Asset Protection Planning: An Accountant’s Guide to Domestic and Foreign Asset Protection Trusts

By:
K. Eli Akhavan, Esq.
Published Date:
Jul 1, 2017

Accountants should have more than a passing familiarity with asset protection. There are three reasons: first, an accountant occupies a unique position in an individual’s personal and business life—he or she has unfettered access to the data comprising a client’s financial existence and operations (to the extent of the client’s disclosure)—and can identify a client’s exposure to lawsuits and creditor attacks; second, an accountant might have to address the reporting and tax compliance ramifications of a sophisticated asset protection plan set up by an attorney; finally, a client might rely on an accountant as a trusted advisor and will request that the accountant review and critique an asset protection plan recommended by a third party.

The following article provides a basic overview of asset protection planning to familiarize accountants with the fundamentals. It focuses on two sophisticated asset protection tools: the domestic asset protection trust (“DAPT”) and foreign asset protection trust (“FAPT”).

Fundamentals of Asset Protection Planning

Asset protection planning can be distilled into two core concepts:

  1. What an individual doesn’t own cannot be taken away from him or her.
  2. Notwithstanding the above, assets that were “fraudulently” transferred from being titled in the debtor’s name can be clawed back and subject to creditor claims. 

Without going in the complexities and nuances of the law, the essential test for fraudulent transfer is whether a transfer of title was made with the intent of hindering, delaying or defrauding creditors. Many states have adopted the Uniform Voidable Transactions Act, which is the successor to the Uniform Fraudulent Transfer Act and the Uniform Fraudulent Conveyance Act. Although there are many distinctions between a “fraudulent” transfer and a “voidable” transfer, for the purposes of this article, the terms may be used interchangeably.

For example, assume a surgeon performs an operation on Monday morning, which results in the patient’s injury or death. On Tuesday, the doctor transfers all his assets to his wife. If the patient or the patient’s estate later wins a lawsuit against the doctor, the assets that the doctor transferred to his wife may be clawed back to satisfy the creditor’s claims. 

Alternatively, if a doctor transfers assets to his wife in advance of an event giving rise to a creditor claim, it is highly unlikely that the assets will be subject to the fraudulent transfer rules. 

Generally, the best time to engage in asset protection planning is significantly in advance of any events that can result in judgment creditor.

Asset Protection Trusts

For clients with heightened and advanced asset protection needs, planners often consider using an asset protection trust (APT). For the purposes of this article, an APT refers to an irrevocable trust formed in a jurisdiction that allows the settlor (also referred to as the grantor) of the trust to be a discretionary beneficiary of the trust—and also provides for laws that are generally more advantageous to a debtor rather than a creditor. When it comes to the choice of jurisdiction for an APT, planners have two general options: a domestic asset protection trust (DAPT) and a foreign asset protection trust (FAPT). A DAPT is an APT that can be formed in any one of the seventeen United States jurisdictions that have adopted self-settled laws. A FAPT refers to an APT formed under the laws of any jurisdiction other than the United States. 

DAPTs

Historically, the general rule in the United States was that a grantor of a self-settled irrevocable trust could not be the discretionary beneficiary of the trust and still have the assets that he transfers to the trust protected from creditors. Accordingly, for purposes of asset protection, an individual could not transfer assets to an irrevocable trust and also be a discretionary beneficiary of the trust. The rule changed in 1997 when Alaska became the first state to provide asset protection benefits on self-settled trusts. Delaware followed shortly thereafter, and currently there are 17 jurisdictions that recognize self-settled asset protection trusts (i.e., the grantor can be a discretionary beneficiary of the trust and still have the assets he or she transferred to the trust be protected from creditors). 

In evaluating which DAPT jurisdiction would best serve a client’s needs, the following factors should be considered: (1) statute of limitations; (2) exception creditors; and (3) conflict of laws. 

Statute of Limitations

Different jurisdictions have different statutes of limitations from the time a transfer has been made to a DAPT. For example, in Delaware, if a future creditor’s claim arose four years after the transfer, the assets can still be subject to clawback. For a pre-existing creditor, the time is further expanded to four years after the transfer or one year after the transfer was or could reasonably have been discovered. 

In contrast, Nevada has a two year statute of limitations under which a fraudulent transfer may be set aside for a future creditor. A pre-existing creditor can set aside a fraudulent transfer within two years after the transfer, or, if longer, six months after the transfer was or could reasonably have been discovered if the claim was based upon the intent to hinder, delay, or defraud a creditor. A transfer is deemed discovered when it is reflected in public record (as opposed to constructive fraud).     

Exception Creditors

In addition to statute of limitations concerns, advisors must also carefully evaluate a client’s creditor concerns to ensure that a DAPT will be an appropriate protection vehicle. Many DAPT jurisdictions provide for “exception creditors” by statute. If a creditor is a classified as an “exception creditor,” the creditor can reach the assets inside the DAPT. Delaware and South Dakota both provide that a divorcing spouse, alimony, and child support payments are exceptions from the general rules protecting assets in a DAPT. Delaware also has an exception for pre-existing torts.     

Currently, the only DAPT jurisdictions that do not have exception creditors are Nevada, Utah, and West Virginia.

Conflict of Laws

The overarching weakness of a DAPT is that a court can deny enforcement of another state’s statutes if there are strong public policy reasons to do so. 

For example, assume a New York resident funds a Nevada APT. Three years later, which is after the statute of limitations for a Nevada DAPT fraudulent transfer claim but prior to a New York statute of limitations (six years), a New York creditor obtains a judgement in a New York court against this settlor. While a settlor may designate which jurisdiction’s laws governs the trust’s administration, public policy concerns may override the designated jurisdiction.  

In other words, a New York judge may ignore the designation of Nevada as the situs of the trust due to public policy concerns. There are very few cases, especially outside the context of bankruptcy, that address conflict-of-law issues. This might be because these cases generally settle outside of court and are most likely favorable to the debtor (possession is 9/10s of the law).  Some would argue that this is proof that a DAPT “works.”   

Nevertheless, a FAPT may be the optimal solution if the debtor is not a resident of the DAPT state and there is concern that a U.S.-based judge might have an anti-debtor perspective.

 FAPT

Hurdles of Foreign Litigation 

The primary advantage of a FAPT over a DAPT is that since the trust and the trustee are domiciled in a foreign jurisdiction, they are not required to respect and enforce U.S. judgments.  For example, if a creditor obtains a judgment in a New York court against a New York debtor, there is no requirement for the foreign court to accept that judgment. Accordingly, a creditor must commence a new case in a foreign jurisdiction that could be thousands of miles away.  The jurisdiction may also require the creditor to post a bond before commencing a lawsuit. This could be costly and expensive, reducing the likelihood of a lawsuit.  

Standard of Proof and Statute of Limitations 

Most FAPT jurisdictions impose a “beyond a reasonable doubt” standard in proving fraud as opposed to the United States’ “clear and convincing” or “preponderance of evidence” standards. The “beyond a reasonable doubt” standard in proving a fraudulent transfer is a higher standard to meet. To illustrate the point without making any judgments, consider that O.J. Simpson was found not guilty of murder because the prosecution couldn’t meet the “beyond a reasonable doubt” standard.   

The statute of limitations for transfers that were made fraudulently is also typically shorter in foreign asset protection jurisdictions. For example, in the Cook Islands, if a trust is settled more than two years after the date of the occurrence of the event giving rise to the claim, then the transfers to the trust are not deemed fraudulent. If the trust is settled less than two years after the date of the event giving rise to the claim, then the creditor must commence a cause of action within one year from the date of the settlement of the trust. In Nevis, a trust is not deemed fraudulent if it is settled after the expiration of two years from when the creditor’s cause of action accrued. As in the Cook Islands, the creditor must commence a cause of action before the expiration of one year from the date of the settlement. The Bahamas also has favorable asset protection laws, although they are not as strong as those of the Cook Islands and Nevis. Under the Fraudulent Dispositions Act, a transfer of assets is voidable if the liability to the creditor existed at the time of the transfer; however, the creditor must establish an intent to defraud in order to unwind the transfer. The creditor must also bring the action within two years of transfer.  

So do I go to Nevada or the Cook Islands? The answer, as you may guess, is “it depends.”  For a Nevada resident (or the resident of any other DAPT jurisdiction) who has absolutely no creditor concerns and wants to set up a Nevada trust for Nevada beneficiaries with Nevada situs assets, the answer is clear—set up a Nevada DAPT. If, however, the client is not a resident of a DAPT state or may have “gray area” creditor concerns that would lead a judge to deem a transfer as “fraudulent,” a FAPT may be the safest choice. Of course, other considerations include the cost of maintaining a foreign trust, U.S. tax reporting requirements, and the administrative inconveniences of dealing with a foreign entity.

Conclusion

For all types of asset protection planning, an accountant should be aware of the fraudulent/voidable transfer implications of planning for a client. The most effective planning occurs well in advance of any litigation concerns. A DAPT and FAPT may be an effective tool, depending on the circumstances.

Please look for Part 2 of this piece, which focuses on less complex asset protection tools, as well as the tax implications of different asset protection structures.  


Eli_akhavanEli Akhavan, Esq., is the managing partner of the Akhavan Law Group LLP, a boutique law firm specializing in the areas of domestic and international asset protection, estate, and tax planning for high net-worth individuals and their families.  Eli’s clients include entertainers, professional athletes, corporate executives, real estate professionals, owners of closely-held businesses, entrepreneurs, and hedge fund and private equity professionals.  Eli designs customized asset protection and privacy planning for his clients to mitigate their exposure to potential future creditors (e.g., family members and business associates).  In addition to his full-time law practice, Eli also serves as an adjunct faculty member at St. John’s University Law School teaching International Taxation.  He is a member of the American Bar Association’s Asset Protection Committee as well as its Estate and Gift Tax Committees. 

 
Views expressed in articles published in Tax Stringer are the authors' only and are not to be attributed to the publication, its editors, the NYSSCPA or FAE, or their directors, officers, or employees, unless expressly so stated. Articles contain information believed by the authors to be accurate, but the publisher, editors and authors are not engaged in redering legal, accounting or other professional services. If specific professional advice or assistance is required, the services of a competent professional should be sought.