The Nevada Asset Protection Trust (NAPT)
Asset protection planning has been around for many years. The wealthiest families have always structured their affairs to ensure that their accumulated wealth would pass from generation to generation without risk of loss due to lawsuits, divorce and excessive taxation. Recently, the explosion of litigation in the United States and a few highly publicized jury awards have caused many to perceive that our legal system is out of control and that their assets are at risk simply because they have wealth. Many have sought to protect the equity in their home or other real estate, the value of their business, their retirement nest egg, or their children's education savings from risk of loss by creating asset protection trusts. How effective asset protection trusts actually are depends on a variety of factors, including, among others, the law governing the administration of the trust.
The Nevada Spendthrift Trust Act
Under Nevada law any person competent to execute a will can create an asset protection trust (also known as a "spendthrift trust") in real or personal property. 1 A "spendthrift trust" is simply a trust which directs a Trustee to provide for the support and maintenance of a beneficiary but, while the trust is in force, the beneficiary is prohibited from voluntarily or involuntarily transferring the trust property. Since the beneficiary cannot compel the Trustee to transfer the trust property, the Trustee cannot be compelled to transfer the trust property to a creditor of the beneficiary. In order to protect the beneficiary's interest in a spendthrift trust, if a beneficiary attempts, or is forced, to transfer the property of a spendthrift trust, the Trustee is required by law to disregard and defeat every assignment or other act, whether voluntary or involuntary, that is contrary to the provisions of the Nevada Spendthrift Trust Act.
While all states allow a Grantor to establish a trust for another beneficiary and protect the assets from that beneficiary's creditors, since 1999 Nevada has allowed a Grantor to establish a trust for the Grantor's own benefit, and protect the assets from the Grantor's own creditors. Nevada is one of a very few states which allow a Grantor to establish an asset protection trust, sometimes called a "self-settled trust" for the Grantor's own benefit, as well as the benefit of the Grantor's loved ones.
To protect the Grantor's interest as a beneficiary of the trust from the Grantor's creditors, a Nevada Asset Protection Trust (NAPT) must:
- be irrevocable
- it must not require any portion of the income or principal of the trust to be distributed to the Grantor
- it must not be intended to hinder, delay or defraud any known creditor; and
- at least one Trustee must be a Nevada resident or must be a bank or a trust company that has its office in Nevada.
The primary advantage that Nevada has over the other states that permit self-settled asset protection trusts is that the time when the assets transferred to the trust become protected from the Grantor's creditors is among the shortest. Under Nevada law, a person may not bring an action to set aside a transfer of assets to a Nevada asset protection trust if the person was a creditor when the transfer was made, unless the action is commenced within two years after the transfer is made, or six months after the creditor discovers or reasonably should have discovered the transfer, whichever is later. If the person becomes a creditor after the transfer, the action must be commenced within two years after the transfer is made.
Although the NAPT is considered a domestic trust for US income tax purposes, we generally recommend including a provision that would permit the Trustee, in its sole discretion, to change the situs of the trust for tax purposes to an offshore jurisdiction when there is an act of coercion or an event of duress against any one or more of the beneficiaries, and the Trustee determines that the interests of the beneficiaries are better served by doing so.
Combining the NAPT With Domestic Entities
To help overcome the perceived loss of control in transferring assets to an independent Trustee, a NAPT can also be funded with equity interests in one or more corporations, limited liability companies, or limited partnerships, in which the Grantor retains some measure of control over the day-to-day operations of these entities. By transferring equity interests in domestic entities to the NAPT, a significantly greater degree of asset protection is afforded for these equity interests than if the interests were simply owned outright.
Gift, Estate and Income Taxation of the NAPT
An irrevocable trust can either be designed to be "tax neutral" or it can be designed so that transfers to the trust are treated as completed gifts and therefore excluded from the Grantor's estate. The trust can also be designed to be treated as a separate taxpayer for income tax purposes, or it can be treated as a "Grantor Trust" under the Internal Revenue Code, just like a revocable living trust, so that all income tax consequences accruing to the trust's assets are reported to the Grantor and carried over to the Grantor's federal income tax return.
Risks of the Strategy
The NAPT is a sophisticated estate planning strategy that should be prepared by well-qualified counsel. Like any asset protection planning strategy, it must be based upon a sound legal foundation of established principals of law. Some question the public policy of any law that permits a person to place their assets in a trust which can be used for their benefit, but which cannot be used to satisfy their legitimate liabilities. In 2009, the Nevada legislature passed important changes affecting Spendthrift Trusts and other Nevada trusts. Among the changes, which also strengthened the protective provisions for beneficiaries of such trusts, are:
1. Nevada now expressly authorizes the Trustee of an irrevocable trust with discretionary distribution powers to “decant” or transfer the trust property to a second trust with different provisions, without first obtaining court approval.
2. Nevada now allows for “directed trusts” which allow the delegation of the Trustee’s investment powers to a third party “Investment Adviser” which allows clients to retain a professional trustee with certain administrative duties, while delegating investment management to their existing professional investment advisers.
3. Nevada also codified provisions for the use of Trust Protectors or Trust Advisers to have certain discretionary powers over an otherwise irrevocable trust.
The Bankruptcy Abuse and Consumer Protection Act of 2005 significantly affected how assets transferred to a Domestic Asset Protection Trust ("DAPT") or "other similar device" will be treated when a debtor is in bankruptcy. The Act provides that if a debtor's property has been transferred to a DAPT or "other similar device" for the subsequent 10 years a creditor in bankruptcy can charge the debtor with thereby "attempting to hinder, delay, or defraud" the creditor. If that charge is upheld, the creditors could get access to the debtor's interest in the transferred asset to satisfy their claims against the debtor. This provision is applicable only in a federal bankruptcy proceeding, not a state court action.
1 An "asset protection trust" is simply a trust created under the laws of a jurisdiction that provides spendthrift protection for a settlor or beneficiary's interest. While the terms "spendthrift trust" and "asset protection trust" are used interchangeably, the Nevada statutes refer only to "spendthrift trusts".