What You Should Know About Lifetime Asset Protection Trusts
1. What is an Asset Protection Trust?
An asset protection trust is an estate planning tool designed to minimize the exposure of assets to seizure by future creditors. In its simplest form, a person (the “trustor”) re-titles ownership of an asset into the name of an irrevocable trust, which is managed by an independent person or company (the “trustee”) for benefit of the trustor. If a lawsuit is filed against the trustor, and a judgment is won, the trust is structured to shield its asset from seizure by the judgment creditor. The existence of the trust can be very effective at encouraging settlements before or during litigation. If a creditor knows that it must incur substantial expenses to litigate the case – and has uncertainty whether the trust asset can ever be seized – there is strong incentive for a creditor to settle at favorable terms.
An asset protection trust is not a tax avoidance tool because it is treated as a grantor trust during the lifetime of the trustor. This means that all income earned by the trust – no matter where located – is reported on the trustor’s personal tax return.
2. What assets may be transferred into an Asset Protection Trust?
Typically, investments such as brokerage accounts, real estate, small business stock, partnership units, and LLC membership interests are used to fund the trust. It is important that the trustor remain solvent after funding the trust in order to avoid violating fraudulent transfer laws. Thus, some assets should be left outside the trust. A transfer is also ineffective when a creditor claim is imminent.
3. Who may serve as trustee?
The trustor may not serve as sole trustee. Without an independent trustee, the trust will be disregarded and fail to provide any protection from creditors. The trustor may retain a power to remove the independent trustee and appoint a new independent trustee.
4.
How does an Asset Protection Trust compare to a corporation or LLC?
How does an Asset Protection Trust compare to a corporation or LLC? The primary benefit of a corporation or LLC is to isolate business assets from personal assets. But even this benefit is minimal when the owner is sued personally. A creditor can seize corporate stock and vote to remove the stockholder from control of the company. In addition, a
creditor can foreclose on the stock and take the corporate assets. A limited liability company (“LLC”) may protect the assets, but the level of protection depends on where the LLC is registered. Although all states have LLC statutes, one state may have better protections than another.
In Arizona, a creditor can obtain a charging order against an LLC. This means that any distributions from the LLC must go to the creditor, but no judge can order a distribution. This is superior to many other states (e.g., California) that permit a creditor to foreclose on the owner’s interest. However, charging orders protect the assets in the LLC, but they do not protect the income stream or distributions to the owner. The asset protection trust solves this problem. When an independent trustee manages a trust owning LLC membership interests, the trustee will decide when and whether to pay out distributions. Under trust law, the beneficiary’s income interest in the trust is protected from creditors if the trustee has full discretion.
The combination of a LLC in a favorable state with a domestic asset protection trust is an excellent way to protect S-corp stock.
5. Where is the trust established?
A domestic asset protection trust is created under the laws of a specific US state. They are only permitted in a handful of states, such as Delaware, Wyoming, Alaska and Nevada. An Arizona resident may establish a trust in one of these states by appointing an independent trustee located in that state. Although growing in popularity, the domestic asset protection trust is relatively new in American law and should therefore be used cautiously.
Foreign asset protection trusts provide the ultimate protection available today. Although they will always require the appointment of a foreign co-trustee, the trust assets may remain in the US – or at least until a possible claim is on the horizon. What creditor would want to bring the lawsuit in a foreign jurisdiction knowing that even a judgment there might not actually lead to seizure of any assets?
6. How much does an Asset Protection Trust cost?
Typically the cost of an asset protection trust prepared by a qualified attorney is about $15,000 to $30,000. There is also usually an annual fee paid to the independent trustee of several thousand dollars depending on the trustee’s level of involvement in managing the trust assets and amount under management.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
Thomas J. Bouman, Attorney
Bouman Law Firm
7650 E. Broadway Blvd. #108
Tucson, AZ 85710
(520) 546-3558
