As we have previously discussed, there is often an inherent conflict between protecting your assets and maintaining control over your assets during your lifetime. This is a give-and-take that is fundamental to many concepts in US federal and state law, as well as the laws of various countries around the globe. In short, nothing is free, and to receive certain legal benefits, you almost invariably have to give up others.
Let’s begin with an example: Suppose you have invested in a piece of property. You bought it to diversify your assets. It was in a location where you thought would be up-and-coming, so you got in early and now it appears that you may have made a good investment. Urban sprawl is getting closer and closer, and your hope is that your children will inherit it and eventually be able to sell it to a developer for a substantial return.
But, in the meantime, you have some concerns: You are getting re-married – which is great, but there is always the possibility of another divorce. You also own your own business, and you can never shake that worry in the back of your mind that someday you’ll face a lawsuit that could cost you everything you own.
So, what do you do? How do you protect your property from potential creditors while also ensuring that it makes its way into your estate plan?
Let’s talk about domestic and foreign asset protection trusts.
Domestic Asset Protection Trusts
A domestic asset protection trust is a planning tool that individuals in the United States can use to shield their personal assets from their creditors. Of course, in order to provide this protection, they must be carefully set up and settled, and there is a give-and-take (as we mentioned above) that we will discuss in greater detail below.
In the US, domestic asset protection trusts are created under state law; and, today, several states offer the ability for individuals to set up domestic asset protection trusts. These states include:
- New Hampshire
- Rhode Island
- South Dakota
Alaska, Delaware, and Nevada were among the first states to offer domestic asset protection trusts, and they remain among the most popular choices for individuals seeking protection for their assets under US law.
Domestic Asset Protection Trusts: The Benefits
The primary benefit of a domestic asset protection trust is the nature of the protection it affords: Once properly formed, your creditors won’t be able to touch any assets that you assign to the trust. Other benefits include:
- Local jurisdiction – You know where your trust exists and you can more-easily follow any legal or economic developments that may impact your trust.
- Legal recognition – Domestic asset protection trusts have grown in popularity in recent years, and as a result, they are becoming more widely recognized by state and federal courts across the country.
- Affordability – As compared to establishing and maintaining a foreign asset protection trust, making use of a domestic asset protection trust will often be more affordable.
- Clarity – State laws specify the amount of time that creditors have access to assets that have been transferred into a domestic asset protection trust. For example, in Nevada, the rule is that creditors are generally barred from pursuing trust assets after two years.
Domestic Asset Protection Trusts: The Drawbacks
However, as we alluded to above, domestic asset protection trusts do have certain limitations. Most notably, one of the hallmarks of any domestic asset protection trust is that the “settlor” (the individual who places assets into the trust) must give up control over the trust’s assets. The more control you retain, the more likely that your creditors will be able to “step into your shoes” and exercise that same level of control on your behalf – which eventually defeats the purpose of putting the trust in place. Some of the other potential drawbacks include:
- Delayed effectiveness – While domestic asset protection trusts generally become effective after a set period of time, this means that there is a window after you establish your trust where your assets may still be exposed.
- Developing case law – Due to the strong protections that they afford, creditors have been challenging the domestic asset protection trust structure in various courts around the country, and some judges have shown a willingness to help protect creditors’ rights.
- Choice of law – If you live in one state, you set up your trust in another, and you have property in a third, which state’s laws apply? This is an issue that can be addressed, but if choice of law remains an open question, this can lead to additional expenses in litigation.
- Fraudulent transfers – If a creditor does try to assert a claim against you, depending on the circumstances, it may be able to argue that your use of a domestic asset protection trust constitutes a “fraudulent transfer” that should be legally disregarded.
Foreign Asset Protection Trusts
At a high level, foreign asset protection trusts are the same as domestic asset protection trusts, with the obvious difference being that foreign trusts are formed overseas. As such, they are governed by the laws of the country in which they are formed, and this offers various benefits and drawbacks, as well:
Foreign Asset Protection Trusts: The Benefits
- No full faith and credit – While US state courts are required to enforce judgments entered in other states, certain countries do not acknowledge US judgments. For example, Belize and the Cook Islands are two popular jurisdictions for forming foreign asset protection trusts because they will not enforce a judgment entered in favor of a creditor in the United States.
- Privacy – Foreign asset protection trusts can offer enhanced levels of privacy as compared to their domestic counterparts.
- Protection from seizure – Assets placed into a foreign trust (and held offshore) will generally be less exposed to a court-ordered seizure than assets held in a domestic asset protection trust.
Foreign Asset Protection Trusts: The Drawbacks
- Assets are offshore – In a typical scenario, a foreign asset protection trust will hold assets that have been deposited into an offshore account (so, in our introductory example, a domestic asset protection trust would be the most likely candidate). This can mean an even more-limited amount of control, as well as potential exposure to economic and political turmoil in the host country.
- Being held in contempt – Due to the lack of control settlors retain over foreign asset protection trusts, some US courts have ordered jail time for those who are unable to pull assets back out of their offshore trusts.
What are the Alternatives?
As you can see, the decision of whether to use a domestic or foreign asset protection trust involves a balancing of factors, and requires a careful assessment of your unique personal circumstances. It is also important to consider the other alternatives that are available. For example, the following all offer some level of protection (though not as much as an asset protection trust), while providing greater flexibility:
- Pre-nuptial agreements
- Revocable living trusts
- Limited liability companies (LLCs)
Learn more about the basics of asset protection planning.
Speak with an Asset Protection Lawyer at Jiah Kim & Associates
If you would like more information about protecting your assets in the US or abroad, we invite you to contact us for a confidential consultation. To speak with an asset protection lawyer at Jiah Kim & Associates, contact us online or call (646) 389-5065 today.
This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.