Posted by Robert L. Arone
Conversations with family, friends, and colleagues can sometimes wander into the topic of lawsuits, divorces, bankruptcies, and other threats that put one’s property at risk of loss to a creditor. Such conversations often leave people shaking their heads, asking what the world is coming to, and feeling vulnerable and frustrated. However, an important tool has become increasingly available to even those of modest means to protect their property from such threats at a reasonable cost and with relatively few hoops to jump through.
The Domestic Asset Protection Trust
A domestic asset protection trust (DAPT) is a legal structure into which a client (as the grantor or trustmaker) can transfer accounts and property such as a home, cash, stocks or other investments. Once transferred into the DAPT, the property is legally protected from future lawsuits, divorcing spouses, bankruptcies, and similar threats. Although the client has transferred these accounts and property to the trust, the client can continue to enjoy the benefit of this property in the DAPT with only minor limitations.
DAPTs work on the legal principle that someone cannot take away from you something that you no longer own. When the client transfers property into a DAPT, the client is actually making a gift of it to the trustee (the person or entity the client chooses to manage, invest, and use the accounts and property) on behalf of the irrevocable trust. The trustee is then under a legal obligation to use the property for the client’s benefit, or for the benefit of those the client has named in the trust.
How a DAPT Works
To create a DAPT, the client signs a trust document and permanently gifts some of the client’s property into the trust. The trust is irrevocable, meaning the client cannot change it. The trustee can make distributions to the client, thereby allowing the client to continue enjoying some benefits of the property in the trust. However, the trustee in most cases needs to be an independent trustee (someone who is not related or subordinate to the client or any other beneficiary and will not inherit anything from the trust) in order to preserve the asset protection properties of the trust. Still, many states allow for a grantor to be a co-trustee and exercise authority with respect to the investment decisions of the trust.
Which States Have DAPT Laws?
Currently, the following states have legislation that authorizes the creation of a DAPT: Alaska, Connecticut, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming.
It is important to remember that DAPT laws can vary significantly by state. Residency requirements of the grantor or trustee of a DAPT vary from state to state, as does the required connection of the grantor with the DAPT state. In some instances your client can live in one state but have a DAPT in a different state. Some DAPT laws are better than others, and their effectiveness may depend upon the location of the property that a client plans to gift into the trust. Given these considerations, it is critical that your client speak with an experienced attorney when setting up a DAPT. Key differences in state law that can have a significant impact on the effectiveness of a DAPT include the following:
- how a DAPT must be set up
- who can serve as the trustee
- how much of a client’s property can be placed in the trust
- which creditors will be blocked from reaching the trust property
- what additional powers (if any) the grantor can exercise over the trust
- how much time must pass before the property placed in a DAPT is protected from creditors
What Kind of Creditor Protection Does a DAPT Provide?
In general, a DAPT allows a client to shield accounts or property owned by the DAPT from any creditor claims that arise after the DAPT is funded and after any applicable time periods or notice requirements imposed by state law have been met. In many states, this protection can even include future claims of a current or future spouse, child, or creditor. It is important that the client consult an experienced attorney regarding the protections the client’s state’s DAPT statutes offer, as these can vary by state.
Despite the protection offered by a DAPT, some creditors will still be able to reach the property owned by the DAPT regardless of which state law the client uses. Currently, no state’s DAPT laws allow a DAPT to be used to
- spend down or qualify a grantor or the grantor’s spouse for Medicaid eligibility;
- defeat state or federal reimbursement claims or rights of recovery for Medicaid benefits paid to the grantor or the grantor’s spouse; or
- defeat creditor claims if property is transferred to a DAPT with the intent to prevent, hinder, or delay a known or present creditor from reaching the property.
Most states’ DAPT laws also provide the following exceptions to the creditor protections:
- taxes (state and federal tax claims must still be paid from trust assets)
- family support obligations such as alimony and spousal support (state laws differ significantly on this topic)
- medical bills of a beneficiary (certain states allow access to the trust property to pay these bills)
Who Is Likely to Need a DAPT?
Not everyone will need a DAPT because not all people face the same kinds of risks. However, there are certain professions and circumstances for which clients may want to consider using a DAPT as part of their estate planning.
- High-risk occupations. Lawsuits are increasingly common against those in certain professions, such as doctors, accountants, lawyers, real estate developers, builders, architects, and business executives. Creating a DAPT to protect a portion of the property owned by clients in these occupations can be an effective shield against risks associated with lawsuits.
- Owning a business. Owning a business can put a client at a higher risk of lawsuits. Using a DAPT can protect the client’s home and other personal property against claims brought against the business.
- Personal injury and accidents. Unfortunately, accidents happen to everyone. Moreover, it is common today for even innocent accidents to lead to litigation and potential loss of personal wealth. A tool such as a DAPT can be a critical part of protecting clients’ property for their families both now and in the future.
Deciding If a DAPT Is Right for Your Client
Deciding whether to use a DAPT should not be undertaken without good legal advice. The following factors, among others, need to be carefully considered with the help of a qualified estate planning attorney:
- How much of a client’s property should the client place in the DAPT?
- What kind of access to trust property will your client need in the future?
- Who will serve as the independent trustee responsible for making distributions to the client?
- Who, besides the client, will be a beneficiary of the DAPT?
- In which state will the DAPT be formed?
- What types of creditors are of most concern to your client, and do the relevant state’s DAPT laws protect the client against such creditors?
Once these questions are answered, you will have a much better sense of whether a DAPT is a tool that will work for your clients. If you have additional questions about DAPTs, please give us a call. We would love to visit with you or any of your clients about this topic, either in person or virtually.