Trusts are creatures of state law. Each jurisdiction has its own legislation authorizing and regulating trusts, and the various trust statutes can differ significantly between states. More practically, the financial objectives you can accomplish with a trust in one state might not be possible in another. When people ask about trusts for asset protection, a/k/a domestic asset protection trusts and Florida law, they’re often surprised that, despite offering an array of asset protection options, this one isn’t a “go to” in Florida. The precarious relationship between FL and asset protection trusts is therefore the focus of today’s article along with an overview of what a domestic asset protection trust is and does.
As a lead in, understand that the fundamental framework of trusts is more or less consistent across jurisdictions. A “grantor” (a/k/a “settlor” or “trustor”) establishes a trust and funds it with assets to be managed by a trustee for the benefit of one or more beneficiaries. But in the nitty gritty details, there can be critical differences. In fact, one trust in particular, the domestic asset protection trust, is an invaluable tool under the laws of some states—but just plain invalid in others.
What Is a Domestic Asset Protection Trust?
A Domestic Asset Protection Trusts (or “DAPT”) is a specific class of trust designed for the express purpose of shielding assets from creditor claims. For the most part, DAPTs are self-settled and irrevocable. “An irrevocable trust” in Florida and elsewhere means that, once the trust is established, the grantor surrenders the right to amend, terminate, or revoke the trust–other than as spelled out in advance in the declaration of trust and allowed under state law. And a trust is “self-settled” if the grantor is also the beneficiary. That is, the grantor transfers assets into the trust, and the trustee then manages those assets for the benefit of the grantor.
The essential idea behind a DAPT is that it allows the grantor/beneficiary to continue enjoying the benefits of trust assets but without any risk of creditor attachment unless and until trust assets are formally distributed (i.e., until the wealth is no longer in the trust). There are a few narrow exceptions, such as for domestic-support obligations and fraudulent transfers. But, for the most part, assets held in a bona fide DAPT would have to be in Fort Knox to be any safer from creditors.
Historically, self-settled trusts were of somewhat limited utility for asset protection—at least with regard to claims against the grantor. But DAPTs have shifted the paradigm in the sixteen states (not including Florida) in which they are recognized. Even within those states, though, the trusts are authorized by specialized laws and, to be effective, must meticulously comply with statutory requirements.
Domestic Asset Protection Trust Requirements
As noted above, DAPT statutes are not uniform, though there are a few general principles that apply more or less across the board. The trust instrument must state that it is governed by the state’s specific code section authorizing DAPTs, or something to that effect. And it needs to include a “spendthrift provision” (a clause baked into the trust instrument that prevents beneficiaries from transferring, selling, or otherwise assigning their interests in the trust). The presence of a spendthrift provision is what stops beneficiaries’ creditors from attaching trust assets until after distribution. The theory is that, if the beneficiary could not compel distribution or voluntarily assign the interest, the creditor cannot attach it involuntarily.
A DAPT also must be funded with at least some assets situated within the state in which the trust is formed. If the trust is funded with real estate, this means the land must be physically located within the state’s borders. Bank accounts must be deposited in a bank chartered in-state, or at least authorized to transact business there. In some situations, a DAPT can satisfy this requirement by holding assets through an LLC organized in the relevant state.
The trustee of a DAPT needs to be a resident of the trust’s state of formation—either a natural person who actually lives there or an entity authorized to serve as a trustee under state law. In some states, a DAPT can have co-trustees, only one of whom needs to be a resident. Even then, the resident trustee must be materially involved in administration, not just a token resident.
And state DAPT laws generally require some sort of legitimate limitation on the grantor/beneficiary’s right to receive distributions of trust principal. The limitation can be an objective standard establishing conditions for principal distributions, or, at the very least, the decision must be within the discretion of the trustee.
How DAPTs Work?
Upon creating a DAPT organized under the laws of a state that recognizes them, the grantor funds the trust with cash, real estate, securities, business interests, intellectual property, or some other valuable assets. The DAPT’s trustee then manages and exercises effective control over the assets. The trustee, though, is bound by the terms of the trust instrument and by the fiduciary duty of all trustees to act in the best interests of beneficiaries.
By definition, the grantor names him or herself as a beneficiary. Otherwise, the trust is just an ordinary spendthrift trust. Notably, though, a DAPT can include other beneficiaries besides just the grantor. In fact, Virginia’s DAPT statute requires that at least one other person be named as a co-beneficiary—or else the trust is invalid and does not protect against creditor claims. In most DAPT states, though, the grantor can be the sole beneficiary.
Because the trust is irrevocable and the grantor no longer exercises control over trust property, the wealth within the trust is safe from creditor attachment until distributed to a beneficiary (and therefore no longer within the trust). And, because beneficiaries do not direct distributions, beneficial interests in the trust likewise cannot be attached to satisfy creditor claims. A grantor can usually continue to occupy real estate and physically use tangible personal property held within a DAPT.
By way of example, let’s say you fund a DAPT in part with shares in a publicly traded corporation. Upon funding, your creditors can no longer attach the shares—they’re safely in the trust. Because the trustee now has legal title to trust assets (including the corporate shares), he or she will be able to vote in corporate matters on behalf of the trust. The trust might be set up so that, when the corporation pays out dividends, the trustee pays out the amount of the dividends (as trust income) to you (as the trust’s beneficiary).
The end result is that the corporate shares are safely shielded from creditors. But when they earn dividends, you get the money. And at no point until the dividend payments are within your hands (or your bank account) do your creditors have any right or opportunity to get ahold of the money. So, you get to continue enjoying the fruits of an income-producing asset, and, if the trustee decides to sell the shares and distribute some of the proceeds, you could even benefit from the principal. But, short of a well-timed attachment that nets the distributions, your creditors have little in the way of recourse.
It’s easy to see why DAPTs are considered such a powerful asset-protection tool—and why creditors find them so frustrating.
DAPT Features in Friendly Jurisdictions
The various jurisdictions that recognize DAPTs have differing features that make the trusts more (or less) attractive in different scenarios. South Dakota, Delaware, and Nevada are generally considered as having particularly strong DAPT statutes.
In a few jurisdictions, notably including Delaware, the grantor can reserve the power to veto distributions, the power of appointment, and the authority to replace the trustee. This means that a grantor, while still enjoying the heightened level of asset protection, can override the trustee’s decision to distribute assets. Or, if the grantor doesn’t like how the trustee is managing the trust or making distributions, he or she can name a different trustee. And the grantor also retains the authority to decide who will ultimately succeed to the grantor’s rights as beneficiary.
South Dakota allows a grantor to retain an interest in the trust’s income and principal, so long as principal distributions are governed by an ascertainable standard or made by a third party. Principal can also be used to pay the grantor’s income taxes and, upon death, estate taxes and administration expenses. Like in Delaware, the grantor can retain a veto, power of appointment, and power to replace the trustee.
A few states allow a grantor-beneficiary to serve as trustee, too. For this to work in Utah, there must also be a co-trustee who otherwise complies with the statute. In Nevada, a grantor-beneficiary can be a trustee if he or she (or a co-trustee) is domiciled in Nevada. Both the Nevada and South Dakota statutes allow creditors to pursue claims against trust assets only under very limited circumstances. The claim must be made within two years of the transfer of assets to the trust, and, to prevail, the creditor needs to provide clear evidence that the transfer amounted to a fraudulent conveyance intended to evade creditors.
Both of the Virginias have DAPT statutes that are much more limited. Along with requiring at least one other beneficiary in addition to the grantor, both states forbid a grantor-beneficiary from retaining any sort of authority to veto the trustee’s distribution decisions.
Domestic Asset Protection Trusts in Florida
As hinted at earlier, while Florida asset protection offers an array of good asset-protection tools, domestic asset protection trusts aren’t among them. Dynasty trusts in Florida and other irrevocable trusts in Florida (including revocable trusts after a trustmaker passes) are a great way for Florida residents to ensure the benefits of a long-term legacy by protecting the transfer of wealth in Florida to family members and loved ones. The key distinction, though, is that Florida limits the creditor protections provided by self-settled trusts. Courts in Florida have held self-settled spendthrift trusts void as against public policy to the extent the trust shields assets from claims of the grantor-beneficiary’s creditors.
As a consequence, in Florida, assets held in a self-settled irrevocable trust can be attached by creditors up to the amount the trustee could distribute to the grantor, even if the trust includes a spendthrift clause. It doesn’t matter if the trustee actually would distribute the assets; if the trustee has the theoretical power to make the distribution, creditors can attach the assets. Florida residents can still use Florida spendthrift trusts to protect assets for someone else—the grantor just can’t be a beneficiary and still enjoy comprehensive spendthrift protections.
The question is a bit murkier when it comes to Florida residents using DAPTs formed in other states. When deciding whether to apply Florida law to a trust ostensibly governed by the laws of another state, Florida courts apply a test looking at the connections to the trust of both Florida and the other state. The court will consider where trust assets are located; where parties connected to the trust (including the grantor, trustee, and beneficiaries) reside; and where the administration of the trust occurs and trust paperwork is prepared and kept. In practice, Florida courts have been reluctant to enforce a DAPT made by a Florida resident under the laws of a DAPT state, particularly if the creditor has a Florida judgment and is attempting to attach trust assets situated in Florida. A Florida resident who, for example, formed a South Dakota DAPT holding South Dakota assets and managed by a South Dakota trustee might have a better chance of success.
Estate planning and asset protection in Florida are 2 areas that should always go “hand in hand” AND as this article demonstrates, there are some pitfalls and misinformation to consider. Florida residents interested in forming an asset-protection trust, or in investigating the various asset-protection strategies available to Florida residents, should consult with a seasoned Florida estate planning attorney for more information.
Steve Gibbs, Esq.