What is an Asset Protection Trust?
An asset protection trust is a trust that protects the trust assets from creditors and liabilities of the beneficiaries. That is, as long as the assets are in the trust they are not the personal property of the beneficiaries and therefore, not subject to the beneficiaries debts. Traditionally asset protection is afforded to beneficiaries of a trust through inclusion of a “spendthrift provision” which specifically prohibits creditors from making claims against a beneficiary’s interest in the trust and prevents the beneficiaries from transferring or pledging their interests in the trust. However, the creditor protection is generally unavailable to the creator of the trust. If an individual establishes a trust of which he or she is also a beneficiary, a “self-settled trust”, the trust is generally ignored for purposes of the creator/beneficiary’s debts and liabilities.
What is Different about a Nevada Asset Protection Trust?
While the law is well established concerning the protection of assets within a trust from the creditors of a non-creator/beneficiary of a trust, the only way the trust assets could be protected from creditors of the creator of the trust (hereafter “Settlor”), was for the Settlor to give up complete control of and benefit from the trust and the trust assets. If the Settlor retained the power to serve as trustee of the trust, amend the trust, receive distributions from the trust, or to derive any benefit from the trust, creditors of the Settlor could attach assets in the trust to satisfy debts of the Settlor.
In an attempt to provide Settlors a way to benefit from assets held in trust without having to give up complete control and benefit from the trust assets, some foreign jurisdictions created laws that allowed a Settlor’s assets in a self-settled trust to be protected from the Settlor’s creditors. These jurisdictions (such as the Bahamas and the Cook Islands) gave rise to so-called “offshore trusts” which offered Settlor’s an additional tool to help protect their assets from claims and liabilities.
Unfortunately, some of the same features that made offshore trusts effective to discourage creditors (being geographically distant and subject to the obscure laws of a foreign jurisdiction), also created greater risks to the Settlor of loss or diminution of trust assets. This risk coupled with increased costs and the post 9/11 environment of greater reporting requirements for offshore trusts and holdings, has further reduced the attractiveness of the offshore trust. Nevertheless, people still desire to protect their assets from an increasingly litigious climate in the United States.
In answer to the desire for additional creditor protection through domestic sources, Nevada has enacted legislation allowing for the creation of self-settled spendthrift trusts. The Nevada Asset Protection Trust (“NAPT”) allows the Settlor to create a trust with his or her own assets, be a beneficiary of the trust and, as long as the technical requirements are complied with (both in form and the function of the trust), the trust assets are protected from any subsequent claims against the Settlor.
What Kind of Creditor Protection does the NAPT provide Settlor?
The Nevada law limits the time period for a creditor to make a claim against the Settlor of a NAPT. If a creditor does not bring a claim against the Settlor within the prescribed period, the claim is barred. Under Nevada law, if a creditor was a creditor of the Settlor at the time the Settlor made the transfer to a NAPT, the creditor must commence an action to challenge the transfer within the later of (a) two years after the transfer, or (b) six months after the creditor discovers or reasonably should have discovered the transfer. A creditor who was not a creditor of the Settlor at the time the Settlor made the transfer to a NAPT must commence an action to challenge the transfer within two years of the transfer. The act that starts the statute of limitations running is the transfer of assets. Therefore, each time assets are transferred to the NAPT, a new transfer has occurred and the statute will begin to run on a claim against that asset.
Even if the statute of limitations does not bar the claim, the creditor is required to show that the transfer was a “fraudulent conveyance.” A fraudulent conveyance is a transfer of an asset with the intent to hinder, delay or defraud the creditor. This may be difficult for the creditor to prove, especially if the creditor’s claim arose after the transfer of assets to a NAPT. However, the intent to hinder, delay or defraud creditors can be inferred if the transfer renders the transferor insolvent. Therefore, the Settlor should not transfer all of his asset into a NAPT. Rather, the NAPT should be used in conjunction with other asset protection tools so the Settlor maintains some assets outside the NAPT, but all assets are afforded some level of creditor protection.
What Kind of Powers and/or Benefits can the Settlor have in NAPT?
As discussed above, traditionally to obtain creditor protection for the Settlor the Settlor could not retain any power or benefit from the trust. Under the NAPT, the Settlor is permitted to retain certain powers and benefits.
Power of Appointment
It is important to remember that a NAPT is an irrevocable trust. Irrevocable trusts can be difficult to work with because once established, the Settlor cannot take back the assets and terminate the trust. Traditionally, for the Settlor to achieve asset protection meant that once the trust was established, the Settlor could not later affect the distributions from the trust. So, if the Settlor later changed his mind about distributions from the trust, there was little the Settlor could do. Now, with the NAPT, the Settlor can retain the ability to change where the trust assets are ultimately distributed. That is, it is permissible for the Settlor to retain a power of appointment with which the Settlor can change who the final beneficiaries are.
One of the reasons the NAPT can provide asset protection to the Settlor is that the powers and duties of the trustee can be allocated among several trustees. As a result, the Settlor can also serve as a trustee of the trust as long as the Settlor’s powers as trustee are permissible. For example, under a traditional trust usually a single trustee is responsible for making distributions from the trust, taking care of all administrative matters (such as filing tax returns and bookkeeping) and overseeing investment and management of the trust assets. Since the Nevada law on NAPTs only restricts the Settlor from being the sole trustee or having the power to make distributions to the Settlor, the Settlor could serve as a trustee of the trust with the authority only to invest and manage the trust assets. A second trustee could be responsible for distributions and/or general administrative matters. As such, the Settlor is complying with the Nevada law and thereby achieving the desired asset protection, but at the same time the Settlor still has the ability to manage and invest the assets as the Settlor chooses. Similarly, because the Nevada law requires that a trustee be a resident of Nevada, if a non-Nevada resident is establishing a NAPT, the general administrative tasks could be reserved to a Nevada resident trustee to perform to thereby satisfy the Nevada resident trustee requirement.
Settlor as Beneficiary
What makes the NAPT unique is that the Settlor can also be a beneficiary of the trust. The only limitation is that the trustee cannot be required to make distributions to the Settlor. While this can be a limitation to the Settlor, it is outweighed by the benefits of the powers and controls the Settlor can retain and still have creditor protection from the trust.
What are the Tax Implications of a NAPT?
Because the Settlor retains powers and controls in the trust, the trust is treated as a grantor trust for tax purposes which means that all items of income and loss of the trust pass through and are reported by the Settlor on the Settlor’s tax return. Similarly, because the transfers into the trust are not a completed gift, there are no gift tax implications. However, the values of the trust assets are includible in the Settlor’s estate for estate tax purposes. Nevertheless, estate tax planning tools can be built into the NAPT to provide for utilization of the Settlor’s estate tax exemption and minimize the potential estate tax liability.
Can this Type of Asset Protection trust be Formed in any State?
There are some other states such as Alaska and Delaware that have adopted laws allowing for a self-settled asset protection trust similar to the NAPT. However, the Nevada laws are preferred because the statute of limitations for creditor claims is the shortest under Nevada’s laws. As discussed above, under Nevada law, a creditor must assert a claim either (a) two years after the transfer, or (b) six months after the creditor discovers or reasonably should have discovered the transfer. Under the laws of Alaska and Delaware the statute of limitations is 4 years after the transfer or 2 years after the transfer should have been discovered. It is to the Settlor’s benefit to limit the creditor’s ability to challenge the transfer to the shortest period possible, and therefore, Nevada’s law is preferable.
Is a NAPT Right for Me?
A NAPT is powerful tool that can provide protection from creditors while still allowing the Settlor some benefit and control of the trust assets. NAPTs could be appropriate for a wide range of people such as professionals, officers, directors, fiduciaries, real estate owners with exposure to legal liability and business owners. However, it is important to remember that NAPTs or any other asset protection tool are only effective as protection against future claims and cannot be used to hide assets from existing creditors or claims. Whether a NAPT is right for you depends on your specific circumstances. An experienced asset protection planning professional can help analyze your situation and determine if a NAPT may be an effective asset protection tool for you.