Asset protection and dynasty trusts

E. Summary

The following tables summarize the provisions, including the factors that make a trust resident for income tax purposes, of those states which have effectively abolished the Rule. The state income tax provisions for determining the residence of a trust are often too complex to be set forth fully in this table, and these provisions should be examined carefully before selecting a state based on its taxation of trust income.

VII. DOMESTIC PROTECTION TRUSTS

A. Missouri Domestic Protection Trusts

(1) the sole beneficiary of the trust or retained the power to revoke or amend the trust; or

(2) one of a class of beneficiaries and retained a right to receive a specific portion of the trust's income or principal.85

Attorneys in Missouri and other states quietly took advantage of this provision. However, at least one court has declared that the Missouri statute did not change the existing rule that prohibited self-settled spendthrift trusts.86

B. Alaska, Delaware, Nevada, and Rhode Island Domestic Protection Trusts-History and Common Concerns

In 1997, Alaska and Delaware enacted legislation to permit the settlor of a trust to remain a trust beneficiary, but still obtain spendthrift protection." Proponents of the Alaska and Delaware statutes assert that the statutes offer the same opportunity to protect one's assets from creditors that otherwise is available only with offshore trusts created in certain debtor-friendly jurisdictions. Determining the truth of this assertion will take some time. In 1999, Nevada and Rhode Island enacted similar legislation.88 In almost every other state, settlors of trusts are denied spendthrift protection. This denial is derived from the English "Statute of Elizabeth," which is embodied in The Restatement (Second) of Trusts (the "Second Trust Restatement"):

156. Where the Settlor is a Beneficiary.

a. Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest.

This provision of the Second Trust Restatement has been applied in many reported cases and appears to be the view commonly held by estate planning professionals throughout the United States. The commonly-held view may not apply universally, however, and a number of exceptions to the rule may exist90 However, clearly most practitioners advise their clients that a self-settled trust cannot insulate assets from the claims of the settlor's creditors as long as the settlor retains any interest in the trust.

One practical effect of this rule is that the rights of creditors to reach a discretionary self-settled trust in which the settlor retains an interest causes any gift made by the settlor to the trust to be incomplete for federal gift tax purposes. For a transfer to be a completed gift under section 2511 of the Internal Revenue Code (the "Code"), the donor must have "so parted with dominion and control as to leave in him no power to change its disposition."9" The Service has ruled that "[t]he transfer of property to an irrevocable inter vivos trust created in, and administered under the laws of, a state in which the trust is deemed a `discretionary trust' whose assets are subject to claims of the grantor's creditors, does not constitute a completed gift."92 The Service went on to state: