3. Moreover, in a state such as Delaware, there should be no state income tax on undistributed income of the trust.13

4. The trust assets may or may not be included in the settlor's estate, depending primarily on whether he or she retains the right (testamentary) to direct or alter the distribution of the trust property.14 If the settlor has not made a completed gift on the funding of the trust, then distributions to beneficiaries other than the settlor will be taxable gifts.  Otherwise, a taxable transfer occurs at death.  Careful consideration should be given to the trade-off between a current taxable gift and estate tax inclusion.

5. The settlor therefore achieves the benefits of creditor protection and state income tax deferral, while retaining both the potential for distributions back to him or her and the ability to control, to one degree or another, the eventual disposition of the trust assets, in exchange for outright control over those assets.

6. Assuming that allocation of GST exemption can be properly managed, the dynasty trust can be a beneficiary of distributions from the trust, whether during the life of the settlor or at his or her death (or both).  The settlor can appoint a "family" trustee to facilitate this process and enhance the effectiveness of the DAPT as a platform for further generational planning, and also can retain a veto power over distributions (although perhaps not without adverse estate tax consequences).15

The DAPT strategy still has a number of unanswered questions, chiefly its basic efficacy as an asset protection strategy.  Substantial doubt exists whether a court in a non-DAPT state would apply the law of the DAPT state, rather than its own state law, particularly if the Trustee were subject to the jurisdiction of the court.16  A court in a DAPT state may find itself obliged under the Full Faith and Credit Clause of the Constitution to give effect to a judgment rendered in a non-DAPT state.  Finally, and perhaps most significantly, the DAPT was severely limited in the bankruptcy context by the imposition of a 10-year lookback period by the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act.17

However, even if the asset protection features of the DAPT eventually fail to withstand challenge, the benefit of state income tax deferral alone may justify the transaction costs, loss of outright control, and general inconvenience involved.  Moreover, if the trust is funded, in whole or in part, with assets that are otherwise exempt from creditors' claims, the other planning opportunities outlined above may make the vehicle attractive even if its "principal" advantage remains uncertain.

Consider, for example, a DAPT that owns permanent life insurance on the settlor (or on the joint lives of the settlor and her spouse).  Permanent life insurance policies with cash value offer significant opportunity for asset protection.  In some states there is creditor protection of some or all of the cash value while living, although this typically is limited to resident insureds.18

The following states have unlimited exemption for the proceeds of life insurance: Alabama, Idaho, Kansas, Michigan, New Mexico, North Dakota, Oregon, Texas, Washington, Delaware, Illinois, Kentucky, Missouri, New York, Ohio, Rhode Island, Vermont, Wyoming, Florida, Indiana, Massachusetts, New Jersey, North Carolina, Oklahoma, Tennessee, and Virginia

A majority of states will not subject the proceeds of a life insurance policy to the claims of the insured's creditors, unless they are payable to the insured's estate or otherwise assigned for the benefit of creditors.19   However, protection can be lost in some states by the following:

?    Making a change of the beneficiary while going through bankruptcy or insolvency.
?    Making an assignment of the policy to a creditor such as a bank.
?    In some states, naming a beneficiary other than a spouse, child or another dependent.20 
?    Reserving the power to make a beneficiary change.
Presumably, then, the life insurance held in the DAPT would be exempt from creditors' claims regardless of the efficacy of the DAPT as an asset protection structure.

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