Asset Protection Trust

An asset protection trust (APT) refers to a fiduciary structure that facilitates estate planning by allowing individuals and organizations to transfer their assets' ownership to a third-party trustee to secure them from any potential claim arising from lawsuits, court orders, or creditors. These trusts are usually irrevocable.

APTs are critical legal arrangements for those who are at high risk of losing their assets and wealth in liens or to creditors, like real estate dealers, financiers, doctors, and others in risky occupations. Such trusts can also be formed by high-net-worth individuals, business entities that trade on credit, and couples who have a prenuptial agreement.

An asset protection trust is a legal facility that helps the asset owners, i.e., individuals and entities, to shield their wealth or assets, including cash, securities, real estate, business assets, recreational belongings, and limited liability companies, from any future legal or financial obligations. Such a trust allows the owners to transfer the ownership of the assets they want to secure to a trustee for management until the same is distributed among the beneficiaries who hold a vested interest in the trust assets. The trust creator can also act as a beneficiary in this arrangement. Thus, the idea is to safeguard the creator's assets from their creditors while confining them to the legal framework.

These trusts are a perfect hedge against potential claims over the creators' assets from their creditors or plaintiffs; however, creating such trusts involves high costs and fees. Moreover, these are complex structures that would require the intervention of an estate planning attorney for proper formation. Although the creators of an APT can avoid the state income tax on the income derived from the APT assets, they have to pay the federal income tax and the estate tax on such wealth or assets.

The individuals create trusts to protect their assets, and an APT is primarily formed to secure the wealth or trust assets from litigation liabilities or other financial claims. However, there are three significant kinds of APTs, as discussed below:

1. Medicaid APT: Since a Medicaid scheme is provided only to those who have assets within a specific limit other than their primary house and vehicle, the old age people transfer all the additional high-value assets to the veteran or Medicaid APT. However, such a trust should be created at least 5 years prior to the filing of the Medicaid application.
2. Domestic APT: Such a trust is formed and registered in the state of the creator's residence. Also, domestic APT is created, managed, and regulated according to state and federal laws. Their establishment is comparatively cheaper and less complicated than an offshore APT.
3. Foreign or Offshore APT: A foreign APT is an offshore trust created by an individual outside their domestic jurisdiction, i.e., in a foreign state. Such a trust is subjected to the laws of that foreign jurisdiction where it is formed and also exposed to their political and economic conditions. These are complex and cost-intensive legal arrangements.

Setting up an APT becomes crucial when a super-wealthy person wants to save their assets from being eroded in a litigation process or claim by creditors; it is a complicated task for a non-legal individual. Therefore, such a fiduciary arrangement for estate planning requires an experienced attorney. 

The three critical steps in the formation of an APT are:

1. The foremost step is to select a jurisdiction that has favorable laws and regulations for the creation of an APT; one such state is Nevada.
2. Next, all the documents for trust creation are prepared similarly to the formation of an irrevocable trust. The creator needs to select a trustee, name the intended beneficiaries, and state the guidelines for the management of the APT in the trust agreement.
3. Finally comes the funding of the APT, which comprises the assets transferable to the trustee, including cash, securities, real estate, business assets, recreational assets, and limited liability companies. Also, the creator needs to go through all the applicable tax regulations and norms before creating the trust to ensure minimum tax liability.

Now that we know the significance of an APT for wealthy individuals, let us go through some examples that demonstrate the need and functioning of these trusts:

Example #1

Suppose Mrs. Nelson is a businesswoman residing in New York. She has assets worth $854,700, including her farmhouse, car, and gold jewelry, other than her home where she lives. Her home is in the name of her husband. In 2017, she formed a Nevada asset protection trust to protect her wealth from any potential litigations arising from her business liabilities. After 7 years, Mrs. Nelson was sued by a creditor, Mr. Datson, to whom she owes $247,000. However, Mr. Datson cannot claim the assets held in Mrs. Nelson's APT, securing them from any such financial obligation.

Example #2

In the legal case of Toni 1 Trust v. Wacker, the issue revolved around the validity of asset transfers into a Domestic Asset Protection Trust (DAPT) amidst creditor claims. The Tangwalls transferred assets to the Toni 1 Trust during ongoing litigation with the Wacker family, who contested these transfers as fraudulent attempts to evade paying judgments against the Tangwalls.

This case involved legal proceedings across different jurisdictions, including Montana state court and the federal bankruptcy court in Alaska, where one of the involved parties, Toni Bertran, had filed for bankruptcy. The Alaska Supreme Court had to determine whether Alaskan courts had exclusive jurisdiction over claims involving Alaskan DAPTs. Despite arguments from the Tangwalls asserting Alaska's exclusive jurisdiction, the court ruled otherwise. They referenced legal precedents and constitutional principles, like the Full Faith and Credit Clause and the Supremacy Clause, to assert that other courts could exercise jurisdiction over claims involving DAPTs, even if the original cause of action arose in another state.

Moreover, it emphasizes the intricacies and uncertainties surrounding DAPT statutes and their efficacy in safeguarding assets from creditors. It further limelights the need for a comprehensive understanding of the legal framework governing asset protection strategies.

Every type of trust has a distinct purpose, and so does an irrevocable APT. However, such an arrangement has certain advantages and disadvantages to be considered by individuals and businesses; these are: