Trusts 101 part 9 - Asset protection trusts

Part nine of our ongoing series on the basics of trust law starts our discussion of asset protection trusts for physicians and how they differ from the common estate-planning trusts you should already have in place.

The basics of Asset Protection Trusts (APTs)

There are many different forms of asset protection trusts available to lawyers and qualified clients and the details vary widely and fill entire books. We start here with a simple outline of some key APT law basics every legal consumer should be familiar with.

Timing is king.APTs of any form are only effective and legal if established and funded with the specific assets well in advance of any liability. This does not mean, “I haven’t been sued yet so it’s still OK”. Any actual or constructive knowledge of a claim, or even a potential future claim or liability based on an event you are aware of, can legally time you out from acting. This makes any transfer of assets from yourself to a trust or any other person or legal entity a potentially “voidable transaction” in furtherance of a “fraudulent conveyance”.

They are irrevocable.In order for trust property to be outside the scope of your personal and professional lability and the reach of a judgment creditor by law it must go into a vehicle that is granted permanent, irrevocable title. If you, as the “grantor” can easily pull it back at will, it is generally not protected from others either. It must truly be the property of the trust. However, this does not mean that that property can’t be sold, converted into another form, collateralized or used and enjoyed in many conventional ways, including by the person creating and funding the trust.

APTs can be set up for yourself. You can establish and fund an irrevocable trust for yourself (known as a self-settled trust) and this is a common feature of many APTs. This unique construction is specifically legally allowed by statute in many domestic and offshore jurisdictions (which is the subject of our next installment). Planners pick those jurisdictions based on a variety of fact specific issues including local law, costs, where you live, your liquid net worth, the level of protection and predictability you seek, and your estate planning needs, to name just a few.

APTs can be established for others. Another common construction allows the creation of trusts for any third-party (or parties) you wish. You can gift or sell a wide range of assets to the trust and in some cases, even keep the income.

They require careful drafting. They must strictly comply with all formational and operational requirements imposed by the trust’s specific jurisdiction. This drafting should also protect the trust’s assets by limiting the trustee’s ability to make any distributions under duress or to a judgment creditor, but should allow enough discretion to allow the trust’s assets to be used for benefit of the beneficiaries, potentially including yourself.

They use 3rd party trustees. They have 3rd party Trustees appointed to manage the trust and its assets. These trustees are ideally neither Grantors nor Beneficiaries and don’t have a personal interest in the trust’s assets.

They are properly funded. Assets with formal title, like real estate deeds, should be formally transferred to the to the trust. Depending on the kind of trust and the trust jurisdiction selected, the assets may be required to be located within the jurisdiction and that an approved local agent, trustee or authority is appointed.

They are tax compliant. Trusts are not secret or “tax free” and report and pay taxes comply with gifting limits and exemptions. Taxes may be the responsibility of the Grantor, the Beneficiary or the trust itself, depending on how it is drafted.

They are not divorce planning tools. If you are already married, and your spouse already has a marital or community property interest in certain joint assets, regardless of how they are currently titled, you cannot effectively use APTs to deprive them of their existing rights and property.

They can be good pre-nup tools. On the other hand, if you are single (or already married but have a pre-nup or post nup) and are funding a trust with your undisputed, legally separate property, an APT can make those separate property assets even more legally distinct, put them in entities that solely benefit you personally, and help protect them from a variety of risks including both liability and divorce.