A Domestic Asset Protection Trust (DAPT) means an irrevocable trust formed under a state law described below which authorizes an independent trustee, in such trustee's absolute discretion (or pursuant to certain specific statutory standards), to make distributions to a class of beneficiaries which includes the settlor. Prior to 1997, almost all states had statutory or case law which provided that it was against public policy to protect the assets of a DAPT from the settlor's creditors. The transfer tax corollary of this public policy was that, since a settlor could relegate the settlor's creditors to the assets of the trust, transfers to the DAPT would be incomplete gifts and the assets would be included in the settlor's gross estate. 

In 1997, Alaska was the first state to enact a usable statute which reversed the above-described policy. The 1997 statute expressly provided, with certain limited exceptions, that creditors of the settlor could not reach assets which the settlor had transferred to a DAPT. Several months later, Delaware followed with a similar statute. In 1999, Nevada and Rhode Island enacted such statutes. In 2003, Utah enacted a statute, effective January 1, 2004. 

In late 2003, attorneys representing each of the five states which have enacted a DAPT law conducted anecdotal, as opposed to scientific, polls concerning the number of DAPTs that have been established in each state. These attorneys contacted institutions and individuals who had indicated an interest in acting as trustees for DAPTs formed for resident and nonresident settlors. Also contacted were estate planning attorneys likely to be involved in creating DAPTs. This poll indicated that a total of approximately 1,250 DAPTs have been established since 1997. Approximately two-thirds of Alaska trusts were designed for both asset protection and transfer tax minimization purposes as compared to approximately one-sixth of the Delaware trusts. Most of the Nevada and Rhode Island trusts were designed only for asset protection. Approximately seventy-five percent of the Alaska and Delaware trusts and twenty percent of the Nevada trusts were designed with a perpetual or dynasty trust plan.

DAPTs offer estate planners and their clients significant new tools. Asset protection has become a frequent concern in our litigious society. Additionally, the opportunity to be able to remove assets and their growth from a client's gross estate, yet still have the ability to make discretionary distributions to the client, is a very attractive tax minimization approach. However, the reversal of long-standing public policy with respect to creditors' rights accomplished by the DAPT state statutes has created a fair amount of doubt among planners about whether the asset protection and transfer tax minimization goals will be achieved. As with any new concept, many planners have opted to monitor DAPT development and track record prior to recommending the approach to their clients. Other planners who are not adverse to business or tax planning risk also desire to fully understand such risk before proceeding. 

Over the past seven years, numerous commentators have analyzed DAPTs and their goals. These analyses have come from diverse sources: some from proponents of DAPTs; others from competing interests such as planners previous committed to foreign asset protection trusts; and third, from the academic realm. Seven years of experience, numerous thoughtful commentaries, and continuing estate planners' interest have raised numerous issues with respect to DAPTs. The goal of this article is to identify and discuss key issues surrounding DAPTs. Hopefully, this will provide the information desired by estate planners so that they can decide whether this approach is appropriate for specific clients. 

Asset Protection. The initial goal is to protect the DAPT assets from creditors of the settlor. In addition, often DAPTs include a perpetual trust plan which provides asset protection for other beneficiaries. 

Transfer Tax Minimization. The goal is to allow a settlor to use the settlor's applicable credit and annual exclusion gifting ability to transfer assets to an irrevocable trust, the assets of which will not be included in the settlor's gross estate. Therefore, the value of those assets plus all of the growth after the transfer will be so excluded. However, if the settlor needs funds from the trust due to a financial reversal or other emergency need, the independent trustee has discretion to make distributions to the settlor.

One approach which may avoid the above consequence is for H and W to each contribute their partnership interest to a DAPT. If they have used their applicable credit and annual exclusion gifting elsewhere, they can make their contributions incomplete gifts. Since an independent trustee would have absolute discretion to determine when distributions will be made, a good argument exists that the Strangi I.R.C. § 2036(a)(2) holding will not apply. This approach also adds a tax purpose to planning that involves incomplete gifts to a DAPT.

As discussed above, many existing DAPTs have been formed for asset protection purposes only. At the settlor's death, the assets of these trusts will be included in the settlor's gross estate for federal estate tax purposes. The reason why transfer tax minimization planning is not used in such trusts is usually because the amount of assets transferred to the DAPT are greater than the client's applicable credit and annual exclusion gifting ability. Therefore, the transfer of assets to a DAPT as “completed gifts” would require out-of-pocket payment of federal gift tax. 

In order to avoid the transfer from being a completed gift, all DAPT statutes allow the settlor to retain a power to veto a distribution from the trust, or retain a testamentary non-general power of appointment. However, the retention of a testamentary power may not make gifts incomplete if the trustee has discretion to make distributions to beneficiaries other than the settlor. Retained powers may be structured so that they may be released, fully or partially, in the future in order to complete gifts to the trust.

As indicated in the anecdotal poll described above, approximately two-thirds of the trusts created under the Alaska statute are formed for the dual purposes of asset protection and transfer tax minimization as compared to only approximately one-sixth of trusts created under the Delaware statute. Several reasons may explain this difference in approach. Delaware settlors may be contributing substantial larger amounts to their trusts. Also, Alaska practitioners have favored using dual or more purposes for forming a DAPT in order to minimize the risk that a court may characterize transfers to the DAPT as fraudulent transfers. 

Whether a DAPT is to be used for asset protection only, or both for asset protection and transfer tax minimization, the asset protection foundation must exist. That is, the DAPT state law which restricts creditors from reaching assets of the trust must apply to the DAPT. In Issues 3 through 14, below, this asset protection foundation is analyzed and discussed. In Issues 15 through 18, below, additional questions relating to transfer tax minimization are analyzed and discussed.

Choice of Law. The creditor may argue that the court should apply the spendthrift trust law of the state of residence of the settlor, rather than the law of the DAPT state.

Fraudulent Transfer. The facts may support an argument that the settlor's transfer to the DAPT was fraudulent and therefore should be set aside. Again, a choice of law issue may exist. The fraudulent transfer law of the settlor's state of residence may be more creditor-friendly than that of the DAPT state. 

Improper Implementation. The facts may support an argument that the settlor has, through an implied agreement or other improper implementation, retained controls over the DAPT in a manner which will allow the court to conclude that the requirements of the DAPT statute have not been met. Attacks under this general category include the following: (1) implied agreements between the settlor and the fiduciary; (2) the trust has been implemented in a manner so that it is merely the “alter-ego” of the settlor; or (3) the trust is a “sham” because of the manner in which it has been implemented.

It is very important to understand the difference between obtaining a valid judgment against the settlor as compared to such a judgment against the DAPT trustee or over DAPT assets. A judgment against the settlor will only entitle the creditor to reach the settlor's assets. The DAPT assets are no longer owned by the settlor. Therefore, even though a creditor is able to obtain jurisdiction over the settlor in the settlor's state of residence, and then subsequently obtain a judgment against the settlor, this does not allow the creditor to reach the DAPT assets.

To reach the DAPT assets, a creditor of the settlor will first have to bring an action in state or federal court which can obtain jurisdiction over the trustee of the DAPT or the DAPT's assets. If such jurisdiction is obtained, then the creditor can assert one or more of the types of attacks discussed in Issue 3, above.

Planning for the Most Desirable Forum. It is generally assumed that if a creditor challenges a DAPT that it will be to the settlor/debtor's advantage to have the challenge occur in a court located in the DAPT state. The theory is that a DAPT court (whether state, federal or bankruptcy) will more likely apply DAPT law than a court located in another state. Therefore, jurisdiction planning for a DAPT is very important. Choices of trustees, lack of DAPT trustee contacts with the settlor's state of residence, and implementation planning can avoid or minimize the risk that a court located outside the DAPT state will have jurisdiction over the trustee or the trust assets.

No Trustee Contacts; No Personal Jurisdiction. Assume that a nonresident of a DAPT state forms a DAPT which has a trustee located only in the DAPT state. Assume that the DAPT is funded by transferring assets, such as security accounts and other intangibles, to the trustee in the DAPT state. Assume further that the trustee has no contacts with the settlor's state of residence. If a creditor of the settlor brings an action in the settlor's state of residence, that state court will not have the ability to obtain personal jurisdiction over the DAPT trustee or the trust assets.

If instead, the creditor had sued in a federal court located in the settlor's state of residence, based upon either diversity or federal question jurisdiction, again, the court would not be able to obtain personal jurisdiction over the DAPT trustee or the trust assets. However, a bankruptcy court, whether located in the settlor's state of residence or in the DAPT state, will have jurisdiction over the DAPT trustee and the trust assets. This is because a bankruptcy court has national jurisdiction.

Trustee Contacts. Even if the DAPT only has a corporate trustee located in the DAPT state, a state or federal court located in the settlor's state of residence may be able to obtain personal jurisdiction over such trustee based upon the forum state's long-arm statute and various contacts which the corporate trustee may have with that state. However, these contacts must be more than typical trustee communications with a settlor or beneficiary. The ultimate long-arm question will be whether the DAPT trustee purposely availed itself of the benefits of doing business in the settlor's state of residence. The court will analyze how numerous and deliberate the contacts were, and how close the relationship is between the contacts and the litigation.

General media advertising, attendance at professional conferences, articles in national press and journals, and providing promotional materials and website material may not be enough to satisfy the due process requirements for jurisdiction. A contemporary illustration of such general advertising contacts is provided by the internet. Is the fact that a trustee maintains a website on the internet enough to provide a due process basis for jurisdiction in states which can access the internet material? The developing law in this new area of personal jurisdiction distinguishes between passive internet sites which only provide information and interactive sites which conduct business transactions. Commentators suggest that the test should seek to determine if the defendant engaged in intentional conduct expressly aimed at the plaintiff in the forum state.

In Rem Jurisdiction. Assume the above facts except that some of the assets transferred to the trust include real estate located in the settlor's state of residence. This will give a court located in the settlor's state of residence in rem jurisdiction over the asset.

Several approaches have been suggested to avoid such in rem jurisdiction. The real estate could be contributed to a limited partnership or limited liability company formed under DAPT state law. Such a contributed interest should be considered intangible personal property with a situs in the DAPT state. However, if the real property is involved in any income-producing activity then the DAPT limited partnership or limited liability company may be required to register in the settlor's state of residence and submit to its jurisdiction. One commentator has suggested the alternative approach of the settlor selling the real estate to the DAPT or to another grantor trust in exchange for an installment note. The note would be secured by the real property. The note would then be contributed to the DAPT. Again, the promissory note should be considered intangible personal property which has its situs in the DAPT state. While a court located in the settlor's state of residence may be able to obtain jurisdiction over the real property, it will have reduced value due to the fact that it is subject to a lien securing the promissory note.

Co-trustee Located in Settlor's State of Residence. Here, the state or federal court located in the settlor's state of residence will be able to obtain personal jurisdiction over the co-trustee, and therefore the judgment will be entitled to full faith and credit in courts located in the DAPT state.

Assume that a nonresident of a DAPT state establishes a DAPT. Assume that a creditor sues the settlor in a court located in the settlor's state of residence and obtains a judgment. Next, assume that as part of that suit, or in a separate action in the settlor's state of residence, the creditor proceeds against the trustee of the DAPT in order to enforce the judgment against the trust assets. Assume that the court in the state of residence chooses that state's spendthrift trust rules and/or fraudulent transfer rules and enters a judgment against the trustee. The creditor then proceeds to the DAPT state and asks a court located there to enforce the judgment against the trustee based upon the Full Faith and Credit Clause.

A basic requirement for full faith and credit is that the judgment be valid. One requisite for validity is that the forum court possessed jurisdiction. Assume that the DAPT trustee did not participate in the court action in the settlor's state of residence and had few, if any, contacts with that state. Then, that state's jurisdiction over the DAPT trustee and the assets such trustee holds will be highly questionable. Consequently, full faith and credit may well be denied.

Assume that a nonresident of a DAPT state establishes a DAPT. Subsequently, the settlor is sued in either state or federal court by a creditor. The court may be located in the settlor's state of residence or in the DAPT state. Assume further that the court obtains jurisdiction over the trustee of the DAPT. The creditor will argue that the court should choose the spendthrift trust law of the settlor's state of residence, rather than the law of the DAPT state. If the court chooses to apply the law of the state of residence, which does not allow DAPTs, then the creditor will be allowed to reach the assets of the trust. Therefore, the issue is which state's spendthrift trust rules apply–those of the DAPT state or the rules of the settlor's state of residence? A sub-issue is whether this question is one of administration or validity of the trust. 

Administration. If the question is one of administration of the trust, the settlor's choice of DAPT law in the trust instrument controls. The Restatement (Second) Conflict of Laws § 273(b) provides that whether the interest of a beneficiary of a trust of movables is assignable by him and can be reached by his creditors is determined “in the case of an inter vivos trust, by the local law of the state, if any, in which the settlor has manifested an intention that the trust is to be administered . . . .”

Validity. If the question is one of validity of the trust, section 270 of the Restatement again provides that the settlor's choice of DAPT law in the trust instrument will prevail if the DAPT state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship under the principles stated in § 6 . . . .”

Generally, the DAPT state will satisfy the requirement of having a substantial relation to the trust. However, a factual determination will need to be made as to which state has the most significant relationship to the trust.

Strong Public Policy. Further, and equally important, a determination will need to be made whether application of the DAPT's state law will violate a “strong public policy” of the settlor's state of residence. For example, the settlor's state of residence may allow one or more other approaches which are essentially the same as a self-settled spendthrift trust. Consider state statutes which provide creditor protection for “self-settled” techniques such as: IRAs, life insurance, annuities, homesteads, tenancies by the entirety, and similar planning approaches. If the state of residence allows some or all of such self-settled approaches, a significant argument can be made that the state does not have a “strong public policy” against self-settled asset protection planning.

Professor Scott, in his treatise, “The Law of Trusts,” states that differences in spendthrift trust law are not enough to establish a “strong public policy” which would justify disregarding the law of the state of administration chosen by the settlor.

Professor Siegel, generally analyzing the public policy exception in the conflict of laws area, states the following:

An interesting example of this choice of law issue is provided by the New York case of Hutchinson v. Ross . A Quebec resident created a trust in New York, using a New York corporate trustee, and contributed funds which the settlor had on deposit with a New York financial institution. Subsequently, creditors tried to reach the trust assets, arguing that the trust was invalid under the laws of Quebec because it violated a statutorily required antenuptial agreement entered into by the settlor and his spouse. The Court of Appeals of New York instead applied the law of the state of New York on the grounds that the intent stated in the trust document was that New York law should govern, and that was where the trust property was situated. Again, in Intercontinental Hotels Corp. v. Golden , the New York Courts enforced a foreign gambling claim as not against public policy even though that type of gambling was not legal in New York state. Also, see the bankruptcy court cases discussed in Issue 10, infra .  

Rule of Validation. Professor Siegel describes a rule of validation with respect to trusts as follows: 

The Restatement (Second) Conflict of Laws in section 6, comment g, reaffirms that “. . . the courts seek to apply a law that will sustain the validity of a trust of moveables ( see §§ 269-270).”

Conclusion. The above-discussed authorities favor application of the choice of law stated by the settlor in the trust instrument. A court may instead apply the spendthrift trust law of the settlor's state of residence if the court concludes that such state has the most significant relationship to the trust and that the DAPT spendthrift trust rule violates a strong public policy of the resident state. When will a court do so? The “rule of thumb” has been that the risk of non-DAPT law being applied is greater when the issue is being considered by a court located outside of the DAPT state.

Planning. If a creditor cannot avoid the application of the DAPT spendthrift trust law, then an alternative may be to attack the transfer to the DAPT as fraudulent. Most fraudulent transfer situations can be avoided by good planning. Estate planners should follow the due diligence procedures discussed in Issue 19, below, in order to determine whether existing liabilities and foreseeable future liabilities are present. If so, then the settlor's contemplated transfer to the DAPT may result in fraudulent transfers. Therefore, either the DAPT should not be formed, or its formation should be postponed until a time when the liabilities have been satisfied or secured.

However, even when no known liabilities exist, the possibility that a future creditor will challenge a transfer to a DAPT as fraudulent cannot be completed eliminated. Consequently, from a settlor's standpoint, it will be advantageous if the fraudulent transfer law which is applied is law which is favorable to the settlor. The “rule of thumb” is that this will be the DAPT state fraudulent transfer law. For example, see the Alaska fraudulent transfer law described below.

Substantive Law. Alaska, Delaware, Rhode Island, and Utah all have express exceptions which exclude fraudulent transfers from their spendthrift trust protection.

Delaware, Nevada, Rhode Island, and Utah are among forty-two states that have adopted the Uniform Fraudulent Transfer Act. That Act provides, in part: 

Alaska has not adopted the U.F.T.A. Prior to 2003, Alaska law allowed a creditor to successfully challenge a transfer to a trust if the “transfer was intended in whole or in part to hinder, delay, or defraud creditors or other persons . . . .” In 2003, the above provision was amended to restrict a creditor's challenge to situations where “[t]he settlor's transfer of property in trust was made with the intent to defraud that creditor.” The terms “in part,” “hinder,” “delay,” and “creditors or other persons” were considered too ambiguous to allow for consistent application.  

Nevada's statutes do not expressly state that fraudulent transfers are exceptions to its spendthrift trust provisions. Rather, the statutes allow a creditor to bring an action within two years after the transfer is made, or six months after the creditor discovers, or reasonably should have discovered, the transfer, whichever is later. Perhaps these provisions will be read together with Nevada's fraudulent transfer statute to require the creditor to establish that the transfer was fraudulent before it will be set aside.

Statute of Limitations and The Discovery Exception. Many clients who form DAPTs do so pursuant to what has been called the “nest egg” concept. That is, they want to set aside a certain portion of their net worth in a trust which will be protected from future events. They generally will have no known existing liabilities but are involved in activities, either work or recreational related, which create risks. These clients want assurance that after a certain period of time a creditor cannot attack the DAPT and reach its assets.

One of the major asset protection goals of DAPT statutes is to set a time limit upon the period when assets transferred to the trust will be vulnerable to attack. This limit is generally set at four years (two years in Nevada). However, each statute has a “discovery exception” which allows a creditor to assert a fraudulent transfer attack more than four years (two years in Nevada) after the transfer. This discovery exception provides for attacks “within one year (six months in Nevada) after the transfer was or could reasonably have been discovered by the claimant.”

Under the U.F.T.A., the creditors who can attempt to take advantage of the discovery exception are both existing and future creditors who are asserting that the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor of the debtor. Under Alaska law prior to the 2003 amendment, only existing creditors could assert the discovery exception, but the definition of “existing creditors” was uncertain. As a result, a client who has no existing claims pending will not have certainty that after the four-year (two-year in Nevada) period has expired, the assets of the DAPT will be safe from attack.

In 2003, the Alaska Legislature attempted to resolve this ambiguity by clarifying the distinction between an existing and future creditor. The 2003 Alaska amendment limits the definition of an existing creditor to a creditor who: “(1) can demonstrate, by a preponderance of the evidence, that the creditor asserted a specific claim against the settlor before the transfer; or (2) files another action, other than [a fraudulent conveyance action], against the settlor that asserts a claim based on an act or omission of the settlor that occurred before the transfer, and the action described in this sub-subparagraph is filed within four years after the transfer.” These new fraudulent conveyance provisions should provide much greater certainty concerning the fraudulent conveyance exception, and a settlor should know within four years of a transfer whether a creditor can attempt to challenge a transfer as fraudulent.

As discussed in Issue 7, above, the laws of the DAPT state and the settlor's state of residence may be significantly different with respect to what must be proved to establish a fraudulent transfer and the burden of proof. For example, see the discussion in Issue 7, above, relating to the difference between U.F.T.A. provisions and those of the state of Alaska. Therefore, if a creditor attacks a transfer to a DAPT on the grounds that the transfer was fraudulent, it will be necessary to determine which state's fraudulent transfer law will apply.  

Choice of Substantive Law. The Restatement (Second) Conflict of Laws does not directly address this subject. See section 235, comment c, which indicates that a transfer of land in fraud of the transferor's creditors may be determined by the law governing the tort (rather than the law of the situs); section 244, which provides that a claim for fraud between the transferor and the transferee is determined by the law of the state which has the most significant relationship to the parties, the chattel, and the conveyance; and section 245, which provides that questions as to the effect of a conveyance upon a third party who has an existing interest in the chattel will be determined by the law of the state where the chattel was located at the time of the conveyance.

Professor Siegel, discussing gratuitous transfers, states: 

The above-discussed rules indicate that the choice of law may depend upon where the transfer occurred. Therefore, good planning will make sure that all transfers funding the DAPT occur in the DAPT state.

Choice of Statute of Limitations. Regardless of which state's substantive law is applied, it appears that the limitations period of the forum state will control. Assume that a court in the settlor's state of residence is not able to obtain personal jurisdiction over the trustee of the DAPT. Therefore, a creditor who desires to attack the settlor's transfer to the DAPT as fraudulent will need to bring an action in the DAPT state. The question is whether the DAPT state limitations period applies to such a cause of action or whether the limitations period of the settlor's state of residence controls.

The Restatement (Second) Conflict of Laws § 142 provides in part:

Planning. In summary, as noted at the beginning of Issue 7, it is important to actively plan to minimize the risk that a transfer to a DAPT will be set aside as a fraudulent transfer. If jurisdiction over the DAPT trustee or assets cannot be obtained in the settlor's state of residence, then a creditor will be forced to proceed in a court located in the DAPT state. That court, whether state or federal, may apply the DAPT statute of limitations applicable to fraudulent transfers. If this law is similar to Alaska's 2003 provision, and if there were no existing creditors as narrowly defined by Alaska law, then the creditor will be required to proceed with a fraudulent transfer action within four years of the transfers to the DAPT.

The third type of creditor attack upon a DAPT can be generally described as improper implementation. This is a catch-all category that commentators have also labeled as alter-ego theory or sham theory. This is the same type of general concept which can be used to attack the validity of any entity, whether trust, limited partnership, limited liability company or corporation. In essence, the theory is that after formation of the entity the key parties have failed to respect the separate existence of the entity and the basic requirements for proper implementation of the entity.

No Agreement. In order to preserve the independence of the trustee, there must not be any agreement between the independent trustee and the settlor regarding distributions. The existence of such an agreement would allow the settlor's creditors to reach the trust assets because the settlor would have a right to the distribution of the assets. An additional result would be inclusion of the assets in the settlor's gross estate. Such an agreement could be written, oral, or implied through a pattern of distributions. If such a collusive relationship exists, then the trust is a “sham,” and is the settlor's “alter-ego.”

It would be more likely that a court might imply an agreement between the trustee and settlor if the independent trustee had a relationship with the settlor. Such relationships would include being a close relative, close friend, or employee. Because the transfer tax and asset protection advantages depend on the premise that the settlor's creditors cannot reach the assets in the trust, it is very important to choose a trustee who will minimize the risk that an implied agreement will be found.

A “rule of thumb” has developed concerning the portion of a client's assets which should be transferred to a DAPT. This “rule” limits such assets to no more than one-third (conservative) to one-half (aggressive) of the client's net worth. The rationale for this “rule” is that a settlor would not give away assets which the settlor knew with some certainty that he or she would need in the future, unless the settlor also knew that he or she could get the assets back. Thus, the transfer of too large a proportion of the settlor's assets to a DAPT invites a court to find that an agreement exists between the settlor and the trustee.

Statutory Requirements. Another type of improper implementation would be to fail to comply with the requirements for applicability of DAPT state law. All DAPT states require that the DAPT trust have a situs trustee, who is a resident individual or trust company or bank of the DAPT state. This trustee must maintain records and prepare or arrange for the preparation of income tax returns, on an exclusive or non-exclusive basis, and must participate in trust administration. Some trust assets need to be located in the DAPT state. Failure to comply with these requirements will result in DAPT law not being applied to the trust.

Formalities. Another area where a DAPT would be vulnerable to “alter-ego” theory is if the settlor or members of the settlor's family continued to manage trust assets that had been transferred to the DAPT. If such management is desired, the assets should first be contributed to a family limited partnership (FLP) or family limited liability company (FLLC). The clients may desire that they, or family members, be the general partners or managers. Then, the clients transfer the FLP limited partnership interest or the FLLC non-managerial interest to the DAPT. In this way, clients or their family members may retain the ability to manage assets without violating the actual property ownership of the assets.

Other types of improper implementation may not be enough in themselves to be fatal to a DAPT's asset protection but may make it easier for a creditor to pursue an approach to reach the DAPT's assets. For example, as discussed in Issue 4, above, it is assumed that it will be to the settlor's advantage to have any attacks upon the DAPT occur in courts located in the DAPT state. Therefore, careful implementation would avoid trustee contacts with the settlor's state of residence. Further, care must be taken not to appoint a co-trustee who resides in the settlor's state of residence. The same concerns may apply to trust protectors and trust advisors, depending upon the DAPT state law.

In order to maximize the probability that DAPT state law will be applied, all trust funding should be accomplished in the DAPT state. The trust document should be signed in the DAPT state. The DAPT trustee should have custody of all of the trust assets.

If a proceeding is successfully filed in a federal bankruptcy court, then the creditor's jurisdiction problem is solved. The bankruptcy court has national jurisdiction and therefore will have jurisdiction over the DAPT trustee and the trust assets for the purpose of determining whether such assets should be included in the bankruptcy estate.

A bankruptcy proceeding may be initiated voluntarily by the settlor in the state where the settlor resides. Such residence needs to have been for a period of at least ninety-one days. Therefore, if a settlor desires to declare bankruptcy, the settlor may change residence to the DAPT state in order to have the bankruptcy court located in that state. Alternatively, the settlor may be forced into involuntary bankruptcy by the settlor's creditors. If there are more than twelve creditors, then three or more must file for involuntary bankruptcy. If there is only one large judgment outstanding, plus a number of small creditors who are being timely paid, there may not be three creditors who want to see a bankruptcy filed and their debts discharged. If there are less than twelve creditors, then only one is required to file for involuntary bankruptcy. Attorney fees and damages may be awarded against a creditor who improperly files an involuntary bankruptcy proceeding. Therefore, this tactic needs to be carefully evaluated by a single large creditor.

Statutory Interpretation Issue. 

Assume that creditors have forced the settlor into involuntary bankruptcy. However, § 541(c)(2) of the Bankruptcy Code provides:  

A settlor will rely upon this express exemption for spendthrift trusts based upon application of DAPT spendthrift trust law. Therefore, in order to include the trust assets in the bankruptcy estate, the creditor must persuade the court to not apply DAPT spendthrift trust law (see below) or to narrowly construe this provision to exclude the recent DAPT state statutes. The latter argument would be that the § 541(c)(2) spendthrift trust exception was only intended to apply to spendthrift trusts created by third parties and not to the newly enacted self-settled spendthrift trust statutes. Only with such a narrow construction would the Supremacy Clause give § 541(c)(2) precedence over conflicting state DAPT provisions. Then, the trust assets would be included in the bankruptcy estate. Commentators have concluded that such a narrow construction is unlikely. Rather, Congress would need to amend § 541(c)(2) in order to achieve a narrow construction that would exclude DAPT state statutes.

Resolve Fraudulent Transfer and/or Improper Implementation Claims. Since the bankruptcy court will have jurisdiction over the trustee and the trust assets, it may also consider and resolve a fraudulent transfer claim brought by the creditor. However, as discussed in Issues 7 and 8, the bankruptcy court may adopt the DAPT state law with respect to such a claim. Further, the bankruptcy court may consider improper implementation, alter-ego, and sham theory arguments.  

Choice of Spendthrift Trust Law. If the creditor fails to convince the bankruptcy court to narrowly construe § 541(c)(2), as discussed above, then the creditor would argue that the bankruptcy court should choose the law of the debtor's state of residence with respect to spendthrift trust restrictions. This is the likely focal point for a creditor's challenge of a well-planned DAPT. Such a DAPT will not be vulnerable to fraudulent transfer or improper implementation claims. It is unlikely that a bankruptcy court will narrowly construe § 541(c)(2) as discussed above. Therefore, a creditor will be left arguing that the bankruptcy court should choose to apply the law of the debtor-settlor's state of residence with respect to spendthrift trust restrictions. The bankruptcy court will consider all of the matters discussed in Issue 6, above, relating to choice of spendthrift trust law.

Numerous bankruptcy courts have considered the choice of spendthrift law with respect to third-party settled trusts. These courts have applied the law where the spendthrift trust was administered rather than the law of the state where the bankruptcy court was located. There does not appear to be any reason why self-settled discretionary spendthrift trusts should be treated differently than third-party settled trusts with respect to the choice of the spendthrift trust law.

If a bankruptcy court chose to ignore the above-referenced substantial authority with respect to spendthrift trusts created by third parties, and determined the issue was one of validity of the trust (see Issue 6) and, further, made all of the factual determinations necessary to choose the spendthrift law of the settlor's state of residence, then it could apply that law and include some or all of the trust assets in the bankruptcy estate.

Compromise Planning: Limit the Debtor's Property Interest. A bankruptcy court will only have jurisdiction over “all legal and equitable interests of the debtor.” A settlor may be willing to limit the settlor's interest in the trust assets. For example, often a married settlor will be willing to be only a contingent beneficiary. That is, the settlor will only become a beneficiary if the settlor's spouse is incapacitated, deceased, or if the marriage is terminated. Alternatively, a settlor's interest could be limited to only discretionary distributions of annual income from the trust assets. Other beneficiaries may be given ascertainable interests which would limit a trustee's power to make distributions to the settlor and consequently limit or even prevent the trust assets from becoming part of the bankruptcy estate. For example, during the settlor's lifetime, an ascertainable standard might be provided for distributions to the settlor's descendants for education and emergency health and emergency support needs. After the settlor's death, this standard would end and the trustee would have absolute discretion over distributions. Such a plan would arguably limit the settlor's property interest and therefore limit a bankruptcy court's ability to reach assets. However, during the settlor's lifetime creditors of the settlor's descendants could argue that the standard will allow them to reach trust assets. Therefore, the standard should end at the settlor's death. Another approach would be to provide for unitrust payments which would be divided among settlor's descendants during settlor's lifetime.

Conclusion. A bankruptcy proceeding overcomes the often substantial hurdle of obtaining personal jurisdiction over the trustee and the trust assets. However, initiating such an action may not be possible. Even if a bankruptcy proceeding is allowed, the court's choice of law is not predictable. Relevant choice of law rules favor the law directed in the trust instrument. (See Issue 6.) Very substantial authority exists with respect to third-party spendthrift trusts where bankruptcy courts have chosen the spendthrift trust law where the trust was administered. In view of these authorities, the expectation is that with respect to well-planned DAPTs the bankruptcy court will apply DAPT spendthrift trust law. However, in poorly planned situations or those involving very unsympathetic facts, a bankruptcy court may well decide to apply the spendthrift law of the settlor's state of residence. In those situations, the compromise planning discussed above may limit the amount of trust assets included in the bankruptcy estate.  

To violate the Contract Clause, a DAPT statute must substantially impair the obligations of parties to existing contracts or make them unreasonably difficult to enforce. The violation of the Contract Clause occurs because of the retroactive effect of the statute upon contracts that exist on the date of enactment of the statute. Creative arguments have been made in support of a Contract Clause violation by the new DAPT statutes. The settlor's response would be that a contract creditor still has adequate remedies under the state's fraudulent transfer statute. The contract creditor would contend that if the transfer does not constitute a fraudulent transfer, then the settlor has successfully protected assets which the contract creditor could otherwise have reached.

The Contract Clause contention applies only to contract creditors who existed on the date of enactment of the DAPT statute. Therefore, with respect to, for example, Alaska and Delaware statutes, this argument could only be made by contract creditors who existed in 1997. As time continues to expire, this argument will become factually irrelevant to settlors forming new DAPTs.

Statutes. Each DAPT statute provides express exceptions to the statute's spendthrift protection. With respect to the above subjects, Alaska allows a child support claimant to reach the assets of the trust if the settlor is in default by thirty or more days at the time of the transfer to the trust. Delaware and Rhode Island provide exceptions for debts related to child support, and for alimony or property division claims that existed on or before the date of the qualified disposition. Nevada does not provide any statutory exceptions. Utah allows a child support claimant to reach the assets of the trust if the settlor is in default by thirty or more days at the time of the transfer to the trust and allows spousal claims for alimony or property division.

Child Support. With respect to child support, federal statutes have been enacted to facilitate the collection of court ordered child support. However, personal jurisdiction is still required for full faith and credit. Therefore, a state court in the settlor's state of residence will need to obtain personal jurisdiction over the DAPT trustee in order to reach the DAPT assets.

Alimony. As described above, some states do not provide an exception for alimony. Others provide a limited exception, and one state provides an unlimited exception. An argument has been made that even if a DAPT state's law does not provide an express exception for alimony, the DAPT state courts may well construe the DAPT statutes to allow claims. The legislative history of the relevant DAPT state statute may resolve this issue.

Property Division. Similarly, two of the above states do not provide any exception for a property division. Two states provide a limited exception, and one state provides an unlimited exception. Here, it is less likely that the courts, for policy reasons, would construe the DAPT law to add an unlimited exception for a property division. However, a spouse may be able to reach some of the DAPT assets by claiming that the spouse owned such assets prior to their contribution to the DAPT. The success of such an argument may depend upon the time the trust was created and the source of assets which were contributed to the trust. If the trust was created prior to marriage, or with assets which the settlor inherited during marriage, then the spouse may have no rights to such assets. However, if the assets were contributed during marriage from either community property or from property in a common law state which that state considers “marital property,” then one-half of such assets may be considered to belong to the spouse.

The question here is whether the federal government may satisfy a tax liability of the settlor from the assets in a DAPT which the settlor had created prior to incurring such tax liability. More specifically, does the federal tax lien apply to assets of the DAPT in such a situation? With respect to third-party settled trusts, the IRS' position is that if the trustee has absolute uncontrolled discretion to make distributions to the debtor-beneficiary, then the debtor's interest in the trust is not subject to the federal tax lien. There does not appear to be any reason to treat self-settled discretionary spendthrift trusts differently from third-party created spendthrift trusts with respect to federal tax liability.

Both Alaska and Delaware have statutes which facilitate the movement of a fully discretionary trust from a non-DAPT state to a DAPT state in order to take advantage of that state's spendthrift trust law. Further, in Alaska if the trustee has absolute discretion over the trust assets, the trustee may appoint the assets to a new trust; for example, one using a perpetual trust dispositive plan.

If applicable state law prevents the settlor's creditors from reaching the trust assets, then I.R.C. § 2038 does not apply because, as of the date of the settlor's death, the settlor does not have the power to revoke the trust by relegating creditors to the trust assets. The remaining estate tax issue is whether, pursuant to I.R.C. § 2036(a)(1), the settlor has retained enjoyment of, or the right to income from, the trust assets. Initially, the plain language of the statute which requires “retention” does not seem to apply to a settlor-beneficiary who may receive distributions only pursuant to the absolute discretion of an independent trustee. There are a number of authorities that support the conclusion that retention within the meaning of § 2036(a)(1) does not exist with respect to the rights of a discretionary settlor-beneficiary.

Academic Commentary. Shortly after the Alaska statute was enacted, a primary journal, Practical Drafting, commented:

Another analyst, Professor Dodge, states that “[t]he better rationale for the exclusionary rule here is that the grantor has not 'retained' the income from the transferred property.”

Professors Stephens, Maxfield, Lind and Calfee state in their treatise: 

* * * 

One critical analyst of the authorities (listed in note 83), Professor Pennell, finds some to be indirect or not on point but concedes there is supporting authority for the conclusion that the trust assets will not be included in the settlor's gross estate. He concludes, “[t]he answer to that question has not adequately been provided by case law or rulings.”

Finding “retention” under the existing language of I.R.C. § 2036, based only on the settlor's status as a discretionary beneficiary, is a significant stretch. In a similar situation involving questionable coverage by I.R.C. § 2036 of joint purchases of property, the Treasury Department found the need for a statutory change. Professor Pennell concluded, “[i]t was sufficiently unclear whether I.R.C. § 2036(a)(1) would apply to such a case that I.R.C. § 2702(c)(2) specifically addresses this form of transaction.

Future Amendment or Regulatory Change. If I.R.C. § 2036 is amended to expressly include DAPTs, and if such amendment is stated to be a change in the law, then its effect should be prospective. Existing DAPTs should be grandfathered. If the amendment is stated to be only a clarification of the law, this issue of statutory interpretation will continue for existing DAPTs. Nevertheless, as a practical matter the Service may take a much less aggressive position in regard to trusts formed prior to the amendment. Interestingly, if there were a statutory change in I.R.C. § 2036 with regard to DAPTs, there is no certainty that the change would be designed to produce inclusion of the trust assets in the settlor's gross estate. Congress' recent legislative changes in the transfer tax area have gone in the other direction. The best example is the Economic Growth and Tax Relief Reconciliation Act of 2001, which has as its ultimate goal the repeal of the estate tax. A reasonable argument can be made that I.R.C. § 2036 should be amended to expressly allow a settlor to create a DAPT in any jurisdiction in order to facilitate gifting by settlors who are concerned about possible future financial reversals. Such an accommodation might help alleviate the tension between complete repeal of the estate tax and the “sunset” that exists under the Economic Growth and Tax Relief Reconciliation Act of 2001.

Alternatively, it has been speculated that the Treasury Department may attempt to affect DAPTs in the guidance that it has promised with respect to I.R.C. § 2036 in the 2003-2004 Priority Guidance Plan. However, the promised guidance is limited to tax reimbursement provisions in grantor trusts. Even if the guidance were expanded and any impacting regulatory provision is upheld by the courts, the “grandfathering” discussed above should also apply to any change.  

Compromise Planning. Conservative settlors who are concerned that the courts may construe I.R.C. § 2036 to apply to DAPTs may want to restrict the trustee's authority to make discretionary distributions to the settlor. For example, distributions could be restricted to income (or principal) from only a certain identified portion of assets. Alternatively, the settlor may be included as only a contingent beneficiary. That is, the settlor will only become a beneficiary if the settlor's spouse is incapacitated, deceased, or if the marriage is terminated.

DAPTs have also become a vehicle for the ownership of life insurance on settlors' lives. For example, suppose the clients wish to purchase a second-to-die life insurance policy that will develop substantial cash value and will benefit from income tax-free inside buildup. However, the clients want the ability to reach the value of the policy if they have a financial reversal. If the policy is owned by a DAPT, the independent trustee may borrow from the insurance company, or even cash-in the policy, in order to make discretionary distributions which are needed by the settlors. The fact that the settlors are discretionary beneficiaries of the trust does not appear to be enough to conclude that they have retained “incidents of ownership” in the policy. Nevertheless, careful choices of trustees and drafting are necessary in order to ensure that such incidents of ownership are not attributable to the clients.  

In a state that has not enacted a statute which allows DAPTs, a settlor's creditors can reach the maximum amount that the trustee could distribute to the settlor. Therefore, the settlor could “run up” debts, and the settlor's creditors could reach the trust assets to satisfy these obligations. Another way of looking at the situation is that the settlor, indirectly, has retained the ability to reach the trust assets through incurring debts. The settlor can “relegate” the settlor's creditors to the trust assets.

The above-described indirect retention of the trust assets prevents the settlor's transfer to the trust from being a completed gift for gift tax purposes. Reg. § 25.2511-2(b) provides that a gift is complete if the donor “has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or for the benefit of another . . . .” The above reasoning illustrates that this test is not satisfied by DAPTs in non-DAPT states. Such indirect retention would result in the trust assets being included in the settlor's gross estate under I.R.C. §§ 2036 and 2038.

When the above-described policy which allows creditors to reach the assets of a self-settled discretionary spendthrift trust is reversed, then the position can be taken that contributions to such trusts are complete for gift tax purposes and should be excluded from the settlor's gross estate. That is, since a settlor's creditors cannot reach the assets of a DAPT, the settlor has not retained the ability to “relegate” the settlor's creditors to the assets of the trust.   

However, most of the five states have created exceptions to this reversal of policy. Some of these exceptions arguably allow the settlor to “relegate” the settlor's creditors to the assets of the trust in order to satisfy the excepted type of liability. The issue is whether such exceptions are significant enough to render the settlor's transfers to the trust incomplete for gift tax purposes and includable in the settlor's gross estate. Certain of these exceptions should not do so. For example, the exceptions for Alaska, Delaware, and Rhode Island would all be known at the time the DAPT was created. If such exceptions existed, either the DAPT would not be formed or sufficient assets would be set aside to satisfy such liabilities. However the Utah statute appears to go too far. As a result, transfers to a DAPT created under present Utah law may be incomplete gifts with the above-described tax consequences.

It is important to consider the difference between pure asset protection cases and transfer tax litigation. The highly publicized recent foreign trust asset protection cases involved extreme facts and equities that would influence most courts to sympathize with the plaintiff-creditor. The situation is quite different when the asset protection issue is hypothetical and needs resolution only so that the transfer tax issue may be determined.

With respect to residents of DAPT states, sound arguments exist that their DAPTs, if well planned and implemented, will provide asset protection for their settlors. As a result, strong arguments exist that assets of the DAPT should not be included in the settlor's gross estate. The asset protection foundation for a nonresident settlor using a DAPT is not absolute. The interesting question is whether such a foundation needs to be perfect for transfer tax purposes. Theoretical approaches exist for a creditor to reach assets of the DAPT, if the facts are right and if the court follows a specific decision-tree. Are these approaches certain enough to undermine the asset protection foundation, for transfer tax purposes, of a carefully planned and implemented DAPT created for a nonresident?

A court, considering only the transfer tax question, could take one of several approaches to this question. The court could require absolute asset protection in order to achieve transfer tax exclusion. That is, any “nick in the armor” is enough for the tax issue to fail. Alternatively, the court could recognize that in many situations adequate asset protection will exist. Therefore, the court may require the IRS to establish that it is more probable than not that the asset protection foundation will fail before including the DAPT in the settlor's gross estate. A third alternative might be for the court to attempt to consider all arguments and authorities existing at the time of the litigation and attempt to globally resolve whether DAPTs provide substantial asset protection for nonresidents of DAPT states.  

Nonresident clients considering the use of a DAPT for transfer tax minimization should do a downside analysis. The main downside risk would appear to be that the settlor has lost the opportunity to do some different planning with the settlor's annual exclusion gifts and with the portion of the settlor's applicable credit amount used for the SSDS Trust. Would the settlor have done such different planning? How do the risks and rewards of such different planning compare to the DAPT approach?

An attorney, accountant, financial advisor, or other professional assisting with the formation of a DAPT must be careful not to participate in an fraudulent transfer. Such participation could result in the creditor suing the professional for conspiracy to commit a fraudulent conveyance, aiding and abetting a fraudulent conveyance, or a similar cause of action.

Some DAPT statutes attempt to protect professionals who assist with the formation of DAPTs by expressly stating that a creditor may not bring such an action against the professional. However, a creditor could still attempt to bring such an action in the state of residence of the settlor. The action could be brought against professionals located both in that state and in the DAPT state, if jurisdiction could be obtained. Further, such statutes will probably be narrowly construed by the courts. For example, does the statute protect an attorney who assists the settlor in forming a limited partnership or a limited liability company and transferring assets to such an entity which also provides some asset protection? This is a typical initial transaction, and then interests in the entity are transferred to the DAPT.  

The professional also needs to carefully explain the ambiguities and risks of this type of asset protection and tax planning to the client. The newness of the DAPT statutes, the lack of any significant authority, and the general ambiguities of asset protection planning need to be carefully explained and documented. This is especially important in situations where the client chooses trade-offs in order to retain control or reduce expense. Such documented explanation should prevent the professional from being held responsible by the client if the DAPT is attacked by a creditor or the IRS.

In view of the above exposures, the following types of due diligence and information providing procedures should be considered by attorneys and other professionals advising clients with respect to DAPTs. If these techniques are followed, and planning implemented (or terminated) accordingly, professionals should not be at risk.  

Know Your Client. Practitioners will want to avoid being drawn into fraudulent transfer situations. In order to do so, you must know the client's financial situation, the client's business or employment, the client's reasons for seeking asset protection planning, and the client's present creditor situation. If a client has been referred by another professional, often that professional will be a good source of information concerning the client's situation and motives.  

Creditor Check. A creditor check may be run to verify the settlor's representations concerning existing liabilities.

Affidavit. Alaska now statutorily requires that a settlor forming a DAPT execute an affidavit stating certain representations concerning the transferred assets, the settlor's intention, and the settlor's financial situation.

Financial Statements establishing that the transfer will not render the settlor insolvent. 

Accountant's Opinion Letter stating that the accountant is familiar with the settlor's financial situation and that the contemplated transfer will not render the settlor insolvent. 

References. If the client is a new client, the attorney may request personal references from the client's banker, referral attorney or other professional and other persons who know the client's financial situation. 

An Agreement may be entered into between the settlor and the attorney forming the trust.

Information Letter. It is very important that a thorough information letter be provided by the attorney to the settlor. This letter should describe the settlor's stated goals, the planning involved, the uncertain status of DAPT law, the risks involved, the dispositive plan used in the trust, the trustees chosen and the risks of the choices used, the settlor's loss of control, whether a complete or incomplete gift has been used and the tax consequences of such a gift, the asset protection risks, the transfer tax risks, the income tax consequences of the trust, and the tax compliance and other implementation necessary to maximize the chance of success of the trust planning.

Seven years have elapsed since the enactment of the first DAPT statutes. However, authority and review remain sparse. The discussions of the choice of law, Full Faith and Credit Clause, and the bankruptcy court scenarios demonstrate that most of these issues are both highly fact specific and depend upon unpredictable decisions of the courts located in the settlor's state of residence, the DAPT state, and bankruptcy courts. When cases are decided in the future, the decisions may be narrow and limited to the specific situation involved. Further, the asset protection cases which are litigated to judgment often involve extreme facts, as demonstrated by the offshore cases.

In regard to personal jurisdiction issues, Professor Boxx states, 

With respect to DAPT tax issues, only three current private letter rulings exist: PLR 9837007, which concluded that gifts were complete when made to an Alaska DAPT designed for transfer tax reduction; and PLR 200148028 and PLR 200247013, both of which found that gifts were incomplete when made to a Delaware trust designed only for asset protection and also ruled that the Delaware trust was not a grantor trust for income tax purposes. The IRS has refused to rule further on such trusts.

Despite the formation of numerous DAPTs, practitioners in Alaska and Delaware report that as yet there is no significant IRS audit experience. Anecdotal information indicates that several settlors of DAPTs have died, and the IRS has not challenged the exclusion of such trusts from the settlors' gross estates. Consequently, there has been no administrative or judicial review of such trusts.

A legislative resolution of the effectiveness of transfer tax planning with DAPTs is also unpredictable. At some point before 2010, Congress will likely “rethink” the transfer tax changes enacted by the 2001 Tax Act. Section 2036 could be amended to resolve the transfer tax issue. But which way?

In view of the above-described limited arguments available to the Service with respect to residents of DAPT states, and the fact-specific character of the issues involving nonresident settors, there may continue to be a lack of significant judicial authority in this area. In regard to the I.R.C. § 2036(a)(1) transfer tax issue, Professor Pennell concludes, “[t]his issue will take time to resolve, and there may be fits and starts as various courts analyze the question.” Because of this lack of authority, if an asset protection or transfer tax question does arise, the parties often may find a negotiable resolution.

The key to a successful DAPT formed by a nonresident will be in planning and implementation. A DAPT should not be formed if a settlor has existing liabilities which cannot be satisfied with non-DAPT assets. Trustee choices should be made so as to minimize the risk of implied agreement contentions and to ensure that jurisdiction over the trustee will only be in the DAPT state. Statutory requirements and the formalities of trust ownership should be carefully followed. As a result, the DAPT will not be subject to attack pursuant to the theories of fraudulent transfer, improper implementation, alter-ego, or sham transaction.

Careful jurisdiction planning will result in any asset protection attack being brought in courts located in the DAPT state or in bankruptcy court. The only remaining significant issue will be choice of law. Relevant choice of law rules and existing case law favor selection of DAPT state spendthrift trust law. This law will protect the DAPT assets from being reached by the settlor's creditors. This will probably be the basis for resolution of controversies relating to well-planned DAPTs. Undoubtedly, there will be cases involving extreme facts which, for fairness reasons, will force the courts to find a way to apply non-DAPT law. However, if planners are careful, such cases will be aberrations.

¹The breakdown is as follows: Alaska, 681; Delaware, 400; Nevada, 150; Rhode Island, 17; Utah, 0 (Utah's law took effect January 1, 2004). The poll was created for use in the panel discussion entitled “Everything You Always Wanted to Know About Domestic Asset Protection Trusts But Could Never Find Out,” at the 38 th U. of Miami Heckerling Inst. on Est. Plan. (Jan. 2004). The poll was conducted by the panelists.

²T.C. Memo 2003-145.

³See discussion in Issue 2, infra .

⁴Mirabello, “Charting a Course to America: Pre-Immigration Planning,” 33 U. of Miami Heckerling Inst. on Est. Plan. (1999).

⁵Nenno, “The Domestic Asset Protection Trust Comes of Age,” 38 U. of Miami Heckerling Inst. on Est. Plan. (2004), Part XII(E).

⁶I.R.C. § 677(a). See PLR 200247013 and PLR 200148028. Nenno, id. , Part XII(D).

⁷See Akers, “But I Just Wanted a Few Strings Over the Trust Assets for Me and My Family,” 38 th U. of Miami Heckerling Inst. on Est. Plan., pp. 2-48 through 2-64 (2004); in general, see Pennell, 1 Estate Planning § 5.11 (Aspen 2003).

⁸However, Utah does not protect DAPT assets from the claims of a spouse, whether the marriage was entered into before or after formation of the DAPT. Utah Code Ann. § 25-6-14 (Lexis Supp. 2003).

⁹Alaska Stat. § 34.40.110(b)(2) (Lexis Supp. 2003); Del. Code tit. 12 § 3570(10), b, 1 and 2 (Lexis 2003); R.I. Gen. Laws § 18-9.2-2(9)(ii)(A) (Lexis 2003); Nev. Rev. Stat. § 166.040(2)(a) (Lexis 2003); Utah Code Ann. § 25-6-14(2)(e)(i) and (ii) (Lexis Supp. 2003).

¹⁰Retention of such powers, in a DAPT structured only for asset protection, also allows a settlor to retain substantial control. Additional control may be retained by a settlor by appointing a family trustee who will have some or all of the administrative responsibilities for the trust. These are not tax-sensitive duties (Pennell, 2 Estate Planning § 7.3.3, p. 320 (Aspen, 6 th ed.), and should not affect creditor protection of the trust.

¹¹For example, in Rose v. FirStar Bank , 819 A.2d 1247 (R.I. 2003), the Supreme Court of Rhode Island held that the lower court did not have personal jurisdiction over an Ohio corporate trustee, which had periodically sent statements, checks, and other documents to a Rhode Island beneficiary and had communicated occasionally with the beneficiary by telephone. The court concluded that the trustee never purposely availed itself of the benefits of doing business in Rhode Island, and the beneficiaries' trust mismanagement claims did not arise out of the trustee's Rhode Island contacts.

¹²Rule 4(k) of the Federal Rules of Civil Procedure provides that the federal court will have the same personal jurisdiction as a state court in the state where the federal court sits.

¹³See note 55, infra .

¹⁴See note 11, supra .

¹⁵See Boxx. Gray's Ghost –A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1211-1212 (2000).

¹⁶Zippo Manufacturing Co. v. Zippo Dot Com , 952 F. Supp. 1119 (W.D. Pa. 1997).

¹⁷Reid, Operationalizing the Law of Jurisdiction: Where in the World Can I Be Sued for Operating a Worldwide Web Page? , 8 Comm. L. & Pol'y 227 (2003); Gasparini, The Internet and Personal Jurisdiction: Traditional Jurisprudence for the Twenty-First Century Under the New York CPLR , 12 Alb. L.J. Sci. & Tech. 191, 228-229 (2001).

¹⁸The latter approach was suggested by Gideon Rothchild at the panel discussion referred to in note 1, above.

¹⁹See discussion in Issue 5.

²⁰U.S. Const. art. IV, § 1.

²¹18 Moore's Federal Practice § 130.04[3] (Matthew Bender 3d ed.).

²²Id .; Restatement (Second) of Conflict of Laws § 92, comment e.

²³See Boxx, Gray's Ghost–A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1227.

²⁴Professor Boxx describes the above type of situation as follows:

²⁵Restatement (Second) Conflict of Laws § 270.

²⁶See Danforth, “Rethinking the Law of Creditors Rights,” Hastings L.J. 287, 325, 333 through 343 (2002). .

²⁷Austin W. Scott and William F. Fratcher, The Law of Trusts , § 626 at 414 (4 th ed., 1989).

²⁸Siegel, Conflicts in a Nutshell § 57 (2d ed., West Pub. Co. 1994).

²⁹262 N.Y. 381, 187 N.E. 65 (1933).

³⁰254 N.Y.S.2d 527, 203 N.E.2d 210 (N.Y. 1964).

³¹Further analysis of this conflict of laws issue may be found in: Blattmachr and Zaritsky, “North to Alaska–Estate Planning Under the New Alaska Trust Act,” 32 U. of Miami Heckerling Inst. on Est. Plan. (1998); Hogan, Once More Unto the Breach: Planning for a Conflict of Laws With Alaska and Delaware Self-Settled Spendthrift Trusts , 14 Probate & Property (Mar./Apr. 2000); and, generally, in Moore, “Choice of Law in Trusts: How Broad is the Possible Spectrum?” 36 U. of Miami Heckerling Inst. on Est. Plan. (2002).

³²Siegel, Conflicts in a Nutshell § 96 (2d ed., West Pub. Co. 1994).

³³Also see § 270, comment d, Restatement (Second) Conflict of Laws .

³⁴Alaska Stat. § 34.40.110(b)(1) (Lexis Supp. 2003); Del. Code tit. 12 § 3572(a) and (b) (Lexis 2003); R.I. Gen. Laws § 18-9.2-4(a) and (b) (Lexis 2003); Utah Code Ann. § 25-6-14(1)(c)(ii) (Lexis Supp. 2003).

³⁵U.F.T.A. §§ 5(a) and 4(a) (1984).

³⁶Alaska Stat. § 34.40.110(b)(1) (Lexis Supp. 2002).

³⁷Nev. Rev. Stat. § 166.170 (Lexis 2003).

³⁸Alaska Stat. § 34.40.110(d)(1)(B) (Lexis Supp. 2003); Del. Code tit. 6 § 1309, tit. 12 § 3572 (Lexis 2003); R.I. Gen. Laws § 18-9.2-4(b)(1) (Lexis 2003); Nev. Rev. Stat. § 166.170(1)(b) (Lexis 2003).

³⁹For example, consider an estate planning attorney who drafts a will, or an accountant who gives estate planning tax advice to a client. Subsequently, the attorney or accountant forms a DAPT. Ten years later a beneficiary under the will determines that she has been harmed by the attorney or accountant, successfully sues and obtains a judgment, and then discovers that the professional had previously transferred a portion of his assets to the DAPT. At the time the attorney or accountant formed the DAPT, was this creditor an “existing creditor” who may qualify under the discovery exception?

⁴⁰Alaska Stat. § 34.40.110(d)(1)(B) (Lexis Supp. 2003).

⁴¹Professor Ehrenzweig, discussing the controversial New York Court of Appeals case of James v. Powell , 225 N.E.2d 741 (1967), concludes that the conflicts law of torts controls fraudulent conveyances, and therefore the tort rule of the forum applies. Ehrenzweig, Fraudulent Conveyances in Conflicts Law , 66 Mich. L. Rev. 1679, 1689-1696 (1968).

⁴²Siegel, Conflicts in a Nutshell § 90 (2d ed., West Pub. Co. 1994).

⁴³Some commentators have speculated that adoption of the Uniform Enforcement of Foreign Judgments Act might provide a creditor with an argument that would prevent a court from denying Full Faith and Credit based upon expiration of its statute of limitations. (Nenno, supra note 5, Part XI(B).) However, the uniform act expressly defines a “foreign judgment” as “any judgment, decree, or order of a court of the United States or of any other court which is entitled to full faith and credit in this state.” See Alaska Stat. § 09.30.260 (Lexis 2002). Therefore, it appears that the uniform act does not change the above conclusion with respect to the applicable statute of limitations.

⁴⁴Osborne, “Asset Protection and Jurisdiction Selection: Clearing Up Your Situs Headaches,” 33 U. of Miami Heckerling Inst. on Est. Plan. (1999), at 14-20.

⁴⁵E.g. , Alaska Stat. § 34.40.110(b)(3) (Lexis Supp. 2003).

It should be noted that gifts to a fully discretionary trust cannot be “split” under I.R.C. § 2513 with a spouse who is a discretionary beneficiary. See Handler and Chen, Fresh Thinking About Gift Splitting , 14 Tr. & Est. 36 (Jan. 2002); Benjamin, When Should the Option to Split Gifts be Chosen? , Est. Plan. 24 (Jan../Feb. 1995).

⁴⁶Restatement (Second) of Trusts § 155, comment b (1957); Rothschild, “Protecting the Estate From In-Laws and Other Predators,” 35 U. of Miami Heckerling Inst. on Est. Plan., pp. 17-21 through 17-23 (2001).

⁴⁷See, e.g. , Alaska Stat. § 34.40.110(b)(3) (Lexis Supp. 2003).

⁴⁸See Reg. § 20.2036-1(a), which finds “retention” under § 2036 if such an agreement exists.

⁴⁹Cases involving I.R.C. § 2036 and an implied understanding of grantor access are discussed in Boxx, Gray's Ghost–A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1244-1251 (2000).

⁵⁰See Danforth, “Rethinking the Law of Creditors' Rights in Trusts,” 53 Hastings L.J. 287, 302 (2002).

⁵¹The above-described concerns about an implied agreement between the settlor and a trustee also apply with respect to settlors and trust protectors and trust advisors. Some DAPT statutes expressly recognize the use of trust protectors who have powers to change trustees and make certain modifications to the trust agreement. See Alaska Stat. § 13.36.370 (Lexis Supp. 2003). Similarly, some DAPT statutes authorize the use of a trust advisor who may advise the trustee but whose advice is not binding upon the trustee. See Alaska Stat. § 13.36.370 (Lexis Supp. 2003).

⁵²Some DAPT statutes attempt to nullify the risk of an implied agreement by stating, “An agreement or understanding, express or implied,” between the settlor and the trustee that attempts to grant or permit the retention of greater rights or authority than is stated in the trust instrument is void. See Alaska Stat. § 34.40.110(j) (Lexis Supp. 2003); Del. Code tit. 12 § 3571 (Lexis 2003).

⁵³Alaska Stat. § 13.36.035(c) (Lexis 2002). Under the revised Alaska Trust Company Act, inidividuals may only serve as fiduciaries pursuant to certain specific exemptions. (Alaska Stat. § 06.26.020 (Lexis 2002).) Del. Code tit. 12 § 3570(9) (Lexis 2003); R.I. Gen. Laws § 18-9.2-2(8) (2003); Nev. Rev. Stat. § 166.015(1)(d) (Lexis 2003).

⁵⁴Alaska Stat. § 13.36.035(c)(1) (Lexis 2002); Del. Code tit. 12 § 3570(9) (Lexis 2003); R.I. Gen. Laws § 18-9.2-2(8)(ii) (Lexis 2003); Utah Code Ann. § 25-6-14(1) (Lexis Supp. 2003).

⁵⁵Section 1334(e) of Title 28, United States Code; and Bankruptcy Rule 7004(d).

⁵⁶Section 1408 of Title 28, United States Code.

⁵⁷11 U.S.C. § 303(b)(1).

⁵⁸11 U.S.C. § 303(b)(2).

⁵⁹See Boxx, Gray's Ghost–A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1229-1230 (2000); Drake, Bankruptcy Practice for the General Practitioner (West Group 2003). A settlor who has named himself or herself as the family trustee of the DAPT may have additional problems if a bankruptcy proceeding is initiated. The bankruptcy trustee has the power to direct the legal and equitable interests of the debtor. The concern is that the bankruptcy trustee may well succeed to the powers of a settlor who has named himself or herself as the administrative trustee (see note 10) of a DAPT. In such circumstances, the bankruptcy trustee–DAPT trustee may make decisions and take positions which are not favorable to protection of the DAPT assets from creditors. See Sjuggerude, Defeating the Self-Settled Spendthrift Trust in Bankruptcy , 28 Florida St. Univ. L.R. 977, 992 (2001). .

⁶⁰Delaware and Utah statutes expressly provide that their spendthrift trust law is to be considered a restriction described in § 541(c)(2). A bill has been introduced in Alaska to add such a provision.

⁶¹Osborne, “Asset Protection and Jurisdiction Selection: Clearing Up Your Situs Headaches,” 33 U. of Miami Heckerling Inst. on Est. Plan. (1999), at 14-24.

⁶²U.S. Const. art. VI, cl. 2.

⁶³Prof. Eason, Developing the Asset Protection Dynamic: A Legacy of Federal Concern , 31 Hofstra L. Rev. 23, 57; Sjuggerude, Defeating the Self-settled Spendthrift Trust in Bankruptcy , 28 Fla. St. U. L. Rev. 977, 999 (2001). DAPT resident settlors could still rely on the DAPT statute as a state law exemption independent of 11 U.S.C. § 541(c)(2). Nonresident settlors could not because 11 U.S.C. § 541(c)(2 limits state law exemptions to those of the debtor's domicile state.

⁶⁴See Nenno, “The Domestic Asset Protection Trust Comes of Age,” 38 U. of Miami Heckerling Inst. on Est. Plan. (2004), Part XI(C), where the following cases are discussed: Spindle v. Shreve , 111 U.S. 542, 547-548, 28 L. Ed. 512, 514,, 4 S. Ct. 522, 524-525 (1884); Newman v. Magill , 99 B.R. 881, 882 (C.D. Ill. 1989); In re Hecht , 54 B.R. 379, 382-383 (Bankr. S.D.N.Y. 1985), aff'd sub nom . Togut v. Hecht , 69 B.R. 290, 291 (S.D.N.Y. 1987); Heidkamp v. Galliher (In re Hunger) , 272 B.R. 792, 795 (Bankr. M.D. Fla. 2002); In re Hunter , 261 B.R. 789, 791 (Bankr. M.D. Fla. 2001); Schwen v. Ramette (In re Schwen), 240 B.R. 754, 757 (Bankr. D. Minn. 1999); Dzikowski v. Edmonds (In re Cameron) , 223 B.R. 20, 24 (Bankr. S.D. Fla. 1998); In re Gower , 184 B.R. 163, 165 (Bankr. M.D. Fla. 1995); McCauley v. Hersloff , 147 B.R. 262, 264 (Bankr. M.D. Fla. 1992); In re Portner , 109 B.R. 977, 987 (Bankr. D. Colo. 1989); In re Graham , 1989 Bankr. Lexis 1283 (Bankr. D. Vt. 1989); In re Sanders , 89 B.R. 266, 269 (Bankr. S.D. Ga. 1988); In re Kragness , 58 B.R. 939 (Bankr. D. Or. 1986); In re Hall , 22 B.R. 942, 943 (Bankr. M.D. Fla. 1982); and In re Remington , 14 B.R. 496, 502 (Bankr. D.N.J. 1981).

⁶⁵11 U.S.C. § 541(a)(1).

⁶⁶U.S. Const. art. I, § 10, cl. 1.

⁶⁷Osborne, “Asset Protection and Jurisdiction Selection: Clearing Up Your Situs Headaches,” 33 U. of Miami Heckerling Inst. on Est. Plan. (1999), at 14-26.

⁶⁸Id.

⁶⁹Osborne, supra , and Boxx, Gray's Ghost–A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1230 (2000).

⁷⁰Osborne, supra , at 14-26. Boxx, supra , at 1240.

⁷¹Boxx, supra , at 1240, n.295.

⁷²Alaska Stat. § 34.40.110(b)(4) (Lexis Supp. 2003).

⁷³Del. Code tit. 12 § 3573 (Lexis 2003); R.I. Gen. Laws § 18-9.2-5(1) (Lexis 2003).

⁷⁴Utah Code Ann. § 25-6-14(2)(c)(v) and (ix) (Lexis Supp. 2003).

⁷⁵The Full Faith and Credit for Child Support Orders Act, 28 U.S.C. § 1738B(c).

⁷⁶See Richard W. Nenno, supra note 1, Parts III through VII, XIII, and XIV; also see Restatement (Second) of Trusts § 157 (1959).

⁷⁷See Brooks v. Brooks , 733 P.2d 1044, 1055 (Alaska 1987).

⁷⁸Section 6321 of Title 26 of the United States Code.

⁷⁹Chief Counsel's Advice, ILM 200036045.

⁸⁰See Nenno, “The Domestic Asset Protection Trust Comes of Age,” supra note 1, Part XI(E).

⁸¹Alaska Stat. § 13.36.043 (Lexis 2002); Del. Code tit. 12 §§ 3570(8), 3572(c), and 3575 (Lexis 2003).

⁸²Alaska Stat. § 13.36.157 (Lexis 2002).

⁸³These authorities include: PLR 9332006; PLR 8037116; Estate of German v. United States , 85-1 USTC ¶ 13.610 (Ct. Cl. 1985); cf., Estate of Uhl v. United States , 241 F.2d 867 (7 th Cir. 1957). See also Estate of Wells , T.C. Memo 1981-574 (1981).

⁸⁴Prac. Drafting, (published by U.S. Trust Co. of N.Y.), July 1997, at 4891.

⁸⁵Dodge, 50-5th T.M. (BNA), Transfers With Retained Interests and Powers , p. A-23.

⁸⁶Stephens, Maxfield, Lind & Calfee, Federal Estate and Gift Taxation (7 th ed., Warren, Gorham & Lamont 1996), ¶ 4.08[4][c], p. 4-154.

⁸⁷Pennell, 2 Estate Planning § 7.3.4.2 (Aspen 2003).

⁸⁸Id. , p. 7.345.

⁸⁹Faulty implementation of the trust could result in estate tax inclusion. The specific choices of trustees, documentation, and pattern of distributions may justify a court finding that an agreement existed between the settlor and the trustee to make certain distributions. This would constitute the retention of an income interest, and I.R.C. § 2036 would apply. (See Reg. § 20.2036-1(a), which finds “retention” under I.R.C. § 2036 if such an agreement exists.) The result would be inclusion of trust assets in the settlor's gross estate.

⁹⁰I.R.C. § 2702(c)(2), enacted in 1990.

⁹¹Pennell, 2 Estate Planning § 7.3.4.1, p. 7.334 (Aspen 2003).

⁹²If the settlor's interest applied to all the trust assets and I.R.C. § 2036 were held to apply, the assets would all be included in the settlor's gross estate. On the other hand, if the settlor desired an interest in only part of the trust assets, then only the proportion “retained” would be included in the settlor's gross estate. Reg. § 20.2036-1(a). See Mahoney , 831 F.2d 641, 60 AFTR2d 87-6152 (CA-6, 1987); Estate of Tomac , 40 T.C. 134 (1963); Rev. Rul. 79-109, 1979-1 C.B. 297.

⁹³See PLR 9434028; Reg. § 20.2042-1(c).

⁹⁴I.R.C. § 2036 would probably apply because the settlor has retained the enjoyment of, and income from, the property by the settlor's ability to incur debt which the settlor's creditors may satisfy from trust assets. I.R.C. § 2038 would apply because the above-described ability to relegate creditors to the trust assets allows the settlor to revoke the transfer of assets to the trust. Rev. Rul. 76-103, 1976-1 C.B. 293; Rev. Rul. 77-378, 1977-2 C.B. 347; Paolozzi v. Comm'r , 23 T.C. 182 (1954), acq. 1962-1 C.B. 4.

⁹⁵Alaska allows a child support claimant to reach the assets of the trust if the settlor is in default by thirty or more days at the time of the transfer to the trust. (See Issue 12.) Delaware and Rhode Island provide an exception for debts related to child support, and for alimony or property division claims that existed on or before the date of the qualified disposition. These states also provide an exception for tort claimants who suffer injury on or before the date of the qualified disposition by a settlor. (See Issue 12; Del. Code tit. 12 § 3573(2) (Lexis 2003); R.I. Gen. Laws § 18-9.2-5(2) (Lexis 2003).) Nevada does not provide any statutory exceptions. Utah provides numerous exceptions: court judgment or order rendered within three years after trust created; child support if the settlor is in default by thirty or more days at the time of transfer to the trust; public assistance; taxes, alimony or property division; a transfer inconsistent with any written representation made to a creditor of settlor to induce the creditor to enter into a transaction or agreement with the settlor; and a transfer in violation of any written agreement, covenant, or security interest between the settlor and creditor. (Utah Code Ann. § 25-6-14(2)(c) (Lexis Supp. 2003).)

⁹⁶For example, Federal Trade Comm. v. Affordable Media, LLC , 179 F.3d 1228 (CA-9, 1999); In re Portnoy , 201 B.R. 685 (S.D.N.Y. 1996); and In Re Brown , 4 Alaska B.R. 279 (D. Alaska, Mar. 11, 1996).

⁹⁷Shaftel, “Alaska's Experience With Self-Settled Discretionary Spendthrift Trusts,” 29 ETPL 506, 517 (Oct. 2002).

⁹⁸For example, see Alaska Stat. § 34.40.110(e) (Lexis Supp. 2003); Del. Code tit. 12 § 3572(d) (Lexis 2003).

⁹⁹Alaska Stat. § 34.40.110(k) (Lexis Supp. 2003).

¹⁰⁰Such an agreement may cover the following subjects: (i) The assets which the settlor plans to transfer to the trust; (ii) the fraction of the settlor's net worth which is being transferred to the trust; (iii) the settlor's understanding of important aspects of the state's DAPT law; (iv) the settlor's understanding of the uncertain aspects of this area of asset protection and transfer tax minimization law; (v) that the attorney will not assist in a fraudulent transfer; (vi) that the attorney is relying upon a full disclosure by the client; and (vii) that a breach of the client's full disclosure to the attorney will allow the attorney to resign as counsel.

¹⁰¹The following articles discuss the above subjects:

¹⁰²Boxx, Gray's Ghost –A Conversation About the Onshore Trust , 85 Iowa L. Rev. 1195, 1221 n.149 (2000).

¹⁰³Prior to enactment of the DAPT statutes, the Service issued a number of rulings relating to self-settled offshore trusts and self-settled trusts governed by state law which the taxpayers represented prevented creditors from reaching the trust assets. These rulings are consistent with the analysis in section III of this article. PLRs 7733062, 8037116, 8829030, 9332006, 9535008, and 9536002. See Manley, “Estate Planning and Asset Protection Using Self-Settled Alaska Trusts,” 33 U. of Miami Heckerling Inst. on Est. Plan., Special Session materials.

¹⁰⁴Pennell, 2 Estate Planning § 7.3.4.2, pp. 7.345-7.346 (Aspen 2003).