Pros and Cons of Domestic Asset Protection Trusts

What Is a Domestic Asset Protection Trust?

A domestic asset protection trust (DAPT) is a self-settled irrevocable trust that protects the trust’s assets from the grantor’s future creditors while still allowing the grantor to be a discretionary beneficiary. The trust must be formed under the laws of a state that specifically authorizes this type of asset protection..

How Does a Domestic Asset Protection Trust Work?

A domestic asset protection trust is a type of self-settled trust created by a trust agreement that features asset protection provisions.

A trust is a self-settled trust if and when the person (settlor) who creates the trust and transfers the assets to the trust is also a trust beneficiary.

Many states have laws that are hostile to self-settled asset protection trusts. But, there are a few states that have enacted statutes that expressly protect assets held in these self-settled trusts.

Trusts created under these favorable state statutes are referred to as domestic asset protection trusts. The DAPT statutes provide that assets you transfer to a trust for the benefit of yourself, and possibly family members, cannot be reached by your civil judgment creditors.

All states’ DAPT statutes require that you appoint a trustee that is either an individual domiciled in the state or a trust company licensed in the state.

We find that the DAPT works best when the trust has additional state connections, such as real property or financial accounts, located within the DAPT state.

Fraudulent Transfers to a DAPT

A fraudulent transfer means a transfer of legal ownership of your assets to another person or trust that is intended to delay or hinder your creditors.

Your transfer of your assets to your trust may be deemed fraudulent if there was a legal claim pending at the time of the transfer. The same claimant may bring a fraudulent transfer action if they obtain a civil judgment and attempt to collect on it.

The judgment creditor’s remedy is either a reversal of the fraudulent transfer or a judgment against the recipient of the transfer for the value of the assets conveyed.

All states have a statute addressing fraudulent transfers. State statutes have a “statute of limitations” that limits the time period after a transfer to a trust that creditors have to assert fraudulent transfer lawsuits.

The statute of limitations for transfers to a DAPT trust in many DAPT states is shorter and more challenging for creditors compared to fraudulent transfer claims against other types of transferees.

Also, most DAPT states impose a high standard of proof for fraudulent transfer claims. Creditors must prove their fraudulent transfer allegations by “clear and convincing evidence” instead of the mere preponderance of evidence standard otherwise applicable to most civil litigation.

What Are the Best States for Domestic Asset Protection Trusts?

There are 21 states with some form of self-settled trust asset protection trust laws. There are important distinctions among these states’ asset protection laws. These are the most important things you should consider in evaluating where you form your DAPT:

1. Does the DAPT state have an income tax?
2. How long is the statute of limitations for creditor-initiated fraudulent transfer attacks?
3. Does the state’s DAPT statute remove asset protection for certain priority creditors, such as alimony or child support?
4. Do trust settlors have to file an affidavit of solvency for asset transfers to their trust?

We recommend our clients form a domestic asset protection trust in either Nevada or South Dakota. These states have no state income tax, a short two-year statute of limitations for fraudulent transfers, and do not require an affidavit of solvency for transfers.

Both states have several well-established and reliable trust companies offering DAPT trustee services. Nevada law provides no exception from protection for claims for alimony or child support.

Trust Protectors of Domestic Asset Protection Trusts

Domestic asset protection trust agreements typically include a position known as the “trust protector.”

The trust protector is a person or company other than the trustee. The DAPT agreement grants the protector the authority to better protect the trust from creditors.

These powers include the right to govern distributions to the settlor, the right to fire and replace the trustee, the power to change beneficiaries, and the power to amend the trust agreement for tax purposes or to improve asset protection.

We recommend that our clients appoint a trusted attorney or CPA as a trust protector.

Do Domestic Asset Protection Trusts Really Work?

Domestic asset protection trusts are very effective asset protection tools for people residing in the DAPT state. The DAPT statutes are designed and intended to protect the state’s own residents.

Whether a standard DAPT is as effective for residents of states lacking a good DAPT statute is a different question. The answer depends upon a court’s evaluation of what are referred to as “conflict of law” principles.

The issue is whether the laws of the debtor’s residence or the laws of the DAPT state where the trust is formed control the protections afforded the debtor and his trust property when the debtor does not reside within the DAPT state. Even if the trust agreement states that the trust is created and is interpreted under the laws of a DAPT state, the court may not accept the choice of state law expressed in the trust agreement.

Does Florida Recognize Domestic Asset Protection Trusts?

Florida does not allow domestic asset protection trusts. A Florida resident who creates a DAPT in another state, like Nevada or South Dakota, is still subject to Florida law.

Florida courts will not recognize asset protection for a trust where the person who created the trust is also a beneficiary. That means a Florida resident’s creditors can still reach the trust assets, even if the trust was properly formed in a DAPT jurisdiction.

Some states, including Florida, have a public policy against any self-settled asset protection trust, regardless of the law chosen within the trust agreement.

Other non-DAPT states are not as hostile to asset protection trusts created by the statutes of a DAPT state, especially if the debtor has a trustee and assets located in the DAPT state.

Other Problems

Another practical problem with domestic asset protection trusts is that the trustee and a trust protector typically reside in the DAPT state, where they are subject to U.S. court jurisdiction and orders.

If a fraudulent transfer complaint is initiated against your asset contributions to a DAPT, your trustee will turn over your trust assets to a creditor if ordered by a U.S. judge. The trustee is not going to expose itself to legal and financial risk defending your assets against your creditors in the face of a domestic court order from any state.

Alternatives to Domestic Asset Protection Trusts

There are other asset protection trusts that provide better asset protection for Florida residents and others residing in non-DAPT states. These alternatives are an offshore asset protection trust and a family irrevocable trust.

Offshore Trusts Provide Better Asset Protection

An offshore asset protection trust is a trust for the benefit of a settlor created and administered under the laws of a foreign jurisdiction with favorable asset protection laws.

Offshore trusts typically require a foreign trustee and often, a foreign trust protector as well. Offshore trust jurisdictions do not recognize U.S. civil judgments, and their laws make it difficult for judgment creditors to pursue fraudulent transfer claims. Currently, Cook Islands trusts have the best offshore trust statutes and foreign trustee companies.

A creditor may find it difficult and expensive to pursue fraudulent transfer actions against trustees residing beyond the jurisdiction of U.S. civil courts. The offshore trustee likely will ignore any U.S. civil court action directed against the trust.

Offshore trusts are a good option for asset protection after a lawsuit is filed and transfers to the trust are clearly intended to protect assets from a judgment.

Offshore trust are less effective if you plan to file bankruptcy.

Offshore trusts are complicated, and you should expect to pay at least $15,000 in legal fees plus a small amount of fees to the foreign trustee.

A Family Irrevocable Trust Provides Effective and Cost-Efficient Asset Protection.

A family irrevocable trust is an irrevocable trust you create for the benefit of your family, including your spouse and descendants. You are initially not a permissible beneficiary, so this trust is not a self-settled trust that offends Florida’s policy and precedent against self-settled asset protection trusts.

A family irrevocable trust appoints a trusted friend or family member as a discretionary trustee with authority to make discretionary distributions of income and principal to your family beneficiaries, primarily your spouse. Your spouse can then pay living expenses, make investments, or transfer her money to an asset-protected financial account. The trust agreement has provisions to protect against divorce.

Additionally, this type of trust provides for another trusted professional or friend who serves as trust protector. The trust protector has the right to add you, the settlor, as a trust beneficiary and direct distributions to yourself.

The trust agreement includes provisions that protect trust property and trust distributions from your creditors. These protections are effective under Florida law. This type of irrevocable trust is also effective if you decide to file for bankruptcy.

We believe that Florida law clearly protects this type of irrevocable trust from your civil creditors. The family irrevocable trust is simpler and less costly than the offshore trust alternative when established in advance of creditor claims.

Frequently Asked Questions