Other Considerations

April 13, 2006

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When deciding whether to set up a Delaware or Alaska asset protection trust, there are a number of miscellaneous issues to consider.

Fees. There will be legal fees for drafting the trust and fees charged by the trustee for administration of the trust. These costs, in many cases, will pale in comparison to the savings that can be generated if the trust protects you from a major judgment creditor--provided, of course, that the trust is upheld as valid.

The irrevocable nature of the trust. Because the trust will have to be irrevocable, the decision to establish the trust should be well thought out. Once established, you cannot change your mind as to particular provisions (for example, you can't remove your wayward son from the list of contingent beneficiaries) or as to whether the trust should have been created in the first place.

Discretionary distributions. Further, because the trust should not be structured to make mandatory distributions of income or principal, you will have to depend on the trustee's judgment in deciding whether to make a requested distribution.

However, you will have provided the trustee with guidance in making discretionary distributions in the trust document. Further, many clients use a letter addressed to the trustee requesting, but not requiring, that distributions be made when requested under certain circumstances. While not bound by such a letter, trustees know they will not be in business long if they gain a reputation as being unresponsive to client's requests. Thus, in practice, requests generally are honored.

Estate tax and income tax considerations. Assets within a properly constituted asset protection trust should escape federal estate taxes. Thus, the trust also functions as an estate planning device.

Transfers to the trust should be deemed completed gifts. Such transfers would reduce the unified estate tax exemption ($2 million for 2006-2008). However, the trustor could transfer up to $12,000 in 2006 and 2007, per beneficiary of the trust (other than to himself or herself), without reducing the exemption (see our discussion on this annual gift tax exclusion).

The trust ordinarily would be a separate tax-paying entity, absent special language that establishes a different result. This may not be desirable, as it creates additional administrative burdens and costs, and usually results in higher taxes. However, special language can be used to make the trust a grantor trust. In that case, the trust's income would all be taxed to the trustor, at his or her individual rates, and reported on the trustor's individual income tax return, Form 1040. This option is likely to lower the tax burden and administrative costs of the trust.

Other clauses. A domestic asset protection trust should have a trust protector clause, anti-duress clause and change of situs clause. These clauses are most commonly found in offshore trusts and are discussed in that context.

Risk. Finally, the law concerning the validity of domestic asset protection trusts is not yet settled. You need to be aware that the trust may be challenged, and there is a possibility that the trust will be declared invalid. For this reason, some consideration should also be given to establishing an offshore asset protection trust rather than a domestic one.