Trusts
A common form of asset protection is a "trust."
Asset protection planning is simply the process of
organizing one's assets in advance to safeguard them
from loss or dissipation because of potential risks.
One method of protection can be found in a trust which
severs legal and beneficial title to property by
investing legal title in a trustee and equitable title
in the beneficiary.
The trust is a popular but often complex legal
device employed by citizens of English common law
nations in order to achieve various purposes such as
protecting heirs and avoiding probate. A trust can
provide a lifetime income and control of the post-
mortem disposition of wealth in an advantageous way for
the benefit of a spouse, child or other individual.
In its simplest definition, a "trust" is a
property interest held, used and/or cared for by one
person for the benefit of another. The earliest known
example is an Egyptian testamentary trust part of a
will written in 1805 B.C. In the Middle Ages, when the
Knights Templar acted as international financiers, the
trust was a common method used for royal and
ecclesiastical investors who wished to shield their
identity.
Over centuries the concept of the trust has been
greatly refined by use and development, especially in
British Commonwealth nations and the United States.
Court decisions have also played a large role in
shaping U.S. trust law down to the finest of details,
often with major legal and tax consequences.
Domestic Trusts
Decades ago the trust was promoted by U.S.
investment advisers and lawyers (whose assistance has
become essential for trust creation) as one of the best
methods for people of wealth to both avoid creditor or
other attacks and guarantee the future use they intend
for their property after death. Unfortunately for many
U.S. investors and/or their heirs, many of these trust-
advocating financial advisors provided legally faulty
trust plans and implementing documents later nullified
by state or federal court decisions or U.S. Internal
Revenue Service rulings beginning in the 1970s. In the
U.S. there have been a host of bogus "trust experts"
offering supposedly fool-proof trust arrangements which
the courts subsequently found to be non-binding or
illegal.
Depending on applicable national and local tax
law, properly created trusts often can avoid
inheritance taxes which diminish or destroy the value
of property sought to be passed to the next generation.
But the attorney you choose to create your trust must
know U.S. federal and state trust and tax law
thoroughly, or you and your heirs could not only lose
money and assets but be tied up in legal and tax
battles for years.
Trust Creation
The person who creates a trust, usually called the
"grantor" or "settlor," conveys legal title to his
property or money (the "corpus") to a third party (the
"trustee"), perhaps a trusted friend, professional
financial manager or a bank which has a trust
department, to be managed or invested by the trustee
for the benefit of a named person(s) or other
"beneficiary." A document the grantor must sign
describing the terms of the trust, called a
"declaration" or "indenture" gives specific details of
the manner in which the trust is to be administered and
how its income is to be distributed, either or both
during the grantor's life or afterward.
The Testamentary Trust
Trusts can be created while the grantor is living
("inter vivos") but the most common form is a
"testamentary trust" included by a person in his last
will, to take effect at death. This allows provision
for loved ones, especially when the grantor has concern
about the beneficiary's ability to manage his or her
own affairs, i.e., the so-called "spendthrift trust"
the assets of which are immune from creditor attacks.
While popular, testamentary trusts have distinct
disadvantages often unexplained by legal advisors:
estate and income taxes must be paid at the death of
the grantor although successive estate tax levies often
can be avoided as trust property passes to
beneficiaries and their heirs in later years;
testamentary trusts are subject to initial probate and
sometimes to continuous court supervision which often
entails great legal expense; all the activity of the
testamentary trust and its trustee is a matter of
public record and scrutiny.
In addition to trusts created in wills, trusts can
be created formally ("express trusts") by contract, or,
when real or personal property is involved, by a deed
of trust. An "implied trust" may result in the absence
of a formal trust when a court finds its creation from
factual circumstances.
Under the law legal title and ownership to the
trust corpus passes from the grantor to the trustees.
Control of these assets is vested in the trustee(s) so
long as the trust exists. The trust beneficiary
receives only an equitable title to the income or
property of the trust as limited under the terms of the
trust declaration. Powers and duties of a trustee can
be broad or narrow according to the declaration but
should carefully reflect the grantor's intentions as to
how the trust is to be used.
Living Trusts: Revocable and Irrevocable
A "living trust," in contrast to a testamentary
trust, is created by the grantor to take effect and
operate immediately while he or she is still alive. It
avoids many of the liabilities of a testamentary trust.
A "revocable living trust" is a paper entity
sanctioned by Anglo-American law to which a grantor can
transfer his title to assets in any amount and of any
kind, real, personal or mixed; money, insurance
policies, a home, auto, boat, shares of stock, or
ownership of a corporation. Usually there are several
trustees named to manage the affairs of the transferred
property which is held in the name of the trust.
Because it is revocable, the grantor retains the power
during his life to vary the trust terms, withdraw
assets, or even end the trust by formal revocation.
But upon the death of the grantor, the trust which
avoids probate immediately becomes irrevocable. Under
its terms it is then administered by the trustees for
the benefit of the named beneficiaries.
There are real benefits to a revocable living
trust, the most obvious being the grantor's ability to
manage the trust assets during his life and to end the
trust whenever changed circumstances dictate. Other
than his ability to arrange for the desired provision
for family or others upon his death, the grantor
receives no real immediate financial benefits from such
a trust. But for a spouse or heirs as beneficiaries,
there are many benefits in addition to acquiring income
from trust assets. These advantages include:
- avoiding judicial probate with attendant
expense and time delays (trust property is not included
in the grantor's personal estate);
- allowing the uninterrupted operation of a
family business placed in trust;
- avoiding public scrutiny of personal financial
matters;
- causing no temporary stop in income for
beneficiaries during probate after death;
- allowing the trust settlor a choice of the most
advantageous law to govern the trust which can be
created in any political jurisdiction.
Trust Tax Advantages
Under United States tax laws, income and assets of
a revocable or irrevocable trust are subject to state
and federal death taxes. But such trusts can be
arranged so that upon the subsequent deaths of named
beneficiaries, or their heirs, further death taxes can
be avoided, a real but often distant advantage for the
trust beneficiaries. You should know that there exists
a substantial body of American case law in which the
I.R.S. has successfully challenged some trusts as being
no more than evasive devices seeking to avoid tax
liability.
The "Business Trust"
One type of trust which once was popular in the
United States is the so-called "business trust." This
hybrid legal device was designed to operate a business
and have it produce a profit as compared to other
conventional trusts which mainly sought asset
protection and passive income. The business trust is
an association of trustees who actively hold title to
property and operated a business under the terms of a
trust agreement for the benefit of shareholders who are
the owners of the trust and share in profits. This
arrangement is somewhat like a corporation but is
easier to form since it requires only a signed
agreement. Since this trust is entirely private it can
avoid many government reporting requirements and
conceal the actual owners.
Obviously this arrangement does little to provide
asset protection and thus the complicated business
trust has nothing to do with asset protection.
Trust Disadvantages
U.S. domestic trust law restricts the nature and
extent of benefit and/or control that a settlor can
retain after creating a trust. The law says when a
settlor fails truly to place his former assets out of
his own reach then those assets may not be out of reach
of the settlor's creditors, past, present or future.
This judicial doctrine has often been used, years
later, when a court examines the way in which the trust
property was actually handled, to upset even the best-
intentioned trust plans.
In addition courts are hospitable to suits by
creditors of the settlor who allege the trust was only
a sham to avoid payment of just debts or judgments.
Points to consider:
- Income, Interest, and Dividends:
The financial productivity of a trust will depend
on the nature of the assets placed in trust, the
restrictions placed on trust management and the
financial acumen and ability of the trustees. If it is
a revocable or living trust, the settlor who creates
the trust will probably be around for a time as one of
the trustees; he retains partial management, the power
of revocation and can change assets or trust
provisions. If it is a testamentary trust, the settlor
is deceased and the beneficiaries can only hope the
chosen trustee is a good financial manager. The
creation of a trust does not guarantee any particular
level of income. Trusts have thrived financially, but
they also have failed because of bad management or even
illegal or dishonest acts by those in charge.
- Reporting requirements: A living trust
generally need not be reported but many U.S.
jurisdictions require some registration of trust
creation. A testamentary trust, as part of a will, is
subjected to probate court review and approval and as
such comes under public scrutiny. If a trust is
legally challenged by a party in interest or by the
I.R.S. it can become the subject of prolonged court
proceedings in the public spotlight.
- Exchange controls: If the U.S. imposes
currency, price or other economic controls an existing
trust, either domestic, or a foreign asset protection
trust, and its income will undoubtedly be affected in
myriad ways.
- Protection from creditors: Poorly created
Anglo-American trusts often have been subjected to
successful state and federal court attack by creditors
or the I.R.S. alleging the device is simply a debt or
tax avoidance mechanism. Using broad principles of
common law, U.S. courts have declared many trusts legal
nullities based on a wide variety of technical grounds
thus stripping the settlor and his assets of creditor
protection. American courts have invalidated trusts,
among other reasons, because there was insufficient
independence on the part of trustees; the settlor
retained actual control of the "irrevocable trust"
assets or income; there was assignment of pre-tax
personal services and related income to a trust; the
trust was found to be a "sham devoid of economic
reality," and; on the general grounds that the trust or
its objectives were "against public policy" as in the
case of the famous recent Girard trust in Pennsylvania.
(After more than a century of operation and millions of
dollars in grants, the Girard trust provision providing
educational scholarships to needy male students was
found by a state court to be "against public policy"
since it did not include help to needy females).
In recent years American courts have begun
imposing added fines and penalties after taxes on those
found guilty of attempting to create trusts for tax
avoidance. Revocable trusts have proven especially
vulnerable to attacks by determined creditors and often
are treated by U.S. courts as additional assets of a
debtor although such trust assets are more difficult to
attach.
- Taxation: Most trusts are subject to U.S. and
state death taxes at the time of the settlor's passing
although they can be drafted to avoid further death
taxes when beneficiaries or later heirs die. U.S.
income taxes are imposed on trust income, which is
imputed to the settlor in revocable trusts, just as on
any other ordinary income he might receive.
- Convenience: The creation of a trust is a
delicate and complex matter requiring expert legal and
tax advice, often in more than one country, as we have
seen. Because of highly technical provisions essential
to proper trust creation, few laymen have the ability
to judge the end product but must take the word of
their legal advisors. Similarly, trust administration
must meet strict established legal and I.R.S. rules,
regulations and reporting requirements or the trust may
be subject to court attack and dissolution.
Termination is also an issue. While Anglo-
American revocable trusts can be terminated at any time
and testamentary trusts are revocable until the
settlor's death, some other types of trusts are
irrevocable regardless of changed circumstances.
- Cost of Creation: The creation and
administrative cost of a trust can be huge, especially
in the case of a testamentary trust which is challenged
in court after the settlor's death or in the case of a
foreign asset protection trust which will be examined
in the next chapter.
