Private Client Services Update – Virginia Has Authorized Asset Protection Trusts – But Do They Work?
Virginia recently joined 13 other states which have enacted legislation allowing the creation of domestic asset protection trusts (DAPTs). The new statute, section 64.2-745.1 et seq. of the Virginia Code effective July 1, 2012, allows a person to create an irrevocable trust benefitting him or herself, which protects assets transferred to the trust against the claims of creditors of the trust maker or ‘settlor.’
Virginia’s self-settled spendthrift trust law contains more restrictions than the legislation enacted by other states. First, creditors with claims existing at the time of the creation of the asset protection trust have a five year period in which to make claims against assets in the trust. This claim period is longer than the period allowed in most other states which have enacted DAPT statutes. Second, an independent trustee is required in order to preserve the asset protection attributes of the trust. The settlor, a spouse, descendants, siblings, parents, employees of the settlor and entities under the control of the settlor cannot serve as trustee. Finally, a trust created purely to defraud known creditors is not effective.
The availability of Virginia DAPTs offers a statutorily created planning tool with great potential. The law offers asset protection advantages to many trusts created for purposes beyond mere creditor protection, such as insurance trusts and land trusts. That said, it must be noted that the Virginia self-settled creditor protection trust strategy has not yet withstood a challenge in the courts where Federal law could take away these Virginia protections. Thus the safety of Virginia asset protection trusts remains untested.
Recent decisions in other jurisdictions have made it clear that asset protection trusts are not unassailable. An earlier article distributed by the Kaufman & Canoles Private Client Services Group explained the actions of a Federal Bankruptcy Court in ruling an Alaska DAPT ineffective as against creditors in Battley v. Mortensen. 10 B.R. 146 (Bankr. D. Alaska 2011). The bankruptcy court in Battley concluded that the purpose of the trust was evidence of an intent to defraud creditors because the stated purpose was “to maximize the protection of the trust estate or estates from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes.” Although Mortensen was solvent when he created the trust, the stated purpose of the trust made clear his intent to hinder, delay and defraud present and future creditors. The transfer of the property to the trust, therefore, was voided.
More recently, the U.S. District Court for the Eastern District of New York permitted the IRS to collect unpaid taxes from assets held in a DAPT. In United States v. Evseroff, No. 00-CV-06029 (E.D.N.Y., April 30, 2012), the government successfully reached all of the assets held by a trust created by Jacob Evseroff, using those assets to satisfy Evseroff’s tax delinquencies. The United States District Court looked to Evseroff’s intent to determine that the conveyances of his primary residence and a large sum of cash to a DAPT were fraudulent. At the time of the conveyances to the trust, Evseroff was well aware of his tax liabilities. Prior to the conveyances to the trust, he had received two letters from the IRS and a notice of deficiency indicating he had a tax liability of more than $700,000. Further evidence of his intent to shield his assets from creditors was that he continued to retain the benefits of ownership of assets in his DAPT after the transfer.
Offshore trusts, the precursors to domestic asset protection trusts created in the United States, were successfully attacked by creditors in two separate 2012 cases. One, from the Illinois Supreme Court, suggests that even DAPTs which are created properly may still be vulnerable to judgments in those states that do not have legislation permitting DAPTs. Rush Univ. Med. Ctr. v. Sessions, 980 N.E.2d 45 (Ill. 2012).
These recent successful challenges to asset protection trusts have generally involved poor structuring of the trusts, or fairly blatant efforts to use asset protection trusts improperly to evade taxes or gain advantage in a divorce. Virginia lawyers eagerly await confirmation from the courts that properly structured DAPT planning offers solid asset protection. Until that happens, conservative use of this planning tool is in order.
Gregory R. Davis is the managing partner of the Williamsburg office of Kaufman & Canoles and a member of the firm’s Executive Committee. His broad practice includes estate planning, corporate law, real estate, and land use.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2020.