Asset Protection Trusts

  When people hear of asset protection trusts, they often think of shady off-shore arrangements intended to skirt laws or hide money from the government.  While this is undoubtedly how some asset protection trusts are used, there is a new breed of domestic asset protection trusts, endorsed by several states, that can provide legitimate creditor protection.

  Domestic Asset Protection Trusts - A domestic asset protection trust is a self-settled trust (i.e. you create the trust for yourself), to which you can transfer assets, that will eventually be protected from your creditors.  These trusts provide an ideal estate planning vehicle for professionals, or anyone scared by the possibility of future creditors or lawsuits.

  Spendthrift Provisions -  The hallmark of any asset protection trust is a "spendthrift provision," which prohibits the beneficiary from alienating (i.e. transferring or selling) the right to income from the trust.  This means that the creditors of the beneficiary are unable to get at the assets of the trust to satisfy the debts of the beneficiary.

  Which States - Colorado has not adopted domestic asset protection trusts, but Colorado residents can take advantage of trusts created under the laws of other states.  Utah, Nevada, Alaska, Wyoming, and Delaware are examples of states that have passed statutes specifically authorizing domestic asset protection trusts.  While the law in each state is different, most practitioners agree that the law of Nevada is most favorable to debtors, because of its shorter statute of limitations on transfers (2 years), and its lack of state income tax.

   Income Tax Consequences - These trusts are often drafted as grantor trusts for income tax purposes, which means that the IRS disregards the existence of the trust, and taxes any income earned by the trust directly to the grantor.  Thus, the existence of a domestic asset protection trust usually has no impact on the income taxes of the grantor.  The grantor can choose to have the trust taxed as a separate entity (by not retaining certain powers), in which case the trust would be responsible for its own taxes.

  Estate Tax Consequences - A domestic asset protection trust is not generally viewed as a good estate tax avoidance tool, because the person creating the trust simply retains too much control over the trust assets to exclude them from his or her taxable estate.  Several provisions of the Internal Revenue Code can be used to pull the assets of this trust back into the taxable estate of the grantor, including 2036, 2038, and 2041.