection Trust?

There are three parties to any trust agreement: (1) a Settlor, who creates the trust and funds it with assets, (2) a Trustee, who holds legal title to the assets in trust for the beneficiaries, and (3) the Beneficiaries, who are eligible to receive benefits from the trust. In most trusts, the Settlor and Beneficiary are different people. In a self-settled trust, the Settlor is also a Beneficiary. In concept, the idea is incredible: contribute any amount of property to the trust and while creditors can’t touch it, you can enjoy it as much as you want. The reality is that these arrangements just don’t work as advertised.

Public policy has long been clear that you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[1] In other words, if a Settlor/Beneficiary has access to trust cash, property, vehicles, etc., so does a creditor.

Offshore jurisdictions were the first to market self-settled trusts by promising protections in a foreign jurisdiction that is not bound by the laws of the United States. In 1997, Alaska was the first state to enact a DAPT statute. Since then, over a dozen United States jurisdictions have enacted DAPT statutes. However, creditor attorneys have developed successful techniques to pierce these trusts. By frequently siding with creditors in these cases, courts have rebuffed the zeal of offshore and domestic jurisdictions to establish and promote self-settled trusts as superior asset protection tools.

Court Cases Defeating Domestic Asset Protection Trusts (DAPTs)

When it comes to self-settled trusts, there is an elephant in the room and that elephant has a name: Bankruptcy. In states that don’t recognize self-settled trusts, a debtor’s interest in a self-settled trust is subject to bankruptcy.[2] The Mortensen case made clear that Federal Bankruptcy Law can even defeat a self-settled trust in states that recognize, protect, and advocate self-settled trusts.[3] In Mortensen, an Alaska resident created a self-settled trust under Alaska’s DAPT statute under ideal circumstances: he was solvent and there were no judgments against him. Several years later he ended up in a bankruptcy court sitting in Alaska. The court applied Federal Bankruptcy Law instead of Alaska law ruling that the trust assets were reachable by the creditors in the bankruptcy under Section 548(e) of the Federal Bankruptcy Code.[4]

Another problem with a DAPT is a potential lawsuit arising in a state that does not recognize or protect self-settled trusts. In Dexia Credit Local v. Rogan, the Seventh Circuit Court ruled that despite the debtor’s trust having been created in a DAPT state, Illinois law applied instead.[5] Another huge blow to DAPTs came on May 17, 2013 in Waldron v. Huber where, among other things, Washington State law applied rather than Alaska law where the DAPT was formed.[6] The result was that the trust assets were not protected. Based on the Dexia Credit and Huber cases, one shouldn’t expect that a self-settled trust will be upheld in a state that does not allow them. Numerous other cases indicate that a court can apply the law of the state where the court is located and not recognize the laws of the state where an entity was formed.[7]

If self-settled trusts don’t work in bankruptcy and don’t protect against laws of DAPT unfriendly states, then you can just avoid declaring bankruptcy and avoid contacts outside of your DAPT friendly state, right? Not so fast. Unfortunately, even if you are careful not to get sued in the wrong state and manage to avoid voluntary bankruptcy, your creditors could file an involuntary bankruptcy petition against you. The court cases and the bankruptcy code have shown that even though a self-settled trust is created pursuant to a DAPT statute, the trust is still vulnerable.

Court Cases Defeating Offshore Trusts, aka Foreign Asset Protection Trusts (FAPTs)

Many asset protection promoters claim that offshore trusts are impermeable, in contrast to the absence of a single court case to support their claims. Why do they sell a product that has such an abominable record? It’s a calculated risk that the resulting liability of a few failed trusts that are actually challenged will be vastly overshadowed by those that are never tested. In other words, they know that the majority of their clients will never get sued or go bankrupt. For those who are sued or face bankruptcy however, if the trust is self-settled, its assets are not protected.

Although promoters of FAPTs claim foreign laws protect you because the trust is not subject to the jurisdiction of U.S. Courts, there are many court cases showing how offshore trusts fail. For example, it is well established that an offshore trust cannot protect onshore assets.[8] Numerous other cases show that even though a court in the United States may not have jurisdiction over the FAPT, they have jurisdiction over the debtor and can order the debtor to repatriate the trust assets or face incarceration for contempt. In In re Lawrence the debtor was jailed for over six years for refusing to repatriate assets, in Bank of America v. Weese the debtors paid settlement of over $12,000,000 in order to avoid incarceration, and in U.S. v. Plath the debtor was held in contempt for refusing to obey the court order to disclose details about offshore accounts despite the fact that there was no fraudulent transfer.[9] These are just a few lowlights of the long list of failed FAPT strategies.

For a time, offshore trust peddlers used US v. Grant as the one court case that supported their strategy, because it was the single case where a court did not hold the debtor in contempt. The purported steel bulwark of the Grant opinion came crashing down when, in the Spring of 2013, a Florida court ruled against the very strategy FAPT promoters touted, dealing a huge blow to the offshore asset protection industry.[10] In Grant, Raymond Grant created two self-settled trusts offshore (FAPTs), one for his own benefit and one for the benefit of his wife. Raymond funded both FAPTs at a time when he was solvent and had no known claims against him, once again ideal circumstances. Years later, Raymond died and the IRS obtained a $36 million dollar judgment against Raymond’s wife Arline. The U.S. moved to hold Arline in contempt of court for failing to repatriate the assets in the offshore trusts to pay the tax liability. Initially, the court refused to do so because Arline had never exerted control or received benefits from these trusts. But later when it was proven that Arline had received funds from the trust through her children’s accounts, the court issued a permanent injunction prohibiting Arline and her children from ever receiving any benefits from the trusts. Ultimately a very expensive “asset protection” strategy kept the assets protected from creditors, but also out of reach of those the trust was created to benefit. If your goal is to protect assets from both creditors and yourself, an offshore trust may be a great fit. If, however, you seek any self-settled benefits at all, look elsewhere.

Solution – Non-Self-Settled Trust

The alternative to the self-settled trust is simple, remove the one aspect of the trust that creates all of its vulnerability; make the trust non-self-settled. A non-self-settled trust, aka third party trust, has the support of state and federal statutes, the federal bankruptcy code, and an overwhelming number of court cases. Since the Settlor is not a beneficiary, the creditors of the Settlor cannot reach the trust assets, even in bankruptcy.[11] A properly drafted third party trust can still benefit the settlor without disrupting the asset protection. The settlor could potentially benefit from the trust through a spouse who is a beneficiary. For example, the settlor could live in a trust owned residence free from rent so long as the spouse is a beneficiary.[12] The settlor could be an income only beneficiary and still protect the trust principal.[13] The settlor could also maintain flexibility by appointing a trust protector or through the use of a special power of appointment.

If the trust has discretionary spendthrift language, the assets are also shielded from the creditors of the beneficiaries. If Raymond Grant had created a non-self-settled discretionary spendthrift trust for his wife Arline, instead of creating the two FAPTs that failed, the assets would have been protected from the IRS judgment and Arline and other trust beneficiaries could still have benefitted from the trusts. For example, the trust could have purchased a home for Arline to live in and paid Arline’s credit card bills.[14]

If true asset protection is the goal, consumers and especially promoters should remember the old adage that pigs get fat and hogs get slaughtered. The court cases make it clear that a non-self-settled trust provides proven asset protection, whereas a self-settled trust lays out the welcome mat, flips on the light, and leaves the front door wide open to creditors. If you self-settle, you settle for an inferior trust.

[1] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[2] Federal Bankruptcy Code 11 U.S.C. 541. See also In re Simmonds, 240 B.R. 897 (8th Cir. BAP (Minn.) 1999).

[3] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011).

[4] 11 U.S.C. 548(e).

[5] Dexia Credit Local v. Rogan 624 F. Supp 2d 970 (N.D.Ill. 2009).

[6] Waldron v. Huber (In re Huber), 2013 WL 2154218 (Bk.W.D.Wa., Slip Copy, May 17, 2013).

[7] American Institutional Partners, LLC v. Fairstar Resources, Ltd. (where Utah law applied against a Delaware-formed LLC), 2011 WL 1230074 (D.Del., Mar. 31, 2011), Malone v. Corrections Corp. Of Am., 553 F.3d 540, 543 (7th Cir. 2009) (a district court in diversity applies the choice-of-law rules of the state in which it sits).

[8] In re Brooks, 217 B.R. 98 (D. Conn. Bkrpt. 1998) (where the offshore trust was disregarded because it was self-settled and the onshore assets were seized).

[9] In re Lawrence, 279 F.3d 1294 (11th Cir. 2002), Bank of America v. Weese, 277 B.R. 241 (D.Md. 2002), and U.S. v. Plath, 2003-1 USTC 50,729 (U.S. District Court, So. Dist. Fla. 2003).

[10] US v. Grant, 2013 WL 1729380 (S.D.Fla., April 22, 2013).

[11] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2) and Restatement (Third) of Trusts Section 58(2), In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002), Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997).

[12] Revenue Ruling 70-155, Estate of Allen D. Gutchess, 46 T.C. 554 (1966), PLR 9735035.

[13] In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

[14] United States v. Baldwin, 391 A.2d 844 (1978) or U.S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) (where the trust assets were not subject to tax lien because the trust was not self-settled).

Law and Precedent Supporting the 541 Trust®

STATEMENT OF THE LAW

Our 541 Trust® is built on two irrefutable legal principles:

1.         With respect to an irrevocable trust, a creditor of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit (Essentially, if the trust is self-settled, it is vulnerable).  See Uniform Trust Code Section 505; RESTATEMENT (SECOND) OF TRUSTS Section 156(2) and RESTATEMENT (THIRD) OF TRUSTS Section 58(2). This principle has been adopted in hundreds of cases throughout the country and many states have enacted statutes with this identical language. For example, see Alabama Code Section 19-3B-505; Ariz. Rev. Stat. Ann. §14-7705; Cal. Prob. Code § 15304; Ga. Code Ann. § 53-12-28(c); Florida Trust Code Section 736.0505(b); Ind. Code Ann. § 30-4-3-2; Kan. Stat. Ann, §33-101; La. Rev. Stat. Ann.§2004(2); Michigan Code Section 7506(c)(2), Mo. Ann. Stat. § 456.080.3(2); Mont. Code Ann. § 72-33-305; N.Y. Civ. Prac. L. & R. § 5205(c); Ohio Code Section 5805.06; Okla. Stat. Ann. tit. 60, §175.25G; Pennsylvania Code Title 20 §7745; R.I. Gen. Laws § 18-9.1-1; Tex. Prop. Code Ann. §112.035(d); Utah Code Section 75-7-505(b); Virginia Code Section 55-545.05 ); W. Va. Code §36-1-18 (1985); Wis. Stat. Ann. §701.06(1).

2.         A settlor can retain a special power of appointment without subjecting the trust to the claims of creditors.   See RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS Section 22.1; US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681; Delaware Code Section 3536; Georgia Code Section 23-2-111; New York Code 10-7.1; Also see cases set forth below.

APPLICATION OF LAW TO THE 541 TRUST®

The 541 Trust® is an irrevocable trust that includes the following features:

1.         The settlor is not a beneficiary and no distributions can be made to or for the settlor’s benefit.

2.         The settlor retains a “special power of appointment” which allows the settlor to change the trustees, the beneficiaries, or the terms of the 541 Trust® at any time (except that the assets cannot be distributed to or for the settlor’s benefit). In addition, the settlor can appoint assets to any other person at any time.

Creditors have no claim against the 541 Trust® because no distributions can be made for the settlor’s benefit. The cases and statutes set forth below show that these powers of appointment do not give creditors any claim against the 541 Trust®There are no statutes, cases, secondary sources or commentaries to the contrary.

COURT CASES

In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002) Defendant funded irrevocable trust and retained an income interest and a special power of appointment over principal. 11th Circuit analyzes creditor’s access to an irrevocable trust. The trust principal was not included in the defendant’s bankruptcy estate. To read the case, follow this link: In re Jane McLean Brown

In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH)) – Assets of an irrevocable trust were not subject to the creditors of the settlor despite the fact that the trustees and beneficiaries had power to appoint the assets to the settlor.

Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997) – 5th Circuit Court holds that the portion of the trust that was not self-settled is not included in the bankruptcy estate, and assets subject to a special power of appointment are excluded from the bankruptcy estate. To read this case, click Shurley v. Texas Commerce Bank                 

In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982) – A court cannot compel the exercise of a special power of appointment and the assets of the trust were not included in the bankruptcy estate of a permissible appointee. To read this case, click In-re-Hicks

In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994) – The interest of a contingent beneficiary was included in the bankruptcy estate, but the interest of a permissible appointee of a power of appointment was too remote to be property and was not included in the bankruptcy estate. To read this case, click In re Knight

In re Colish, 289 B.R. 523 (Bankr.E.D. N.Y. 2002) – The interest of a contingent beneficiary was included in the bankruptcy estate. The court distinguished this from Knight and Hicks where the interest of a permissible appointee under a power of appointment was not included. To read this case, click Colish-v-United-States

Cooley v. Cooley, 628 A.2d 608 (1993) – A special power of appointment is not a part of the marital estate that can be awarded in a divorce action. As one of the possible objects of the defendant’s power, the plaintiff possesses no more than a mere expectancy. To read this case, click Cooley-v-Cooley

 Cote v. Bank One, Texas, N.A., No. 4:03-CV-296-A, 2003 WL 23194260 (N.D. Tex. Aug. 1, 2003) – Permissible appointee is not an “interested person” with standing to sue the trust. This is relevant because if the permissible appointee has no standing to sue the trust, neither should a creditor of a permissible appointee.

Avis v. Gold, 178 F.3d 718 (1999) – Permissible appointee had no interest which could be included in the bankruptcy estate, or to which an IRS tax lien could attach, prior to the time the power was exercised in favor of the debtor.

Horsley v. Maher, U.S. Bankruptcy Ct. Case No. 385-00071 (1988) – debtor was a permissible appointee of Trust A and a beneficiary of Trust B. Trust A was not included in the bankruptcy estate because “the debtor holds no interest in Trust A.” The assets of Trust B were included in the bankruptcy estate.

  1. S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) – Assets subject to discretionary special power of appointment not subject to tax lien

Spetz v. New York State Dep’t of Health, 737 N.Y.S. 2d 524 (Sup. Ct. Chautauqua Co, Jan. 15, 2002) – New York Supreme Court holds that special power of appointment does not cause trust assets to be taken into account for purposes of Medicaid qualification

Verdow v. Sutkowy, 209 F.R.D. 309 (N.D.N.Y. 2002) – Assets subject to special power of appointment not taken into account for purposes of Medicaid qualification

United States v. Baldwin, 391 A.2d 844 (1978) – Assets subject to special power of appointment not subject to tax lien

Estate of Ballard v. Commissioner, 47 BTA 784 (1942), aff’d, 138 F.2d 512 (2nd Cir. 1943) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Kneeland v. COMMISSIONER OF INTERNAL REVENUE, 34 BTA 816 – Board of Tax Appeals (1936) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Helvering v. Helmholz, 296 US 93 (Supreme Court 1935) – Assets of trust not included in wife’s estate merely because the beneficiaries had the power to terminate the trust and return the assets back to the wife.

Price v. Cherbonnier, 63 Atl 209 (1906) – Creditors of the donee of a special power of appointment cannot reach the assets subject to the power.

Gilman v. Bell, 99 Ill. 194 (1881) – Assets subject to power of appointment not subject to claims of creditors.

Jones v. Clifton, 101 US 225 (1879) – Assets subject to power of appointment not subject to claims of creditors.

Holmes v. Coghill, 33 Eng. Rep 79 (1806) – Assets subject to power of appointment not subject to claims of creditors.

____________________________________________________________________________

For an excellent summary of the law supporting this kind of trust (from an unrelated law firm), see Asset Protection Planning with Trusts – A Practical Overview by Alexander A. Bove, Jr. published in Journal of Practical Estate Planning (CCH Inc., April-May 2002).

How to Attack an Asset Protection Trust and How to Defend Against Such an Attack

If you read all the asset protection cases out there, you will find that there are really only three ways to attack a well crafted asset protection trust: (1) attempt to prove that the transfers to the trust were fraudulent transfers, (2) attack a self-settled asset protection trust by using the laws of a state or jurisdiction that doesn’t recognize self-settled trusts, or (3) attack the trust based on several related theories referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory. For purposes of this article, the third category will be referred to as “veil piercing.”

Fraudulent Transfers

It is easy to completely avoid and prevent an attack based on a fraudulent transfer theory. You simply transfer your assets to your asset protection trust in advance of a problem, lawsuit, or bankruptcy. Note that the courts analyze fraudulent transfers based on if a prudent person in your situation might or could have foreseen liability given the circumstances. 

For example, in Albee v. Krasnoff,[1] Mr. Krasnoff was a fifty percent owner of an investment partnership with hundreds of investors. Mr. Krasnoff conveyed a home to an irrevocable trust for his wife. Five years later it was discovered that Mr. Krasnoff’s partner had embezzled money from the partnership. All the investors lost money and sued the partnership as well as Mr. Krasnoff and his partner. The investors argued that the transfer to the trust was fraudulent because it occurred after the investment had been made, but the court ruled that the transfer was not fraudulent because it was done for estate planning purposes and Mr. Krasnoff had no knowledge of the fraud or the potential claim when the transfer was made.

In another court case called, In the Matter of Damrow,[2] the court examined two separate transfers by the same person, and the court found that one of them constituted a fraudulent transfer, and the other did not. When the first transfer was made, in January of the year 2000, Mr. Damrow had guaranteed significant loans to several lenders, but he was not behind on payments. When the second transfer was made, in November of 2001, Mr. Damrow was behind on payments and several creditors had initiated collection activities. The court found that the second transfer was fraudulent because Mr. Damrow was insolvent when he made it, and the first transfer was not fraudulent because he was not insolvent when the first transfer was made.

If you make a transfer with actual intent to hinder, delay, or defraud a creditor, or if you make a transfer at a time and under circumstances that appear to be a fraudulent transfer, then a creditor can obtain a judgment against the trust regardless of how well the trust is designed and drafted. Countless court cases make it unmistakably clear that no asset protection trust, domestic or offshore, can be relied upon to protect assets if the transfers are made at a time and under circumstances that are likely to result in a fraudulent transfer.

Even if you do have a current lawsuit or judgment against you, you may be able to make a transfer to an asset protection trust that is not a fraudulent transfer if you retain sufficient assets in your name to satisfy the pending judgment. The test that is used to determine if a transfer is fraudulent is based on your specific facts and circumstances. If you have any question whether a transfer could be considered fraudulent, you should consult legal counsel regarding your specific situation.

In summary, the best way to defend against a fraudulent transfer attack is to create and fund your asset protection trust at a time when you are not insolvent, the transfer does not render you insolvent, you have no judgments against you, you are not behind on payments, and you have no reason to believe that substantial liabilities or judgments are imminent. If you do so, the fraudulent transfer attack is avoided and you can move on to the next phase of the analysis.

Self-Settled Trusts

The common law rule in the United States has always been that if a settlor is also a beneficiary of a trust, the settlor’s creditors can reach the maximum amount which the trustee can pay to the settlor. (See Restatement (Second) of Trusts, Section 156 and Uniform Trust Code Section 505). Over the past thirty years, several domestic and offshore jurisdictions have passed statutory laws providing that the assets of a self-settled trust (a trust in which the settlor is also a beneficiary) are protected from creditors. Almost all offshore and domestic asset protection trusts are based on these new laws which provide asset protection for a self-settled trust.

If you create a self-settled asset protection trust in a supportive jurisdiction, a creditor could attack your trust by arguing that the law of a different jurisdiction applies. For example, if you create a Delaware asset protection trust, a creditor from New York may argue that New York law applies instead of Delaware law because the offense occurred in New York and the offended party is a resident of New York. Because the laws of the State of New York do not allow a debtor to protect assets in a self-settled trust, the New York courts could potentially allow a New York resident to obtain a judgment against the trust. Similarly, it is possible that a federal court (including a bankruptcy court) could refuse to recognize the laws of a jurisdiction that provides asset protection for a self-settled trust. Because domestic self-settled asset protection trusts have only been around for 13 years, there are no court cases on this issue at the present time. There are however, two federal bankruptcy cases where the bankruptcy court has refused to recognize the self-settled trust laws of a foreign jurisdiction because it is against the policy of the federal bankruptcy courts.[3]

In the Portnoy case cited above, Judge Brozman of the Federal Bankruptcy court said, “I think it probably goes without saying that it would offend our policies to permit a debtor to shield from creditors all of his assets because ownership is technically held in a self-settled trust.”[4]

In Dexia Credit Local v. Rogan,[5] Dexia sued Peter Rogan for fraud, conspiracy, and other torts and obtained a judgment against him for $124,000,000. Rogan had established a trust under Bahamian law which protects the assets of a self-settled trust from the creditors of the grantor. The Illinois court said that it would not honor the laws of a jurisdiction where doing so would violate the public policy of the State of Illinois.

You can avoid an attack based on a self-settled trust theory by simply not using a self-settled trust. If you create an irrevocable trust for your spouse and children and you are not included as a beneficiary, the risk of an attack based on a self-settled trust theory is completely eliminated.

There are other ways that you can potentially receive benefits from a trust without being included as a beneficiary. For example, you could receive a salary for managing companies owned by a trust. Or, the trust could provide distributions to your spouse, which your spouse could later transfer to you as a gift or allow you to enjoy as a collateral benefit of being married to a wealthy spouse. Another option is to grant your spouse or some other person a special power of appointment. This is a power to appoint the assets of a trust to anyone except for the person who holds the power (or their estate or their creditors). The special power of appointment could be used to provide benefits to you if necessary, even though you are not a beneficiary of the trust. Many statutes and cases support the fact that a special power of appointment does not create creditor rights.[6]

In summary, you can avoid an attack based on a self-settled trust theory by not using a self-settled trust. However, this creates other risks because it means that you are left out as a beneficiary. The best way to solve this problem is to include a special power of appointment in the trust, and design a system of trustees and trust protectors that ensures that no person has power to abuse the trust.

Veil Piercing

The only other way to attack an asset protection trust is to argue that the trust is not to be respected as a separate legal entity from the debtor. This attack is often referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory. There are many court cases discussing and applying these theories to determine if a creditor can pierce an irrevocable trust.

For example, in Dean v. United States,[7] George and Catherine Mossie established an irrevocable trust for the benefit of their children for estate planning purposes. They transferred assets to the trust on December 4, 1990. At the time the transfer was made, they were not aware that their tax return from 1988 was being audited. Later the IRS, audited all their returns from 1987 to 1990 and assessed back taxes and penalties against the Mossies in the amount of $281,093.95. The IRS placed a federal tax lien on the assets of the trust by claiming that it was the alter-ego of the Mossies, and the trustees sued to have the lien removed.

It is interesting to note the following facts pertaining to the alter-ego analysis:

  1. Except for a brief period at the beginning of the trust when Catherine Mossie used her personal checking account to pay rental expenses for the trust property, all trust checks were signed by the trustees and not the Mossies.
  2. All deeds, transfer documents, tax returns, and promissory notes pertaining to the trust were signed by the trustees.
  3. All management decisions concerning the trust were made by the trustees.
  4. The trustees did allow Catherine Mossie to live in a home owned by the trust without rent.
  5. The trust owns a car which it makes available for the personal use of George and Catherine Mossie.
  6. The trust owns a vacation home which it has made available to Catherine without rent, once or twice.
  7. George and Catherine Mossie have received no money from the trust, except for reimbursement for nominal trust expenses paid by the Mossies.
  8. The trustees were two of the Mossie’s four daughters.

The court recited the general rule for applying the alter-ego doctrine which is that a separate entity will be respected unless it was so dominated that it had “no separate mind, will or existence of its own.” The court found that the Mossies had established the trust for legitimate estate planning purposes and that the legal control of the trust assets had shifted to the trustees. It is true that the trustees had allowed the Mossies to receive some collateral benefits from the trust but the court said that is how families do function and should function and small deviations from the trust are not enough to invalidate the whole trust. In the end, the court ordered the IRS to return the trust property to the trustees and release the tax liens against the trust property.

Another example is the case called, In re Vebeliunas.[8] In the Vebeliunas case, a wife established an irrevocable trust for her husband (the “debtor”), naming herself as the sole trustee. The court found that the creditor was not able to pierce the veil of the trust, despite the following facts: (1) the debtor was indicted for fraud, (2) the debtor filed for bankruptcy to obtain relief from his creditors, (3) the bankruptcy court sought to have the debtor declared the alter ego of the trust and to have the trust assets treated as part of debtor’s bankruptcy estate, (4) the debtor’s family received and retained rent proceeds from trust, (5) the debtor and his family lived on property owned by the trust without paying rent to the trust; (6) the debtor granted easements on property owned by the trust, (7) the debtor and his wife deducted from their personal tax returns real estate taxes and interest expenses relating to the trust, (8) the debtor granted mortgages on property owned by the trust, (9) the debtor pledged the trust property in order to obtain bail in his criminal case; and (10) the debtor represented to several banks that his revocable trust owned the property which was actually owned by the irrevocable trust. Although the debtor probably pushed the limits of dominion and control over the trust in this case, this case illustrates the fact that a court will generally uphold an irrevocable trust as a separate and distinct legal entity unless the debtor exerts so much dominion over the trust that it has no separate identity.

Similarly, in Miller v. Kresser,[9] a mother created a trust for her son and named another son as the trustee. The beneficiary son was sued for over $1,000,000. The trial court found that the beneficiary son exerted significant control over the trust by taking money out without the trustee’s knowledge, dominating investment decisions, and keeping possession of the trust checkbook. The Florida 4th District Court of Appeals upheld the creditor protection provided by the trust even though “the facts in this case are perhaps the most egregious example of a trustee abdicating his responsibilities . . . the law requires that the focus must be on the terms of the trust . . . and the trust did not give the beneficiary any authority whatsoever to manage or distribute trust property.”

We think these cases demonstrate the fact that a court will generally uphold the separate existence of a trust, just as they generally uphold the separate existence of a corporation, unless the facts are so egregious as to indicate a total disregard of the legal entity so that it becomes the alter-ego of the debtor.

The solution to avoiding these attacks is really quite simple: (1) the trustee should demonstrate control over the trust and abide by the terms of the trust instrument, (2) the presence of an independent trustee is not required, but it goes a long way to show that the trust is a separate legal entity from the grantor or the beneficiaries, (3) the grantor and beneficiaries should not exert so much control or dominion so that they appear to be the owners of the trust assets, (4) the benefits of the trust should be reserved for the beneficiaries, and (5) transactions with the trust should be on the same terms as would be expected between unrelated parties.

Another way to defend against the veil piercing type of attack is to locate the trust in a state with greater asset protection laws. Currently, the best states are Nevada, Alaska, and South Dakota. A person in any state can create a trust in one of these locations by appointing a trustee in the state where they want the trust to be located. Consider the language of these Nevada Statutes which are designed to protect against a veil piercing attack:

NRS 163.4177 Factors which must not be considered exercising improper dominion or control over trust. If a party asserts that a beneficiary or settlor is exercising improper dominion or control over a trust, the following factors, alone or in combination, must not be considered exercising improper dominion or control over a trust:

  1. A beneficiary is serving as a trustee.
  2. The settlor or beneficiary holds unrestricted power to remove or replace a trustee.
  3. The settlor or beneficiary is a trust administrator, general partner of a partnership, manager of a limited-liability company, officer of a corporation or any other manager of any other type of entity and all or part of the trust property consists of an interest in the entity.
  4. The trustee is a person related by blood, adoption or marriage to the settlor or beneficiary.
  5. The trustee is the settlor or beneficiary’s agent, accountant, attorney, financial adviser or friend.
  6. The trustee is a business associate of the settlor or beneficiary.

NRS 163.418 Clear and convincing evidence required to find settlor to be alter ego of trustee of irrevocable trust; certain factors insufficient for finding that settlor controls or is alter ego of trustee of irrevocable trust. Absent clear and convincing evidence, a settlor of an irrevocable trust shall not be deemed to be the alter ego of a trustee of an irrevocable trust. If a party asserts that a settlor of an irrevocable trust is the alter ego of a trustee of the trust, the following factors, alone or in combination, are not sufficient evidence for a court to find that the settlor controls or is the alter ego of a trustee:

  1. The settlor has signed checks, made disbursements or executed other documents related to the trust as the trustee and the settlor is not a trustee, if the settlor has done so in isolated incidents.
  2. The settlor has made requests for distributions on behalf of a beneficiary.
  3. The settlor has made requests for the trustee to hold, purchase or sell any trust property.
  4. The settlor has engaged in any one of the activities, alone or in combination, listed in NRS 163.4177.

Conclusion

In our experience, most properly designed asset protection trusts are never discovered in the first place. If you are sued or subject to some kind of unexpected liability, the creditor will ask for your personal financial statements. Because you have no ownership in the trust or its assets, they should not be included on your personal financial statements. If your trust is funded more than two years before you file bankruptcy, the trust is usually not discovered through a typical bankruptcy proceeding.

Although an asset protection trust is not discovered in the majority of cases, one should never rely solely on secrecy to defend against every attack. A sophisticated creditor can always get you under oath and ask enough of the right questions to discover the trust. If that happens to you, you should always answer honestly and with confidence that your trust was established for appropriate purposes and that it will hold up on its own merits. The best asset protection trust has the following characteristics: (1) it is funded in advance of a problem, (2) it is created for legitimate estate planning purposes, (3) it is an irrevocable trust that does not include the grantor as a beneficiary, (4) it includes an independent professional trustee in the State of Nevada (although it is possible to use a family member or friend in your home state as long as the parties respect the trust as a separate legal entity), and (5) it includes a special power of appointment which provides flexibility to the trust despite the fact that the trust is irrevocable.

[1] 566 SE 2d 455 (Ga.Ct. Appeals 2002).

[2] Case No. BK02-43392 (Bankr.Neb. 3/13/2007) (Bankr.Neb., 2007).

[3] See In re Portnoy, 201 B.R. 698, and In re Brooks, 217 B.R. 98.

[4] In re Portnoy at 700.

[5] 624 F. Supp. 2d 970 (N.D. Illinois 2009).

[6] See US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681, Delaware Code Section 3536, In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH), In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982), In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994), RESTATEMENT OF THE LAW (SECOND) PROPERTY, Section 13.6.

[7] 987 F. Supp. 1160 (December 4, 1997).

[8] 332 f. 3D 85 (Ct. Appeals 2nd Cir. 2003).

[9] 2010 Fla. App Lexis 6152.

IRREVOCABLE TRUSTS

What is an irrevocable trust? 

As you may guess, it is a trust that cannot be “revoked” or drastically changed. When you give property and assets to a revocable trust to manage and distribute according to rules you helped create, you keep the power to change, remove, sell, and use property and assets in the same way you do now. With an irrevocable trust, you lose the option to ‘take-back’ the assets.

Inflexibility with an irrevocable trust is not a commonly sought-out quality in an irrevocable trust. The most influential reasons for using an irrevocable trust in your estate plan arise when property in a trust is considered “yours” or “not yours.” There are some important times where an irrevocable trust can make sure that money is not considered “yours.”

Asset Protection

Asset protection is an important goal for many prospective clients. Asset protection helps provide peace of mind in knowing that potential future events (like divorce, business troubles, or lawsuits) won’t risk financial security. Using an irrevocable trust helps keep the property you put in trust from being treated as “yours” if one of these events occurs and creditors try to reach the property you intend to protect.

Estate and Gift Tax

It’s important to note that, for many people, gift tax won’t be an issue and the estate tax will affect even fewer. They’re still worth considering, though. A brief explanation: the current estate tax paid out of your estate after death has an exemption of $11,580,000 for a couple in 2020, meaning that very few people will have to actually pay any taxes on money exceeding the exemption amount. Gift tax returns, by contrast, are filed annually when you give large gifts. They add up over your lifetime to reduce that $11.5 million exemption upon death. In 2020, a gift tax return has to be filed if one person gives one other person more than $15,000 in a single year (spouses can gift twice that, and couples can receive twice that). 

Gift Tax: Money in an irrevocable trust can create gift tax liability, so irrevocable trusts can be a useful tool to avoid gift taxes. While trusts have their own tax and accounting responsibilities, putting property in an irrevocable trust is part of making sure that the IRS does not require you to file a gift tax return.

Estate Tax: If your estate is large enough to run up against the $11,580,000 exemption, making your trust irrevocable is part of keeping the IRS from considering that property as part of your taxable estate at death.

Conclusion

While a revocable trust provides flexibility, there are protections it cannot provide that ARE available in a properly drafted irrevocable trust. Irrevocable trusts can protect property from creditors, estate and gift tax, and [income tax?]. McCullough Sparks is experienced in drafting various specialized irrevocable trusts to provide for each client’s needs.