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Asset Protection Planning:

Trusts generally provide excellent asset protection. A self-settled trust is one of the more frequently used types of domestic asset protection trusts (DAPT). It is generally an irrevocable trust where the grantor or settlor is a permissible beneficiary. If properly structured, creditors cannot reach the assets in a self-settled trust to satisfy the settlor's legal obligations. A self-settled trust can be drafted to either keep trust assets within the settlor's estate or remove them, which allows a wealthy individual to establish a self-settled trust even though that individual's gift tax exemption has been fully utilized. In addition to providing asset protection, a self-settled trust may also offer state income tax savings when sitused in a no income tax state such as South Dakota, which is one of the highest rated trust and asset protection jurisdictions.

Generally, the Self-Settled Trust Statutes Require:

  • The trust must be irrevocable and utilize South Dakota law
  • The settlor is to be a discretionary beneficiary
  • At least part of the trust property should be located in South Dakota
  • All or some of the trust administration should be performed in South Dakota
  • At least one trustee must be a resident or institution in South Dakota
  • The transfer may not be a fraudulent conveyance (South Dakota has a 2-year statute of limitations)

Spendthrift Trusts:

Only a few trust jurisdictions, including South Dakota, have self-settled domestic asset protection statutes. However, most jurisdictions, also including South Dakota, offer some asset protection through incorporation of spendthrift provisions into a trust. A spendthrift clause prevents all but exception creditors from attaching a trust. A beneficiary, however, may still have an enforceable right to a distribution, which could remain unprotected by the spendthrift clause. South Dakota has uniquely addressed these potential issues by enacting a discretionary support statute (please see below), which is a codification of the Restatement (Second) of Trusts and the common law.

Discretionary Support Statute

South Dakota was the first state in the U.S. with a "discretionary support statute." According to many advisors, the Restatement (Third) of Trusts may have blurred the line, potentially allowing for a fully discretionary trust to be attached by a beneficiary's creditors as a property interest. South Dakota was the first state to codify the common law and Restatement (Second), which defines the types of interest a beneficiary has in a trust and therefore the rights of a beneficiary's creditors. Consequently, a discretionary interest in a trust is not a property interest in South Dakota. Additionally, limited powers of appointment and remainder interests are also not property interests. This can be advantageous in regard to asset protection. While Nevada and Delaware have more limited versions of this statute, none of the other self-settled states have this type of statute. Please see: "Which Trust Situs is Best in 2014?" by Dan Worthington & Mark Merric, Trusts & Estates, Jan. 2014; "Where Should You Situs Your Trust? A Look at South Dakota's New Third Party Discretionary – Support Statute" by Mark Merric, Steve Leimberg's Asset Protection Planning Newsletter, May 2007.

Beneficiary Defective Trusts

A Beneficiary Defective Trust may provide the trust beneficiary with virtually unlimited control over the trust assets, practically identical to the control that the beneficiary would have if the beneficiary owned the trust assets outright, in addition to all the tax and asset protection advantages unavailable through outright ownership.

A Beneficiary Defective Trust is a trust that is income tax defective for the beneficiary, rather than the grantor. To obtain the tax and creditor benefits, the trust must be funded by someone other than the beneficiary (e.g., a parent).

In a properly structured Beneficiary Defective Trust, a beneficiary can:

  • Be trustee and manage and control the assets
  • Be the primary beneficiary and use the trust assets for whatever purpose they desire, plus receive distributions for HEMS and, if an independent trustee is involved, receive distributions for any purpose
  • Have broad power to appoint the property to anyone other than him or herself, or his or her estate, creditors or the creditors of the estate
  • Make income-tax-free sales and purchases from the trust

LLC and LP Statutes

As previously mentioned, the location of trust property is important from an asset protection standpoint. Consequently, many individuals title assets located in other states to a South Dakota LLC or LP, which in turn is titled to a DAPT. Choosing South Dakota's LLC/LP statutes further ties the trust property to the DAPT jurisdiction, allowing for increased asset protection. The asset protection afforded by LLC and LP statutes varies by state; however, South Dakota is one of the leading jurisdictions. It has "sole remedy charging order" protection which is generally considered the most desirable. A charging order only gives a creditor the rights of a partnership or LLC interest, and it does not give a creditor any voting rights. A charging order is simply a right to a distribution, if and when one is ever made, and it leaves a creditor without any means to force a distribution. This results in a waiting game between the client and the creditor, which usually forces the creditor to settle for significantly less than the original judgment amount.

Many states have judicial foreclosure sale statutes, which allow a creditor to obtain a charging order but no voting rights. A creditor will then typically complain to the court that no distributions have been made from the partnership or LLC. As an additional remedy, the court may then order a judicial foreclosure sale of the limited partnership or LLC interest, which may or may not completely pay off the judgment debt. These statutes generally do not provide great asset protection. For more information on sole remedy charging orders and judicial foreclosure, please see: "Charging Order: What does Sole or Exclusive Remedy Mean?" by Mark Merric, Bill Comer & Daniel G. Worthington, Trusts & Estates, Apr. 2010; "Which Trust Situs is Best in 2014?" by Dan Worthington & Mark Merric, Trusts & Estates, Jan. 2014; "Forum Shopping for Favorable FLP and LLC Legislation," by Mark Merric, www.internationalcounselor.com.

The information on this Private Trusts website is for general information purposes only. Nothing on this or associated pages, documents, comments, answers, emails, or other communications should be taken as legal advice for any individual case or situation. This information on this website is not intended to create, and receipt or viewing of this information does not constitute, an attorney-client relationship.