Development of Domestic Trusts
Once upon a time, in the land of financial planning, the “land” for protection of assets was not the United States. Asset protection trusts were created overseas to circumvent domestic taxes and find protection from creditors that was not readily available under U.S. law.
Development of Domestic Trusts (DAPT)
Over the last two decades, a financial planning vehicle called a “DAPT”, which stands for “domestic asset protection trust”, has evolved as an alternative to taking assets offshore. To take advantage of its protections, a DAPT must have the following elements (although these requirements may vary from state-to-state):
- It must be an Irrevocable trust;
- The trustee must be based in the state being used as the jurisdiction for the trust;
- The settlor must not be insolvent nor intending to file bankruptcy in the foreseeable future;
- Assets must be placed into the trust in a timely manner in the care and administrative of a named trustee; and
- It must name beneficiaries, one of which can be the settlor, as long as he or she is not the SOLE beneficiary.
Prior to 1997, only two states had laws that supported the formation of a trust similar to a DAPT. In fact, these trusts was expressly against the law in all but those states.
Alaska was the first state to actually pass a law which supported the formation of a DAPT. Since that law was passed in 1997, eighteen other states, including Wyoming, have legalized the formation of DAPTs. Some of these laws, while opening the door to the concept, just scratch the surface of the DAPT advantages, and the concept continues to develop through more specific laws as the state lawmakers becomes more amenable to the concept.
The Trouble With DAPTs
Because only 19 states have DAPT laws, one common problem arises when someone who lives in a non-DAPT state wants to use those protections in another state. The problems are due in part to two legal concepts, one of which is no less than a clause in the U.S. Constitution.
The “Full Faith and Credit” clause of the Constitution requires that full faith and credit be given to the public acts, records, and judicial proceedings of each state be given to every other state.
The other concept is known as conflict of laws.
A difference between the laws of two or more states with some connection to a case, such that the outcome depends on which jurisdiction's law will be used to resolve each issue in dispute. The conflicting legal rules may come from U.S. federal law, the laws of U.S. states, or the laws of other countries. For example, a company that is incorporated in one state may own trucks that ship products to other states. While one of their trucks is operating in a state other the state of incorporation, it is involved in an accident that causes injuries to the driver of another vehicle. Because the truck belongs to a company in one state and the accident occurred in a second state, any difference between the laws in the two states regarding accidents must be subject to consideration under the conflict of laws doctrine to decide which state’s laws control.
Because some states even expressly ban DAPTs, a creditor looking for assets in the trust to satisfy a debt will be considering which state’s courts will be most likely to award a judgment against the trust. Many contracts for loans and purchases contain a clause that specifies the state in which suits can be filed, so the state where the DAPT was formed can be important to the ultimate resolution of the debt.
The goal of forming the trust in a state that has sanctioned them by law is to have that state honor the creation of the trust. But it is critical to meet all the requirements of that state’s rules of formation to avoid the trust being voided and being subject to the law of a state that is unfavorable to DAPTs.
Wyoming is one of the states that DOES recognize the DAPT but, as with any other state, it must comply with Wyoming law and not be formed or operated to try to circumvent obligations. Some of those obligations include:
- Child support order
- Assets that have been listed on an application or financial statement to obtain or maintain credit
- Transfers of assets into the DAPT that are made to hide assets that should otherwise be available to creditors (“fraudulent transfers”)
Offshore investment companies have a dubious reputation as allowing assets to be hidden illegally to prevent creditors and others from reaching them. While there are always exceptions to the rule, there are reputable companies that are designed to help investors, not to create an illegal scam. For example, setting up a trust can protect assets from creditors but it is legal to create this as part of an estate plan.
The advantages of offshore investing are primarily designed to serve the wealthiest investors. Tax benefits, confidentiality and asset protections are some of the advantages sought by those choosing offshore investing.
While the advantages are many, there are also disadvantages with investing overseas. One of the most important is the inability to predict foreign economies, politics, and laws. Even given the 24/7 news coverage of political unrest in other countries, it is impossible to follow every development unless you actually work in the investment industry.
Another disadvantage is actually onshore. The U.S. government is carefully monitoring the amount of money being diverted through offshore accounts. A law known as FATCA, or the Foreign Account Tax Compliance Act, requires U.S. citizens to file annual reports on overseas accounts.
One reason that offshore accounts are primarily for the wealthiest investors is due to the initial cost to set one up. If an offshore corporation is required, legal fees and registration fees can be prohibitive.
Obviously the legal requirements for setting up a DAPT, as well as comparing it to other options, is a complicated process. Only the most experienced advisors will be able to provide the advice needed to make beneficial decisions about these strategies.