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Asset Protection Protecting against the claims of future creditors. . . . |
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Asset Protection Protecting against the claims of future creditors. . . . |
© Copyright 1999-2008 by The Rushforth Firm, Ltd. All Rights Reserved.
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1.1 Overview: Many people are concerned about having their assets
taken from them by
creditors. This memo briefly outlines some of the basic techniques that can be used to insulate property
from various claims. This memo is intended for people who want to insulate their assets from future
potential claims. This memo focuses on practical, legal methods intended to discourage and defer future
creditors, bit it does not discuss gimmicks, “bullet-proof” schemes, or illegal methods. This memo does
not address asset protection from existing claims
or the divestiture of assets for welfare qualification
.
1.2 A Spectrum of Asset-Protection: It goes without saying that asset-protection tools and techniques — such as state and federal exemption statutes, various types of insurance, business entities, gift-giving (including gifts to irrevocable trusts), domestic self-settled spendthrift trusts, foreign (offshore) spendthrift trusts, and even expatriation — provide varying levels of protection. In this area of the law, it seems almost axiomatic that control and flexibility diminishes and costs increase as the level of creditor-protection increases. Thus, asset-protection planning starts with the process of finding the level of asset protection that provides an acceptable combination of affordability, flexibility, and effectiveness.
2.1 Who Are My Creditors?: You do not have to look very hard to find people and agencies who want your property. It is too easy to find yourself owing people money, and sometimes unwittingly. Some possible creditors include tax-collecting agencies, accident victims, health-care providers, credit card issuers, business creditors, and creditors of others where you have cosigned or guaranteed their obligations.
2.2 What Property Is at Risk? The general rule of thumb is that if you have the right to
demand something for your own benefit, your creditor can use the law to demand it, too. In the abstract,
the property
that is available to satisfy the claims of your creditors includes about any transferable right
or benefit that you have. It includes property that you own outright (by yourself or with others),
contractual benefits (such as the right to compensation under an employment contract or the proceeds of
a life insurance policy for which you are a beneficiary), and interests under a will or trust are some
examples of “assets” or “property” that are vulnerable to the claims of creditors.
3. Basic Asset-Protection Tools
3.1 Liability Insurance: The best protection against liability is insurance. Before you do anything else, you should seriously consider purchasing or increasing “umbrella” coverage on your homeowners insurance policy. Since those policies rarely cover business-related liability, for any business activities, consider purchasing or increasing liability coverage under your business insurance policy or policies.
3.2 Miscellaneous Exemptions: Nevada law also provides several minor exemptions from
executions upon judgments.
These exemptions are extremely limited and afford no real protection to
anyone who has accumulated possessions of any significant value. The most significant exemption is the
cumulative exemption for retirement funds, which is currently $500,000.
3.3 Home and Homestead: Nevada law provides for several exemptions related to a person’s primary residence.
(a)Limited Medical Exemption. A primary residence is protected from execution
upon a judgment for medical bills, regardless of equity, but this protection ends when no one living
in the residence qualifies as the debtor, the debtor’s spouse, or the debtor’s child who is a minor
or a disabled adult.
(b)Limited Homestead Exemption. As of July 1, 2007, Nevada’s homestead
exemption law
protects up to $550,000 of equity in a person or married couple’s primary
residence. This includes the land and the home, and the home can be a mobile home even if the
owner rents rather than owns the land.
(c)Unlimited Homestead Exemption. For almost eight years, from 1997 to 2005, Nevada law permitted an unlimited homestead for a homeowner who was granted “allodial title” by the state.
(1)The homeowner of an unencumbered single-family dwelling was eligible to apply for an “allodial title”, which is granted when the homeowner prepays the property tax for his or her life expectancy based on the calculations of the state treasurer’s office. The program was discontinued by the 2005 Nevada legislature, but applications that were filed on or before June 13, 2005 were processed, and allodial titles that were issued are still recognized.
(2)Once the “certificate of allodial title is issued, the property became exempt from further property taxes so long as the homeowner owns the property, and the homestead exemption covers the entire equity in the home and all “appurtenances and the land on which it is located”. In other words, for property with “allodial title”, the dollar limitation to the homestead exemption does not apply.
3.4 Business Entities: Business entities—such as corporations, limited partnerships, and limited-liability companies—can provide two types of protection. They can shield business assets from the claims of its owners’ creditors, and they can shield the owners’ assets from the claims of the businesses’ creditors.
(a)Shielding Personal Assets from Business Liabilities. Corporations, limited partnerships, limited-liability companies, limited-liability partnerships, and business trusts came into being for the purpose of allowing persons to form and to own a company as a separate legal entity that can conduct business without exposing those persons to personal liability for the company’s obligations.
(b)Shielding Business Assets from Personal Liabilities. In most states, including
Nevada, the laws relating to limited partnerships and limited-liability companies (LLCs) do not
permit the creditor of a partner or member (“owner”) to force a liquidation of the company. That
would generally be unfair to the other owners. The law permits a court that is enforcing a
judgment to issue a “charging order” that requires the company to distribute the owner’s share of
income to the judgment creditor. A charging order may make the creditor responsible to pay
income taxes on the debtor-owner’s share of the company’s income, even if no income is actually
distributed. This serves as a disincentive for the creditor to ask for a charging order. Under
Nevada law, the charging order is the “exclusive remedy”,
but this is not true for most out-of-state business entities , and out-of-state courts have forced a liquidation of limited partnerships and
limited-liability companies for one-member LLCs and where the court has determined that a
charging order is an inadequate remedy for the creditor, especially if company assets can be
liquidated without reducing the value of the other owners’ interests.
(c)Using Multiple Business Entities to Shield Assets. If a business loses a lawsuit and does not have enough cash to pay the judgment, all of its assets are subject to attachment and sale in order to satisfy the judgment. It can be prudent to divide a business into multiple entities in order to reduce the exposure. For example, suppose you have three apartment complexes in a single limited-liability company. Suppose further that a tenant of one of the apartments is seriously injured and prevails in a lawsuit against the company. Now, all of the company’s assets, including all three apartment complexes, are exposed to that liability. On the other hand, if a separate company were formed and operated separately for each apartment complex, a lawsuit against one company would not affect the other companies’ assets.
3.5 Corporations: A properly established corporation can protect its shareholders from the corporation’s liabilities. If claimants want to establish the personal liability of a corporation’s shareholders, the claimants must “pierce the corporate veil” by arguing (i) that corporate formalities have not be observed, (ii) that the corporation is really the “alter-ego” of its majority shareholder(s), or (iii) that the corporation is under-capitalized.
(a)Corporate formalities include proper formation under state law, the issuance of stock, the adoption of bylaws, regular meetings of shareholders and directors, the maintenance of corporate records, including meeting minutes and accounting records.
(b)The “alter-ego” theory can be used to pierce the corporate veil if the majority shareholder(s) use the corporate assets as though they were their personal assets. This can occur if personal and corporate assets are co-mingled, personal obligations are paid from corporate funds, or if corporate assets are held out to be personal assets.
(c)To counter the argument that a corporation is under-capitalized, the corporation must have sufficient assets and reasonable liability insurance coverage. The corporation cannot be merely an empty shell, with insufficient assets to carry on its business.
(d)If a corporation’s employee (including an officer) does something that harms someone else, that “culpable” employee can be sued individually, and the corporation offers no protection to that employee. It does offer protection to the shareholders, officers, and other employees who were not responsible for the actions of the culpable employee.
3.6 Limited Partnership: Limited partners are protected similarly to shareholders in a corporation, and the same guidelines and limitations apply. They have no personal liability with respect to partnership obligations. Limited partnerships do not participate in the management of the business, so it is far less likely that a limited partner, as such, will be named in a lawsuit for his or her own negligence or other misconduct. A limited partnership must have at least one general partner who is personally responsible, but that general partner can be a corporation.
(a)Under Nevada’s Revised Uniform Limited Partnership Act [NRS Chapter 88], a judgment creditor of a partner cannot usually force the liquidation of the limited partnership. A judgment creditor can obtain a court order directing the partnership to make the debtor partner’s income distributions to the creditor. This order is referred to as a “charging order”. If the creditor obtains a charging order against the partner-debtor’s interest, and the partner-debtor is allocated income for income tax purposes, the creditor may be forced to report the income and pay the resulting tax without ever receiving an actual distribution from the partnership.
(b)By not allowing one partner’s creditor to liquidate the corporation, the limited partnership can serve as a protection for the nondebtor partners. The limited partnership can also serve to protect a limited partner’s nonpartnership assets from the claims against the partnership. The general partner is exposed to partnership liability, but if the general partnership is a corporation, the corporation can protect the stockholders’ personal assets from partnership and corporation liabilities.
(c)The assets of the limited partnership itself are at risk to partnership liabilities. Separate limited partnerships for different assets can insulate one partnership’s assets from the claims against another. For example, if a limited partnership owns several apartment complexes, a claim arising at one apartment complex may result in a lawsuit against the limited partnership, which puts all of the apartment complexes at risk. On the other hand, if each apartment complex was in a separate limited partnership, a lawsuit against one apartment complex would not affect the others.
(d)Partnerships and corporations should exist for valid business purposes, and personal-use assets, such as homes and vehicles, should not belong to business entities in the absence of valid business agreements. In other words, your home should not belong to a business entity unless you are paying rent to the business entity.
3.7 Limited-Liability Companies: Limited-liability companies (“LLC’s) are relatively new, but have gained in popularity. Nevada adopted its law on LLC’s in 1991 [NRS Chapter 86]. An LLC is a hybrid between a corporation and a limited partnership. Like a corporation, all of its owners (“members”) are protected from personal liability for business obligations. For tax purposes, the LLC is a partnership. In other words, a limited-liability company is like a limited partnership with no general partner. Claimants seeking to establish personal liability of LLC members for LLC obligations can use the same arguments that are used to “pierce the corporate veil”, which are discussed in subsection 3.5, above.
3.8 Choice of Business Entity: A business entity is chosen for the protection afforded by state law and optimizing tax-planning strategies.
(a)As mentioned above, state law can provide protection in two ways. First is the protection of a business owner’s assets from business liabilities. Second is the protection of the business’ assets from the owner’s personal liabilities.
(1)There are many choices that provide essentially the same protection for shielding personal assets from business liabilities. With the exception of the sole proprietorship and general partnership, state-recognized business entities, if properly formed and operated, will preclude the general creditors of the business from claiming assets of the business’ owners to satisfy business obligations. Corporations, limited partnerships, limited-liability companies, limited-liability partnerships, and business trusts are on equal footing in this respect.
(2)On the other hand, the limited partnership and the limited-liability company are the only two entities that protect the assets of the business from the judgments against the business owners. This is because the statutes relating to those entities make a “charging order” an exclusive remedy to an owner’s creditors. This is not true for a limited-liability partnership, business trust, corporations, or other entities.
(A)For example, if a creditor gets a judgment against the shareholder of a corporation, that creditor is entitled to the same rights as the shareholder, and, if the shareholder holds a majority of the stock, the creditor can control the corporation. This could be particularly disastrous if the corporation is the general partner of a limited partnership because that could potentially give the creditor control over the limited partnership.
(B)On the other hand, if a creditor gets a judgment against the
member of an LLC, the only remedy the court can give is a “charging order”,
which limits the creditor’s rights to receive income distributions, and the creditor
does not have any vote, let alone control.
(b)For federal tax purposes, the decision is generally to choose from being taxed as
a sole proprietorship (for one-owner entities), a partnership (for entities with at least two owners),
a corporation under Subchapter C, or a corporation under Subchapter S. By using IRS Form 8832,
an entity can tell the IRS how it wants to be taxed.
Ironically, a corporation can elect to be taxed
as a partnership, and an LLC can elect to be taxed as a corporation. An LLC electing to be treated
as a corporation can also elect to be taxed under Subchapter S by filing IRS Form 2553.
(c)A limited partnership’s major flaw is that it must have a general partner, which is liable for the partnership’s liabilities. Traditionally, to avoid personal liability, the general partner was usually a corporation, instead of an individual. Because of the problems discussed in clause 3.8(a)(2)(A), above, we now usually recommend against a corporation serving as the general partner of a limited partnership. A limited-liability company is a better choice.
(d)As a general rule, because an LLC can be taxed as a corporation — and even an S corporation — and provides the best state-law protection against internal and external claims, the LLC is generally the entity of choice in Nevada.
3.9 Limitations of Business Entities: The protection of corporations, limited-liability companies, and other entities can be meaningless as to any debts for which personal guarantees are given. Also, as stated above, no business entity can protect a person from his or her own negligence or intentional misconduct. If personal liability cannot be avoided, then the next level of protection involves having assets that are exempt or placing assets in ownership forms that become obstacles to collection of any amounts found to be due.
3.10 Gifts; Irrevocable Trusts: Assets that are given away are not generally available to satisfy
claims against the donor so long as the transfer is not a “fraudulent transfer”, as defined by law.
This
applies to gifts to irrevocable trusts, which can also be established as “spendthrift trusts” that prevent both
voluntary and involuntary transfers. Irrevocable Trusts are discussed in section 4 of this memo.
4.1 Claims Against A Beneficiary: A beneficiary’s interest in a trust is an asset of the beneficiary and subject to claims unless (1) the beneficiary’s interest is contingent upon the occurrence of an event which has not occurred yet; (2) the beneficiary’s benefits are determined by the trustee’s under the trustee’s discretion; or (3) the trust contains a provision making it a “spendthrift trust” within the meaning of Chapter 166 of the Nevada Revised Statutes (“NRS”) or the similar law of the state having jurisdiction over the trust. To create a spendthrift trust under Nevada law, it is usually enough for the trust instrument to say that “the trust is a spendthrift trust” or “a beneficiary’s interest in the trust is not subject to voluntary or involuntary transfers” for it to qualify as a spendthrift trust.
4.2 Claims Against The Settlor: Assets transferred to an irrevocable trust do not belong to the creator (“settlor”) of the trust and are not subject to claims of the settlor’s creditors except to the extent of any benefits retained by the settlor, unless the transfer of the assets is considered a “fraudulent transfer”.
(a)The traditional irrevocable trust requires the settlor to relinquish all benefits, so that the settlor can honestly say that the settlor has retained no interest in or benefit from the transferred assets. If the settlor retains benefits, most states allow the settlor’s creditors to reach the trust’s assets, at least to the same extent the settlor can. Exceptions to this are discussed in section 6 of this memo.
(b)One trust that is growing in popularity for asset protection is the “Qualified
Personal Residence Trust” or “QPRT”. This trust was originally intended to facilitate the giving
of a remainder interest in a home for a low gift-tax value. Under a QPRT, the Settlor has the right
to use the home for a term of years, but upon the expiration of that term, the home belongs to the
designated remainder beneficiaries (or to the trust for their benefit). Since the gift to the remainder
beneficiaries is irrevocable, it will not be set aside by most courts unless the transfer is considered
a fraudulent transfer.
State courts may try to get value out of the settlor’s right to use the
property, but I know of no Nevada case on this issue.
(c)In Nevada and some other states, the settlor (creator) of a trust can create a “self-settled spendthrift trust” that is exempt from creditors’ claims, which are discussed in section 6 of this memo. In most other jurisdictions within the United States, the settlor cannot create a spendthrift trust for himself or herself. Except as to self-settled spendthrift trusts that are specifically permitted under applicable state law, to the extent assets of a trust are available for the settlor’s benefit, they may also be available to the settlor’s creditors through appropriate legal process; however, this can be made more difficult for a creditor to assert if there are also other beneficiaries who have rights under the trust.
5.1 Generally: When people feel threatened by creditors or even potential creditors, it is a natural reaction to try to transfer assets to trusted persons to try to shelter those assets. NRS Chapter 112 contains Nevada’s Uniform Fraudulent Transfer Act. The law allows creditors to ask a court to allow them to ignore fraudulent transfers for collections purposes. A proof of fraudulent intent is not always required for a transfer to be considered “fraudulent” for the purposes of this statute.
5.2 Problem Areas: Fraudulent transfers come in all varieties:
(a)T owes money to C. T transfers assets to his children, S & D, leaving himself without assets. Since the transferor made himself insolvent (i.e., his debts exceed the fair market value of assets), the transfer is fraudulent and can be set aside. The result would be the same if the transfer was made to a trustee of an irrevocable trust instead of the children.
(b)T owes money to C. T, who is insolvent, transfers assets to his children, S & D, to satisfy a debt T owed them. If S & D have “reasonable cause to believe” that T was insolvent, the transfer can be set aside. Since S & D are “insiders”, the fact that there was adequate consideration does not protect this transfer. (Incidentally, transfers that favor one creditor over another can also be set aside under federal bankruptcy law. See also subsection 5.3 of this memo relating to “insiders”.)
(c)T is in an auto accident. C was injured, and T was at fault. T is concerned that C may sue and ask for more than the limits of his insurance policy. Before C sues T, T transfers all of his assets to his children, S & D. If C files a lawsuit and wins a judgment, the transfer can be set aside because the statute refers to the time “the claim arose” and not to the time of the judgment. Since the transfer was after the “claim arose”, the transfer can be set aside.
(d)T has no debts and transfers all of his assets to S & D. T then makes credit purchases to the extent of his available credit limits. The transfer would probably be set aside, since it would appear that T incurred the debts with full knowledge that he could not pay them. If T could establish that at the time he incurred the credit purchase, his income was sufficient to make the payments, the transfer would probably not be set aside.
5.3 Other Issues: Transfers for full fair market value are not fraudulent conveyances, but transfers to “insiders” are subject to closer scrutiny. “Insiders” include relatives and controlled business entities. If the transferor transfers title, but retains possession or control of the transferred asset, the statute allows the inference to be drawn that the transfer was intentionally fraudulent.
5.4 Future Creditors: Transfers are not usually set aside as fraudulent transfers if a creditor’s claim arises after the transfers; however, they can be if (1) the transfer was made with actual intent to defraud any creditor; or (2) the debts were incurred without reasonable expectation that they would be paid.
6. Self-Settled Spendthrift Trusts
(Also known as “Domestic Asset-Protection Trusts” or “Nevada Asset-Protection Trusts”)
6.1 Generally. A “spendthrift trust” is a trust that precludes a beneficiary or his or her creditors from reaching the assets of the trust contrary to the terms of the trust. A “self-settled spendthrift trust” is a spendthrift trust that includes the trust’s creator (“settlor”) as a beneficiary. Traditionally, self-settled spendthrift trusts were not permitted, but now there is a growing number of states that permit the creation of a self-settled spendthrift trust (SSST), otherwise known as a “domestic asset-protection trust” (DAPT). A DAPT established in Nevada is sometimes called a “Nevada Asset Protection Trust” (NAPT). For the purposes of this memo, we will use the acronym “NAPT” when it refers to a Nevada SSST.
6.2 Current Trend. Nevada, Alaska, Delaware, Rhode Island, Utah, Missouri, Oklahoma, and perhaps other states have adopted statutes that exempt from collection assets trusts under certain conditions. These states have responded to a demand for preventative planning options for those who currently have no known exposure to current creditors, but want to shelter assets from claims of future creditors. This is attractive to those who want to create obstacles to collection without having to move assets to a foreign jurisdiction. Of course, the courts in one state must recognize judgments from any other state under the “full faith and credit clause” of the U. S. Constitution. This means that some of the roadblocks to jurisdiction that are used in foreign countries are not available to discourage a claimant in the courts of any state in the Union. Although judgments from one state must be recognized in all others, each state can establish its own exemptions, such as the homestead exemption and exemptions for retirement funds. So, although domestic asset-protection trusts do not have all of the deterrents that foreign-situs (“offshore”) trusts can provide, they provide better protection than an awkward implementation of one or more business entities for purposes for which they were not intended.
6.3 Types of Trusts. Self-settled spendthrift trusts can be designed in either of two ways:
(a)Settlor as Primary Beneficiary. The most common type is designed so that the creator or settlor of the trust is the trust’s primary beneficiary during his or her lifetime, and no vested or completed gift to any other beneficiary is made by putting assets into the trust. The settlor will generally retain the right to designate other beneficiaries during his or her lifetime and after his or her death, which makes the trust a grantor trust for income tax purposes, making it tax neutral and allowing the settlor’s residence to be an asset of the trust without giving up the capital gain exclusion available for one’s primary residence.
(1)The most publicized use of this type of self-settled spendthrift trust is by persons who feel concerned that one or more potential lawsuits may result in a judgment that renders them unable to provide for themselves and their loved ones, either presently or after death. The domestic self-settled spendthrift trust is seen as a more flexible and less expensive alternative to the “offshore trust”, meaning one that is established under the laws of a jurisdiction other than one of the states within the United States of America.
(2)Creditor protection is not the only reason for establishing this type of trust. It may also be appropriate for a person who is concerned that family, friends, or even strangers may persuade them to make inappropriate gifts or other expenditures. By making the trust irrevocable and qualifying it as a spendthrift trust, the settlor cannot be persuaded to make expenditures or otherwise distribute trust assets without the concurrence of a trusted advisor. This is good for those who just cannot say no when asked for financial assistance.
(3)This type of trust is normally designed much like a revocable trust established for probate avoidance, and it can also include estate-tax planning for couples, including the creation of a bypass or credit-shelter trust and marital trust upon either settlor’s death.
(b)Settlor as Secondary Beneficiary. The second type of spendthrift trust is designed where there is an intent to make a gift for the benefit of children, grandchildren, and/or other beneficiaries, but the settlor may be concerned that a gift to the trust may jeopardize his or her own care and comfort, especially if there is a financial catastrophe that depletes financial resources. In such cases, the settlor of the trust may wish to allow (but not require) the trustee to provide for the settlor’s care if the settlor’s other resources are depleted. While it would be unlikely that the trustee would ever need to provide for the settlor’s benefit, the trust can permit it without making the assets of the trust subject to the claims of the settlor’s creditors. This type of trust is considered a completed gift for federal gift tax purposes, and, to avoid estate taxation on trust assets, the settlor cannot retain any right to change beneficiaries. This trust can be designed as a grantor trust for income tax purposes, but it would be inappropriate for it to hold assets that the settlor uses regularly, such as his or her primary residence. Most Nevada self-settled spendthrift trusts are NOT designed this way, and this memo focuses on the first type of spendthrift trust.
6.4 Potential Challenges to Self-Settled Spendthrift Trusts.
Self-settled spendthrift trusts are
not bullet-proof asset-protection arrangements, but they are useful for assets located in the jurisdiction in
which they are created and probably in the other jurisdictions with laws permitting such trusts (assuming
compliance with such laws). There are a number of arguments that can be raised against the protection
provided by a spendthrift trust, some of which will depend on the court in which the creditor is seeking
judgment, and some of which will depend on the conduct of the settlor and the trustee.
(a)First, the creditor will argue that the trust is a sham, nothing more than the “alter ego” of the settlor. This argument will not be available if the trust is compliant with the law, the trustee strictly follows the terms of the trust, and trust assets and trust income are not commingled with nontrust assets and income. The settlor simply cannot have unilateral control over trust assets; otherwise, this argument will probably be successfully made.
(b)Second, the creditor will argue that one or more transfers of assets to the spendthrift trust were “fraudulent transfers”, which generally means that the transfers were made at a time that the creditor’s claim existed and the transfers made the transferor insolvent. Fraudulent transfers are discussed above (section 5).
(c)Third, if the lawsuit or other enforcement proceeding is being handled by an out-of-state court (meaning out of the state where the spendthrift trust was established), the creditor will argue that the out-of-state court should disregard the trust because its recognition is contrary to that state’s public policy and/or because that state has direct jurisdiction over the assets against which enforcement is being sought.
(d)Fourth, if the legal battle is being fought in federal court, the creditor may ask that court to apply federal law and disregard state trust law.
6.5 Nevada Spendthrift Trust Law. Since October 1, 1999, Nevada law has permitted a self-settled spendthrift trust (SSST), more commonly referred to as a Nevada Asset Protection Trust (NAPT). The 1999 legislation was more of a minor revision to existing laws on spendthrift trusts and fraudulent transfers than a major new act, which means that the protections afforded are based on well-established law. Nevada law does not permit fraudulent transfers, and if you know about a creditor (claimant) when assets are transferred to the trust, those assets will not be shielded as to that creditor. Fortunately, Nevada law limits the time in which a creditor may challenge a transfer. This is sometimes referred to as a “look-back period”, and it applies separately to each transfer to an NAPT. The length of the look-back period depends on whether the creditor existed at the time of the transfer, and that is discussed in paragraph 6.5(b).
(a)Under Nevada, the Settlor may establish a valid spendthrift trust for his or her own benefit if:
(1)There is a connection to Nevada. This requirement is met if one of the following is true:
(A)Some or all of trust assets or income are in Nevada; or
(B)The settlor is a Nevada resident; or
(C)At least one trustee:
(i)has powers that include maintaining records and preparing income tax returns for the trust, and all or part of the administration of the trust is performed in this state; and
(ii)is an individual who is a Nevada resident or is a bank or trust company that maintains an office in this state for the transaction of business and possesses and exercises trust powers.
(2)The trust is irrevocable, although the settlor may have a special power of appointment.
(3)The trust is not intended to hinder, delay or defraud known creditors.
(4)Distributions to the settlor are not mandatory and made only in the discretion of a person other than the settlor.
(5)The trust is subject to Nevada’s statutory rule against perpetuities.
(b)The length of Nevada’s look-back period — the period during which a creditor may challenge a transfer of assets as being fraudulent and voidable — depends on whether the creditor had a claim when the transfer was made.
(1)A creditor whose claim arose after the transfer to a spendthrift trust must commence an action to challenge that transfer within two years after the transfer.
(2)A creditor who had a claim at the time of a transfer to a spendthrift trust must commence an action to challenge a transfer within the later of:
(A)two years after the transfer; or
(B)six months after he discovers or reasonably should have discovered the transfer.
(3)As the law was originally written, it was uncertain whether or not a transfer would be considered “discovered” if the transfer was part of a public record. The 2007 Nevada legislature clarified this law by adding a provision stating that a “person shall be deemed to have discovered a transfer at the time a public record is made of the transfer. . . .” The statute specifically gives two examples of this, including the recording of a deed (“conveyance”) or the filing of a financing statement under the Uniform Commercial Code. Thus, if the Settlor of an NAPT makes a public record of an asset transfer within eighteen months of making the actual transfer, the two year look-back period will apply to that transfer. As a practical matter, this forces the Settlor to choose between privacy and protection against claims that are as of yet unknown but may have been triggered by events occurring prior to the transfer of assets to the NAPT.
6.6 Special Considerations for Nevada Asset Protection Trusts. An NAPT cannot have assets the settlor (trust’s creator) can spend without someone else’s consent, and so it is not usually wise to put all of one’s assets into it. We generally recommend a two-trust approach.
(a)A revocable “spending-money” trust should be established (or may already exist)
to hold the checking account and liquid assets the settlor wants immediate and unfettered access
to. In most cases, upon the settlor’s death, the assets will pour into the NAPT.
(b)Ideally, the irrevocable NAPT should have an independent trustee as the sole trustee, but it is also possible to have the NAPT governed by a board of trustees that includes the settlor (creator) of the trust.
(1)The “managing trustee” has control over the investment of the trust assets. It is possible for the settlor of the trust to serve in this role.
(2)The “distribution trustee” must consent to any distribution to the settlor and to the use of any trust asset (such as a home) by the settlor. The settlor cannot be the distribution trustee, and if the NAPT is being established by a two or more persons, such as a married couple, neither Settlor should serve as a Trustee. Even when an NAPT is being funded with one spouse’s separate property, we also recommend against a settlor’s spouse from serving as a distribution trustee to avoid any argument that the Settlor’s spouse was acting as the Settlor’s “alter ego”.
(3)The “Nevada trustee” must have the power to maintaining trust records and to prepare income tax returns for the trust. If the settlor is a Nevada resident, the settlor’s service as the managing trustee (or a managing cotrustee) meets the statutory requirement. For a non-Nevada settlor, the Nevada trustee can be a bank or trust company or an individual who is a Nevada resident, and it is appropriate in most circumstances for the Nevada trustee and the distribution trustee to be the same individual, bank, or trust company, but this is not expressly required by the law.
(c)For the “cleanest” asset protection, it is probably best if an independent trustee, such as a Nevada bank or trust company, serves as the sole trustee, filling the role of managing trustee, Nevada trustee, and distribution trustee. More often than not, however, the settlor of an NAPT usually wants to serve as the managing trustee of his or her own trust. If the settlor is a Nevada resident, he or she will also usually serve as the Nevada Trustee for the trust. For a non-Nevada settlor, the Nevada Trustee can be a bank or trust company or an individual who is a Nevada resident, and it may be appropriate in some circumstances for the Nevada Trustee and the distribution trustee to be the same individual, bank, or trust company, but this is not required by the law.
(d)The Nevada statutes regarding spendthrift trusts are brief, especially as they relate to self-settled spendthrift trusts. The statutes are new and untested. Here are some questions that some have asked about the NAPT:
(1)Is a transfer to a NAPT a completed gift for gift-tax purposes? No, not unless you want it to be. As mentioned above (subsection 6.3), the trust can be designed where the settlor is the primary beneficiary and retains the right to change beneficiaries, or the settlor can make others the primary beneficiaries and give the trustee the discretion to make distributions to the settlor only if absolutely necessary. Most individuals who establish these trusts are focused on asset protection, and the NAPT is usually designed to allow the settlor of the trust to direct gifts from the trust during the settlor’s lifetime and to designate beneficiaries who will receive the trust assets after the settlor’s death. A settlor’s right to change beneficiaries during life prevents it from being a completed gift.
(2)Does a Nevada asset-protection trust protect assets located in other states? We think it should, but this is untested. We recommend that everyone assume that the answer is “No”. If, for example, a Nevada self-settled spendthrift trust owns real estate in California, and a California creditor sues the settlor of that trust, it is unknown whether the California courts will give “full faith and credit” to the Nevada spendthrift trust laws or whether they will use their jurisdiction over the property to bypass Nevada’s spendthrift trust laws. It is presumed that the argument will be made by the claimant that California should not recognize the existence of and ownership by a Nevada self-settled spendthrift trust because its terms are contrary to that California’s public policy.
(3)Will a NAPT effectively shield its assets from the claims of the IRS or any other agency of the federal government? Probably not. Because of the “supremacy clause” of the U. S. Constitution, the federal government has not been bound by state exemption laws (such as the homestead exemption). On the other hand, if the NAPT is designed to make transfers to it a completed gift, and those transfers are not fraudulent transfers, it could be argued that the assets of the NAPT are not subject to claims against the trust’s settlor.
(4)How does a NAPT affect the settlor’s income taxes? An NAPT is normally designed as a “grantor trust” for income tax purposes, which means that the income on trust assets is taxed to the trust’s settlor as if the trust did not exist at all. In fact, it is not absolutely necessary to have a separate tax identification number or to file a fiduciary income tax return, although it can be argued that both are advisable.
(5)Can the settlor have a credit card, debit card, or ATM card that is paid from an account held in a NAPT? NO! Nevada law defines a spendthrift trust as one that permits distributions only in the discretion of a person other than the settlor. If the settlor has unilateral access to any assets of the NAPT, it might be argued that (a) the Settlor is ignoring the trust, which legally prevents the Settlor from arguing that others honor it or (b) the trust is not a spendthrift trust, and the asset-protection features of the trust are voided. For this reason, it is recommended that there be some assets in a revocable “spending-money trust” to which the settlor may have total access.
(6)Can we arrange for the income from NAPT assets to be automatically deposited into an account out of the NAPT that the settlor has access to? Yes, so long as the automatic deposits can be cancelled at any time in the distribution trustee’s sole discretion.
(7)Can the settlor of a NAPT remove and replace the distribution trustee at will? Probably, but this is not tested. Nevada law merely requires that distributions to or for the settlor be made “in the discretion of another person”. The law does not require that the other person be a trustee (although we recommend that it be), and the law does not specify how that other person is to be designated. Thus, Nevada law does not prohibit a settlor to remove and replace a distribution trustee, but it does open the door for the argument that a distribution trustee who serves at the whim of the settlor is merely an “alter ego” of the settlor. A more conservative approach would be to allow the settlor to remove and replace a distribution trustee only “for cause”, but that would require outlining causes that justify removal. The most conservative approach would be to have a “trust protector” other than the settlor have the power to remove and replace the distribution trustee. At a minimum, we recommend that the settlor’s ability to remove and replace a trustee be suspended at any time the settlor is being sued or when a creditor of the settlor is taking action to claim rights to the income or assets of the trust.
(8)If my exposure to lawsuits decreases, can a NAPT be unwound? Perhaps, but only if the distribution trustee consents to a complete distribution of trust assets. This is not recommended. If one decides to establish a NAPT, it should be with the presumption that the assets will remain inside the trust.
(9)Can I effectively put all of my assets into a NAPT? No. First, from a practical perspective, you do not want to have to seek permission to spend all of your money. Second, you cannot list the assets in a NAPT on a balance sheet or credit application (at least not without a significant explanation). Third, a transfer of all assets to an NAPT will probably make you insolvent under the fraudulent transfer laws, which laws could be invoked by creditors to set aside transfers to the trust. Most advisors recommend funding a NAPT with resources that provide a safety net, rather than funding it with assets representing the bulk of your net worth.
(10)If a husband and wife create a NAPT, can its assets be considered
community property? The law is silent on this issue.
Community property creates rights
in spouses that are inconsistent with ownership in an irrevocable trust where the spouses’
right to the property has been limited. Potentially, the IRS could claim that trust assets
cannot be community property. This would mean that when one spouse dies, only that
spouse’s half of jointly owned property will be entitled to a stepped-up basis for income
tax purposes.
(11)Is it absolutely essential to have a Nevada Trustee? It is not statutorily required to have a Nevada Trustee if the trust has Nevada assets or if the settlor of the trust is a Nevada domiciliary, but we strongly recommend that there always be a Nevada Trustee with at least some of the trust administration being done in Nevada. By doing this, the trust will not be automatically disqualified as a Nevada self-settled spendthrift trust if there are no Nevada assets. This also prevents a challenge to the trust if the settlor becomes or is determined to be a domiciliary of another state.
(12)If a court rules that a transfer to the trust is fraudulent, is the Trustee
permitted to ignore that ruling? No.
More important, the trust documents we prepare
specifically direct the trustee to honor a Nevada court’s ruling regarding a fraudulent
transfer. This provision is included so that the transfer of assets that might be fraudulent
as to a known creditor can be protected as to unknown potential creditors. It is hope that
this type of provision will reduce the settlor’s exposure to criminal charges or civil
penalties for attempting to hinder, defraud, or delay known creditors. We will not
knowingly assist anyone in an attempt to hinder, defraud, or delay the claim of anyone
where the claim is based on an event occurring prior to the transfer of assets to the trust.
7. Other Asset-Protection Techniques
7.1 Division of Assets between Spouses: If one spouse has a high exposure to potential liability
because of his or her occupation or business, it may be advisable to divide the couples’ assets. The one
spouse would retain the assets and income from business that provides the exposure and his or her separate
property, and the other spouse would take the couples’ investments and valuable assets, also as separate
property. To make this work, the couples must agree to the division of assets long before any problems
arise, and there should be little or no community property. Ideally, this agreement should be in a
prenuptial agreement, but a postnuptial agreement can provide some level of protection.
Of course, the
agreement would be binding in a divorce, so it is important that each spouse balance the relative risks and
rewards of this approach. Also, with no community property, the spouses lose the benefit of the stepped
up income tax basis of all appreciated property upon the death of the first spouse to die.
7.2 Foreign-Situs Trusts: Foreign-situs trusts (often called “offshore trusts”) are very popular as a shield against creditors. Assets are transferred to a trust either originally established under, or subsequently made subject to, the laws of a foreign jurisdiction—such as the Cook Islands—that does not automatically honor judgments granted outside its own courts. The settlor may be a trustee, but there is always a trustee who is governed by the laws of the foreign jurisdiction. Until claims are made, the trust may operate as any domestic trust would operate. The trust can be, but is typically not revocable, although a trustee or “trust protector” may be given the power to amend the trust. Transfers to an irrevocable trust can avoid statute of limitations issues, especially with respect to the “fraudulent transfers” issue.
(a)The assets can remain in the United States under the settlor’s control. If claims against the trust are threatened, the foreign trustee exercises its powers to fire the U.S. trustee (usually the settlor) and to take control of all assets. This usually requires that all U.S. assets be liquidated so that they are no longer subject to the control of the U.S. courts, which might mean that assets would have to be sold at fire-sale prices.
(b)The best protection comes from having the offshore trust invest in offshore investments. For example, it would be hard to enforce a judgment against a person who had a Cook Islands trust investing in a corporation established in the Cayman Islands that held assets located in Jersey.
(c)In a well-known court case referred to as the “Anderson case”
, the U. S. Ninth
Circuit Court of Appeals ruled that debtors (the Andersons) could be jailed for contempt of court
for failing to make assets held in an offshore trust available to creditors. The court simply did not
accept debtors’ argument that the assets in the offshore trust were out of their control.
(1)Some commentators originally felt that this signaled the death knell for foreign-situs trusts, but it probably only made people more careful about doing things correctly. The Anderson case quashed some enthusiasm for offshore trusts, but it did involve litigation in a federal court that was brought by a federal agency against people who had enriched themselves in an illegal scam.
(2)The Anderson case demonstrates several important points: (1) no asset-protection technique is perfect; (2) a good technique done poorly may create problems but also may be better than doing nothing; (3) the courts do not believe cheaters; and (4) the federal courts do not like offshore trusts.
(3)The Anderson case has made asset-protection advisors re-think their use of offshore trusts and to consider using domestic self-settled trusts instead.
(d)Regardless of the location of the assets, this type of trust usually discourages creditors from beginning the long legal battle required to challenge the trust and to seek its assets. On the other hand, legal fees to establish an offshore trust are often around $15,000 to $25,000, and the annual fees charged by the foreign trustee can be substantial ($2,500 to $5,000). This type of trust would be appropriate only for large estates with a very high exposure to claims.
8.1 Select the Appropriate Tools: The tools discussed in this memo should be evaluated as to your specific situation. If your exposure to claims is small, adequate insurance, and a homestead declaration may be sufficient. As your exposure increases, you may wish to consider making asset transfers before a claim arises. At the highest level of exposure, you may be willing to transfer a significant portion of your assets to one or more foreign-situs trusts. You must evaluate the price you must pay for each tool (in terms of money and potential loss of control) against the anticipated protection.
8.2 No Guarantee. There is no guarantee that any particular shield will be absolutely bullet-proof. Because of the ever-changing nature of laws, what works today may not work tomorrow. Even so, having assets owned by business entities and irrevocable trusts will provide more protection than simply holding assets in one’s own name, and limited partnerships, limited-liability companies, Nevada self-settled spendthrift trusts, and offshore trusts, when properly utilized, can provide a significant barrier against attacks through litigation.
[END: Version of March 27, 2008]
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