Nevada Asset Protection Trusts

Due to the increased scrutiny placed on offshore banking institutions and offshore trust jurisdictions in light of the tragic events of September 11, the domestic asset pro-tection trust may provide a significant alternative for many individuals who may be exposed to future lawsuits or other creditor claims. This article will explain the basic features of the Nevada asset protection trust (“NAPT”).

WHAT IS A NAPT?

A NAPT is a “spendthrift trust” that permits you and any other parties you choose to be its beneficiaries. A “spendthrift trust” is an irrevocable trust whose assets cannot be demanded by a beneficiary or attached or garnished by a beneficiary’s creditors.

What is significant about the NAPT is that it allows the trust’s creator (referred to as the “Settlor” in this article) to be one of the beneficiaries, yet still obtain creditor protection. Without the benefit of a specific statute permitting such treatment, established common law rules in the U.S. do not allow settlors to establish a “self-settled spendthrift trust” to obtain creditor protection.

There can be more than one Settlor (as in the case of a husband and wife). This article assumes a single Settlor.

WHY NEVADA?

Simply stated, recent favorable changes in Nevada law make it a good choice. Nevada has followed the lead of Alaska and Delaware in permitting a self-settled spendthrift trust. The main advantage of the Nevada laws is a shorter statute of limitations period compared to the other states that have self-settled spendthrift trust laws.

WHAT RESTRICTIONS ARE THERE ON A NAPT?

Under Nevada law, the Settlor cannot be the sole trustee, the Settlor cannot have the unilateral power to make distributions to himself or herself (or for his or her own benefit), and the distributions from the NAPT cannot be mandatory, but must be in the trustee’s discretion. The NAPT is used to provide protection from potential future creditors.

WHO ARE CANDIDATES FOR A NAPT?

The NAPT is used to provide protection from potential future creditors. The prime candidates for asset-protection planning are individuals who are not subject to any existing claims or who have assets sufficient to meet existing claims. NAPTs are appropriate for professionals, officers, directors, fiduciaries, real estate owners with exposure to legal liability, business owners, and individuals exposed to lawsuits arising from claims alleging negligent acts, intentional torts (discrimination, harassment, libel), and contractual claims.

HOW DOES A NAPT WORK?

In General.

A NAPT can be used in the same manner as a standard revocable trust (i.e. a family trust or living trust). Assets are transferred to the NAPT and held by the trustee for the benefit of the beneficiaries. The major difference between a living trust and the NAPT is that the NAPT is irrevocable. Also, after a period of years, generally, creditors may not reach the assets in a NAPT so long as the assets were not transferred to the NAPT to hinder, delay or defraud known creditors.

Even though the NAPT must be irrevocable, the Settlor may retain a “power of appointment” that permits changes to the trust’s ultimate beneficiaries. Also, the distribution trustee can exercise its discretion to order a distribution of all of the NAPT’s assets, thus terminating the trust. The NAPT provides for traditional planning, such as the avoidance of probate, to help manage assets, the eventual distribution of assets to family or charities, and providing for estate tax savings.

Trustees.

Nevada law requires that the Settlor of the trust have some minimal contact with Nevada. The NAPT has three categories of trustees: 1) the Settlor of the NAPT; 2) the Nevada Trustee; and 3) the Distribution Trustee. The Settlor may never be the Distribution Trustee, but the Distribution Trustee can be the same person or entity as the Nevada Trustee.

(a) Settlor(s) as Trustee(s). Unlike most offshore asset protection trusts, the Settlor of a NAPT can serve as trustee of the trust. As discussed further below, the Settlor will have broad authority under the trust to make all investment decisions, but will not have the power to approve distributions to himself.

(b) Nevada Trustee. The Nevada Trustee must be either (1) a Nevada resident or (2) a trust company or a bank with trust powers that is qualified to do business in Nevada. The Nevada Trustee must have the power to prepare the income tax returns and maintain records for the NAPT. The Nevada Trustee’s authority can be limited to just these two areas, or it can be expanded to include distribution decisions as outlined below.

(c) Distribution Trustee. The Distribution Trustee can be either a person or an institutional trustee like a trust company or bank . The Distribution Trustee need not be located in Nevada (compared to the Nevada Trustee who must be a resident of Nevada). The Distribution Trustee’s authority can be limited solely to approving distributions from the NAPT to the beneficiaries of the NAPT (i.e. the Settlor); or the Distribution Trustee may be the same person/entity as the Nevada Trustee. Nevada law requires that for the NAPT to be valid, the Settlor may not have the authority to make distributions to himself. The Distribution Trustee may not be a beneficiary of the NAPT.

(d) The Standard Arrangement. For a Settlor who is a California resident and wishes to form a NAPT, the standard arrangement is to provide that the Settlor retains as much control as possible. This means that the Settlor will be a trustee with broad investment and trust administration authority. The Nevada Trustee will likely be an individual or trust company that has the power to prepare tax returns and maintain records. Finally, the Distribution Trustee can be a trusted individual (such as a non-beneficiary family member other than a spouse, a long time business partner, an attorney, etc.), or a trust company, with the sole power under the NAPT to approve distributions to the Settlor.

Distributions.

The Distribution Trustee must have full discretion to make distributions to the Settlor, but there can be no mandatory distributions of income or principal under the trust. Although the Settlor may be a trustee of the NAPT, the Settlor may not act alone on decisions regarding distributions (therefore necessitating a Distribution Trustee). No distribution may be made from the NAPT without the affirmative approval of the Settlor so that the Distribution Trustee may not unilaterally distribute assets to the beneficiaries.

Investments.

The Settlor of the NAPT has full investment authority. This means that the Settlor may sell assets, transfer assets from one investment to another, and buy additional assets without interference from the Nevada Trustee or the Distribution Trustee. The Settlor may not, however, transfer funds or assets directly from the NAPT to himself or for his benefit. Practically speaking, this means that the Settlor may not transfer money from an account held in the NAPT to an account not held in the NAPT. The Settlor may not pay personal bills, like the phone bill, from an account held in the NAPT. For this reason, we advise our clients to have a checking account outside of the NAPT to pay for personal living expenses.

Statute of Limitations.

The most important aspect of the statutory laws relating to NAPTs is the period during which the assets of a NAPT are vulnerable to the claims of creditors. If a creditor does not bring a claim against the Settlor within the prescribed period, the claim is barred by the statute.

In Nevada, a creditor who was a creditor at the time of a transfer to a NAPT 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 is not a creditor at the time of 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 that particular asset (subject to certain notice requirements).

However, even if the statute of limitations does not bar a claim, the creditor must prove that the transfer was a fraudulent conveyance. A fraudulent conveyance is generally deemed a transfer of an asset with the intent to hinder, delay or defraud that specific 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. Because the intent to hinder, delay or defraud creditors can be inferred if the transfer renders the transferor insolvent (meaning that the value of the transferor’s debts exceeds the value of the transferor’s assets), it is not usually advisable to make transfers that reduce the transferor’s net worth below zero.

IS A NAPT “BULLET PROOF”?

No. Domestic self-settled spendthrift trusts are relatively new, and many of the questions relating to their enforceability are yet unanswered. Because of the U.S. Constitution’s “full faith and credit” clause, judgments from one state must be recognized by another. However, the traditional rule is that each state could set its own exemptions with respect to creditors’ claims, and the use of self-settled trusts in Nevada by citizens of other states may benefit from a “full faith and credit” claim. However, an argument could be made that the “full faith and credit” claim should not apply to a non-Nevada resident’s use of a NAPT. Until these issues are fully litigated, NAPTs will not replace offshore trusts as the vehicle of choice for a higher level of asset protection. Notwithstanding the above, NAPTs provide a relatively coherent tool to discourage the claims of future creditors.

Tax Issues.

For income tax purposes, the NAPT is treated as a grantor trust, which means that all income, deductions, loss, etc. will flow through to the Settlor and be reported on the Settlor’s individual income tax return.

(a) For estate and gift tax purposes, any gift made to the trust will be deemed an incomplete gift and will not be subject to gift tax. However, just like a living trust when the Settlor dies, the trust will be fully taxable for estate tax purposes, less any unused “applicable credit equivalent” for gift and estate tax purposes .

(b) In a two-settlor trust for a married couple, on the first Settlor’s death, the NAPT incorporates standard living trust planning. The trust can contain standard credit-shelter or bypass trust language and also direct the trustee to qualify other property passing to the survivor for the marital deduction or as a qualified terminable interest property trust (“QTIP”).

OPTION TO CHANGE JURISDICTION

The Busch Firm's form of NAPT has provisions that allow the trust to change its jurisdiction to another state or to another country. It is possible that in the future other states will enact “self-settled spendthrift trust” statutes that are more favorable than Nevada law. In this situation, the trust instrument would allow the Settlor to move the jurisdiction of the trust to this state.

More importantly, our form of NAPT allows the Settlor to convert the trust into an offshore asset protection trust. By moving the trust jurisdiction offshore to a location that has favorable laws for this type of trust (e.g. the Cook Islands), there are significant advantages. These jurisdictions have shorter statutes of limitations (one year in some cases), and the foreign jurisdiction will often not enforce U.S. court judgments forcing the creditor to litigate the matter in the foreign jurisdiction. However, there are pitfalls to be aware of and anyone attempting to convert a domestic trust to a foreign trust should consult us prior to proceeding.

CONCLUSION

A NAPT can be a powerful device to limit one’s liability for creditor claims. Although management and control of assets contributed to a NAPT are restricted, the NAPT can provide not only protection from future creditors, but can also be used to save estate taxes, avoid probate, and provide for efficient administration of assets similar to a traditional living trust.