Ohio Legacy Trust Not Likely To Affect Your Income Taxes

Clients frequently ask about potential income tax aspects of an Ohio Legacy Trust. 

An Ohio Legacy Trust will likely have no effect at all on your income tax situation.  The trust will be structured so that it is a grantor trust pursuant to §677 of the Internal Revenue Code.  It meets the requirements of this Code section because trust income may be distributed to the Grantor without the approval of any adverse party.  In less technical terms -- any income from the trust will simply be reported on your personal income tax return. 

An Ohio Legacy Trust can also hold S Corporation stock because it is a grantor trust.  There are certain limitations on what kind of entity can be an S Corporation shareholder.  A grantor trust is one of the entities that can own S Corporation stock.

There are many considerations that go into setting up an Ohio Legacy Trust (or a domestic asset protection trust in any other state that allows one).  But as long as the trust is properly drafted, you should not have to worry about its impact on your personal income tax situation.

Mississippi is Latest State to Enact DAPT Statute

The Mississippi “Qualified Disposition in Trust Act” takes effect today.  Mississippi has now become one of about fifteen states that have a domestic asset protection trust statute.

Each of these state statutes is different.  But they all offer (with certain exceptions) an opportunity for creditor protection - - as long as appropriate formalities are followed. 

This latest DAPT statute provides another reminder that asset protection is becoming more and more “main stream.”  There should be no hesitation in making use of applicable asset protection laws that specifically allow you to better protect your assets.

Asset Protection Trust Should Have Provision Allowing Trustee to Change Situs

Earlier this year Ohio joined a number of other states that allow creation of a domestic asset protection trust.  In Ohio, it is called an Ohio Legacy Trust.

Ohio law (just like the law of every other state) can change at any time.  We currently anticipate no significant change in the new Ohio domestic asset protection trust statute in the near future.  And even if there was a change in Ohio law, it is possible that existing legacy trusts would be “grandfathered.”

But since there can be no assurance that Ohio law will always remain as favorable as it is right now, we include a provision in our Ohio legacy trust to cover a change in Ohio law or policy.  We provide that the trust can essentially be moved to another jurisdiction if necessary - - where hopefully there would be better protection at that time.  We aim to provide the trustee and/or the trust protector with maximum flexibility to protect trust assets.  

Affidavit of Solvency is a Reminder to Plan Before You Have Creditor Problems

Ohio Revised Code §5816.06 requires an affidavit of solvency each time you transfer assets to an Ohio Legacy Trust.  This is a fairly standard provision for transfers to Domestic Asset Protection Trusts in other states as well.  In Ohio, failure to timely file such an affidavit may be used as a basis for an action to set aside the transfer. 

The affidavit of solvency required by Ohio Revised Code §5816.06 must state that:

        ·         The transferor is not made insolvent by the transfer

        ·         The transferor is not contemplating bankruptcy

        ·         There are no pending court actions other than those listed in the affidavit

It is often impossible to sign such an affidavit once you have serious creditor problems.  So this statutory requirement is another reminder to do your asset protection planning before you have any significant creditor issues.

Trusts Require Flexibility

Asset protection planning (and estate planning) frequently involves the use of one or more trusts. Possibilities include an offshore trust, Domestic Asset Protection Trust, irrevocable life insurance trust and various other kinds of trusts. 

Most of these trusts are designed to last for many years. It is therefore important to give the trustee the flexibility to adjust to changing circumstances. Many things can change during the life of a trust. Among the many changes that a trustee may be faced with are:

·         Beneficiary’s creditor problems

·         Changes in family circumstances (including divorce)

·         Cost of living

·         Legal changes

A person setting up a trust is often inclined to impose very specific requirements on the trustee (for example, making specific distributions to beneficiaries each year). But one or more of the changes mentioned above could make a particular distribution problematic. Giving your trustee flexibility and discretion often makes the most sense. This is why I frequently remind my clients that who you choose as trustee of a trust can be just as important as the trust documentation.

In any event, it is important to keep in mind that no matter what kind of trust you establish, you are going to have to give your trustee a certain amount of flexibility to react to future changes.

Who Needs an Ohio Legacy Trust?

Here are some of the people who should at least consider setting up an Ohio Legacy Trust:

  • Business owners
  • CEOs and Directors
  • Physicians
  • Accountants
  • Attorneys
  • People considering marriage
  • Others who are willing to part with total control of a portion of their assets

The following chart (prepared by my partner, Paul Fidler) provides some general guidelines about whether you might benefit from an Ohio legacy trust. The chart would also be applicable to domestic asset protection trusts in other states as well. 

 

 

New Laws In Ohio Offer Much Better Asset Protection Alternatives

The Ohio Legacy Trust Act (part of Ohio House Bill 479) becomes effective on March 27, 2013.  Ohio will become one of approximately 15 states with what is commonly called a Domestic Asset Protection Trust Statute.

Ohio House Bill 479 also increases the Ohio homestead exemption and makes other changes that offer better asset protection alternatives in Ohio.  This new law - - coupled with changes to Ohio’s LLC statute that were made last year - - make Ohio a much better asset protection jurisdiction than it was a year ago.

Alimony and Child Support Excluded from Protection of Ohio Legacy Trust Act

The Ohio Legacy Trust Act, which will become effective in March of 2013, cannot be used to avoid child support or alimony payments.  The new statute (part of Ohio House Bill 479) provides creditor protection under certain circumstances for assets contributed to a legacy trust (also commonly known as a domestic asset protection trust).  But new Ohio Revised Code Section 5816.03 excludes child support and alimony payments from the protection of the statute.  This is consistent with DAPT statutes in many other states.

Certain payments and obligations to a former spouse can be limited by an antenuptial agreement that is entered into prior to the marriage.  The new Ohio Legacy Trust Act should not be considered a substitute for a pre-nuptial agreement. 

Ohio Enacts Domestic Asset Protection Trust Statute

Ohio now has a Domestic Asset Protection Trust statute.  A new section 5816 of the Ohio Revised Code (the Ohio Legacy Trust Act) creates what is commonly known as a Domestic Asset Protection Trust.  The new statute was signed into law by Governor Kasich on December 20, 2012 and will become effective in March of 2013.  The Ohio Legacy Trust Act is modeled after statutes in Delaware and Nevada and several other states that have similar statutes.

The Ohio Legacy Trust Act is part of Ohio House Bill 479  – commonly known as the Ohio Asset Management Modernization Act.  This new law not only creates legacy trusts in Ohio, but has other provisions relating to asset protection.

Ohio House Bill 479 Improves Asset Protection in Ohio

Ohio House Bill 479 - - commonly known as the Ohio Asset Management Modernization Act (OAMMA)  will affect a variety of asset protection strategies in Ohio.  The new law was signed by Ohio’s Governor on December 20, 2012 and will become effective in March of 2013. 

House Bill 479 authorizes legacy trusts in OhioOhio is now one of approximately 15 states that allows this kind of trust, commonly known as a domestic asset protection trust.

The new statute also increases Ohio’s homestead exemption to $125,000; regulates the use and enforceability of certain loan covenants in non-recourse commercial loan transactions; and makes other changes that will affect asset protection planning.

What Are The Best Asset Protection Jurisdictions?

There are many factors to consider in deciding whether a particular jurisdiction is or is not favorable from an asset protection standpoint.  Certain states and foreign countries are clearly better than others.  There is a constant tension between the legal rights of creditors and debtors; and each jurisdiction is to some extent more or less favorable to one or the other.

States like Florida and Texas have virtually unlimited homestead exemptions for principal residences.  Other states have surprisingly low exemptions.

States like Nevada, South Dakota, Delaware and Alaska have had favorable domestic asset protection trust (DAPT) statutes for some time now.  Only about 15 states allow DAPTs.  While these statutes have still not been tested in the courts, they are worth considering as part of an overall asset protection plan.

For non-U.S. jurisdictions, the Cook Islands has been increasingly recognized as a favorable jurisdiction for an offshore trust.  Despite some recent negative publicity, the Swiss banking system provides many advantages for offshore accounts.  Various other foreign jurisdictions have laws that can be utilized for asset protection planning.

You always need to consider your own state’s law no matter what other jurisdictions you utilize for asset protection planning purposes.  But asset protection planning clearly requires a multi-jurisdictional analysis.  There may be significant advantages to setting up a trust, LLC or other entity in a state other than your own.

The key point is that each state and foreign jurisdiction has many laws that affect asset protection planning.  One size does not fit all; and each situation should be looked at individually. 

Bankruptcy Trustee has 10 Years to Challenge Transfer to a DAPT

A number of states have enacted Domestic Asset Protection Trust (DAPT) legislationOhio may soon join those states.  These statutes authorize what are known as "self settled" trusts.  This essentially means that the person setting up the trust is also one of its beneficiaries.  Thus, the person setting up the trust is attempting to protect some of his or her own assets (in addition to possibly protecting the assets for one or more other beneficiaries).

As I have noted in other posts, there is still not a single reported court decision in the United States that specifically upholds this kind of trust.  This is one of the reasons that I have been advising my clients not to put too large of a percentage of their assets into a DAPT.

Another significant consideration is that a bankruptcy trustee can challenge a conveyance to a DAPT within 10 years of the time it is made.  While 11 U.S.C. §548(a)(1) provides a general two year time frame in which a trustee can challenge alleged fraudulent conveyances, section (e)(1) provides a 10 year period with respect to self-settled trusts.

One of the goals of asset protection planning is to make sure that you do not end up in bankruptcy.  But it is obviously impossible to know in advance whether a future bankruptcy might be necessary.  Thus, 11 U.S.C. §548(e)(1) should be a very important consideration in deciding how much to contribute to a DAPT (and whether to form one in the first place).

Ohio Could Soon Have a Domestic Asset Protection Trust Statute

Last month, the Ohio House of Representatives passed House Bill 479, which I have discussed in posts on May 1, 2012 and May 23, 2012.

If the Ohio Senate goes along with the House, there will be a new Section 5816 of the Ohio Revised Code that provides for the Ohio Legacy Trust Act.  This will be a form of a so-called domestic asset protection trust.

Keep in mind that the Ohio Senate could amend the House version, and the final result is still uncertain.  And even if Ohio enacts a Legacy Trust Act, there will undoubtedly be various court challenges to parts of that legislation.

This is a rapidly developing area of law.  There is a constant tug of war between those who are trying to collect debts and those who are trying to protect various assets.  The tug of war will be continuing for quite some time.

Proposed Legislation Would Make Ohio a Leading Asset Protection Jurisdiction

Ohio House Bill 479 -- commonly known as the Ohio Asset Management Modernization Act (OAMMA) --would make Ohio a leading asset protection jurisdiction.  The proposed legislation would:

  • Permit a so-called Domestic Asset Protection Trust (DAPT).
  • Provide an essentially unlimited homestead exemption, similar to those in Florida, Texas and several other states.
  • Specifically protect inherited IRAs.
  • Specifically protect 529 plans from a plan participant's creditors.
  • Make some other changes that would help make Ohio one of the better asset protection jurisdictions in the country.

This is proposed legislation.  As explained recently by Akron Legal News, sponsors of the proposed law argue that it would allow Ohio citizens and business owners to better protect their assets.  It would also provide a legal environment that is favorable to the expansion of banking and trust business.  But it is still too soon to predict whether the proponents of the new legislation will ultimately be able to get it enacted.

Update on Domestic Asset Protection Trusts

A domestic asset protection trust (DAPT) is one of many different entities that may (or may not) be an appropriate part of an asset protection plan.

  • At least eleven states have enacted DAPT legislation.
  • States that have DAPT statutes include Alaska, Delaware, Nevada, South Dakota, Hawaii, Missouri, New Hampshire, Rhode Island, Tennessee, Utah and Wyoming.
  • While there are similarities, each state statute has different provisions.
  • A DAPT must be irrevocable; the trustee must be a resident of the state in which the trust is formed, or a bank, trust company or other financial institution with offices in that state.
  • The validity of these trusts is still unsettled.  There is no reported court decision either affirming or striking down this relatively new type of trust.

Asset protection lawyers have varying views about DAPTs.  Foreign asset protection trusts provide greater certainty because court decisions have either directly or indirectly upheld their validity in many circumstances.  But these trusts are more expensive to set up, and holding assets offshore can create certain issues and reporting requirements that are not applicable to domestic trusts.

My own view is that each client's situation has to be examined individually.  A DAPT might be an appropriate alternative for some (but certainly not all) of a client's assets.  If you are thinking about a DAPT or any other form of asset protection, it is critical that you consult with an attorney who will look at all alternatives (and who is not simply selling a particular kind of trust or other device).

Mortensen Case Highlights Fraudulent Conveyance Issues

A recent decision by the United States Bankruptcy Court for the District of Alaska (In Re: Thomas Mortensen, Case No. A09-00565-DMD) is clearly worth reading -- for a discussion of fraudulent conveyances, Alaska asset protection trusts, applicable statutes of limitations, and a variety of other asset protection topics.  I will likely comment on this recent case in several different posts, but here is a quick initial summary.

U.S. Bankruptcy Judge Donald MacDonald IV held that a transfer by Thomas Mortensen of real estate into an Alaska asset protection trust was a fraudulent conveyance.  The Judge found that there was persuasive evidence of an intent to hinder, delay and defraud present and future creditors. The Bankruptcy Judge voided the transfer of real estate to the trust as a fraudulent conveyance.

There are numerous lessons to be taken from this court decision and here are just two of them --

  • Transferring assets when you are insolvent is likely to constitute a fraudulent conveyance.  While Mortensen was found to be solvent at the time of the real estate transfer, his own testimony from a child support action was used against him in the bankruptcy proceeding. In a child support proceeding against his ex-wife, Mortensen took the position that his divorce had thrown him into heavy debt.  This is simply a reminder that whatever you say in one court case can obviously be used against you in another!
  • Think carefully about choosing the trustee of a trust.  Mortensen named his brother and a personal friend as trustees of his Alaska asset protection trust, and named his mother as a "trust protector."  All of these individuals were named as defendants by the Chapter 7 Bankruptcy Trustee in his adversary action against Mortensen.  While it is perfectly appropriate in many instances to name family members as trustees or trust protectors, you need to consider that these individuals can sometimes be dragged into litigation.

Many court decisions are difficult to read, but the Mortensen case is fairly easy to follow.  It is useful reading for anyone interested in some of the more technical aspects of fraudulent conveyances and other asset protection issues.

 

Domestic Asset Protection Trust Versus Offshore Asset Protection Trust

Alaska was the first state in the United States to pass a domestic asset protection trust statute.  Prior to 1997, this type of protection could only be obtained in offshore jurisdictions such as the Isle of Man.  A number of other states -- including Delaware -- have subsequently enacted similar statutes.  There is now an ongoing debate about the advantages and disadvantages of offshore versus domestic APT's.

I recently came across a good summary of these issues by Jeffrey T. Getty and Kalimah Z. White.  Their article is several years old, but I recommend this link for what I think is a good general discussion of domestic asset protection trusts and their pluses and minuses compared to offshore trusts.

Keep in mind that so-called asset protection trusts (APT's) are a possible alternative -- but certainly not the only alternative -- to shield you assets from creditors.  Whether or not such an arrangement is right for you depends on a number of factors, including your willingness to surrender some degree of control over the assets placed in such a trust.

Surrendering Some Control of Your Assets Required for Asset Protection Trust

Any trust that can help protect your assets from creditors requires that you surrender at least some control over those assets. This goes for an offshore trust; a so-called "domestic asset protection trust"; an irrevocable life insurance trust; and any other trust that gives you creditor protection. If you think about it, this is just common sense. If you retain full control over the assets in a trust, than a judge could order you to hand those assets over to a creditor who has a judgment against you. This is why a revocable grantor trust (frequently used for probate avoidance) provides no creditor protection. Such a trust may be useful to avoid probate, provide asset management, and for other purposes. But it is not going to protect your assets from a judgment creditor.

Surrendering some control of your assets is not necessarily bad, as long as you are willing to do so. But each situation has to be analyzed separately. And, you must be very careful about who you are giving some control to. While this is a broad generalization, it should come as no surprise that the more control you give up, the better creditor protection you get. But surrendering control has its own risks, which should be considered very carefully.

Legitimate asset protection includes a balancing of risks and possible rewards. Always keep in mind that if a particular arrangement looks too good to be true, it probably is. 

Traditional Asset Protection Is Frequently the Best

There are many asset protection strategies, and the more expensive and complex ones are not always the best.  I like the comment made by Jay Adkisson (a nationally recognized asset protection planner) in the May 11, 2009 issue of Forbes Magazine.  He basically says the best ways are the old ways.

While that is a big generalization, there is a lot of truth in it.  Offshore trusts, so called "domestic asset protection trusts" (permitted by statute in states like Alaska and Nevada) and other more exotic asset protection techniques may all have their place --  given the right circumstances.  But for most executives, small business owners, physicians, and others in need of asset protection, more traditional devices should be considered first.  Simply dividing certain assets between spouses may be helpful.  Many  traditional trust arrangements, including an irrevocable life insurance trust (ILIT), can often provide significant protection.  So can one or more limited liability companies.  They are easy to set up and provide excellent protection when properly utilized.   Using a family limited liability company in conjunction with a revocable trust can be a relatively inexpensive way to protect assets, and potentially provide significant estate tax savings.

I advise clients to focus initially on traditional, relatively less expensive asset protection strategies.  If those appear inadequate, then consider other alternatives.  But do not start with the assumption that you need an offshore trust in order to reasonably protect your assets.  Many more ordinary arrangements may provide all the protection you reasonably need -- without many of the drawbacks of more complex arrangements.