Best Situs for DAPTs in 2023

Twenty U.S. states (or 40% of all), now have domestic asset protection trust (DAPT) statutes. Some commentators originally thought that DAPT statutes would be limited to smaller populated jurisdictions, but with Ohio entering the DAPT arena, the DAPT roster gained a populous state that’s also a major banking center. Further, Tennessee, Indiana and Missouri all have DAPT statutes, and they’re the 16th through the 18th most populous states, respectively. While the history of DAPTs is fairly recent in the United States beginning with Alaska in 1996,1 it’s anticipated that more states will adopt DAPT statutes. The most recent state to adopt a DAPT statute is Alabama.

DAPT Origins

A DAPT is a powerful tool to help clients legally shield assets from creditors, while at the same time permit them to be discretionary beneficiaries of their own trusts. However, recent cases demonstrate there may be limits to a DAPT’s effectiveness when residents from outside a DAPT state create a trust sitused in a DAPT state. Further, if a non-DAPT state adopts the Uniform Voidable Transactions Act (UVTA) without modification, this may place significant additional limits on the use of DAPTs by residents of those states.

While DAPT statutes provide a fair amount of asset protection when used in the appropriate circumstances, there are two other types of statutes that increase the asset protection provided for both DAPTs as well as third-party trusts: (1) discretionary support trust statutes; and (2) anti-alter ego statutes.

In our 2021 article in this journal, to illustrate the importance of how discretionary protection and anti-alter ego statutes work in combination with a DAPT statute, we reviewed the excellent analysis provided by Judge Kathleen Kerrigan of the Tax Court in Campbell v. Commissioner.2 That analysis focused on the concept that for the Internal Revenue Service to reach a beneficiary’s interest, that interest needs to rise to the level of a property interest under federal law. See “Anti Alter-Ego Statute Rankings,” p. 60, for those states that have such laws.

We now analyze how asset protection planning statutes intersect with estate planning. In particular, how does a discretionary support trust statute mitigate the gift tax issue of exercising an inter vivos power of appointment (POA)? Also, how does the use of hybrid trusts mitigate the effect of the UVTA, and how do we use these hybrid trusts in charitable estate planning?

Common law discretionary trust protection originated under English law and isn’t related to spendthrift protection. Rather, discretionary trust protection is based on whether a beneficiary has an enforceable right to distributions3 and, therefore, whether a potential creditor might stand in the shoes of that beneficiary. If a beneficiary has no enforceable right, then the beneficiary’s interest isn’t a property interest4 and is nothing more than a mere expectancy that can neither be attached by a creditor,5 nor can a creditor force the trustee to make a distribution.6 That is, a common law discretionary interest is nothing more than a mere expectancy:7

An expectancy is the bare hope of succession to the property of another, such as may be entertained by an heir apparent. Such a hope is inchoate. It has no attribute of property, and the interest to which it relates is at the time nonexistent and may never exist.8

From an asset protection perspective, the Restatement (Second) of Trusts (Restatement Second) referred to distribution interests in four different categories: (1) mandatory interest;
(2) support interest; (3) discretionary interest with simple discretion; and (4) discretionary interest with extended discretion.9 Seldom did practitioners distinguish among types of discretionary trusts as almost always, discretionary trusts were drafted to be with extended discretion. Hence, when asset protection planners use the term “discretionary trust,” they mean the type of discretionary trust in which the trustee has extended discretion resulting with the beneficiary having no enforceable right to a distribution. Further, as discussed below, a discretionary interest with simple discretion may be classified as a type of a support trust.

In general, a mandatory distribution interest would be a distribution standard in which income is payable annually (or quarterly) for life, or a certain dollar amount is to be paid each year. A support interest would be a distribution standard with the words “shall” or “must” coupled with a standard capable of judicial interpretation, such as health, education, maintenance and support (HEMS). With both a mandatory interest and a support interest, the beneficiary has an enforceable right to a distribution, which creates a property interest.10

Conversely, with a discretionary trust as discussed above, the beneficiary doesn’t have an enforceable right to a distribution, and therefore, the beneficiary’s interest doesn’t rise to the level of a property interest. Prior to the Restatement (Third) of Trusts (Restatement Third), under common law in most states, a discretionary trust would be a distribution standard using permissive language such as “may, in the trustee’s ‘sole’ (or ‘absolute,’ or ‘unfettered’) discretion.” Further, such discretionary language will state that the trustee can make unequal distributions among the beneficiaries. While this was the common law general rule prior to the Restatement Third, a small minority of states held that a standard created an enforceable right to a distribution and therefore a property interest. The Restatement Third adopted this distinct minority view and expanded it taking the position that seldom, if ever, a distribution interest wouldn’t create an enforceable right—even if there weren’t standards or guidelines in the trust.11 Almost all lead trust jurisdictions adopted the discretionary support trust statutes so as to codify and turbocharge the Restatement Second in this area. While a discretionary trust12 starts as an asset protection planning tool, it also determines the amount of the gift when an inter vivos POA is exercised and possibly whether there’s any gift at all.

Mandatory Distribution Interests

Treasury Regulations Section 25.2513-(b)(2) provides an example in which a settlor’s spouse receives a mandatory distribution (that is, income for life).  During their lives, the spouses have both a limited POA over the income, as well as a testamentary general power over the principal at death. With a mandatory distribution interest, the beneficiary has an enforceable right to distributions that rises to the level of being classified as property. Therefore, the following tax analysis makes sense. The exercise of the inter vivos limited POA in essence transfers something the beneficiary already owns to another individual. In this respect, the Treasury regulation concludes that the “power of an owner of a property interest already possessed by him or her to dispose of his or her interest, is nothing more, it is not a power of appointment, and the amount is . . . a gift.”

This concept was followed in Register v. Comm’r,13 in which a beneficiary held a life mandatory income interest and an inter vivos limited POA over the remainder. The beneficiary exercised the inter vivos POA over the remainder, which was considered a gift of the mandatory income interest. Also, in Technical Advice Memorandum 9419007, a grandchild had a mandatory income interest, and the trust property would be distributed to the grandchild when they reached age 30. The grandchild exercised an inter vivos limited POA of the “entire interest” before reaching
age 30. The exercise was a gift of the trust property.14

Support Interest

Under common law, a support interest must be distinguished from an ascertainable standard. A support interest means that the beneficiary has an enforceable right to a distribution usually because mandatory distribution language (for example, “shall” or “must”) was coupled with a standard capable of judicial interpretation, such as HEMS. Conversely, under common law, a discretionary trust could be coupled with an ascertainable standard and still be classified as a discretionary trust. For example, under common law, the following distribution language created a discretionary trust:

The trustees may, in the trustees’ sole and absolute discretion, make distributions to the beneficiaries for health, education, maintenance, or support. The trustees may, in the trustees’ sole and absolute discretion make unequal distributions between the beneficiaries.

Conversely, in Private Letter Ruling 9451049 (Dec. 23, 1994), the trustee was to distribute to each daughter “and her descendants all or such amount of trust income and principal, as the trustee determines is appropriate to provide for health, support, and maintenance in the standard of living to which the beneficiaries are accustomed, taking into accounts other funds available for such purpose.” Each daughter also held an inter vivos POA to direct the trustee to distribute her trust corpus. The two daughters decided to appoint their share of the trust corpus to each other. PLR 9451049 concludes that each daughter had the right to periodic distributions on income and principal for HEMS in the standard of living to which each is accustomed. In this respect, it appears that the “is” is being interpreted as “shall,” and each daughter has an enforceable right to a distribution based on HEMS as modified by the accustomed standard of living, thereby creating a property interest that was gifted by the inter vivos POA.

However, the PLR has no direct discussion of any property law issue. Rather, the PLR states that the interest is ascertainable (meaning it has some value) by citing Revenue Ruling 75-550. It then concludes that the exercise of the POA by each daughter would be a taxable gift, valued under the principles of Rev. Rul. 75-550.

Similar to a mandatory interest, a support interest rises to the level of a property interest, and the exercise of an inter vivos POA results in a taxable gift.

Simple Discretion

While we agree that a support interest is a property interest, and it makes perfect sense to value a gift of a property interest, we question PLR 9451049 citing Rev. Rul. 75-550 for valuing the support interest. Rev. Rul. 75-550 doesn’t deal with an inter vivos special POA. Rather, it’s concerned with computinga credit under Internal Revenue Code Section 2013. However, the importance of this revenue ruling is that it attempts to value a discretionary interest in a trust. It’s fairly obvious that the IRS doesn’t have a detailed knowledge of discretionary trust law.
As noted above, there are two types of discretionary trusts under the Restatement Second. One is simple discretion in which the distribution standard merely mentions the word “may” in terms of making distributions to the beneficiaries, combined with an ascertainable standard. For example, “the trustee may make distributions for HEMS.” With this simple discretionary language, the beneficiary has an enforceable right to sue and force the trustee to make a distribution. This appears to be the type of discretionary language used in Rev. Rul. 75-550.15

In the revenue ruling, the average of amounts paid each year in the past to the beneficiaries was used to project amounts that would be received over the beneficiaries’ lifetimes. A present value factor was then applied to reach the value. When there’s a history of distributions and a beneficiary has an enforceable right to a distribution under state discretionary trust law (simple discretion), this approach appears to be reasonable. If the trust interest were sold for fair market value (FMV), the purchaser beneficiary would have an enforceable right to sue for distributions.

PLR 8905035 (Feb. 3, 1989) refers only to discretionary distributions—no sole, absolute or unfettered discretion language is included. Therefore, this also appears to be a discretionary trust with simple discretion. Here, the PLR concludes that using the tables under IRC Section 2512 would be improper because the gift isn’t an absolute right to distributions of income or principal. The PLR refers to the FMV concepts of Treas. Regs. Section 25.2512-1: willing buyer and willing seller. Assuming the distribution interest in this PLR is one with simple discretion, projected distributions that may partially be based on past distributions to a beneficiary may well be a proper method of valuing both a support interest as well as a discretionary interest with simple discretion.

As a discretionary interest with simple discretion creates an enforceable right to a distribution, many practitioners consider this type of a distribution interest as simply a type of a support interest.

Extended Discretion

The PLRs in this area are limited and inconsistent on valuation. The IRS takes the position that the exercise of the inter vivos POA results in something being given, and the only question is how to value it.

In PLR 2002243026 (Oct. 25, 2002), the trustee may distribute in its sole discretion to the beneficiaries. The PLR states the discretionary interest would be valued based on Rev. Rul. 75-550, leading to the conclusion that the average amount paid to a beneficiary each year would be used to project the value over the beneficiary’s life on a present value basis. While this approach would be a viable method of valuation if the beneficiary had an enforceable right to a distribution, it makes little if any sense with a discretionary distribution interest. This is because who would buy a distribution interest if the holder wasn’t able to force a distribution? Further, would the trustee ever make a distribution to a third-party buyer who wasn’t a family member? The value of a gift is based on the value to a donee. In essence, the distribution interest in a discretionary trust with extended discretion should be zero or close to worthless to a third-party purchaser.

While probably still theoretically incorrect from a property analysis perspective, PLR 8824025 (June 17, 1988) uses the sole discretion language and in turn directs that the valuation be done under Rev. Rul. 67-370. That revenue ruling refers to FMV. Then the PLR states the value appears to be negligible.

So while we think the better position would be that the exercise of an inter vivos POA, when the beneficiary holds a discretionary interest (extended discretion), shouldn’t create a gift as there’s no property interest to gift, the IRS appears never to have looked at the property issue involved. Rather, the IRS’ position seems to be that something of value has been gifted, and the only question is how to value it.

Property Interest

To minimize the gift tax issue when an inter vivos POA is exercised, a discretionary beneficial interest (extended discretion) can’t rise to the level of a property interest. When looking at top trust jurisdictions, this raises two questions: (1) does the state have a statute that defines a discretionary trust as not having an enforceable right to a distribution?; and (2) how broad is the definition of a discretionary trust under state law?

The lead trust jurisdictions in the discretionary support category have rejected the Restatement Third’s view of discretionary trust law (that almost always, a beneficiary has an enforceable right to a distribution) and instead have adopted very broad definitions of “discretionary trust.” Generally, these trust jurisdictions focus on the word “may” for classifying a trust as discretionary. The words  “sole,” “absolute” or “unfettered” aren’t required. Conversely, on the opposite end of the spectrum of these statutes is the law in Ohio. This state was one of the few that under common law had very unfavorable discretionary trust law, and unfortunately, that discretionary trust law was codified.16 Under the Ohio Uniform Trust Code, any standard or guideline in an Ohio estate-planning trust creates an enforceable right to a distribution and, therefore, a property interest. High-net-worth clients (those with assets greater than $20 million net worth) and ultra-high-net-worth clients (those with assets greater than $50 million net worth) almost always wish to have at least some distribution guidelines, and many times a standard of some kind, in their trusts or sub-trusts. So not only does this create potential asset protection issues that we’ve discussed in our prior articles in this journal, but also, it adds the valuation issue as applied to the exercise of an inter vivos POA.

DAPT Rankings

Here are our results when ranking DAPT statutes in these three categories: (1) discretionary support statutes; (2) anti-alter ego statutes; and (3) DAPT statutes (that is, qualified disposition statutes):

Discretionary support statutes. Top tier: Alaska, Indiana, Nevada, Oklahoma, South Dakota and Wyoming. Second tier: Delaware, Michigan, Mississippi, Ohio and Tennessee. See “Discretionary Support Statute Rankings,” p. 64.

Anti-alter ego statutes. Top tier: Mississippi, South Dakota and Tennessee. Second tier: Indiana, Nevada and Oklahoma. See “Anti-Alter Ego Statute Rankings,” p. 60.

DAPT statutes. Top tier: Nevada, Ohio and South Dakota. Second tier: Alaska, Delaware, Tennessee and Wyoming. While Nevada and South Dakota are very close, we note that Ohio most likely has the leading edge DAPT statute at this time. See “Domestic Asset Protection Trust Statute Rankings,” p. 66.

Finally, we must consider the UVTA and its impact, if any, on the ability to create DAPTs in states that have adopted the UTVA. See “Uniform Voidable Transactions Act Jurisdictions,” p. 67. In addition, the six states that have both the UVTA and DAPTs appear to have created an internal conflicts-of-law issue (that is, unless the UVTA or DAPT statute were modified to resolve the conflict as discussed below). In addition, a solution to any potential conflict between the UVTA and DAPT statutes is the use of the hybrid trust instead of a DAPT, which will also be further discussed below.

The UTVA

In 2014, the UVTA was adopted and intended to amend and replace the Uniform Fraudulent Transfer Act (UFTA). It differs from the UFTA in significant ways. The status of the UVTA is much the same as it was reported in our 2021 article, with only one additional adopting state. Early promoters of the UVTA applauded it for removing the word “fraudulent” in favor of the more innocuous word “voidable,” clarifying for the public the misperception that a transfer had to include elements of fraud to undo the transfer. By itself, that change seemed to be an improvement over the UVTA’s less clear predecessor. However, a significant problem with the UVTA is associated with Section 10 and its comments, wherein liberties were taken to make “voidable” otherwise legitimate transfers to DAPTs when a grantor resides in a jurisdiction that’s adopted the UTVA with these comments.17 These comments possibly extend rights to creditors who were “neither existing nor anticipated” by the grantor at the time of the transfer, contrary to the interpretive legal view under the UFTA.18

So far, only 22 jurisdictions have adopted the UVTA. As noted in our 2021 article, six jurisdictions that have adopted the UVTA also have adopted DAPT statutes, which seemingly places the statutes at odds with each other. “Uniform Voidable Transactions Act Jurisdictions,” p. 67, lists those jurisdictions and when they adopted the UVTA.19

Voidable Transfers

Gratuitous comments by the reporter of the Uniform Law Commission of the National Conference of Commissioners on Uniform State Law, in Section 4 of the UVTA, imply that transfers to DAPTs are “per se voidable.” However these comments aren’t law, and courts are no more bound by them than they are by any other law journal article.20 The comments cite only older Pennsylvania cases that have been eroded over the years by subsequent decisions. Thus, the comments are no longer based in current generally accepted legal principles or cases.21 Note that the U.S. Supreme Court in Schreyer v. Scott stated that debtors are free to take steps to protect assets from creditors that were neither in existence prior to, nor reasonably anticipated at, the time of transfer.22

Public Policy

Whether a state has a strong public policy against DAPTs is relevant; however, a lack of DAPT legislation in a jurisdiction, whether it’s adopted the UVTA or not, doesn’t necessarily create a presumption of a strong public policy against the laws of DAPT jurisdictions. In a full faith and credit (FFC) claim against a DAPT jurisdiction trustee, the DAPT jurisdiction shouldn’t be required to afford deference to the domicile jurisdiction’s judgment unless the transfer falls within the fraudulent transfer window of the DAPT jurisdiction or the transfer applies to an exception creditor. Because a collection action would often be taken against the trustee of the DAPT in the DAPT jurisdiction,23 this may frequently be the case even in jurisdictions that adopt the comments of the UVTA.

Post-Judgment Collections

A DAPT jurisdiction has a constitutional right to regulate and restrict the manner in which judgments are collected, provided that the rules apply to both in-jurisdiction and out-of-jurisdiction creditors. The stringent fraudulent transfer standards of most DAPT statutes are just that: a restriction and regulation of post-judgment collection actions, which prevent any collection unless the creditor shows that the debtor violated those standards.24

Sufficient Contacts

In a conflicts-of-law analysis regarding a DAPT, a trust settlor can designate the laws that govern the trust so long as there are sufficient contacts with the state.25 UVTA Section 10 states that, “a claim for relief … is governed by the law of the jurisdiction in which the debtor is located when the transfer is made, or the obligation is incurred,”26 ostensibly without regard to whether a different jurisdiction is chosen in a DAPT. This is a significant break from the traditional rule that a settlor can choose which jurisdiction’s trust laws apply so long as there are sufficient contacts with the jurisdiction.27 The “sufficient contacts” requirement was a major issue in a bad facts case—In re Huber.28The Huber court cited to the Restatement (Second) of Conflicts of Laws Section 270(a),29 which states that:

. . . [t]he local law of the state designated by the settlor to govern the validity of the trust [governs], provided that this state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship.

Thus, when the state of Washington had both a substantial relationship with Donald Huber and a long-standing public policy position against self-settled DAPTs, the court ‘disregard[ed] the settlor’s choice of Alaska law, which is obviously more favorable to him, and [applied] Washington law in determining the Trustee’s claim regarding validity of the Trust.’30

Location of Debtor

One of the ways that the UVTA attempts to thwart transfers to DAPTs is the application of Section 10, the governing law provision. UVTA Section 10 states that debtors are “located” in the jurisdiction of their “principal residence.” However, this provision can create a conflict with DAPT laws. Consequently, if a resident of a UVTA jurisdiction makes a transfer to an out-of-jurisdiction trustee in a DAPT jurisdiction, and if the transfer is found to be fraudulent (or voidable) under the UVTA and its comments but is found to be valid under applicable DAPT standards, then there will be an inevitable conflict of laws. This conflict is sharpened because UVTA Section 10 and its comments effectively reject the right of another jurisdiction to assert its interest and laws in connection with a disputed transfer, regardless of which jurisdiction has the most significant relationship to that transfer.31

As noted above, remember that comments don’t have the force of law, and jurisdictions can (and in the case of the UVTA, should) revise their uniform laws to suit their own situations,32 if they even adopt the UVTA in the first place.

States’ Reactions

As discussed in a recent article by Al W. King III, other state legislatures and advisors have expressed that DAPT jurisdictions shouldn’t be required to afford FFC to the domicile jurisdiction’s judgment even if the DAPT jurisdiction adopts the UVTA.33

One example is the non-inclusion of the comments from the UVTA statute.34 This is a result of advisors working with their legislatures on statutory solutions to the shortcomings of the UVTA.35 For example, Indiana rejected the UVTA comments.36 Arkansas specifically rejected certain comments of the UVTA in its legislative history.37 Some states included language in their statutes in anticipation of the UVTA that their DAPT statute shall govern in the event of any conflict.38 This additional language provides state courts with yet another provision to rely on in the event of conflict resulting from a judgment in a UVTA jurisdiction. Jurisdictions that have passed the UVTA should consider amendments, and jurisdictions looking to pass the UVTA should use caution, particularly the DAPT jurisdictions. Choice of trust situs and wealth preservation have long been trust planning concepts that should be protected.39

Despite the UVTA, many advisors suggest that a DAPT will still be upheld, even if the settlor is living in a UVTA jurisdiction when a court determines that a voidable transaction has occurred.40 The creditor would seek to enforce that judgment in the DAPT jurisdiction that hasn’t passed the UVTA. The first issue that a court in a DAPT jurisdiction must decide is whether it must recognize the UVTA jurisdiction’s judgment under FFC principles.

In our view, and notwithstanding the UVTA, jurisdictions should continue to follow the established rule of law, which is that a settlor may designate the law governing a trust unless it can be shown that: (1) trust situs and trust administrative ties to the relevant DAPT jurisdiction aren’t substantial; and (2) creating a DAPT in a DAPT jurisdiction violates a strong public policy of the settlor’s domicile jurisdiction. Unless both of these criteria are satisfied, the DAPT should generally be upheld,41 subject to any exception creditor rule, DAPT-specific fraudulent transfer rule or other exceptions provided by the governing DAPT statute.

Hybrid Trusts

The use of hybrid trusts instead of DAPTs is advisable in most APT planning situations whether or not the jurisdiction has adopted the UVTA. Unlike DAPTs, transfers to irrevocable hybrid trusts aren’t transfers to self-settled DAPTs as they’re created and funded. They’re a transfer to an irrevocable third-party trust when the beneficiaries may be wholly discretionary. Hybrid trusts employ trust protectors to create planning flexibility with respect to the grantor and the grantor’s family by permitting certain changes to the trust in the discretion of the trust protector in the future. Because the grantor isn’t a permissible beneficiary ab initio, and the grantor retains no control over trust assets, creditors can’t reach the assets. In states like South Dakota, even permissible discretionary beneficiaries have no property interests. Investment in insurance policies on the grantor are possible in hybrid trusts because the grantor isn’t an initial beneficiary and doesn’t control the trust in any way. And, the generation-skipping transfer (GST) tax exemption may be allocated to the assets transferred to the hybrid trust to create a zero inclusion ratio. This has the effect of exempting trust distributions from transfer tax as long as the trust is permitted to exist.

Hybrid multi-generational trusts are natural companions to charitable trusts and family foundations in estate planning for clients who are charitably inclined. In particular, clients can benefit both charities and their families with the use of a non-grantor charitable lead unitrust (CLUT)42 and insurance replacement in trust for split interests in charitable remainder trusts (CRTs), annuity trusts, gift annuities, pooled income funds, individual retirement account gifts and others. This is especially true with hybrid multi-generational trusts.

In addition, planned charitable bequests by wills or trusts can also be very effective if the clients need to replace difficult-to-transfer assets. This is done with leveraged life insurance in GST tax-exempt hybrid trusts. This permits the legitimate liquidation of assets through transactions with charitable entities on death.

As a benefit, in most jurisdictions, charitable gifts to trusts and annuity interests aren’t reachable by creditors unless the creditor can prove that the assets were fraudulently transferred.

Let’s discuss the non-grantor CLUT and charitable bequest specifically.

Non-grantor CLUTs. A gift to a non-grantor trust significantly reduces or eliminates estate, gift and GST tax exposure of the asset that the family receives in the future (because of the time value of money) as long as the remainder multi-generational family trust exists. The asset is placed in the CLUT for a term of years or the life of the donor with a unitrust income interest flowing annually to charity. The non-grantor CLUT provides an annual income tax benefit to the client because the income produced by the gift asset isn’t included in the client’s annual tax return; rather, the CLUT reports the income and is provided a charitable deduction for distributions to the designated charity. GST tax exemption may be allocated to the CLUT remainder interest that the family trust will receive in the future, ab initio, resulting in a zero-inclusion ratio.43 Thus, at the end of the CLUT term, the CLUT assets are transferred to the family’s multi-generational trust free of all transfer tax for generations.

CRTs with insurance. CRTs provide either an annuity or unitrust income benefit to the donor for a term of years or life (lives) with the remainder designated to charity.44 CRUTs can provide a significant income tax deduction at the time of their funding. In addition to the charitable income tax deduction, assets in the trust grow income tax free, thus providing a hedge against inflation for trust income. The unitrust income received by the donor will be based on the four-tier system: (1) ordinary income; (2) capital gains; (3) tax-free income; and (4) return of principal. This permits the ability to spread recognition of capital gains income from the sale of the gift asset throughout the life of the trust. The CRUT remainder passes to charity and thus qualifies for the charitable estate and gift tax deduction. But what about the family? Often, the client purchases a life insurance policy on the life or lives of the donors, which replaces the value of the charitable asset in the family hybrid trust. The benefit to the family in a multi-generational trust is that the proceeds from the insurance policy remain free from estate and GST taxes for as long as the trust is permitted to exist under the applicable rule against perpetuities. The result of the charitable gift transaction, when combined with life insurance, is a significant lasting benefit to the family and charity that wouldn’t otherwise be possible.

The insurance replacement strategy works similarly for other types of split-interest charitable gifts. The choice is what the client decides to do to replace the remainder interest that transfers to charity for the family.

Planned bequest to charity. In this situation, the client sells a limited partnership to the hybrid trust for the benefit of their family and future generations in exchange for a note. The partnership produces sufficient income to make note payments with a surplus. The client continues to receive note income for the term of the note. The client’s hybrid trust purchases sufficient insurance to pay off the note at death. The client will gift the note to their favorite charity on their death. The life insurance proceeds are used to pay off the note, and the business is owned by the trust tax free with a step-up in basis. The charity receives a generous gift (the charity could be a family foundation or donor-advised fund).

The estate tax, income tax and philanthropic benefits of charitable gifts are greatly enhanced to the family in a multi-generational setting because of the perpetual or near-perpetual family and charitable legacy that such transfers make possible. The elimination of the estate tax for future generations through effective use of the GST tax exemption makes such bequests practical.

Evaluation Factors

Like any comparison of jurisdictions article, different authors will have different conclusions regarding the most important factors when evaluating a jurisdiction. Because about half of the U.S. population will experience at least one divorce, protection against marital claims is one of the most significant factors when evaluating the strength of a trust statute. The primary key to protecting against a marital claim may well be whether a beneficiary has an enforceable right to a distribution. This protection typically isn’t found in DAPT statutes but rather in the discretionary support legislation enacted by many states (or, in some instances, in state common law). Some of the more important DAPT protective features include limiting a creditor’s claim solely to a fraudulent conveyance, debtor-friendly fraudulent transfer law and forcing litigation into the DAPT state.

Certain charitable gifts combined with hybrid trusts provide enhanced asset protection, a beneficial interest to society and help to leave an estate tax-free legacy for family.

Endnotes

1. Prior to 1996, 18 nations had provided offshore asset protection trust (APT) statutes.

2. Campbell v. Commissioner, T.C. Memo. 2019-4.

3. Restatement (Second) of Trusts, Section 155(1) and Comment (1)b.

4. Mark Merric, “How to Draft Distribution Standards for Discretionary Dynasty Trusts—Part II,” Estate Planning Magazine (March 2009). Endnote 41 lists cases from 16 states noting that a discretionary distribution interest isn’t a property interest, http://internationalcounselor.com/thirdpartytrust_article.html.

5. Ibid., at endnotes 42 and 43, which list cases from 18 states noting that discretionary interests couldn’t be attached at common law. Please note that the Restatement (Third) of Trusts (Restatement Third) and the Uniform Trust Code (UTC) reverse common law in this area allowing a creditor to attach a discretionary interest. However, five UTC states have modified the national version of the UTC to retain common law in this area.

6. Restatement (Second) of Trusts (Restatement Second), Section 155(1) and comment b.

7. United States. v. O’Shaughnessy, 517 N.W.2d 574 (Minn. 1994); In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991); In re Canfield’s Estate, 181 P.2d 732 (Cal. App. 1947); In re Horton, 668 N.W.2d 208 (Minn. App. 2003); Fortune v. First Union Nat. Bank, 371 S.E.2d 483 (N.C. 1988).

8. Dryfoos v. Dryfoos, 2000 WL 1196339 (Conn. Super. 2000), unreported case.

9. For a detailed discussion of the difference among mandatory, support and discretionary interests see Mark Merric, “Drafting Discretionary Dynasty Trusts—Parts I through III,” Estate Planning Magazine (February, March and April 2009).

10. Mark Merric, Michael Bland and Mark Monsasky, “Beware of Federal Super Creditors,” Trusts & Estates (July 2010).

11. Restatement Third, Section 60, comment e; Section 50 comment on subsection (2), d, first paragraph; Section 50, comment on subsection (1), b, third paragraph last line.

12. For purposes of this article, the term “discretionary trust” means that the beneficiary doesn’t have an enforceable right to sue for a distribution. Rather, such discretion is vested in the sole, absolute or unfettered discretion of the trustee.

13. Register v. Comm’r, 83 T.C. 1 (1984).

14. See alsoRevenue Ruling 79-327. But see Self v. U.S., 135 Ct. Cl. 371 (1956), which was decided before the enactment of the current Treasury regulations.

15. Unfortunately, the revenue ruling didn’t quote the entire distribution standard. So it’s not certain that this was a discretionary trust with simple discretion.

16. Bureau of Support in Dep’t of Mental Hygiene & Correction v. Kreitzer, 243 N.E.2d 83 (Ohio 1968).

17. Uniform Law Commission, Uniform Voidable Transactions Act (UVTA), www.uniformlaws.org/shared/docs/ Fraudulent%20 Transfer/2014_AUVTA_Final%20Act_2016mar8.pdf.

18. Schreyer v. Scott, 134 U.S. 405, 414-415 (1890). The U.S. Supreme Court held that individuals have a right to protect against future issues, stating, “Under such circumstances, the presumption of any fraudulent intent is rebutted, and it is manifest that he had done no more than any businessman has a right to do, to provide against future misfortune when he is abundantly able to do so.”

19. www.uniformlaws.org/committees/community-home?CommunityKey=64ee1ccc-a3ae-4a5e-a18f- a5ba8206bf49.

20. George D. Karibjanian, Gerald Wehle and Robert Lancaster, “A Memo to the States—The UVTA Is Flawed… So Fix It!!!” LISI Asset Protection Planning, #367 (May 2018), citing Professor Jay D. Adkins’ response to criticism of the UVTA comments.

21. See Al W. King III, “Be Aware of the Uniform Voidable Transactions Act,” Trusts & Estates (October 2016); see also Section 4, Comment 2 of the UVTA, citingMacKason’s Appeal, 42 Pa. 330, 338-39 (1862); Ghormley v. Smith, 139 Pa. 584, 591 (1891); Patrick v. Smith, 2 Pa. Super. 113, 119 (Super. Ct. 1896).

22. Supra note 18.

23. Note that if a domestic asset protection trust (DAPT) jurisdiction adopts the UVTA and specifically includes Section 10 Governing Law, and Section 4, Comment 2, this could prove problematic and possibly prevent legitimate wealth preservation planning using DAPTs in that state.

24. See Richard Nenno and John Sullivan, “Domestic Asset Protection Trusts,” BNA 868-1 TM (2010), at p. A-53 et seq.

25. See King, supra note 21.

26. Ibid. See also Restatement (Second) of Conflict of Laws Sections 270 and 273 (1971); Riechers v. Riechers, 267 A.D.2d 445 (1999). In dictum, the Riechers court stated, “[a] cause of action would not lie to set aside the trust since the trust was established for the legitimate purpose of protecting family assets for the benefit of the Riechers family members.” The defendant-husband established an irrevocable trust in the Cook Islands, holding 99% of a Colorado limited partnership owning over $4 million of marital assets. The court held that it didn’t have jurisdiction over the corpus of the offshore trust. Nevertheless, the court ruled that the trust assets were part of the marital estate and were subject to inclusion in the calculation of the total marital assets. See also TrustCo Bank v. Susan M. Mathews, C.A. No. 8374-VCP, V.C. Parsons (Del. Ch. Jan. 22. 2015), in which a New York bank made a loan to a Florida limited liability company (LLC) with a personal guarantee by the defendant to construct self-storage facilities in Florida. The lender sued three Delaware DAPTs, contending that the defendant fraudulently transferred assets. The defendant claimed that the Delaware or Florida 4-year statute of limitations (SOL) should apply and not New York’s 6-year SOL. The court applied the 4-year Florida SOL and held that the plaintiffs’ fraudulent transfer claims were time-barred, finding that Florida and Delaware had more significant relationships than New York; Florida’s contacts included foreclosed real estate and business; Delaware contacts included Delaware trusts and Delaware trustees. The court further held that if New York had been deemed to have a more significant relationship, then Delaware’s “borrowing statute” (which states if a cause of action arises outside of Delaware, then either the applicable Delaware limitations period applies or that of the state where the cause of action arose, whichever is shorter) would apply, and thus Delaware’s SOL would apply.

27. See King, supra note 21.

28. In re Huber, 201 B.R. 685 (Bankr. W.D. Wash. May 17, 2013). Additionally, in Huber, an Alaska LLC (99% owned by the DAPT and 1% owned by the settlor’s son) held entities and real property located in Washington; the settlor’s son, based in Washington, was also the manager of the LLC. The case also featured fraud and bankruptcy issues and provides a useful lesson on how not to structure a DAPT to receive maximum situs protection and how not to administer a DAPT considering the substantial presence test of Restatement (Second) of Conflict of Laws Section 273.

29. See King, supra note 21.

30. Ibid. Additionally, Internal Revenue CodeSection 270(a) states that IRC Section 273 applies so long as the law doesn’t violate a strong public policy of the state that has the most significant relationship to the trust.

31. Moreover, the UVTA’s comments even suggest that a true principal residence of a debtor in a DAPT state can be overlooked if a court concludes that a debtor’s residence is “notional,” “short term” or an act of “asset tourism.” The UVTA comments actually invite courts to fish for reasons to ignore the UVTA’s own statutory rule giving priority to the laws of a settlor’s principal residence. As a result, individuals who in good faith move into a DAPT jurisdiction, settle a DAPT under that jurisdiction’s laws and then unexpectedly move out of that jurisdiction could have their DAPT judicially invalidated, even though the DAPT transaction occurred entirely within a DAPT state.

32. Ibid.

33. Al W. King III, “The Uniform Voidable Transactions Act—Continue to Be Aware!” Trusts & Estates (September 2020).

34. See“New York City Bar Association (City Bar) Report on Legislation,” which specifically provided commentary that it rejected the comments of the UVTA, https://s3.amazonaws.com/documents.nycbar.org/files/2007UVTABillMemo_Commercial&Bankruptcy_FINAL_10.6.16.pdf.

35. Seesupra note 20.

36. Indiana Code 32-18-2-23. “However, in interpreting solely this chapter, comments released by a committee of the National Conference of Commissioners on Uniform State Laws shall not be considered as authority.”

37. Arkansas Act 1086, Section 2.

38. See, for example, S.D. Codified Laws Section 55-16-9; see also similarly exclusive jurisdiction statutes in some DAPT states such as Alaska (Alaska Stat. Section 34.40.110(k)), Delaware (12 Del. C. Section 3572), Nevada (Nev. Rev. Stat. Ann. Section 166.120) and South Dakota (S.D. Codified Laws Section 55-16-13).

39. See King, supra note 21.

40. George D. Karibjanian, “Two DAPT States Adopt the UVTA—Smart Move or Falling for the Long Con?” www.wealthmanagement.com(April 11, 2017).

41. Al W. King III, “Defend Against Attacks on DAPTs?” Trusts & Estates (October 2014). Creditors may argue that there was a fraudulent conveyance to the trust. For this claim to prevail, the creditor must prove that there was intent to hinder, delay or defraud a specific creditor. This argument, generally, is subject to a “clear and convincing” or “preponderance of the evidence” standard of proof, which varies depending on the DAPT state’s statute. There’s also an SOL for a fraudulent conveyance (usually two to four years), depending on state statute, after which time a cause of action or claim for relief with respect to a transfer of the settlor’s assets to a DAPT is extinguished, and the creditor may not be able to reach the assets. An existing creditor at the time the DAPT is established may also have the period of time starting from when the creditor discovers or reasonably could have discovered the transfer to bring its claim (usually six months to a year), depending on state statute. Note that Nevada and South Dakota fraudulent conveyance periods are two years, and Alaska, Delaware, New Hampshire and Wyoming are four years. South Dakota and Nevada now have notice by publication statutes that begin the time at publication of notice instead of reasonably discovered.

42. IRC Section 4947(a)(1).

43. While generation-skipping transfer (GST) tax exemption may be allocated to the present value of the remainder interest of a charitable lead unitrust, modified estate tax inclusion period rules apply to charitable lead annuity trusts (CLATs), see 26 CFR Section 26.42-3(a). In general, in determining the applicable fraction with respect to a CLAT: (1) the numerator is the adjusted GST tax exemption; and (2) the denominator is the value of all property in the trust immediately after the termination of the CLAT. This makes GST tax planning impractical for CLATs.

44. Charitable remainder trusts are authorized under IRC Section 664.