Case Law
Since not all states support domestic asset protection trusts, lawsuits have challenged the validity of those in which the grantor or the assets don’t reside in the state where the trust was established. For example, in 2018, in a case known as Toni 1 Trust v. Wacker, two Montana families were tied up in litigation when one of them sought to shield assets by transferring them to a trust in Alaska. The courts ultimately nullified the trust, declaring the transfers fraudulent since they were made solely to avoid an existing obligation.
Similarly, in Waldron v. Huber, the owner of a real estate investment and development concern in Washington state created a domestic asset protection trust in Alaska to shield his assets from debt obligations he couldn’t meet. The court again found that the trust was a fraudulent transfer of assets made with the intent of avoiding already established creditors.
“Technically, these were bankruptcy and fraudulent transfer cases, not choice-of-law cases,” says Steven Oshins, managing partner at Oshins & Associates in Las Vegas. There still hasn’t been a case where a domestic asset protection trust lost because of a legal issue, he says.
Jeffrey Lauterbach, a family office consultant in Chadds Ford, Pa., agrees. “The little bit of case law that exists primarily concerns people doing a bad job of planning—putting all their money in the trust when they knew they had claims against them,” he says.
Still, if your client or client’s assets are in a state that doesn’t support domestic asset protection trusts, Lauterbach suggests making sure the trustee does reside in the state where the trust is established.
Hybrid Trusts
To avoid such potential complications, Oshins often recommends a hybrid version of the domestic asset protection trust. It’s like a third-party spendthrift trust—not self-settled, meaning the grantor is not a beneficiary. The difference is, the trustee can add beneficiaries, including the grantor, later on, at which point it reverts to a regular DAPT.
A Patchwork Of State Laws
If a client’s state doesn’t support domestic asset protection trusts, it might pay to shop around. Each state that allows the trusts has different rules. “Nevada and South Dakota are regularly ranked as the most supportive of protecting assets, with statutes designed to provide maximum protection,” says Steven Skancke, chief economic advisor at Keel Point in Washington, D.C.
Some no-income-tax states exempt earnings on DAPT assets from state income taxes, while others specifically do not. “Most states don’t protect against child support awards,” says Eva Victor, senior vice president and director of wealth planning at Girard, a Univest Wealth division in King of Prussia, Pa.
Moreover, most states have a three- or four-year statute of limitations before establishing protection of assets in the trust, though Nevada’s waiting period is just two years. “This gives Nevada a leg up when marketing DAPTs,” says David Work, managing director of estate and financial planning at Hightower in Dallas.
Keep Some Assets Outside The Trust
Whatever the merits of asset protection trusts, it’s a good idea to keep some assets outside of them. Trust assets are out of reach, after all, and your client will need other funds to live on in retirement.
Keeping some assets separate is also essential for establishing the trust’s validity. “Attorneys who do this work have developed a set of best practices,” says Lauterbach, the family office consultant. “Many of them require an affidavit of financial solvency from the client to demonstrate or at least claim that they can support themselves independently of the trust.”
Ultimately, asset protection trusts are just part of “building a strong liability shield,” says Mallon FitzPatrick, a managing director and principal at Robertson Stephens in San Francisco. A combination of liability insurance, a limited liability company (LLC) or family limited partnership (FLP), and an asset protection trust is often best. “Layering an LLC inside the asset protection trust further shields the assets,” he says.