Banking & Finance and Law

Trust law keeps assets from creditors

Michigan joins 16 other states in allowing Domestic Asset Protection Trusts, which reduce estate tax liability.

February 24, 2017
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For wealthy individuals and those in high-risk professions, asset protection and estate tax avoidance in Michigan just got a bit easier.

Gov. Rick Snyder signed the Qualified Dispositions in Trusts Act, which took effect Feb. 5, making Michigan the 17th state that permits Domestic Asset Protection Trusts (DAPTs), a form of irrevocable trust that can provide extra protection for potentially at-risk assets.

According to Nick Reister — chair of the trust and estates practice group at Grand Rapids-based law firm Smith, Haughey, Rice & Roegge — physicians, business owners and executives are the most likely to benefit from DAPTs.

Individuals in those professions are considered at higher risk for creditor exposure.

Reister said as long as the DAPT is set up properly, the person creating the trust will be able to protect his or her assets from creditors after a two-year period, starting with the date the assets are transferred to the trust.

He noted the waiting period ensures a settlor cannot evade what is due to creditors if the settlor already owes a debt and is being sued for payment.

“The benefit of this style of trust changes the rules for a creditor proving that a transfer is fraudulent,” Reister said. “Historically, if a creditor was trying to collect on a judgment, they could use presumptions, even coincidences to prove that a transfer (of assets) was intended to defraud a creditor.

“This firms up what the creditor has to prove. As long as the settlor abides by the rules and funds this trust according to the rules set up in the act, and if … those assets stay in a trust more than two years, the creditor has fewer options for accessing those funds, and they have to prove an actual intent to defraud the creditor.”

According to an article by statewide law firm Dykema, before this act, a person had to transfer assets to a trust in an out-of-state jurisdiction, such as Delaware, Alaska or Nevada, but now they can be transferred to trusts set up by residents of Michigan.

One type of DAPT the act creates is called a Hybrid DAPT. A newsletter from estate planner Steve Leimberg, of Leimberg & LeClair Inc., notes this version is “a third-party irrevocable trust generally set up for the benefit of the settlor’s spouse and descendants in which the settlor isn’t a beneficiary, but which gives the settlor the power to appoint a trust protector who has the power to add and remove beneficiaries, including the power to add or remove the settlor.”

Reister said he expects clients mainly will use this tool to control their estate for future use without fear of losing funds.

“You’ll see trusts people set up and put a few million in and it will be their safety net, their nest egg they put away without losing control of it,” he said. “In the past, if people wanted to pass something on to their kids, they would set this up and have limited ability to control it. Now, people will set up these trusts and have more control, and there’s a higher likelihood that it will pass out of their creditor’s control, so it can go on to the family or charity.”

Another type of DAPT is the Two-Grantor Hybrid DAPT, which is the same as the Hybrid DAPT except the assets in the trust are communal property between the settlors, generally spouses who want to pass on assets to their descendants.

The final type of DAPT, the Completed Gift Hybrid DAPT, according to Leimberg is “more of an estate tax avoidance trust” rather than a way to protect the settlor’s assets from creditors.

According to Leimberg, the gift hybrid is “a third-party irrevocable trust just like any other trust to be designed to move assets out of the settlor’s estate for gift and estate tax purposes. The ability to appoint a trust protector who can add and remove the settlor as a discretionary beneficiary creates a back-door emergency ability to get assets back.”

This back-door capability might be necessary should estate tax laws change, Reister said.

The estate tax “has fluctuated a ton in the last 20 years. There’s rumor it’s going to be repealed or changed in the coming years, but even if it goes away, it’s likely to come back (with a new administration),” Reister said. “One of our challenges is helping clients plan with some flexibility. These DAPTs allow that flexibility.”

In 2016, the estate and gift tax exemption was set at $5.45 million per individual, up from $5.43 million in 2015. That means an individual can leave $5.45 million to heirs and pay no federal estate or gift tax, and a married couple may shield $10.9 million from federal estate and gift taxes.

Reister said those considering setting up any of these types of DAPTs should be aware the Qualified Dispositions in Trusts Act is a complex piece of legislation, and it takes a proactive approach to make it work.

“This statute is eight pages long, and it’s complex, so it’s not something that should be done alone,” he said. “It’s not something you can put on a shelf and forget. It’s an investment, but you’ve got to give it attention.”

Because the DAPT doesn’t protect assets already being sued, it’s more of a planning tool, Reister added.

“Readers have to be proactive instead of reactive. They can’t just wait until the midnight hour to set one of these things up.”

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