Alaska Domestic Asset Protection Trusts
ALASKA SELF SETTLED DISCRETIONARY SPENDTHRIFT TRUSTS
Why Would You Want To Form An Alaska Domestic Asset Protection Trust?
Prior to 1997, almost every state had a statutory or case law policy which provided that if a person (the settlor) created a trust, and was a discretionary beneficiary of the trust, then that settlor's creditors could reach the assets of the trust. This type of trust is technically called a self-settled discretionary spendthirft trust, and is more commonly referred to as a domestic asset protection trust (a DAPT). However, in 1997 Alaska changed its law to prevent the settlor's creditors from reaching the assets of such a trust. One consequence of this new law is to allow a person to form a trust and make substantial "completed" gifts to the trust while still being a discretionary beneficiary of the trust. The settlor's applicable credit (which in 2009 protected $3,500,000 from tax) would be used to offset any tax produced by those gifts. Arguably, all of the property contributed to the trust, and its appreciation, would not be subject to federal estate tax at the settlor's death. While this type of gifting is very attractive from a tax standpoint, in the past many people have hesitated to accomplish such substantial gifting because they were concerned that they might need some or all of the property in the future. That is, if their economic circumstances drastically changed, they would want to have access to such property. Under Alaska's new law, such completed gifts can be made, and if the settlor needs some of the assets in the future, the trustee can distribute them to the settlor.
The IRS has ruled favorably that the transfers to this type of trust will be "completed" gifts. However, the IRS has not yet ruled on whether the assets would be subject to the settlor's estate tax at death. This remains a gray area of the estate tax law.
Who Should Consider Using A Domestic Asset Protection Trust?
This planning technique makes the most sense for clients who fit the following profile:
- They have a potential estate tax problem that would be partially alleviated by making gifts that use the annual exclusion and applicable credit amount; and
- They are also concerned that if their economic fortunes drastically change, they may need access to the funds given away. Therefore, we can exclude very wealthy clients who can afford such gift-giving without any realistic concerns about needing the assets in the future.
How Do You Form An Alaska Domestic Asset Protection Trust? An Alaska domestic asset protection trust is an irrevocable trust. The settlor transfers assets to the trust, and reports them as completed gifts on a federal gift tax return. The dispositive plan of the trust generally gives an independent trustee the discretionary power to make distributions to a class of beneficiaries, which often include the settlor, the settlor's spouse, and the settlor's descendants. In addition, some settlors desire to use a perpetual trust plan, (see the information on Perpetual Trusts).
Asset Protection Trusts. Some Persons Form Alaska Domestic Asset Protection Trusts Primarily for Asset Protection Purposes. They do not "complete" gifts to the trusts under the Federal Gift and Estate Tax laws. As a result, these trusts are included in the settlor's estates at their death, and subject to the federal estate tax. The degree to which these trusts provide asset protection will be dependent upon a number of factors. This is a gray area of the law and results cannot be predicted with certainty.
Nonresidents. The framers of the new statutory trust provisions considered that persons located outside of Alaska may well be interested in using Alaska's domestic asset protection trusts. In order to provide an adequate Alaska nexus for such nonresidents, the Legislature required that such trust have an Alaska qualified trustee. Such a trustee must be an individual domiciled in Alaska or an Alaska trust company or bank. Other co-trustees may be nonresidents. The Alaska trustee's powers must include maintaining records for the trust on an exclusive or non-exclusive basis, and preparing and arranging for the preparation of any income tax returns that must be filed by the trust, again on an exclusive or non-exclusive basis. In addition, with respect to this type of trust, some assets need to be located in Alaska.
When a nonresident forms an Alaska domestic asset protection trust, certain additional issues exist. If the nonresident issued in his or her domiciliary state, a "choice of law" issue exists. That is, will the court in the domiciliary state apply that state's rules or Alaska's rules with respect to the domestic asset protection trusts? If the court in the domiciliary state enters a judgment against the settlor then an issue exists concerning whether the "Full Faith and Credit Clause" of the U.S. Constitution will require Alaska courts to give effect to the judgment. If, instead, the settlor files for bankruptcy or is forced into bankruptcy by a creditor, an issue exists concerning whether the bankruptcy court will apply Alaska law or the law of the settlor's residence. These additional issues are highly fact dependent. As yet, there has been little case law indicating how they would be resolved. The ultimate question is whether these issues are enough to undermine the asset protection foundation, for transfer tax purposes, of a carefully implemented Alaska domestic asset protection trust created by a nonresident of Alaska.
This is a "gray area" of the trust law. We cannot be certain that the creditor protection and tax benefits will be upheld by the courts. Nor can we be sure that trusts created by non-residents of Alaska will qualify for such benefits, even though Alaska residents’ trusts may so qualify.
As discussed above, the asset protection concept contained in this legislation, which also forms the basis for the above-discussed tax benefits, represents a substantial change of policy in the United States. Neither the Alaska courts, nor other state or federal courts, including federal bankruptcy courts, have had an opportunity to consider such legislation. Therefore, we do not have any judicial guidance with respect to this new law. The uncertainty created by lack of judicial decisions is greater when a non-Alaska resident is involved both because of additional factual complexity and because a court outside of Alaska may be called upon to consider this new Alaska legislature.
The Alaska Legislature appears to be committed to supporting this new trust law and other new trust provisions. However, members of the Legislature will change in the future, and there is no guarantee that the trust law will not be adversely changed. Further, federal bankruptcy courts may adopt new bankruptcy rules, or Congress may adopt new bankruptcy legislation, which adversely affects the creditor protection benefits created by the new Alaska law.
The Internal Revenue Service has recently issued a private letter ruling holding that the assets of an Alaska Self Settled Discretionary Spendthrift Trust formed by an Alaska resident will not be subject to federal estate tax at the settlor’s death.
NOTE: In 2010, the Federal Estate Tax does not apply.
Alaska domestic asset protection trusts are thoroughly discussed in various articles which are on the Articles Page of our website.
Our Office is available to discuss whether an Alaska domestic asset protection trust would be appropriate for implementation of your estate planning.
SHAFTEL LAW OFFICES, P.C.
1029 West Third Avenue, Suite 600
Anchorage, Alaska 99501
FAX: (907) 278‐6015