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CHAPTER 1

Protecting the Estate from In-lawsand Other PredatorsGIDEON ROTHSCHILD.

Synopsis

t 1700 Introductiont 1701 Potential lia iltiest 1702 Truts - In General

t 1702. Overvewt 1702. TrutsBenefitst 1702. Truts as an Alternative to an UGMA/UT Account

t 1703 Spendtht Truts

. Gideon Rothchid, Esq. : Gideon Rothschild is a partner with the New York City lawfinn of Moses & Singer LLP, where he co-hairs the estate planning and wealth preservation

group. He is a member of the Advisory Boards of BNA' Tax Managemt the AmericanAcademy of Estate Planning Attorneys, the Asset Protection Journal, Keeping Current, ThePractical Accountant and Offshore Finance U. A. He has authored numerous articles for

publications including the New York Law Journa Journal of Asset Protection and Estate Planningand is a contrbuting author to West Co.'s Geeral Practice in New York and Kluwer Trutsin Prme Juridictions. Mr. Rothschild is also the co-author of the forthcoming revised

BNATax Managemt portolio on Asset Protection Planning.

Mr. Rothschild is the Chair of the Committee on Asset Protection of the Real Propertyand Probate Section of the American Bar Association and a member of the New York

StateBar Association, the Society of Trust and Estate Practitioners (STEP), the Offshore Institutethe Estate Planning Council of New York and the Association of the Bar of the City of NewYork. He has lectured frequently on aset protection and

estate planning to professionalgroups including the New York University Federal Tax Institute, the University of Miami'Philip Heckerling Institute, the Southern Federal Tax Institute, the New York State BarAssociation, the American Bar Association and the American Institute of Certed PublicAccountants. Mr. Rothschild is also licensed as a

Certied Public Accountat.The author acknowledges Daniel Rubin and Lori Sattler

, associates with Moses & SingerLLP, for their contrbutions to this article.(Matthew Bender & Co. , Inc. 17-

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11 1705

'D 1706

1 1707

11 1708

1 1709

1 1710

2001 INSTITUTE ON ESTATE PLANING 17-

'J 1704

1: 1703. Overvew1 1703.2 Self-Setted Spendthft Truts1 1703. Quafied Personal Residence Truts'D 1703. Exceptions to Spendthft Trut ProtectionDomestic Aset Protection Truts1: 1704. Overvew1 1704. Possible Chalenges to Domestic Aset Protection TrutsDiscretionar Truts'I 1705. Overvew'D 1705. Requiements'J 1705. Supplementa Needs Truts

Support Truts

t 1706. Overvew1 1706. Support Trut SuggestionsSuggestions to Maxze Trut Protection1: 1707. Overvew'J 1707. Spendthft Proviion'D 1707.3 Sprig Proviion1 1707.4 Trutee/Protector Proviions11 1707. Discretionar Distrbutions and Beneficiares

'I 1707. Trut Term

'I 1707. State Income Tax Considerations11 1707. Use of Propert'I 1707. Mior Beneficiares1 1707.10 Split Interest Truts'I 1707.11 Termatig Beneficial Interest11 1707.12 Conversion of Absolute Trut Interest into Discretionary TrutInterest'I 1707.13 Powers of Appointment1 1707.14 Power to Withdraw Trut Prcipal'I 1707. 15 Segregation'J 1707. 16 Power to Withold Mandatory Distrbutions'D 1707.17 Power to Change Trut Situ'I 1707.18 Trut/LP/LLC CombinationLited Parerships'J 1708. Overvew'I 1708. The Chargig Order

'I 1708. Litations'J 1708.4 Banptcy of a General Parer1 1708.5 Max the Protection of a Lited ParershipLited Liabilty Companes1 1709. Chargig Order

1 1709. Advantaes/DisdvantaesMielleous Aset Protection Considerations1 1710. Disclaiers'I 1710. Powers of Appointment1 1710. Joint Ownership of Propert

(Matthew Bender & Co. , Inc.

17- PROTECTING THE ESTATEI 1701

1700 Introduction

The 'management, preservtion and distribution of wealth is the primarygoal of estate planning.

In the past, however, many estate planners havelimited their energies to minimizing taes and providing for the orderlydisposition of wealth to the client's intended beneficiaries to the exclusionof asset protection planning, to the potential

disservce of their clients.The concept of asset protection planning seemed to be a novel one tomost people ten years ago. Many viewed such planning as

limited tooffshore strctures and were suspicious of clients ' motivations when assetprotection planning was sought. It is only recently that asset protectionplanning has become recognized as an important and integral aspect of

the planning process. Modern society now requires that

every estateplanner account for the possibility that the client's estate plan be defeatedby his intended beneficiaries

' exposure to a creditor risk.This article will focus on those concepts which can be

easily integratedinto the trditional domestic estate planning process which planners shouldconsider to minimize creditor risk. These include the use of the spendthritdiscretionary and support

trsts as well as Jj!lited partnerships and limitedliability companies. Consideration

will also be given to powers of appoint-ment, disclaimers and other tools. This article will not, however, addressforeign asset protection trusts and the reader is directed to refer to otherpublished articles in this regard.

11 1701 Potential Liabilties

Many consider today s social and economic environment both morelitigious and more hazardous to the

preservation of wealth than in yearspast. This view is supported when one observes the ever expanding theoriesof liability, the rise in jury awards

, increasingly result oriented Courts andthe high incidence of marital separation and divorce. Based on theseproblems of modern society, it is clear that traditional forms of protection

against potential liabilities may be inadequate. For example, in the areaof insurance , a particular risk may be uninsurable or appropriate

coveragemay be prohibitively expensive or may become so while the risk remainsoutstanding.

Corporate offcers and directors may also need additional protection.The "corporate veil" may be pierced and in certain circumstances

, offcersand shareholders can be held liable even without a piercing of thecorporate veil. Similarly, a "responsible person " can be held personallySee, e.g. Gideon Rothschild, Establishing and Draftig Offshore Asset Protection TrutsEstate Planning, Volume 23/Number 2.

(Matthew Bender & Co" Inc,

'I 1701 2001 INSTITUTE ON ESTATE PLANING 17-4liable for failing to withhold certain taxes. There is also potential forindividual liability under the Comprehensive Environmental ResponseCompensation and Liability Act of 1980 ("CERLCA"

Perhaps one of the areas most ripe for encountering possible liabilityfocuses on pre- or post-nuptial agreements. First

, the language in theagreements may be poorly drated thus leading to potential court proceed-ings. With the rise in the divorce rate

, the courts are deluged with actionswhich seek to set aside pre- and post-nuptial agreements on several frontsincluding duress, failure of adequate disclosure and the ineffective

assis-tance of legal counsel. In addition, couples may not enter into an agree-ment, either because they feel uncomfortable in broaching the subject or

for any number of other reasons including time or family pressures. Assetprotection planning may work

as an alternative or "backstop" to a pre- orpost-nuptial agreement for anyone who is married or who is consideringmamage.

As can be witnessed by the examples listed above, which are by no meansexhaustive, certain classes of beneficiaries, both obvious and not so obviousmay be at particular risk. These individuals include professionals such asdoctors, lawyers, accountants and architects, offcers and directors of widelyheld or public compani

and owners, managers and developers of realestate, all of whom are candidates for incorporating asset protectionfeatures within an estate plan.

To ilustrate the need for asset protection , we need look no further thantwo recent cases. The first is a divorce proceeding wherein the defendantwife claimed that her husband' s remainder interest in a 10 year term trustsettled by his mother was subject to equitable distribution. The trust

, whichwas to terminate Soon after the divorce proceeding was commencedprovided that the trstee distribute the corpus to the grantor

s childrenper stirpes. The value of the husband's interest in the trst property was$19 milion dollars. The Connecticut Court held that this

was a vestedproperty right, which , under state law, is transferable and awarded theSpouse 20% of the corpus. Imagine the mother s reaction when she learnedthat her soon to be ex-daughter in law would receive almost $4 miliondollars! 2

The second case (discussed further in,. 1710.1) involved a modest estateleft to the decedent s son , who at the time had a ta lien filed against him.Although he disclaimed the ' inheritance in a timely manner, the Supreme Court held that the inheritance

was a property right under federallaw to which the IRS lien attached notwthstanding an effective disclaimerunder state law. 3

2 Dryoos v. Dryoos, 2000 Conn. Superior Lexis 2004.

3 Drye Family Trust v. United States, 152 F.3d 89 (8th Cir. 1998), afd 120 S.Ct. 475 (1999).(Matthew Bender & Co. , Inc.

17- PROTECTING THE ESTATE 1( 1702.

In both these instances, had the donor/decedent provided for a continu-ing trust for the son s benefit, the assets would have continued to beprotected from their predators.

The foregoing examples are only a few which demonstrate why assetprotection planning considerations should become a part of every estateplanner s "tool box" and , when and where appropriate , incorporated intothe client's estate plan.

1( 1702

1( 1702.

Truts in General

Overvew

Today, trusts serve a number of purposes in estate planning. Mostcommonly, modern trusts are incorporated into an estate plan for theprimary, if not exclusive , intended purpose of minimizing taation. How-ever , trusts should also be recognized as a useful device to protect assetsfrom the beneficiary s predators and creditors.

A review of the history of trusts helps us to understand how this planningtechniqu developed. The modem fonn of trst owes its origins (as wellas an historical function as an asset protection tool) to the system of "useswhich is reported to exist as far back as the 13th century. In order to defeatcreditors, a debtor would convey legal title to the debtor s land to anotherindividual but, nevertheless, retain the use of the land to himself. Becausethe debtor no longer held legal title to the land , the debtor s creditors wereunable to attach the land in satisfaction of their claims. The "use" arrange-ment was also popular since it avoided the onerous feudal taxes which wereimposed upon the occurrence of various events including the death of theowner of the property. In order to recapture lost ta revenues, the Statuteof Uses4 was passed in 1536 converting the use interests into legal estates

owned by the beneficiaries thereof. The restrictions imposed by the Statuteof Uses were gradually refonned and by the 17th century the modem fonnof trust came into existence.

1( 1702. TrutsBenefits

The trusts of today serve a number of estate planning purposes, includingta minimization. For example, a "credit shelter" trst is commonly usedto preserve for the benefit of the surviving spouse that portion of thedecedent's estate which is exempt from estate taxes by reason of thedecedent s unified credit while at the same time preventing the propertyfrom later being taed as a part of the survving spouse s estate. In addition

427 Hen. VIII, c.O (1536).(Matthew Bender & Co. . Inc.

'I 1702. 2001 INSTITUTE ON ESTATE PLANING 17-

property against which a suffcient amount of the transferor s GST exemp-tion has been anocated can pass from generation to generation withoutfurther transfer tax if such property is transferred and retained in continu-ing trst.

Trusts can provide additional benefits, other than minimizing taes. Bycreating a trst, assets may be protected from a beneficiary s own extrava-gance or bankrptcy. Trusts also serve to protect assets for the benefit ofthe intended beneficiary by limiting the exposure of the assets to possibleclaims which may arise in tort, in contract or by virtue of statute , by reasonof the actions of the beneficiary. Another benefit of creating a trst liesin the fact that a trst serves to protect assets from the beneficiary s spousein-laws and other potential predators and preserves wealth within theintended class of beneficiaries (i. , the descendants of the grantor). Inpartcular, the potential to protect property from a beneficiary s creditorsthrough the simple mechanism of transferring the property in trst

, ratherthan outright, weighs heavily in favor of a more widespread use of trusts.In certan planning situations, estate planners often fail to consider the

benefits of using a trst. For example , where a parent decides to transferthe ownership of a life insurance policy to his or her children in orderto pennit the death benefit to pass without estate tax, the cash value anddeath benefit could subject to the potential claims of the childrencreditors. 5 Clearly, the same tax result could be achieved by using anirrevocable "insurance" trust while at the same time providing the guaran-tee that should one or more of the children predecease , the proceeds winnot be paid to their survving spouses. In addition , consideration shouldbe given to continuing the asset protection by providing that the propertybe retained in trust for as long as possible under the trust s governing law.Another common situation which should be re-evaluated is the outrightmarital bequest.

1702. Truts as an alternative to an UGMA/UT AccountTrusts should also be considered as an alternative to a Unifonn Gifts/

Transfers to Minors Act account ("UGMA" UTMA" account). In weighingwhether to use a trust over a UGMAjUTMA account, one must look tothe fact that the balance of the account must be paid outright to thebeneficiary upon attaining either age eighteen or twenty-one; at which timeeither because of the beneficiary s tender age or because of externalcircumstances , it may be inappropriate to distribute the account to the

5 For a state by state analysis of exemptions available for life insurance see, Gideon Roth-schild and Daniel Rubin , Creditor Protection for Lie Insurance and Annuities

, Journal ofAsset Protection , May 1999, also available at ww.mosessinger.com/resources.(Matthew Bender & Co. , Inc.

17- PROTECTING THE ESTATE 1( 1702.

beneficiary. This may be especially true when one considers that substantial(and often unexpected) growth within the UGMA/UTMA account canoccur over the course of those eighteen to twenty-one years.

Even where the account was established with the intent that it be usedto cover a substantial expense such as higher education there is nothingthat requires the beneficiary to use the account proceeds for such purpose.In light of the beneficiary s newfound "financial freedom , the beneficiarymay decide not to continue his or her education, or may obtain ascholarship and , therefore, not need to use the account proceeds to coverhis or her higher education expenses. Another factor favoring the use ofa trust over an UGMA/UTMA account occurs when one considers that thebeneficiary s maturity and financial abilty are unlikely to be fully developedat the age when the law requires that the account be distributed to thebeneficiar outright.

One potential risk lies in the fact that the beneficiary s spouse (or at thevery least the strength of the beneficiary s marrage) is unlikely to be knownwhen the child reaches majority. Similarly, the estate planner must recog-nize that the property will be subject to the child's creditors, both duringthe existence of the UGMA/UTMA account and following an outrightdistrbution to the child. On the other hand , a trust will also protect theassets from the beneficiary s creditors. For example , if the minor benefi-ciary becomes involved in an automobile accident a trust will protect hisor her assets from potential creditors.

In contrast, a trust provides a number of benefits for a relatively youngand immature beneficiary. Subject to the applicable rule against perpetu-ities, if any, a trust for the beneficiary and his or her issue can continuefor the beneficiary s entire lifetime. A trust can also provide for professionalfinancial management until such time as the beneficiary has acquiredsufcient financial ability. With this in mind, when structuring distributionsto the beneficiary, a possible recommendation is to stagger the distributionsin order to allow the beneficiary to "gradually" acclimate him or herselfto the ownership of substantial wealth. For example , the trust might providefor the distribution of principal to the beneficiary in thirds at age thirty,thirty-five and forty. If the beneficiary should waste the first third throughexcessive spending, and lose the second third through an unwise businessventure , the beneficiary will hopefully have learned enough to preserve thefinal third when it is ultimately distributed.

If an UGMA/UTMA account has previously been-established , considerusing a family limited partnership as a fall back option. The custodian ofthe UGMA/UTMA account can contribute the account assets to a familylimited partnership (in which the beneficiary s parents are the general(Manhew Bender & Co. , Ine.)

'I 1703 2001 INSTITUTE ON ESTATE PLANING 17-

partners) in exchange for an interest therein. In this manner, when thebeneficiary attains the age of majority, the beneficiary will only becomeentitled to an interest in the limited partnership (which provides its ownasset protection) rather than the underlying assets.

Despite all of the benefits associated with creating a trust over an UGMA/UTMA account, the additional cost inherent in creating, maintaining andaccounting for trusts, not to mention the potential increased incometaation by reason of the substantially compressed income tax bracketsapplicable to trsts (where the trst is not a "grantor trst ), is a consider-ation which must be weighed when deciding whether to establish a trustfor relatively small sums.

1( 1703

1( 1703.

Spendthft Truts

Overvew

A spendthrift trust is defined as a trust "in which the interest of abeneficiary cannot be assigned by him or reached by his creditors. . . .This tye of trust possesses many positive asset protection planning benefits.A spendthrift trust may be "created to provide a fund for the maintenanceof a beneficiary and at the same time to secure the fund against hisimprovidence or incapacity; provisions against alienation of the trust fundby the voluntary act of the beneficiary or by his creditors are its usualincidents. . . .

Today, the validity of spendthrift trsts in protecting trust property froma beneficiary s creditors is practically universally accepted in the UnitedStates. It was actually not until the Supreme Court decision in Nichols v.Eaton in 1875 , however, that a break with the English common law onspendthrift trusts was effected and their validity became generally acceptedthroughout the United States. In establishing the modern rule with regardto spendthrift trusts, the Supreme Court stated that " (wJe concede thatthere are limitations which public policy or general statutes impose uponall dispositions of property, such as those designed to prevent perpetuitiesand accumulations of real estate. . . . We also admit that there is a justand sound policy. . . to protect creditors against frauds upon their rights.. . . But the doctrine, that the owner of property. . . cannot so disposeof it, but that the object of his bounty. . . must hold it subject to the debtsdue his creditors. . . is one which we are not prepared to announce asthe doctrine of this court. 9 Interestingly, the pre-Nichols rule providing

6 2AAustin W. Scott & Willam F. Fratcher, The Law of Trusts S 151 , at 83 (4th ed. 1989).7 Black' s Law Dictionary 1400 (6th ed. 1990).891 U.S. 716 (1875).9 Id. at 725.

(Matthew Bender & Co. , Inc.

17- PROTECTING THE ESTATE 'I 1703.

that disabling restraints are void as against an individual's creditors remainsupon public policy grounds, the law in England to this day.

A spendthrift trust is usually created by a mere demonstration of thesettlor s intent that the beneficiary s trust interest should not be subjectto either voluntary or involuntary alienation. For example, in Texaslegislation provides that " (a) declaration in a trust instrument that theinterest of a beneficiary shall be held subject to a ' spendthrift trust' issuffcient to restrain voluntary or involuntary alienation of the interest by

a beneficiary. . . ." 11 In other jurisdictions, the creation of a spendthrifttrust is effected by default. 12 In either such circumstance , however, theprudent estate planner should ensure that an express and inclusivespendthrift" provision is drafted into the trst agreement.

A spendthrift trst which is valid under state law will also be excludedfrom the estate in bankruptcy. 13 The bankrptcy code provides that " (a)restriction on the transfer of a beneficial interest of the debtor in a trustthat is enforceable under applicable non-bankruptcy law is enforceable ina case under this title. 14 While many states have recognized the validityof spendthrift trusts, some have chosen to limit the scope .of protectionof such trusts. For example, Virginia law limits spendthrift protection tothe first $1 000 000 of trust assets. IS

1( 1703. Self-Setted Spendthft Truts

When assessing the possibilty of establishing a spendthrift trust, it isimportant to consider that the vast majority of states do not recognize the

10 See, e. Surman v. Fitzgerald (In re Fitzgerald), I Ch. 573 (1904), rev g 1 Ch. 933

(1903), (stating that although restraints on the alienation of beneficial trust interests arenot pennitted under English law, they are not so far contrary to public policy as to precludethe English courts from enforcing them in trusts validly created under Scottish law). See

also Adam 1- Hirsch , Spendthrift Trusts and Public Policy: Economic and CognitivePerspectives, 73 Wash. U. L. Q. 1 (1995) (discussing the economic and social factors whichwarrnt the recognition of spendthrift trst restrctions).

11 Tex. Prop. Code , tit. 9 S 112.035 (2000).12 See, e. Y. Est. , Powers and Trusts S 7-1.5 (a) (1) (McKinney 1999). ("The right of

a beneficiary of an express trst to receive the income from property and apply it to theuse of or pay it to any person may not be transferred by assignment or otherwse unlessa power to transfer such right, or any part thereof, is conferred upon such beneficiary bythe instrment creating or declaring the trst

Restatement (Second) of Trusts S 157 (1959). With regard to an exception for depen-dents, see, e. NY. Est. , Powers & Trusts S 7-1.5(d). With regard to an exception for theUnited States see, e.g. First Northwestern Trust Company v. Internal Revenue Servce , 622

2d 387 (8th Cir. 1980); United States v. Rye 550 F.2d 682 (1st.Cir. 1977) (an interestin a spendthrit trst constitutes the tapayer s property for purposes of a federal ta lien.

11 U. C. S 541(c)(2).11 U. C. S 541(c)(2).

IS Va. Code. Ann. S 55-l9(B) (Michie 2000).

(Matthew Bender & Co. , Inc-

'I 1703. 2001 INSTITUTE ON ESTATE PLANING 17-

validity of spendthrift clauses to protect a settlor s retained beneficialinterest in the trust (a so-called "self-settled trust ), even though thesettlor s interest may be wholly discretionary. The law is well establishedon this point. " (1) Where a person creates for his own benefit a

trst witha provision restraining the voluntary or involuntary transfer of his interesthis transferee or creditors can reach his interest. (2) Where a person createsfor his own benefit a trust for support or a discretionary trust, his transfereeor creditors can reach the maxmum amount which the trustee under thetenns of the trst could pay to him or apply for his benefit. 16 The factthat the settlor did not intend to defraud creditors is found to be immate-rial. 17

The foregoing rule is even applicable where the self-settled trust is adiscretionary or support trust (each discussed in more detail hereinbelow).The reason being that where a trust is purely discretionary, there is apossibility that the trst may be invaded by the settlor to pay his or herdebts. Thus, if the trustee has absolute discretion to pay the income orexpend it for the settlor s benefit, then he or she could pay it all to thesettlor even though the trustee had the discretion to pay it to

others. ISThe public policy which subjects to the demands of a settlor s creditors

the income of a trust which th trustee in his discretion may pay to thesettlor applies no less to a case where the trstee might in his discretionpayor use the income for others. " 19

Another factor to consider is whether the settlor s beneficial trst interestwill be protected where the settlor transfers property in

trst for the benefitof his or her spouse with only a remainder interest retained for the settlorown benefit. If effective , this tye of trust presents useful planning opportu-nities since the settlor is unlikely to need to have the trust property directlyavailable to him so long as the trust property is available for the benefitof his spouse. Although it has been noted both that " (tJhe mere fact thatthe interest of a beneficiary of a trust is a future rather than a presentinterest does not prevent him from assigning it or prevent his creditorsfrom reaching it" and that " (wJhere his interest is vested, the mere factthat it is subject to being divested does not prevent his creditor fromreaching it . . . " the delay in vesting together with the potential ofdivestiture should serve to reduce the value of the settlor s retained interest

16 Restatement (Second) of Trusts S 156 (1959).17 2A Austin W. Scott & Wiliam F. Fratcher, The Law of Trusts S 156, at 165-167 (4thed. 1989). IS 2A Austin W. Scott & Wiliam F. Fratcher, The Law of Trusts S 156, at 167 (4th ed.

1989).120 Conn. 211 , 223 (1942). As to purely discretionary trusts see, e. Greenwich Trust

Company v. Tyson, 120 Conn. 211 , 223 (1942).(Manhew Bender & Co. , Inc_

17- PROTECTING THE ESTATE 1( 1703.

vis a vis his creditors and provide substantial leverage in settlementnegotiations. 20

Although a "self-settled" spendthrift trust may not be protected from thesettlor s creditors in most states, this is not to say that a non self-settledspendthrift trust cannot still indirectly benefit the settlor. As noted abovea spendthrit trst for the benefit of the settlor s spouse can satisfy financialneeds which also impact upon the settlor. For example, the trust canpurchase a vacation home for the settlor s spouse , which the settlor canenjoy along with his spouse and the rest of his family without negating theprotection which the trust afords. One must always consider the possibility,however, of the settlor s spouse either predeceasing or divorcing the settlor.

Lastly, "reciprocal" or "crossed" trusts (also sometimes called "parallel"trsts) are unlikely to be upheld as protective of the beneficiary s interestwhere the settlor of the first trust is a beneficiary of the second trust andvice versa. This is because the trsts, when uncrossed, are effectively "self-settled" trusts. It should, of course , be noted that the reciprocal trustdoctrine has actually developed as a tax construct for the purpose ofpreventing a form over substance avoidance of the estate tax. Howeverwhile there is no available case law to the express effect that reciprocal trustsare to be deemed "self-settled" for asset protection purposes , consider thatmost reciprocal trust cases find for inclusion in the deceased settlortaxable estate pursuant to Internal Revenue Code 2036(a) (1) as atransfer of propert with a retained interest.

1( 1703. Qualfied Personal Residence TrutsIn light of the self-settled trust rule , it is imperative to consider the impact

on certain split-interest trsts (i.

, "

QPRTs

" "

GRATs

" "

CRATs

" "

CRUTsand "GRUTs ) which are commonly used for estate planning purposes. Itis a well settled rule that " (wJhere the only interest that the settlor hascreated for himself under the trst is a right to the income for life or forsome other period, it is this interest alone that his creditors can reachunless the creation of the trst was a disposition in fraud of his creditor.

While Qualified Personal Residence Trusts ("QPRTs ) are commonlyused to leverage the settlor s unified credit exemption amount in connec-tion with a transfer of a personal residence of the settlor; the same trustmay also provide substantial asset protection to the settlor. In creating theQPRT, the settlor has transmuted his or her interest in real property froman absolute interest, subject to foreclosure and sale, into a mere right to

20 2A Austin W. Scott & Willam F. Fratcher, The Law of Trusts 162, at 236 (4th ed.

1989) .Id. at 156, at 167.

(Mallhew Bender & Co. , Inc.

t 1703.4 2001 INSTITUTE ON ESTATE PLANING 17-

reside in the residence for a term of years. Moreover, the settlor s rightto reside in the property may be coincident to a concurrent right of thesettlor s spouse. If the settlor does not have a spouse with a concurrentright to the use of the residence , a creditor of the settlor may be able tocause the sale of the property within the trust, which (under a properlydrafted QPRT) would have the effect of converrng the QPRT into a grantorretained annuity trust for the remainder of its initial term of

years. Eventhen, however, the annuity interest which the creditor can reach issubstantially less valuable than an immediate

right to possess the entirecorpus. Estate planners should also consider continuing the property intrust past the required initial term of years in order to maintain thespendthrift protection for the benefit of the settlor

s beneficiaries.

An undisputed benefit of creating a QPRT is that by establishing thetrust, one can counter a future creditor s claim that the transfer of thesettlor s personal residence to the QPRT should be voided as a fraudulentconveyance. Specifically, since a substantial estate tax savings was likelyrealized in connection with the creation of the QPRT, it is at least as likelythat the settlor s intent was estate tax savings rather than an

intent todefraud his creditors.

While the benefits of creating a QPRT are numerous, there are certancircumstances where a transfer of the settlor s principal residence to aQPRT may be inappropriate. For example, where the settlor is domiciledin a state with an unlimited homestead exemption which mayor may notextend to a residence held in a QPRT. Another such situation arises wherethe settlor may own the real estate together with the settlor s spouse astenants by the entirety (which would provide its own limited asset protec-tion) and, under the circumstances at issue, ownership of the real propertyas tenants by the entirety is believed to aford greater protection than woulda QPRT.

, "

1( 1703.4 Exceptions to Spendthft Trut Protection

Overvew

Notwthstanding the general validity of the spendthrit trust rule, thereare exceptions that exist with respect thertto. The interest of the benefi-

ciary often can be reached in satisfaction of an enforceable claim againstthe beneficiary by the beneficiary s spouse or child for support, or by thespouse for alimony. Similarly the beneficiary s interest is not safe fromcreditors seeking to recover for necessary servces rendered to

the benefi-ciary or necessary supplies furnished to him or her. In the same veinservces rendered and materials furnished which

preserve or benefit the(Marthew Bender & Co.. Inc.

17- PROTECTING THE ESTATE 1703.4

interest of the beneficiary are also enforceable claims , as are claims against

the beneficiary by the United States or a State to enforce a ta claim.

Public Policy Exceptions

In general , these exceptions to the protection afforded by a spendthrifttrst concern themselves with the nature of the creditor s claim. On theone hand are those instances where the claimant dealt with the beneficiaryof the claimant s own free will and fully cognizant of the limitations onthe claimant s potential for recovery of his or her claim and willng tosubmit thereto. On the other hand is the case of the spouse or child ofthe beneficiary for support or alimony. It is clear that public policy dictates

that the beneficiary should not be pennitted to have the enjoyment of his

or her interest under the trust while neglecting to support his or herdependents. Despite the exception with respect to child support andalimony, " (e)ven though the beneficiary s wife has obtained a decree foralimony directing the beneficiary to pay certain sums to her, she cannot

compel the trustee to pay her the full amount so decreed unless the courtwhich has jurisdiction over the administration of the trust deems it to befair to the beneficiary himself to compel the trustee to make such payment.The result is much the same as though the trust were created, not solely

for the benefit of the beneficiary, but for the benefit of himself and his

dependen ts. " 23

Tort Creditors

Another exception to spendthrift trust protection relates to tort creditors.It is possible that a person who has a claim in tort against the beneficiary

of a spendthrift trust may be able to reach that interest under the trust. In Sligh v. First National Bank of Holmes County, 25 the defendant was a

beneficiary of two spendthrift trusts which had been established for hisbenefit by his mother. In 1993, the defendant was involved in a motorvehicle accident which left the plaintiff paralyzed. The plaintiff won a civiljudgment against the defendant and tried to collect against the trusts

alleging that the defendant's mother had actual knowledge that thedefendant was an alcoholic and had created the trusts to shield his interestfrom the likely claims of involuntary tort creditors. The Mississippi Supreme

Court ultimately allowed the plaintiff to collect against the trusts by

concluding that spendthrift protection should not extend to judgments

22 Restatement (Second) of Trusts S 157.23 Restatement (Second) of Trusts S 157 , cmt. b. (1959); See also Read v. United States

ex reI. Department of Treasury, 169 F.3d 243 (5th Cir. 1999).24 Restatement (Second) of Trusts S 157, cmt. a. (1959).

25 704 So. 2d 1020 (Miss. 1997).

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1: 1703.4 2001 INSTITUTE ON ESTATE PlANING 17-

arising from gross negligence and intentional torts. 26 The Mississippilegislature promptly negated the import of Sligh in future cases throughenactment of the "Family Trust Preservation Act of 1998. 27 That act

provides that except in the case of a self-settled trust, a beneficiary s interestin a spendthrift trust may not be transferred nor subjected to a moneyjudgment until paid to the beneficiary.

Cases Involvig United States or a State to Satify a Tax ClaiAnother well recognized exception to the protection afforded by a

spendthrift trust may be found in cases involving the United States or aState to satisfy a ta claim against the beneficiary. In Interal Reenue Sericev. Or (In re Orr), 28 the Fifth Circuit recognized the unique status held bythe government as a creditor and found that " the government does notstand in the shoes of an ordinary creditor seeking to attach distributionsfrom a spendthrift trust. Consistent with the imperative nature of taxcollection 6321 gives the government an advantage over ordinarycreditors in collection matters. Moreover, the rationale for shifting the riskof default to creditors, who ought to examine the terms of a trust beforeagreeing to accept the right to future distributions as collateral , does notapply to the government, which imposes the income tax unilaterally andwithout reference to spendthrift protections. 29 Similarly, in Leuschner v.First Wester Bank and Trust 30 the Court stated that " (tJhere is no doubtthat the paramount right to collect taxes of the federal governmentoverrides a state statute providing for exemptions.

Creditor Funhed Necessar Servces or Supplies

As mentioned previously, another exception to the asset protectionaspects of the spendthrift trust occurs where the claimants renderednecessary servces or furnished necessary supplies to the beneficiary. Againit appears that public policy dictates such an exception. Without thisexception , a beneficiary would be unable to obtain necessary assistanceand a refusal to enforce such a claim is not required to protect thebeneficiary s interest under the truSt. Similarly, where a claimant ren-dered servces or furnished materials which preserve or benefit the interestof the beneficiary, an exception will be found. The basis for the exceptionlies in the doctrine of unjust enrichment. 32

26 ld. at 1028.

27 Miss. Code Ann. 91- 501 , et seq. (1998).180 F.3d 656, 663 (5th Cir. 1999).1d.

1261 F.2d 705, 708 (9th Cir. 1958).31 Restatement (Second) of Trusts 157, cmt. c. (1959).

Restatement (Second) of Trusts 157, cmt. d. (1959).

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17- PROTECTING THE ESTATE 11 1704.

1( 1704

1( 1704.

Domestic Aset Protection Truts

Overvew

Although the general rule in this countr is one of non-recognition ofself-settled spendthrift trsts , Alaska, Colorado , Delaware , Missouri , Nevadaand Rhode Island grant spendthrift trst protections , to a greater or lesserextent, even where the settlor has retained a beneficial trust interest(provided, of course , that the transfer is not a fraudulent conveyance). 33In addition , new legislation is pending which, if enacted, will also pennitindividuals to create effective self-settled spendthrift trusts in Texas andNew York. 34 Based on two cases involving federal estate tax issues, certainself-settled spendthrift trst protections may also be aforded under Indianaand Maryland law.

A. Alaska

The Alaska Trust Act, (effective April 2, 1997) modified Alaska s previ-ously undistinguished common law body of trust legislation in an effortgenerally touted as making the State of Alaska a domestic alternative toforeign situs asset protection trusts. In contrast to the Restatement (Sec-ond) of Trusts 156(2), Alaska now permits a settlor to create a trst forhis own benefit which Wii1 be protected from the settlor s future creditorsso long as the settlor does not retain the right to revoke or terminate the

trst. In addition, the settlor must not be in default by thirty (30) days ormore in making a child support payment and the settlor s ability to receivedistributions from the trust must be within the discretion of the trusteesrather than mandatory.

To protect existing creditors, the transfer of property to the trust mustnot be intended to hinder, delay or defraud creditors (i.e. a "fraudulentconveyance" which is generally subject to a four (4) year statute oflimitations under Alaska law). 36 Under the Alaska statute 37 a creditor

existing at the time the trst is created must bring suit within the later offour (4) years from the transfer or one (1) year after the transfer is, or

33 Alaska Stat. 34.40. 110 (Michie 2000), Colorado Rev. Stat. 38-10-111 (2000), Del.Code Ann. tit. 12, 3571-3576, Mo. Ann. Stat. 456.080 (West 2000), Nev. Rev. Stat.

166.040 (2000), R.I. Gen. Laws 18-9.2 (2000).34 See H.R. 1553, 76th Leg. , (Tex.) (introduced Feb. 17 , 1999), available in Westlaw, TX-

BILLS Database , and New York State Assembly Bil 09053 (introduced August 5 , 1999),avalable in Westlaw, NY-BILLS Database.

35 Estate of Uhl v. Comm , 241 F.2d 867 (7th Cir. 1957), and Estate of German v. Comm7 Cl. Ct. 641 (Ct. Cl. 1985).

36 Alaska Stat. 34.40. 110 (Michie 1997).Id.

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1 1704. 2001 INSTITUTE ON ESTATE PLANING 17-

reasonably could have been , discovered. A creditor arising after the transferto the trust is made must bring suit within four (4) years from the transfer.The statute further prohibits a challenge to a trust (except as otherwseprovided above) on the grounds

. . . that the trust or transfer avoids ordefeats a right, claim , or interest conferred by law on any person by reasonof a personal or business relationship with the settlor or by way of a maritalor similar right. " 38

Several formalities must be met in order to successfully establish anAlaska" trst. A mere choice of law clause will not be sufficient to establish

the trust as an Alaska trust. At least one trustee must be either a trustcompany or a bank with trst powers with its principal place of businessin Alaska, or an individual resident of Alaska. 39 In addition, some of thetrust assets must be deposited in Alaska, either in a checking or brokerageaccount or other similar account located in Alaska, and the Alaska trusteeduties must include both the obligation to maintan the trust s records andto prepare or arrange for the preparation of the trust s income tax returns.Although neither of these latter requirements must be

exclusive to theAlaska trstee, part or all of the trst's administration must occur in Alaskaincluding the physical maintenance of the trust s records in Alaska. Consistent with the foregoing requirements , an Alaska trust may be settledby any person , regardless of whethe r not they are domiciled in Alaska.

Colorado

Although Colorado does not have asset protection legislation, per selegislation provides that " (a)l deeds of gift, all conveyances, and alltransfers or assignments, verbal or wrtten , of goods, chattels, or things inaction , or real property, made in trst for the use of the person making

the same shall be void as against the creditors existing of such person

(emphasis added). 42 The statute has been interpreted to provide spend-

thrift protection to self-settled trusts where there were no creditors existingat the date of creation of the trust at

issue. 43

C. Delaware

The synopsis of the Act notes that the purpose of the legislation is toallow settlors to reduce their estate tax by excluding creditors ' claimsagainst self-settled trusts. The Act notes that it "is intended to maintain

38 Alaska Stat. 13.36.310.39 Alaska Stat. 13. 36.390(1).40 Alaska Stat. 13.36.035.41 Alaska Stat. 13.36.035.42 Colorado Rev. Stat. 38-10-Ill (2000).43 See

, e. Connolly v. Baum (In re Baum) , 22 F.3d 1014 (10th Cir. 1994).

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17- PROTECTING THE ESTATE 11 1704.

Delaware s role as the most favored jurisdiction for the establishment of

trsts." The Delaware Statute applies to "qualified dispositions" made onor after July 1 , 1997. 44 A "qualified disposition" is defined as a dispositionby or from a transferor to a trustee who is (i) a Delaware resident, bankor institution authorized by Delaware law to act as a trstee , and who (ii)maintans or arranges for custody in Delaware of some or all of the trustcorpus, maintains records (on an exclusive or nonexclusive basis), preparesor arranges for the preparation of fiduciary tax returns or otherwsematerially participates in the trst s administration.

In Delaware, a trst must be irrevocable but can include several of thefollowing favorable provisions for the settlor. The trust may provide thatthe settlor may retain the power to veto distributions. Provisions may alsobe included which permit the settlor to retain a special power of appoint-ment and to receive income, principal or both in the sole discretion ofa trustee who is neither the settlor nor related or subordinated to thesettlor. The Act also permits the settlor to retain a specific percentage (notto exceed 5%) of the principal annually.

Provided that the transfer of property to the trust was not intended tohinder, delay or defraud creditors (i. , a fraudulent conveyance) no actionto enforce a judgment shall be brought for attachment against suchqualified disposition. Vader the relevant Delaware code provisions, a

creditor existing at the time a transfer to a trust is made must commencean action to enforce a judgment within the later of four years of the transferor one year after the transfer was or could reasonably have been discoveredby the creditor. 45 If the creditor s claim arose after the transfer the actionmust be brought within four years of the transfer.

Despite the protections aforded by the Delaware statute , certain credi-tors may, however, avoid qualified dispositions. Those creditors include anyperson to whom the settlor is indebted on account of an agreement orcourt order for support, alimony or property distribution in favor of aspouse , former spouse or children; or any person who suffers deathpersonal injury or property damage on or before the qualified dispositionwhich death , personal injury or property damage was caused by thetransferor or another person for whom the transferor is liable.

MiourMissouri law provides that " (a) provision restraining the voluntary or

involuntary transfer of beneficial interests in a trst will prevent the settlorcreditors from satisfyng claims from the trst assets except. . . (t)o th

44 Del. Code Ann., tit. 12 , S 3570, et seq.

45 Del. Code Ann. , tit. 12 S 3572(b).

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1l 1704. 2001 INSTITUTE ON ESTATE PLAING 17-

extent of the settlor s beneficial interest in the trust assets , if at the timethe trust was established or amended: (a) The settlor was the sole benefi-ciary of either the income or principal of the trst or retained the powerto revoke or amend the trust; or (b) The settlor was one of a class ofbeneficiaries and retained a right to receive a specific portion of the incomeor principal of the trust that was determinable solely from the provisionsof the trust instrument. 46 By negative implication , Missouri law shouldtherefore , uphold self-settled spendthrift trust protections where the settlor(a) was not the sole beneficiary of the trust, (b) did not retain the powerto revoke or amend the trst, and (c) did not retain a right to receive aspecific portion of the trust.

Notwthstanding the Missouri legislation 47 state and federal courts haverefused to validate the protections

seemingly provided thereby. In Mark-muelle v. Case (In re Markmuelle), 48 the Court found that while " (w)e findserious flaws (in this argument regarding spendthrift trust protections) . . .we note that the common-law rule against self-settled spendthrift trusts isapparently still valid in Missouri to the extent it permits creditors to reacha beneficiary s income interest. Furthermore, spendthrift provisions willonly be upheld if they contravene "neither a statute nor public policy. " Thepublic policy of Missouri is that one may not settle their own spendthrifttrust and avoid their creditors. . . (internal citations omitted). Similarreasoning was set forth in In re Enpeld 49 where the Court stated as follows:Rev. Stat. Section 456.080.3(2) . . . simply codifies the traditional prohibi-

tion against extending spendthrift protection to a trust beneficiary who isalso the settlor of the trst. Certainly, it is inequitable to allow an individualto put his assets beyond reach of creditors through the simple expedientof creating a spendthrift trust.

Nevada

Effective October 1 , 1999 , Nevada amended its trst law to providespendthrift protection for self-settled trusts meeting certain require-ments. 50 Those requirements are as follows: (i) the trust must be irrevoca-ble; (ii) the settlor may only be a discretionary beneficiary of the trust: (iii)the transfer can not have been intended to hinder, delay or defraud anyknown creditors; (iv) all or part of the trust property must be located inthe State of Nevada; all or part of the administration of the trst must beperformed in the State of Nevada: and (vi) at least one Nevada resident

46 Mo. Ann. Stat. S 456.080(3) (West 1992).

47 Mo. Ann. Stat. S 456.080(3).51 F.3d 775, 776 (8th Cir. 1995).

49133 B.R. 515, 519 (Bankr. W.D. Mo. 1991).50 Nev. Rev. Stat. S 166 (1999).

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17- PROTECTING THE ESTATE 1( 1704.

is a trustee of the trust and has powers which , at a minimum, include

maintaining the trust s records and preparing the trust s ta returns.

Under Nevada law, the settlor may retain a veto power over trustdistrbutions or hold a testamentary special power of appointment withoutdefeating the spendthrift trst protections. In addition

, a creditor may not

bring an action with respect to propert transferred to a spendthrift trustunless brought within two years after the transfer or six months after the

creditor discovers or reasonably should have discovered the transferwhichever is later. If a person becomes a creditor after the transfer is madehe or she must bring the action within two years after the transfer.

Rhode Island

The explanation to the Rhode Island legislation provides that " (t) his act

facilitates the establishment in Rhode Island of irrevocable trusts which willallow trst settlors to transfer assets in trust in order to protect them from

the claims of certain creditors." The legislation applies to "qualified

dispositio " made after June 30 , 1999. A qualified disposition is a transferto a trst which is irrevocable, incorporates the laws of Rhode Island to

govern the validity, construction and administration of the trust andcontains a resuiction on the assignment of income or property, and furtherprovides that the settlor may retain only the following powers: a power to

veto trst distributions; a tdi'tmentary special power of appointment; anda right to receive distributions in the sole discretion of one or more trusteeswho are neither related to nor subordinate to the settlor.

With respect to a Rhode Island trust, a creditor may not bring an actionto avoid a qualified disposition if the creditor s claim arose before thetransfer was made unless the action is brought within four years after thetransfer or, if later, within one year after the transfer was or couldreasonably have been discovered by the creditor. Similarly, an action may

not be brought where the creditor s claim arose after the transfer, unless

the action is brought within four years after the transfer is made.

1704. Possible Chalenges to Domestic Aset Protection Truts

Estate planners should beware of potential problems which may arise

with the use of domestic trusts for asset protection. Notwthstanding theenactment of specific asset protection trust legislation in several states,

substantial uncertainty exists as to the degree of protection which is actuallyprovided by domestic asset protection trusts. Unlike an offshore jurisdic-

tion, the "Full Faith and Credit Clause" of the United States Constitution

requires each state to recognize and enforce the validly rendered judgment

51 R.I. Gen. Laws S 18-9, et seq.

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'I 1704. 2001 INSTITUTE ON ESTATE PLANING 17-

of a sister state. 52 By contrast, the asset protection legislation of selectoffshore jurisdictions will provide for the non-recognition of foreign (i.United States) judgments. This wil require a plaintiff to re-litigate theplaintiffs case in the offshore jurisdiction (and potentially after the statuteoflimitations on the plaintiffs claim has already run). If the creditor bringssuit in a state which does not recognize the validity of self-settled spendthrifttrusts, the creditor will be much more likely to obtain a judgment againstthe trust. Pursuant to the Full Faith and Credit Clause, the creditor maythen be able to enforce that judgment in the state in which the trust issited without being hampered by that state s asset protection legislation.

Domestic asset protection legislation may also be held to violate theContract Clause" of the United States Constitution. 53 Since the Contract

Clause prohibits the enactment of any state law which impairs the obliga-tion of contracts, legislation which precludes the enforcement of judgmentsagainst property which remains for the beneficial use of the settlor/debtoris arguably unconstitutional.

Another significant consideration with respect to domestic asset protec-tion arises in relation to the "Supremacy Clause" of the United StatesConstitution. Under that Clause, federal law (i. , the Bankruptcy Code)may override domestic asset protection legislation where the two are inconflict. 54 ...

Perhaps most significant is the fact that various factors which serve toenhance the asset protection aforded to self-settled trusts under the lawof select offshore jurisdictions are not replicated under domestic assetprotection legislation. A domestic asset protection trust will remain subjectto the jurisdiction of the domestic court system , which may prove lesssympathetic to the concept of a valid self-settled spendthrift trst than willcourts of certain select offshore jurisdictions which are decidedly pro-debtor. Additionally, in some offshore jurisdictions proof beyond a reason-able doubt is required to prove a fraudulent conveyance and the statuteof limitations applicable to fraudulent conveyances is as short as one year.Finally, many offshore jurisdictions do not permit attorneys to provide legalservces in exchange for a contingent fee. Therefore , where the assetprotection afforded a self-settled trust is an overriding concern , strongconsideration should be given to the use of an offshore jurisdiction in lieuof a domestic one.

52 U.S. Constitution , Arcle See. 1.53 U.S. Constitution , Article I , See. 10; See, e. Leslie C. Giordani and Duncan E. Osborne

Wil the Alaska Trusts Work? , J. Asset Protection , September/October 1997 , at 13.

54 U.S. Constitution , Article VI , See. 2.(Matthew Bender & Co. , Inc.

17- PROTECTING THE ESTATE 'I 1705.

1I 1705 Disetionar Truts

1I 1705. Overvew

Even where the validity of a spendthrift trust is not recognized, other

tyes of protective trsts can be used to protect the beneficiary s intereston the basis that the beneficiary s interest in the trust is sufficiently tenuousso that it does not qualify as a property right which is subject to attachmentby creditors.

Discretionary" trsts are trusts in which distributions to the beneficiaryare left wholly within the discretion of the trstee and (generally) withoutregard to any ascertainable standard. Discretionary trusts are defined inBlack' s Law Dictionary as " (tJrusts where the trustee or another party hasthe right to accumulate (rather than payout) the income for each year.Depending on the terms of the trust instrument , such income may beaccumulated for future distrbutions to the income beneficiaries or addedto corpus for the benefit of the remaindermen. 55 By using a discretionary

trst, the beneficiary s creditors cannot compel the trustee to pay any partof the income or principal. 56 This is so due to the nature of the benefi-ciary s interest rather than due to a prohibition of alienation. Because thebeneficiary cannot compel payment to him or herself or for his or herbenefit, the assets of the'trust remain out of creditor reach. 57

Thus, discretionary trusts differ from spendthrift trsts. The interest ofa beneficiary of a discretionary trust does not, in the first instance , qualifyas a property right; therefore , even preferred creditors are precluded fromaccessing a discretionary trust in satisfaction of their claims against thebeneficiary. 58

1I 1705. Requiements

Depending on the jurisdiction , a discretionary trust mayor may notaford protection against claims of the beneficiary s creditors where thetrustee s discretion is subject to a standard and whether the standard isitself subject to the absolute and uncontrolled discretion of the trustee.For example , in a technical advice memorandum, the Internal RevenueServce determined that a taxpayer had an identifiable property interestin a trust to which a federal ta lien could attach where the trst provided

55 Black' s Law Dictionary 467 (6th ed. 1990).56 Restatement (Second) of Trusts 155(1) (1959). 57 Restatement (Second) of Trusts 155 , cmt. b. (1959); 2A Austin W. Scott & Willam

F. Fratcher, The Law of Trusts 155, at 154 (4th ed. 1989).58 See, e. First Northwestern Trust Co. v. Internal Revenue Servce , 622 F.2d 387 (8th

Cir. 1980).

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that the trustee "shall pay to or apply for the benefit of (the taxpayer),

as much of the net income (or, if the trstee should determine that theincome payments are insufcient, so much of the principal , as well) as thetrustee, in the. . . trustee s discretion shall deem necessary for (thetapayer s) proper health , maintenance, support, and education 59 (em-phasis added). In so holding, the Internal Revenue Servce stated that " (w)ebelieve that, here, the tapayer has, at a minimum, the right to an amountnecessar for his health , maintenance , support, and education , as providedin the trst and that that right is subject to collection.

Similarly, in United States v. Taylo 61 the trust provided that the trusteesshall pay" to the beneficiary so much of the income from the trst as the

trstees deem necessary for the proper care , maintenance, and support ofthe beneficiary. The court held that because the "shall pay" language ismandatory it conveyed an intent of the testator that his son was to receivesupport payments from the net income of the trust if he needed suchsupport. Thus, the Court found that the trust was not discretionary becausethe trustee could be compelled to exercise his or her discretion. 62 Incontrast, however, in First of Ameca Trust Company v. United States 63 theta 'Court held that a trust was discretionary notwthstanding language thatthe trustee "shall" pay the income and so much of the principal as thetrstee in the exercise of sole discretion should deem necessary for thebeneficiary s support, comfort and 'welfare. The prudent estate plannershould , however, work to avoid creating a "discretionary" trst subject toa standard except in instances where the settlor insists upon the use of thestandard and fully comprehends the potential problems which it maycreate.

Unless the discretionary trst also contains a valid spendthrift clause oris restricted under state law, the beneficiary can generally assign his interestin the trust. The fact that the trustee is given discretion as to the amountpayable to the beneficiary, however, may in and of itself be held to beindicative of the settlor s intent that the beneficiary s interest also beinalienable. 64 Even if the beneficiar s interest in a discretionary trust not also determined to be inalienable , however, a creditor that seizes theinterest of the beneficiary can still only hope that the trustee will exercisethe trustee s discretion to make a distribution; the creditor still cannot forcethe trstee to do so.

59 Tech. Adv. Mem. 2000-176-65 (Sept. 11 , 2000).Id.254 F. Supp. 752 (N.D. CaI. 1966).

62 Id. at 755.

93-2 T. M. (CCH) 50 507 (1993).64 See, e. 2A Austin W. Scott & Wiliam F. Fratcher, The Law of Trusts 152.4, at 119

and 155 at 157 (4th ed. 1989).

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17- 1( 1705.PROTECTING THE ESTATE

A court will generally not substitute its judgment for the judgment ofa trustee , provided that the trstee exercises the trustee judgment in goodfaith and within reasonable bounds. Even where the trustee s discretionis stated to be absolute and uncontrolled (or in similar broad terms),however, the trustee s exercise of that discretion will nevertheless remainsubject to judicial review. This rule , however, has been statutorily alteredin at least one state so that a trustee s discretion which is stated to beabsolute will not be interfered with for any reason.

A trust does not protect the beneficiary s interest where the discretionof the trustees is merely as to the time of payment, and where thebeneficiary is ultimately entitled to the whole or to a part of the trustproperty. For example in In re Nicholson s Estate 67 the Court found thata will providing that "all moneys remaining & other things of value (wouldbe left to a trustee) to be kept in trst for his two boys to be given themat (trustee s) discretion" conferred discretion in the trstee merely as tothe time and manner of payment.

11 1705. Supplementa Needs Truts

A different form of the discretionary trust is found in a "supplementalneeds" trust. A supplementa needs trust is defined as ". . . a discretionarytrust established for the ben fit of a person with a severe and chronic orpersistent disability. . . . 68 A supplemental needs trust is created with theintent of benefiting the beneficiary while at the same time accomplishingtwo related goals. The first is protecting the trust fund from the claims ofgovernmental units charged with providing certain benefits to the benefi-ciary. The second is to preserve the beneficiary s entitlement to governmen-tal servces (i.

, "

Medicaid" ) which are granted based upon the financialneed of the recipient. The discretion granted to the trstee of a supplemen-tal needs trust will generally expressly preclude the distribution of trustassets which may supplant, impair or diminish government benefits orassistance for which the beneficiary may otherwse be eligible or which thebeneficiary may be receiving. Some states have enacted specific legislationto enable such trusts to enjoy protection from creditors. 69

A supplemental needs trust should be considered where the beneficiaryis already receiving government benefits at the time of the creation of atrst or such benefits are being contemplated or where the beneficiary is

65 Read v. United States ex reI. Department of Treasury, 169 F.3d 243 254 (5th Cir. 1999).66 Nev. Rev. Stat. 166. 110 (1991).

50 A.2d 283 (1946).68 NY. Est. , Powers and Trusts 1.12(5) (McKinney 1999).69 See, e. Y. Est. , Powers and Trusts 1. (a)(5)(ii) (McKinney 1999).

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t 1706 2001 INSTITUTE ON ESTATE PLANING 17-

suffering under a physical or mental impairment which may qualify thebeneficiary for government benefits at some point in the future.

1( 1706 Support Truts

1( 1706. Overvew

A "support trst" is a trust which empowers the trustee to pay to thebeneficiary as much of the trst income as is necessary for the beneficiarysupport, education and maintenance. 70 Like a discretionary trust (andunlike a spendthrift trust) a support trust is

protective of the beneficiaryinterest by reason of the very nature of the beneficiary s trust interest; towit, the beneficiary is only. entitled to distributions which are required forhis support. If a support trust provides that "the trstee shall payor applyonly so much of the income and principal or either as is necessary for theeducation or support of the beneficiary, the beneficiary cannot transferhis interest and his creditors cannot reach it.

1( 1706. Support Trut Suggestions

The definition of what constitutes support varies by jurisdiction. Somejurisdictions define support by reference to the beneficiary s station in lifeand in other jurisdictions support i defined under a more objectivestandard. Since courts will generally defer to the intention of the settlorthe trust agreement ideally should define what the settlor intends to includewithin the concept of the beneficiary s "support." Notably, the termsupport" is generally deemed to include the support

of the beneficiarydependents.

Support trusts are most appropriate (i) in jurisdictions which do notrecognize spendthrit trust protections, and/or when (ii) the settlor doesnot want to give the trustee expansive discretion over distributions.Notwthstanding the foregoing, however, an express spendthrift clauseshould nevertheless be included in any support

trust (at least wherespendthrit protection is recognized). Absent the inclusion of a spendthriftclause, income in excess of amounts required for the beneficiary s supportmay be subject to seizure by the beneficiary

s creditors.

1( 1707

1( 1707.

Suggestions to Maxze Trut Protection

Overvew

Within the broad outlines of "spendthrift" trsts

, "

discretionary" trsts.and "suppor " trsts , certain factors, including, significantly, the inclusion70 Black' s Law Dictionary 1513 (6th ed. 1990).71 Restatement (Second) of Trusts S 154 (1959).

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17- PROTECTING THE ESTATE 11 1707.4

of certain special trust provisions within the trust agreement, can maximizethe protection aforded by such trusts.

In this regard the general rule of thumb is that the greater the benefi-ciary s control and/or access to the trust property, the less protection isaforded the trust property from the beneficiary s creditors.

1( 1707. Spendthft Proviion

All trust agreements should include an express spendthrift provision andthe trst should be situated in a jurisdiction which recognizes the validityof spendthrift trusts. When drafting a trust with spendthrift provisionslanguage substantially similar to the following should be incorporated inorder to maximize the protection of the trst fund:

During the continuance of any trust established hereunder, no benefi-ciary of said trust, whether as life tenant or remainderman , shall haveany right or power to assign or otherwse anticipate, mortgage, alienatecharge or encumber either income or principal, or to give orders inadvance upon the Trustees for the payment of income or principal , norshall such trust and Trustees in any way become liable for any of theindebtedness of such beneficiary or be subject to any legal process,bankruptcy proceedings,. or the claims, interlerence , or control of thecreditors of such beneficiary.

1( 1707. Sprig Proviion

Ideally, the trust should give the trustee the power to "sprinkle" trust

propert among more than one beneficiary (perhaps, the beneficiary andthe beneficiary s descendants), rather than limiting the trustee s discretionto a single beneficiary.

1( 1707.4 Trutee/Protector Proviions

The instrument should provide for at least one independent trusteewhose consent is required for the distribution of trust property to thebeneficiary. A restraint on alienation will be found ineffective where thesame person is given both the entire legal and beneficial interest in theproperty (i. , the sole trstee is also the sole beneficiary) under the theorythat no trst exists where there is no separation of the legal and equitableinterest in property. 72 Where the trustee is one of several beneficiarieshowever, a valid trust is held to exist as to both the trustee!. beneficiaryinterest and the other beneficiaries ' interests. Therefore

, "

(i)f A holds upona spendthrift trust for A and B , A's interest, being an interest under the

72 See 2A Austin W. Scott & Wiliam F. Fratcher, The Law of Trusts S 99.

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trst and not a legal interest merely, cannot be assigned by him or reachedby his creditors. 73 It is still advisable to provide for the appointment ofan independent trustee in an effort to foreclose any suggestion by thetrstee/beneficiar s creditors that the law should be otherwse or that thetrust is, in fact, somehow a "sham." The inclusion of an objectivelyindependent trstee is especially important in the case of a self-settled trst;where the more independent the trstee, the less merit will be given toa creditor s potential argument that the trustee s "discretionary" power todistrbute trst assets is a "sham" by reason of some prearranged under-standing between the parties. Even where the trust is not self-settled , wheremaximum asset protection is needed, a bank or trust company can benamed as trustee in lieu of an individual.

Where an asset protection trust names a protector, the trust protectorshould be someone other than the settlor. By doing so , any potential claimsthat the settlor has retained excessive control over the trust are negated.This is so notwthstanding the fact that an ability to remove and replacetrstees (i.e. , the "standard" power of a protector) does not rise to the levelof a right to afect beneficial enjoyment under the Internal Revenue Code

2036(a)(1).7

1( 1707. Discretionar Distrbutions d Beneficiares

The trst agreement should provide that the beneficiary s receipt of adistribution of either income or principal is solely within the discretionof the trustee without reference to any identifiable or ascertainablestandard and provide the trstee with the power to make distrbutions onbehalf of the beneficiary rather than pennitting only the direct distrbution

of trust property to the beneficiary. In a similar vein , consideration shouldbe given to including the beneficiary s spouse or significant other as anadditional discretionary beneficiary. By including such a provision, if andwhen there exists a creditor issue which prevents distributions from beingmade directly to the beneficiary, distrbutions can instead be made to thebeneficiary s spouse or significant other for the benefit of that individualas well as the beneficiary. The following language implements the abovesuggestion and serves to maxmize the protection of the trst fund:

During the Beneficiary s lifetime , the Trustee may pay to or apply forthe benefit of such one or more of the Beneficiary, the Beneficiarydescendants and/or a Beneficiary s spouse , in such amounts and

2A Austin W. Scott & Willam F. Fratcher, The Law of Trusts 99. , at 57; See alsoAvera v. Avera, 253 Ga. 16 (1984).

74 See, e.g. Wall v. Commissioner, 101 T.G 300 (1993); Rev. Rul. 95-58, 1995-36 I.R.B.16.

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17- PROTECTING THE ESTATE 'I 1707.

proportions, as the Trustee, in its sole and absolute discretion maydetermine, from time to time , for any purpose.

Where a beneficiary s spouse is named as a beneficiary of the trust it maybe preferable to name the beneficiary s spouse by reference to a definedterm rather than by name. By doing so, the beneficiary s spouse can beautomatically excluded as a beneficiary upon a divorce and the beneficiarynew spouse will be automatically included upon the beneficiary s remar-riage. The following language may be used in order to maximize theprotection of the trust fund in this regard:

The 'spouse ' of an individual means the person to whom the individualis marred and living with (unless the individual or spouse is institutional-ized) as of the time reference to a particular provision hereof is madeand is to be applied. If there is no such person for a given period oftime , due to any reason whatsoever (other than the death of theindividual during the individual's lifetime while the individual is marriedto the partcular person), then during such time this Agreement shallbe read, interpreted and constred as if the spouse of the individual hadfailed to survve the individual. An individual's ' survving spouse ' meansthe person (if any) survving the individual to whom the individual ismarred at the time of the individual's death.

1( 1707.6 Trut Tenn

Estate planners should also consider a lengthy trust term when creatinga trust; ideally, the trust agreement should provide that the trust propertyremain in trst for the maximum possible period. It is , therefore , beneficialto create the trust in a jurisdiction which provides for the perpetualexistence of trsts. In most states, however, the term of a trust is limitedso that it cannot continue to exist beyond the "Rule Against Perpetuitiesperiod (generally, no later than twenty-one years after the death of adiscernible group of individuals then living or ninety years after the trust'screation). To date , fourteen states have repealed the Rule Against Perpetu-ities thereby encouraging the creation of dynasty trsts in those jurisdic-tions. Those states are: Alaska, Arzona, Delaware , Florida (which allows

trsts created after December 31 2000 to continue for a maximum periodof 360 years), 75 Idaho , Ilinois, Maine , Maryland , New Jersey, Ohio , Rhode

Island, South Dakota , Virginia, and Wisconsin. Where the grantor wishesto provide for an outrght distribution at a specified point in time , thetrstee or another person (other than the beneficiary) should be grantedthe right to extend the term of the trst (which power would be exercisedin the event that a creditor problem exists at the time the trust would

75 Florida Stat. 689.225(2) (t).

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otherwse tenninate). A slight variation on this provision is a "hold back"provision (discussed at 1 1707. 17) which allows the trstee to withhold anotherwse mandatory distrbution in the event of a creditor problem. Notehowever, that where the beneficiary himself has affnnatively allowedproperty to which he is entitled to remain in trust, he has most likelythereby created a "self-settled" trst. 76

1( 1707. State Income Tax Considerations

Alaska, Arzona, Delaware (where the settlor is not a resident), Ohio andSouth Dakota provide the additional benefit of not imposing a state incometa on trust income. State level income ta may, nevertheless , be imposedwhere the trust is structured as a "grantor trst" for income tax purposes.

When drafting the trust, additional consideration should be given as towhether a state other than the state of trust administration or trusteeresidence can impose a ta on the income of the trst. 77 The law is wellestablished that a settlor s designation of controllng law will govern theadministration of a trust. "If the settlor creates a trust to be administeredin a state other than that of his domicile , the law of the state of the placeof administration, rather than that of his domicile , ordinarily is applicable.Thus a settlor domiciled in one state may create an inter vivos trust byconveying property to a trust company of another state as trustee anddelivering the property to it to be administered in that state.

1( 1707. Use of Propert

In conjunction with continuing the trust for the maximum possibleperiod, the trst agreement should also encourage the trustee to acquireassets for the use of the beneficiary in lieu of making distributions of trstproperty to the beneficiary. The following language is an example of howto maximize the protection of the trust fund in this regard:

The Settlor has established this trst as a vehicle to provide the currentbeneficiaries with the use and enjoyment of the trst propert free ofcharge , rather than making distributions of trst assets to such beneficia-ries; the purpose being to preserve the trust principal from creditorsfuture ex-spouses and income and trnsfer taes. In making distrbutionsthe Trustee should take into account a beneficiary s other resources , it76 See, e. In re Doris L. Morrs , 151 B.R. 900 (C.D. II 1993); Hartsfield v. Lescher, 721Supp 1052 (E.D. Ark. 1989). Compare Matter of Dornbush, 627 N. 2d 232 (N.Y. SUIT.

Ct. 1995); In re St. Joseph' s Hospita, 133 B.R. 453 (S.D. Il. 1991).77 See, e.g. Chase Manhatta Bank v. Gavin, 249 Conn. 172 (1999).

2A Austin W. Scott & Wiliam F. Fratcher, The Law of Trusts 626, at 419 (4th ed.1989). See also Restatement (Second) of Conflct of Law 270.(Manhew Bender & Co. , Inc.

17- PROTECTING THE ESTATE t 1707.

being the Settlor s intent that each of the beneficiaries, to the extentthey are capable of so doing, should provide for their own support andliving expenses. The foregoing is to guide the Trustee only and, notwth-standing such guidance, the discretion of the Trustee is absolute andshall be exercised by the Trustee in accordance with the Trustee s best

judgment, guided by what appear to be the best interests, as interpretedby the Trustee alone, of the eldest beneficiary of each such trust andsuch beneficiary s family as a whole , as may seem appropriate in canyngout the Settlor s original intent hereunder.

Similarly, the trustee should also be empowered to make loans to thebeneficiary (whether they be secured or unsecured) or to make equity

investments in business entities controlled by the beneficiary, rather thandistributing trust property outrght to the beneficiary.

1I 1707.9 Mior Beneficiares

When a trust is created for a minor beneficiary pursuant to InternalRevenue Code S 2503 (c), in order to qualify the transferred property forthe exclusion from git tax thereunder, in lieu of an automatic distributionat age twenty-one consider providing the beneficiary with a mere withdrawalwindow. Under the applicable treasury regulations

, "

. . . a transfer doesnot fail to satisfy the 'conditions of section 2503(c) by reason of the merefact that. . . (2) The donee , upon reaching age 21 , has the right to extendthe term of the trust. . . . 79 Stil, an estate planner should consider

whether the beneficiary s failure to withdraw, within that window, the

property to which the beneficiary is entitled, would effectively create a self-settled trust.

1I 1707. Split Interest Truts

Notwthstanding the clear asset protection benefit of continuing propertyin trust for the maximum allowable period, split-interest trusts (i.

QPRTs

" "

GRATs" and "GRUTs ) lend themselves to the commonly mademistake of an outright distrbution upon the expiration of the initial trustperiod. Because the existence of the estate tax inclusion period precludesthe possibility ofleveraging the settlor s GST Exemption in connection with

a split-interest trust, the estate planner s "knee jerk" reaction in draftinga split-interest trst is to draft an outrght distribution of the trust property

to the settlor s children upon the expiration of the term of the retainedinterest. Instead, consider a continuing trust for the children , grandchil-

dren and more remote descendants until the expiration of the rule against

perpetuities period. A continuing trst will preserve the trust property from

79 Treas. Reg. 25. 2503-(b).

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the beneficiaries ' potential creditors and wil also ensure that the trustproperty does not pass to an in-law or other unintended beneficiary in theevent that the beneficiary should die prematurely-a potentially cata-strophic event under certain circumstances.

The trstee can be given the power to grant a testaentary general powerof appointment to the beneficiaries in appropriate cases to ensure that theestate ta will be imposed in lieu of the generation-skipping transfer where to do so would reduce overall transfer taxes. In addition , othertechniques (which are beyond the scope of this Article) may exist toleverage CST exemption on the property transferred to a split-interest trst(i. , a "CRAT remainder sale

1I 1707. Tennatig Beneficial Interest

In extreme cases , the trust agreement should provide for the tenninationof the beneficiary s beneficial trst interest upon the occurrence of an eventwhich calls into question the protection of the trust fund. For examplethe trust agreement may provide that the beneficiary s beneficial trustinterest terminates in favor of another beneficiary in the event that thefirst beneficiary is at any time deemed insolvent, or the trst agreementmay provide that an attempted alienation by the trust beneficiary, or anattempted attachment by the beneficiary s creditors will cause the benefi-ciary s beneficial trust interest to be forfeited in favor of another benefi-ciary. The Ninth Circuit has held such a provision effective to withstandeven a federal ta claim on the basis that such provision left no propertyinterest remaining which could be attached by the beneficiary s creditors.

1I 1707. Conversion of Absolute Trut Interest into DiscretionarTrut Interest

A less drastic alternative involves the conversion of an absolute trustinterest into a discretionary trust interest. In Domo v. McCarthy, 81 the Courtrecognized such an alternative and found that the newly created discretion-ary trust could not be reached by creditors. In the alternative , considergiving the trustee the power to exclude beneficiaries by revising the trust'sbeneficial interests. Such a provision may prove of particular use withina self-settled spendthrift trust settled under the law of Alaska, DelawareNevada or Rhode Island. If the settlor/beneficiary s beneficial trust interestis ultimately detennined to subject the trust to estate ta inclusion or tocreditors, the trustee (or a third part) can then exclude the settlor as apotential beneficiary of the trust. Such a provision may also prove useful

80 In re Fitzimmons, 896 F.2d 373 (9th Cir. 1990).66 Ohio St. 3d 312, 317 (1993).

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if the settlor s relationship with one or more of the trust beneficiariesdeteriorates after the trust is funded (in some instances, most likely becausethe trst has now been funded).

To accomplish this result of converting the trust from an absolute trustto a discretionary trust, the following language may be used:

During the Settlor s lifetime the Trustee may, in the exercise of soleand absolute discretion , by a signed declaration in wrting declare thatthe person or persons or members of a class named or specifed (whetheror not ascertained in such declaration) who are , would be or might beor become (but for this provision) a Beneficiary hereof: (i) shall bepartially excluded from future benefit hereunder; or (ii) shall cease tobe a Beneficiary hereunder. Any such declaration may be revocableduring the continuance of this Trust or irrevocable and shall have effectfrom the date specified in the declaration.

1I 1707.13 Powers of Appointment

The trust agreement should also limit any power of appointment givento a beneficiary so that the power does not rise to the level of a "general"power of appointment. The Internal Revenue Code defines a "generalpower of appointment

" ;; , "

. . . a power which is exercisable in favor ofthe decedent, his estate , his creditors , or the creditors of his estate.. . .Although this definition is most significant for federal tax purposes, it is

also a useful definition for detennining whether a beneficiary s power ofappointment is too broad for asset protection purposes. Powers of appoint-ment are addressed in greater detail below.

1I 1707.14 Power to Withdraw Trut Pricipal

A provision commonly found in trusts provides the beneficiaries with thepower to withdraw trust principal. Even where such power would cause littleor no adverse ta consequence as with a so-called "five and five" power ora withdrawal power limited to the beneficiary s health , education , supportor maintenance 83 such power could potentially cause the trust propertysubject thereto to be deemed available to the beneficiary s creditors. 84

Where so-called "Crummey" powers are required to be included in the trustagreement, consider providing the trustee with the power to exclude trustbeneficiaries from receiving a Crummey power with respect to future

1.RC. 2041 (b) (1).83 See l.RC. 2514(e) and 2041 (b) (1) (A).84 At least one state , Texas, statutorily provides that a limited Crummey power of with-

drawal does not cause the powerholder to be a settlor for purposes of the self-settled trustrule. Texas RS. See. 1l2.035(e).

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contributions to the trust. In this regard , the following language issuggested:

The Trustee may, by an instrument in writing executed before acontrbution, exclude one or more individuals from having withdrawalrights over that contribution or any future contribution or both. TheTrustee may not, however, limit or alter any rights resulting from priorcontrbutions. "

1( 1707. Segregation

A trustee should be advised to segregate trust assets which have thepotential for creating liability (i. , rental real estate) from other trustproperty. This can be accomplished by the trust creating a separate singlemember limited liability company to separately hold each asset

which couldpotentially cause liability to the trust fund. As an additional precautionagainst the "corporate" veil being pierced, a single trust holding some assetswhich potentially expose the trust to liabilty and other assets which do notcan be split into two separate trusts. This approach

was addressed in

the Matter of JosePh Helle Inter Vivos Trust 85 whereby the Court permittedthe trstees to divide the trust into two trsts, one to hold the real estateand the other to hold the securities expressly for the purpose of creditorprotection.

1( 1707.16 Power to Withold Mandatory Distrbutions

The trst agreement should also provide the trustee with the power towithhold otherwse mandatory distrbutions if the trstee, in the exerciseof sole and absolute discretion , should deem the distrbution to be adverseto the beneficiary s interest (for example , due to the existence of a creditorproblem at the time the distrbution would otherwse be required to bemade). Since a "hold-back" provision creates, in effect, a discretionary trstat such point in time as a distrbution would otherwse have to be madeit should seIVe to protect the beneficiary s trust interest from creditor claimsin the same manner as had the trst been wholly discretionary from theoutset. However, a non-discretionary trust with a hold back provision differsfrom a purely discretionary trst in that it places the onus upon the trusteeto justifY, to the beneficiary, and potentially to the

court as well , the trsteedecision to withhold what would otherwse have been a mandatory distrbu-tion. In order to maximize the protection of the trust fund in this regardthe following language is useful:

If the Trustee shall , in the exercise of sole and absolute discretiondetermine that circumstances exist making it clearly contrary to the best

613 N.Y.S.2d 809, 810 (N.Y. SUIT. Ct. 1994).

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interests of a Beneficiary to receive a distrbution of principal which isotherwse required to be made hereunder, the Trustee may refrain frommaking all or any part of such distrbution until the Trustee shalldetermine that such circumstances no longer exist. Circumstances in aBeneficiar s life which would justify exercising that discretion includewithout limitation , being a defendant in serious litigation or beinginvolved in bankrptcy proceedings or similar financial or matrmonialdifculties , being physically, mentally or emotionally unable to properlyadminister the assets to be distributed, or living under a form ofgovernment or other condition making it highly likely that the

assets tobe distrbuted would be subject to confiscation or expropriation.

1( 1707.17 Power to Change Trut Situ

The trst agreement should grant the trustee the discretion to changethe situs of the trst from its current situs to that of another jurisdictioneither within or without the United States, and to appoint either a successortrustee or a co-trustee in order to enable the trust to be validly governedby the law of such other jurisdiction. This tye of provision is useful inseveral situations. For example , where the law governing the original trustsitus changes to the detrment of the beneficiaries, or the law of anotherjurisdiction changes so as to become more appealing than the law govern-ing the original trust situs. Giving the trustee this tye of power is alsohelpful where the particular circumstances surrounding the trst warranta change of situs as, for example , where increased asset protection concernswarrnt that the trst be sited under the laws of an "asset protection havensuch as Alaska, Delaware , the Cook Islands or Nevis. The following languagemay be used to provide such discretion:

The original situs of the Trust created hereunder shall be the State of. The situs of any Trust created hereunder may be maintained

in any jurisdiction (including outside the United States), as the Trusteein the exercise of sole and absolute discretion , may at any time deter-mine , and may thereafter be transferred at any time or times to any otherjurisdiction selected by the Trustee without any need to obtain theapproval of any court. Upon any such transfer of situs, the Trust fundmay thereafter, at the election of the Trustee of said Trust, be adminis-tered exclusively under the laws of (and subject, as required, to theexclusive supervsion of the courts of), the jurisdiction to which it hasbeen transferred. Accordingly, if the Trustee of any Trust createdhereunder elects to change the situs of any such Trust, the Trustee ofsaid Trust is hereby relieved of any requirement of having to qualify inany other jurisdiction and of any requirement of having to account inany court of such other jurisdiction.

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1I 1707. Trut/LP /LLC Combination

Another planning technique to consider is that of combining a trust witha limited partnership or limited liabilty company in order to provide anadditional layer of asset protection , since a creditor s remedy (against thetrust, or against a beneficiary s interest therein) may thereby be limitedto a charging order against the limited partnership or limited

liabilitycompany interest. Where the trust is a self-settled trust created under thelaw of a domestic jurisdiction, such as Alaska or Delaware, the use of anAlaska or Delaware limited partnership or limited liability company will alsoincrease the settlor s contacts with that state , providing further justificationfor the application of that state s law to the trust. The use of an underlyinglimited partnership or limited liability company may also permit continuedinvestment management and control of the trust assets by the trust settlor(in the capacity of a general partner of the limited partnership

or amanager of the limited liability company) without jeopardizing the natureof the transfer as a completed gift to the trst.1I 1708 Lited Parerships

1I 1708. Overvew

Black' s Law Dictionary defines a limited partnership as "a type ofpartnership comprised of one or more general partners who manage the

business and who are personally liable for partnership debts, and one ormore limited partners who contribute capital and share in profits but whotake no part in running the business and incur no liability with respectto the partnership. 86 A limited partnership can serve both an

assetprotection role and a business role.

From an asset protection standpoint, a limited partnership is beneficialbecause a creditor of a limited partner will not be able to satisfy its claimagainst the debtor limited partner out of the assets of the limited partner-ship. This is so because assets owned by the limited partnership areconsidered to be owned bya separate entity, rather than by anyone ormore of the individual limited partners. 87 Moreover, the right to managea limited partnership is personal to the general partner. This precludesa creditor/assignee of the general partner s limited partnership interestfrom directing the investments of the limited partnership or mandating

86 Black' s Law Dictionary 928 (6th ed. 1990).87 See, e.g. Rev. Rul. 73-24, 1973 GB. 602 (holding that since a partnership checking

ac-count is an asset and property of the partnership and not an asset or property of theindividual partner, the checking account is not subject to levy to satisty a ta assessed againstan individual partner); Taylor v. S & M Lamp Co. , 190 Cal. App. 2d 700, 707 (Cal. Ct. App.1953).

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17- PROTECTING THE ESTATE 'I 1708.

distrbutions from the limited partnership. Finally, a creditor of a debtorlimited partne may be limited to a mere "charging order" remedy with

, regard to the debtor partner s partnership interest.

1( 1708.2 The Chargig Order

A "charging order" is " (a) statutorily created means for a creditor of ajudgment debtor who is a partner of others to reach the debtor s beneficialinterest in the partnership, without risking dissolution of the partner-ship. 88 If the creditor s remedy against the debtor limited partner withrespect to the partnership interest is, in fact, limited to a charging orderthe creditor will obtain only the rights of an assignee of the debtor limitedpartner s partnership interest. As an assignee of the debtor limited part-ner s interest, the creditor will be limited to the right to receive partnershipdistrbutions when and if made. 89 The charging order does not entitle thecreditor to become a limited partner and does not entitle the creditor tovote on partnership matters. Additionally, the charging order will notentitle the creditor to inspect or copy partnership records, or even to obtainthe limited partnership s business and tax information which is usuallyavailable to limited partners as a matter oflaw. 90 In the context of a "familylimited partnership, the charging order may prove to be a hollow remedyto the creditor since the general partner will probably be a relative of thedebtor limited partner and sympathetic to his or her plight.

Where the limited partership agreement has been drafted with an eyetowards asset protection, the general partner, in order to provide thedebtor limited partner with leverage to negotiate a favorable settlement

with his creditor, will have broad discretion to make, or refrain frommaking, distributions from the partnership. There is also the possibilitythat, notwthstanding the fact that no distributions may ever actually bemade, taable income may, for income ta purposes, be chargeable to thecreditor assignee who has obtained a charging order. This would result inthe creditor assignee realizing "phantom" inc.ome on which tax mightnevertheless have to be paid. The revenue ruling finding this resulthowever, dealt with a voluntary assignment of the partnership interest atissue rather than an involuntary assignment occasioned by virtue of acharging order. As a consequence , many practitioners feel that overly broadreliance has been placed on the potential asset protecri :m effect of thisruling.

88 Black' s Law Dictionar 233 (6th ed. 1990).89 Revised Unifonn Limited Partnership Act 703.90 Id.; See also Temple v. White Lakes Plaza Assoc. , Ltd. , 816 P.2d 399 (1991).91 Rev. RuI. 77-137, 1977 LR.B. 178.

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In any event, where phantom income would be realized by the creditorassignee (if, in fact, the creditor assignee must realize such incomepursuant to the Revenue Ruling), all of the remaining non-debtor partnerswould also realize phantom income. Even in the family limited partnershipsituation where the general partners are likely most sympathetic to thedebtor limited partner, this may mandate current distributions in anamount suffcient to cover the partners ' tax liabilties on the phantomIncome.

1I 1708. LitationsLimitations may, however, exist on the asset protection afforded by

limited partnerships. In part based upon the drafters ' use of the permissivetenn "may" under 703 of the Revised Uniform Limited Partnership Act

RULPA" ), it is unclear whether the charging order is, in fact, the exclusiveremedy allowed. A number of cases have , however, held that the chargingorder is the exclusive remedy allowed under the RULP A. 92 Other caseshowever, expressly provide that the charging order is a non-exclusiveremedy and that the partnership interest of the debtor limited partner isalso subject to garnishment. 93 Even where the charging order is held tobe an exclusive remedy, sale of the partnership interest may also bepermissible where the creditor has demonstrated that monies collectedunder the charging order are insuffcient to satisfY the judgment. Of coursethe purchaser of such interest remains a mere assignee of the debtorlimited partner s interest rather than a full-fledged limited partner. Inaddition , the language stated in 504 of the Revised Uniform PartnershipAct ("RUPA") indicates that there are other remedies for creditors in thatit provides that a court may: "

. . .

appoint a receiver of the share of thedistribution due or to become due to the judgment debtor with respectto the partnership and make all other orders, directions , accounts , and

92 In In re John R Stocks, a Florida Bankrptcy Court found that no right to forecloseexisted where the matter involved the rights of a judgment creditor of a limited partnerin a limited partnership under the Uniform Limited Partnership Act. In In re Smith, 17

R 541 (Bankr. M.D. Ga. 1982) the Court found " (wJhile no Georgia case could be foundby this Court dealing with this procedure of applying for a "charge order " several courtin other jurisdictions have analyzed it.

Cf Pischke v. Murray (In re Pischke). 11 B.R 913(Bankr. Ct. E.D. Va. 1981); Bank of Bethesda v. Koch , 44 Md. App. 350, 408 A.2d 767 (Md.Ct. Spec. App. 1979), Baum v. Baum , 51 Cal.2d 610 335 P.2d 481 (Cal. 1959); Sherwoodv. Jackson, 121 Ca. App. 354, 8 P. 2d 943 (Cal. Dist. Ct. App. 1932). But see Nigr v. Lotz216 Ga. App. 204 (1995). .

93 See, e. In re Allen , 228 B.R 115 , 121-122 (Bankr. W.D. Pa. 1998) (". . . this Courtholds that a judgment creditor in Pennsylvania may garnish a judgment debtor s interestin a partership or limited partnership notwthstanding the availabilty of a charging orderagainst the same interest.

);

see also Lauer Constrction , Inc. v. Schrift, 123 Md. App. 112(1998).

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17- PROTECTING THE ESTATE t 1708.

inquiries the judgment debtor might have made or which the circumstancesof the case may require" and/or "

. . .

order a foreclosure of the interestsubject to the charging order at any time.

A. Alter Ego ClaiUnder certain circumstances , the limited partnership may be deemed

to be an alter ego of the debtor limited partner (i. , the court may allowa piercing of the "corporate" veil). Where the debtor limited partner isalso the sole owner of a corporate sole general partner and there existsa pattern of non-adherence to requisite corporate and limited partnershipfonnalities the asset protection status may be subject to successful chal-lenge. Some of the factors which have been found to support the alter egoargument in the corporate context include inadequate capitalization of thecorporation, failure to adhere to corporate formalities, the comminglingof corporate and personal funds and complete dominance of the corporateentity by the shareholder or shareholders thereof. Of course, since apartnership, by its very nature , does not require many corporate formalities(such as the annual election of directors, the keeping of minutes, or theholding of meetingsl.' it will likely be more difficult (though by no meansimpossible) for a creditor to prevail in arguing that the limited partnershipis a mere "alter ego" of the debtor limited partner. In an effort to combatsuch arguments, however, the books and records of the limited partnershipshould be properly maintained and include wrtten resolutions relating toany major action of the limited partnership.

Business Puose ArguentAnother argument a creditor of a limited partner may raise is that the

limited partnership lacks a business purpose and that the limited partner-ship should, therefore , be disregarded as a separate entity. In Evans v.Galardi 94 the court stated that "where , as in the instant case , the partner-ship is a viable business organization.

. .

there is no reason to permitdeviation from the prescribed statutory process." Thus, by implicationwhere the limited partnership is not a "viable business organization" thecourt may not limit the creditor to a charging order remedy. In Hellmanv. Anderson 95 it was held that a limited partnership interest may beforeclosed so long as doing so does not unduly interfere with the businessof the limited partnership. In Estate of Harron v. Comm,, 96 the Court foundproof of a business purpose where the partnership was created "as a means

546 P.2d 313, 321 (Cal. 1976).233 Cal. App. 3d 840 (CaI. Ct. App. 1991).52 T. M. (CCH) 1306 (1987).

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of providing necessary and proper management of decedent s propertiesand that the partnership was advantageous to and in the best interests ofdeceden t. " 97

An additional business purpose may include the use of the limitedpartnership to maintain assets within family unit. 98 Although an irrevocabletrust could serve the same purpose, an agreement of limited partnershipcan be amended much more easily than an irrevocable trst. Other benefitsinclude control over the distributable cash flow, the consolidation ofinvestments, allowing for economies of scale and overall cost savingssimplifyng annual giving, avoiding probate on out of state property,providing for arbitration to resolve family disputes, and allowing for thenecessary and proper management of limited partnership assets. 99

Where the partnership is owned in its entirety by the judgment debtors(for example, where the limited partners are also the sole shareholdersof a corporate general partner), there is arguably no justification forlimiting the creditor s recourse to a charging order. But, in Evans v. Galardiit was held that " (p)laintiff would have us adopt an exception to (Califor-nia s) statutory prohibition against execution. . . to cover those cases inwhich the partnership is o':ed entirely by the judgment debtors. He arguesthat the purpose underlying the enactment of these statutes is to protectinnocent partners from the injustice and hardship they may suffer whenpartnership property is sold in execution of a judgment against an individ-ual partner. . .This purpose , so the argument goes, is not furthered bydisallowing execution against specific partnership assets in cases when thejudgment debtors own the entire proprietary interest in the business. Wedecline plaintiffs invitation to recognize such an implied exception to therequired use of the statutory charge procedure. " 100

11 1708.4 Banptcy of a General ParerThe bankruptcy of a general partner is an additional risk. Such bank-

ruptcy may result in a bankrptcy trstee liquidating the limited partner-ship. To avoid this result, the agreement of limited partnership shouldinclude a provision requiring that the general partner s interest convertto a limited partner s interest upon a creditor obtaining a charging orderagainst a general partner. A creditor may be able to obtain an orderrestricting the general partners from converting assets of the limitedpartnership, making distributions to other partners or paying the general

97 See also Uniform Partnership Act S 6(1).98 See, e. Moore v. Commissioner, 62 T. M. (CCH) 1128 (1991).99 Bischoff v. Commissioner, 69 T.C. 32, 39-41 (1977).100 Supra at note 94.

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partners their management fees, and may compel the general partners toprovide regular accountings and copies of tax returns to the creditor. Theseare effective tools giving the creditor leverage to satisfy a judgment.

1I 1708.5 Maxg the Protection of a Lited Parership

Certain steps may be taken to maximize the protection afforded by thelimited partnership. The certificate and agreement of limited partnershipshould each be drafted (as they now can be under the Internal Revenue

Sernce s "check the box" regulations) to provide the limited partnershipwith perpetual existence. Perpetual existence will avoid any possibility thatthe creditor of a debtor limited partner will be able to satisfy his claim outof the assets of the limited partnership by the simple expediency of thelimited partnership s automatic dissolution at the end of a set period. Theagreement of limited partnership should not provide that the deathincapacity, retirement or other event of withdrawal of a general partnershall cause a dissolution of the partnership (even though the agreementof limited partnership might then allow a majority in interest of the limitedpartners to vote to continue the partnership). Additionally, the agreementshould require the consent of all partners to liquidate the limitedpartnership.

When creating a limited partnership, consideration should also be givento naming more than one general partner. In the alternative , use of acorporation, limited liability company or trust as the general partner, will

preclude the possibility of the tennination of the limited partnership byreason of the death or incapacity of the last acting general partner. Theagreement should restrict the transferabilty oflimited partnership interestsby providing that a limited partner can only transfer his or her interestwith the prior written consent of either the general partners or the

remaining limited partners , which consent may be given or withheld inthe exercise of sole and absolute discretion. Absent such consent, atrnsferee will then only receive an interest as an assignee.

Yet another matter to entertain is whether it is feasible to restrict theownership of limited partnership interests to family members or anothersimilarly restrctive class of owners. In the same vein , it is wise to providefor a right of first refusal to limit the salability of the limited partnershipinterest by a judgment creditor following the potential failure of thecharging order as an exclusive remedy and attachment by the judgmentcreditor. The agreement should also specifically disallow any entitlementon the part of the limited partners to the return of their capital contrbu-tions prior to the dissolution of the limited partnership and should allow

the general partners to retain the profits of the limited partership for the

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t 1709 2001 INSTITUTE ON ESTATE PLANING 17-40

limited partnership s reasonable operating needs (including anticipatedfuture needs), as determined by the general partners in the exercise ofsole and absolute discretion. This last provision will enable the generalpartners, if sympathetic to the plight of a debtor limited partner

, tojustifiably withhold distrbutions during the existence of a charging order.This will provide the debtor limited partner with leverage in the settlementof the creditor s claim.

It is important, however, to note that where one or more of the partnershas obtained their interests in the limited partnership by gift from thegeneral partner, such authority to retain profits should be limited to theretention of only such amounts as are objectively necessary for the reason-able business needs of the limited partnership or else the Internal RevenueServce may deem the gifted interest as includable in the general partnergross estate. l0l A similar problem exists with regard to obtaining thepresent interest gift tax exclusion pursuant to Internal Revenue CodeS 2503.

All formalities relating to the limited partnership s existence as an entityseparate and distinct from the partners thereof should be strictly adheredto by the partners. For example, all partnership assets should be titled inthe name of the limited partnership and any insurance policies on assetswhich are transferred to the limited partnership must be revised to reflectthe partnership as the new owner of such assets. The books and recordsof the limited partnership should be kept complete and up to date. Anymajor action of the limited partnership should be the subject of a wrttenpartnership resolution which, in particular, demonstrates that the properconsents for such action were obtained. All distributions from the limitedpartnership should be made in proportion to the partners ' relative interestsin the limited partnership and transactions between the partners and thepartnership should be minimized, and in all events should be strictly atarm s length.

1I 1709 Lited Liabilty Companes

1I 1709. Chargig Order

As with limited partnerships, creditors must face the possibilty that thecourts will enforce the charging order remedy as the exclusive remedyagainst a debtor s interest. In this regard, Section 504(a) of the UniformLimited Liabilty Company Act ("ULLCA") provides that " (?)n applicationby a judgment creditor of a member of a limited liability company or ofa member s transferee , a court having jurisdiction may charge the distrbu-tional interest of the judgment debtor to satisfy the judgment." The

101 I.R.C. 2036 and 2038.

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17-41 PROTECTING THE ESTATE t 1709.

comment to this section provides, in pertinent part that " (a) charging orderis the only remedy by which a judgment creditor of a member or amember s transferee may reach the distributional interest of a member ormember s transferee." Notwthstanding the potential creditor protectionaforded by the foregoing, however, ULLCA S 504(b) provides that " (t)hecourt may order a foreclosure of a lien on a distrbutional interest subjectto the charging order at any time." Some states, in enacting limited liabilitycompany legislation, however, have expressly chosen to exclude theforeclosure language which is contained in the ULLCA. 102 Like thecreditors of a debtor limited partner in a limited partnership, the creditorsof a debtor member in a limited liabilty company may argue that thelimited liability company lacks a business purpose. In this vein , the ULLCAprovides that " (a) limited liability company may be organized under this(Act) for any lawful purpose, subject to any law of this State governing orregulating business." 103 In contrast, however, the expansive language ofthe Delaware Limited Liabilty Company Act, provides, in pertinent partthat " (a) limited liabilty company may carry on any lawful businesspurpose or activity, whether or not for profit. . . ." 104 .

1I 1709. Advantaes/Disadvantages

From an asset prot"ection perspective, the limited liability company hasboth advantages and disadvantages over the limited partnership. One ofthe primary advantages is that limited liabilty companies are more flexiblethan limited partnerships. This is because in the vast majority of states , alimited liability company need have but a single member, while a limitedpartnership, by definition , requires at least two partners. A single memberlimited liability company can , under the Internal Revenue Servce s "checkthe box" regulations , choose to be deemed "disregarded as an entityseparate from its owner" for federal tax purposes. 105 More specifically,unless an election to the contrary is made a domestic limited liabilitycompany with a single member will be automatically disregarded as anentity separate from its owner. 106

Single Member LLCs

A single member limited liabilty company which , although for federalta purposes is disregarded as an entity separate from its owner, arguably

102 See, e. ~ 4.06 of the Texas Limited Liability Company Act. But see ~ 7.03 of theTexas Revised Limited Partnership Act which includes the foreclosure language, and hencemakes it applicable to charging orders entered against Texas limited partnership interests.

103 ~ 112(a).

104 Del. Code. Ann. , tit. 6 ~ 18-106(a).105 Treas. Reg. ~ 301.7701-3(a).106 Treas. Reg. ~ 301.7701-3 (b) (1).

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stil serves to protect the limited liability company interest of a debtormember. The "disregarded entity" concept is a ta fiction which even theInternal Revenue Servce has determined does not interfere with the assetprotection aforded by the limited liability company since state law, ratherthan the federal ta law, controls that issue. The Internal Revenue Servcehas determined that " (t)he mere fact that the LLC entity is disregardedfor federal ta purposes does not entitle the Servce to disregard the entityfor purposes of collection. " 107 Depending on the facts of the case , wherethe Internal Revenue Servce is a creditor (like any other creditor), it mayhave several collection options including collecting the tapayer s distribu-tive interest in the limited liability company, or collection from the assetsof the limited liabilty company on the basis that it is the alter ego of thetapayer. On the other hand, however, since the charging order remedyseeks to effect a balance between the creditor s right to recover on thecreditor s claim and the members ' right to not have their business inter-rupted, consider whether the equation becomes unbalanced where thelimited liability company has only the debtor member as an owner.

B. Alter Ego ClaiAs with a limited partnershIp, the limited liability company may be

deemed to be an alter ego of the debtor member where there exists apattern of non-adherence to requisite limited liabilty company formali-ties. 108 In addition , since a single member limited liability company doesnot fie income ta returns, it may be more likely to be deemed the alterego of its member than is a limited partnership.

C. Liabilty Exposue of General ParerNo person need retain unlimited liability under a limited liability

company, whereas in order to negate the liability of the general partnerin a limited partnership, a second entity (such as a corporation or a limitedliability company) would be required to act in such capacity. As a practicalmatter, however, in many family limited partnerships the unlimited expo-sure of the general partner should be of little concern if the majority ofthe limited partnership s assets consists of securities and other assets whichare unlikely to expose the general partner to liability.

D. New Entity

There appears to be one signifcant disadvantage of the limited liabilitycompany; since the limited liability company is a relatively new entity, there

107 Tech. Adv. Mem. 1999-13-300 (April 18, 1999).108 See, e.g., Hollowell v. Orleans Regional Hospital, 1998 U.S. Dist. Lexis 8184, No. 95-

4029 (E.D. La. 1998).

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is less certainty as to many important issues affecting limited liabilitycompanies compared to limited partnerships.

1I 1710 Micellaneous Aset Protection Considerations

1I 1710. Disclaiers

A. Def'mition

A "disclaimer" is defined in Black' s Law Dictionary as ". . . (t)he refusalor rejection of an estate or right offered to a person. The disavowal , denialor renunciation of an interest, right, or property imputed to a person oralleged to be his. . . . The rejection , refusal, or renunciation of a claimpower, or property. " 109

Requiements

The requirements of an effective ("qualified") disclaimer are set forthunder Internal Revenue Code S 2518. In order to be effective, thedisclaimer must be in wrting and such wrting must be received by thetransferor of the interest, his or her legal representative, or the holder ofthe legal title to the pl'perty to which the interest relates. Such wrtingmust be received not later than the date which is nine months after thelater of: the date on which the transfer creating the interest in the would-disclaimant is made; and the day on which the would-be disclaimant attansage twenty-one. 110 An additional requirement specifies that the would-disclaimant must not have accepted the interest or any

of its benefits.Finally, as a result of such refusal, the interest must pass without anydirection on the part of the would-be disclaimant and pass to either thespouse of the decedent; or to a person other than the would-be disclai-mant. 111

Based on the fact that the ta consequences of a "qualified" disclaimerfor gift ta purposes are so important, the requirements for an effectivedisclaimer under the law of most states is often at least as restrctive as isrequired under the Internal Revenue Code. 112 Where the requirementsfor an effective disclaimer under state law are less restrictive than underthe Internal Revenue Code, however, a disclaimer can exist which iseffective under state law (i. , for asset protection purposes) but whichcarres adverse federal gift ta consequences. For example

, "

(i)f a New Yorkcourt allows a person to disclaim more than nine months after the transfer

109 Black' s Law Dictionary 464 (6th ed. 1990).110 I.R.C. ~ 2518.111 Id.112 See, e.g. Y. Est. , Powers and Trusts ~ 2-1.11.

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it will constitute a gift (for gift ta purposes) to the person who gets theproperty as a result of the disclaimer, but it will successfully insulate theproperty from the disclaiming party s creditors since the renunciation isretroactive to the date of the transfer. " 113 In order to make the disclaimerpalatable to a would-be disclaimant, however, care should be taken toqualify the disclaimer under Internal Revenue Code S 2518 , even wherethe terms of that section are more restrctive than is required under thegoverning state law.

Effect of Disclaier

Since , at common law, a person is not obligated to accept a gift, wherea disclaimer is effectively made the individual who would have otherwsereceived the property at issue (the "disclaimant ) is often deemed to havepredeceased the transferor. Similarly, the Internal Revenue Code providesthat "

. .

. if a person makes a qualified disclaimer with respect to anyinterest in property, this subtitle shall apply with respect to such interestas if the interest had never been transferred to such person." 114 An effectivedisclaimer will relate back in time to the original gift, so that the disclaimantis considered as never having obtained an interest in the property at issueto which a creditor s lien !:n attach. The disclaimer will relate back to atime immediately before a decedent s death. 115 As a result, generally, thedisclaimed interest is not transferred to the disclaimant at the decedent'sdeath. As there is no transfer of an interest to the disclaimant, there isnothing to which a lien can attach. Consequently, creditors of the disclai-mant and his estate have no claim against or right in the disclaimedproperty. 116 It is, therefore, because of the relation back doctrine thatdisclaimers are a powerful asset protection tool.

Disclaiers as a Plang Tool

An estate planner might consider using a disclaimer where a lack offorethought has allowed a gift to be made to a beneficiary who is facinga creditor problem. In the alternative , and where the beneficiary is thetransferor s spouse, one planning technique is to consider drafting dis-claimer provisions into a trust or last will and testament where the

113 Turano, Practice Commentary, McKinney s Cons. Laws of NY, Book 17B, EPT 2-1.11at 242; See also Matter of Dominguez, 143 Misc.2d 1010, 541 N. 2d 934 (NY Cty. Surr.Ct. 1989).

114 I.RC. ~ 2518(a).

115 National City Bank of Evansville v. Oldham, 537 N.E. 2d 1193, 1196 (Ind. Ct. App.1989); But see Pennington v. Bigham, 512 So. 2d 1344 (Ala. 1987) (holding that by virteof judgment creditor s lien on inherited real property, disclaimer by insolvent debtor wasof no effect).

116 National City Bank of Evansville, Oldham supra.(Mattew Bender & Co., Inc.

17-45 PROTECTING THE ESTATE 'I 1710.

beneficiary spouse s creditor problems are contemplated, but are notconsidered a suffciently serious problem to warrant an automatic distribu-tion in trst. For example , such circumstances might warrant an outrightgift with a contingent trust for the beneficiary spouse in the event that thebeneficiary spouse should ultimately disclaim the outrght gift.

Exceptions to General Rule

There are exceptions to effective disclaimers for asset protection pur-poses. Where the would be disclaimant is a minor, an effective disclaimermay not be possible. Although the disclaimer could, in theory be effectedby the minor s guardian , there is a possibility that the disclaimer wouldnot be deemed to be within the minor s "best interests" by the court. Somestates have statutorily provided an additional exception that a disclaimeris ineffective if the would-be disclaimant is insolvent at the time thedisclaimer is made. 117 Yet, other states statutorily provide that the creditorsof a disclaimant have no interest in the property which is disclaimed. 11s

In a recent dispute, the Supreme Court held that disclaimed propertycan be reached by the federal government in order to payoff the disclai-mant s federal ta liens. In Drye Family Trust v. U.S. 119 the Court held thatstate property law has no afect on the ability of the federal governmentto reach disclaimed ptbperty to satisfy tax liens of the disclaimant. TheCourt found that the right to inherit is a property right subject to thefederal ta lien, and the fact that the inheritance is subsequently voidedby an effective state law disclaimer will not afect the federal government'sinterest in that property right.

1I 1710. Powers of Appointment

Overvew

A "power of appointment" has been defined as " (a) power or authorityconferred by one person by deed or will upon another (called the "doneeto appoint, that is, to select and nominate , the person or persons who areto receive and enjoy an estate or an income therefrom or from a fundafter the testator s death, or the donee s death , or after the terminationof an existing right or interest. " 120 In general , there are two classes of

117 See, e. Fla. Stat. Ann. ~ 732.801(6) (West Cum. Supp. 2000); Mass. Gen. Laws Ann.Ch. 191A ~ 8 (West 1990); Minn. Stat. Ann. ~ 525.532 (West 1986); NJ. Stat. Ann. ~ 3B:9-(West Cum. Supp. 1999); Wash. Rev. Code Ann. ~ 11.86.051 (WestJ998).

11S Md. Code Ann. , Est. & Trusts ~ 9-204(f); Mo. Rev. Stat. ~ 469.010 (1997); Tex. Prob.Code Ann. ~ 37A (2000).

119 Supra note 116.

120 Black' s Law Dictionary 1171 (6th ed. 1990).

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'I 1710. 2001 INSTITUTE ON ESTATE PLANING 17-46

powers of appointment

, "

general" powers of appointment and "non-general" (also sometimes called "special" or " limited") powers ofappoin tmen t.

A general power is defined as a right to appoint to whomsoever the doneepleases including himself or his estate. By contrast, under a non-generalpower the donee is restrcted to the objects (other than the donee or hisestate) as is designated in the deed or wil creating the power. 121 Forexample , a non-general power can give the donee the limited right toappoint to his issue or can be broader by allowing the donee to appointto anyone except himself, his creditors , his estate or the creditors of hisestate. The foregoing distinction between general and non general powersof appointment is extremely important for asset protection purposes sinceproperty subject to a non-general power will not be subject to the claimsof the donee s creditors and property subject to a general power may

subject to the claims of the donee s creditors.

B. Distictions General versus Non-General Powers ofAppointment

The question arises as to why this distinction is made? Non-generalpowers of appointment are not subject to creditor claims because the doneeof the power has no beneficial)nterest in the property subject to thepower. 122 This is also the case under the Federal Bankrptcy Code , whichprovides that " (p)roperty of the (bankruptcy) estate does not include.

. .

any power that the debtor may exercise solely for the benefit of an entityother than the debtor. 123

Since the donee of a general power of appointment, however, does havea beneficial interest in the property subject to the power, under certaincircumstances the property will be subject to the claims of the doneecreditors. The general rule , however, is that not even property subject toa general power of appointment can be reached by the donee s creditors(provided that the donee was not also the creator of the general power)until the power is actually exercised by the donee , unless it is otherwseprovided by statute. 124 The justification for the foregoing rule was wellsummarized in Gilman v. Bell 125 which found that " the donee of the power

121 Black' s Law Dictionary 1171 (6th ed. 1990).122 2A Austin W. Scott & Willam F. Fratcher, The Law of Trusts ~ 147. , at 69 (4th ed.

1989); See, e.g. NY Est. , Powers and Trusts ~ 10-7. 1 (McKinney 1999), which provides that(p)ropert covered by a special power of appointment is not subject to the payment of

the claims of creditors of the donee , his estate or the expenses of administering his estate.12311 U. c. ~ 541(b)(I). 124 2A Austin W. Scott & Willam F. Fratcher, The Law of Trusts ~ 147. , at 69-70 (4th

ed. 1989).

125 99 Il. 144, 149-150 (1881).

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only receives the naked power to make the property or fund his own. Andwhen he exercises the power, he thereby consents to receive it, and thetitle thereby,vests in him, although it may pass out of him eo instanti

the appointee." A number of states , however, statutorily provide thatcreditors can reach property subject to an unexercised general power ofappointment. For example, in Alabama

, "

(e) very special and beneficialpower is liable to the claims of creditors, and the execution of the samemay be ordered for their benefit. " 126 A similar rule applies in New York , 127

Tennessee 128 and in the context of bankruptcy. 129

Where a person creates a general power of appointment in himself, theproperty can be reached by such person s creditors, whether or not thepower is exercised or even presently exercisable. 130

C. Aset Protection and Powers of Appointment

There are several ways in which a power of appointment can be usedto provide creditor protection. 131 In those jurisdictions which follow thegeneral rule that an unexercised general power of appointment is notsubject to the claims of the donee s creditors, a general power of appoint-ment over property can be transferred to the donee in lieu of a transferof the actual property with the intent that the beneficiary exercise thepower in his favor, as he 'tomes to require the property, and only in theabsence of immediate creditor claims. A limited power of appointmentexercisable in favor of an extremely limited class (which includes , of coursethe intended beneficiary) can be granted to the intended beneficiaryspouse with the intent that the property be meted out to the beneficiaryas required. The grant of a limited power of appointment to the spousehas three main benefits over an actual gift of the property itself to suchspouse. The donee will have no conflct of interest since in no event willthe donee be able to vest the propert in him or herself. In addition , the

126 Code of Ala. ~ 35-305 (2000).127 N.Y. Est. , Powers and Trusts ~ 10- 2 (McKinney 1999).128 Tenn. Code. Ann. ~ 66-1-106 (2000).129 11 U. C. ~ 541 (a) (1); In re Shurley, 171 B.R 769 (Bankr. WD. Tex. 1994) (because

a general power of appointment can be exercised for the benefit of the donee herself, itis included in the donee s bankrptcy estate), rev d on other grounds 115 F. 3d 333 (5th Cir.1997) .

130 N.Y. Est. , Powers and Trusts ~ 10-7.4 (McKinney 1999), which provides that " (pJropertycovered by a general power of appointment which, when created , is not presently exercisableis subject to the payment of the claims of creditors of the donee, his estate .and the expensesof administering his estate , only (1) If the power was created by the donee in favor of himself.

131 The author is grateful to Alexander Bove , Esq. , who first brought the use of powersof appointment as an asset protection tool to his attention.(Matthew Bender & Co. , Inc.

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property cannot become subject to the claims of the donee s creditors.Lastly, the potentially serious adverse ta consequences which could existupon a gift of the property from the spouse to the intended beneficiaryare not imposed upon an exercise of a limited power of appointment.

1I 1710. Joint Owership of Propert

There are three tyes of joint ownership of property, with the followingcharacteristics significant to asset protection.

Tenancy in Common

Although a tenancy in common may be had as to either real or personalproperty, and although there are far fewer restrctions on the establishmentof a tenancy in common than there are for other forms of joint ownershipof property, the ownership of property with another as tenants in commonprovides only negligible benefits for asset protection purposes. This is sobecause each tenant may, voluntarily or involuntarily, alienate his_or herinterest in the property without the consent of his or her co-tenants. Ofcourse, the creditor of a co-tenant will not actually be able to enjoy theuse of the property subject to '(he tenancy in common exclusive of theremaining co-tenants without first obtaining a judicial partition of theproperty. This may diminish the value of the property to a creditor andaford some slight leverage to the debtor tenant in common in settling thecreditor s claim at less than its full value.

B. Joint Tenancy

Like a tenancy in common , a joint tenancy provides only negligibleprotection , because each tenant may, voluntarily or involuntarily, alienatehis or her interest in the property without the consent of the remainingtenants. To the extent that the interest is not alienated during life, it willpass to the survving joint tenant or tenants upon the death of a jointtenant. When an interest in a joint tenancy is alienated, either voluntarilyor involuntarily, the recipient of the alienated interest takes title as a tenantin common with the remaining tenants (who remain joint tenants asbetween themselves).

The same small modicum of leverage applies to a creditor of a tenantto a joint tenancy as applies to a creditor of a tenant to a tenancy incommon; to wit, the creditor will not be able to enjoy the use of theproperty exclusive of the remaining co-tenants without first obtaining ajudicial partition of the property.

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C. Tenancy by the Entiety

A tenancy by the entirety is a form of joint ownership of property whichis available only to a husband and a wife. In some jurisdictions, only realproperty can be held as tenants by the entirety. Other jurisdictions haveexpanded the tyes of property which can be held as a tenancy by theentirety. In New York, for example , the shares of stock of a cooperativeapartment corporation allocated to an apartment or unit together with theappurtenant proprietary lease can also be held by a husband and wife astenants by the entirety132 and in Pennsylvania, personal property includingsecurities can be held as tenants by the entirety. 133

Like ajoint tenancy, a tenancy by the entirety will serve to pass a deceasedtenant s interest in the property to the survving tenant by operation oflaw. Unlike ajoint tenancy (and for that matter, a tenancy in common),however, a tenant by the entirety cannot alienate his or her interest in thetenancy or terminate the tenancy without the consent of the other tenant.It is this fact that provides asset protection to property held in a tenancyby the enrirety form. Property which is exempt from creditors by reasonof a tenancy by the entirety under state law will also be exempted fromthe estate in bankrup.t(:y. 134 Thus, one might wish to consider the assetprotection aforded by clients holding title to their real estate as tenantsby the entirety before recommending dividing up the joint estate forpurposes of estate equalization to ensure that each spouse s estate can makemaximum use of the unified credit.

There are several limitations which exist, however, with regard to theasset protection aforded by holding property in a tenancy by the entirety.First, a tenancy by the entirety provides no asset protection to a jointcreditor of the two tenants. Second, a tenancy by the entirety is automati-cally terminated upon the dissolution of the tenants ' marriage , whetherby divorce or by death; the timing of which may be less than fortuitousfor one of the tenants.

Pensions and Individual Retirement Accounts

Pension plans which are qualified under the Employee RetirementIncome Security Act ("ERISA"), and hence contain an anti-alienationprovision as required under that Act, have been held by the United States

Supreme Court to be protected from creditors. 135 By cOI)trast, the creditor

132 Y. Est. , Powers and Trusts ~ 6-2. 1(4) (McKinney 1999).133 Madden v. Gosztonyi Savings & Trust Co. , 200 A. 624, 331 Pa. 476.134 11 U. C. ~ 522(b) (2) (B).135 Patterson v. Shumate, 112 S.Ct. 2242 (1992).

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protection aforded to individual retirement accounts and non-ERISA plansvaries on a state by state basis. 136 Even those states which statutorily exemptindividual retirement accounts from the reach of creditors, do not necessar-ily exempt the more recent "Roth IRA.

Where the client resides in a state in which an individual retirementaccount is not exempt from creditors, when available the client shouldretain his fund within the qualified plan rather than effecting a roll-overinto an individual retirement account. Similarly, in order to preserve thefund from the beneficiary s potential creditors after the death of theemployee , consider the use of a so-called "conduit" trst as the accountbeneficiary.

By contrast, where an individual retirement account is exempt fromcreditors, a roll-over into an individual retirement account in the nameof the survving spouse is doubly advisable. A roll-over wil enable thesurvving spouse to maximize the deferral of income taxation on the

. account by minimizing the minimum required distributions through useof an extended pay-out period and will also ensure protection of theindividual retirement account from the spouse s creditors.

Qualfied State Tuition Program

Under Internal Revenue Code S 529 , a person may make contributionsto an account for the purpose of providing for qualified higher educationexpenses for a designated beneficiary. 137 Such contributions qualify for thegift ta annual exclusion under S 2503(b). The donor can contribute upto $50 000 per donee and elect to apply such amount ratably over a five-yearperiod for purposes of the gift tax exclusion. A major benefit of suchaccount is the ability of the donor to use such funds for his or her ownbenefit (subject to a 10% penalty). As a result, it would appear that suchaccounts would generally be available to the donor s and beneficiarycreditors. Recognizing such potential , some states have enacted legislationwhich exempt such accounts from both the donor s and beneficiarycreditors. 138 Accordingly, planners may wish to consider establishing theseaccounts in those states which offer creditor protection for clients who mayhave creditor exposure and who may otherwse be reluctant to makecompleted gifts or establish more costly trusts.

136 For a state by state chart of exemptions, see Gideon Rothschild and Christopher Alliots, Protecting Retirement Plans , J. Asset Protection, Marchi April 1997, available atww.mosessinger.com/resources.

137 I.RC. ~ 529(b) (1) (A).138 See, e. Alaska Stat. ~ 14.40.802(h) (1); Va. Code Ann. ~ 23-38.81 (E).

(Matthew Bender & Co., Inc.