Published by: Estates, Gifts and Trusts Journal; BNA Tax Management
Author: Patricia Donlevy-Rosen, Esq.
Date of Publication: March, 2004
On July 10, 2003, Alaska amended its 1997 Alaska Trust Act (the “2003 Bill”) in an effort to stay in the forefront of the growing list of states seeking to generate trust business by providing settlors with creditor protection and estate freeze legislation. This type of legislation attempts to rival that offered by certain offshore jurisdictions. The 2003 Bill makes Alaska more attractive as an domestic asset protection situs. As a state in the United States, however, Alaska falls short of providing the ultimate protection offered by certain offshore jurisdictions – lack of U.S. court power to upset asset protection planning.
From the viewpoint of domestic creditor protection, the 2003 Bill’s expansion of the protection afforded to self-settled trusts with spendthrift provisions is significant. By clarifying and narrowing the exceptions to spendthrift protection afforded by trusts, Alaska has made:
- (1) the type of, and proof of, intent required to sustain an attack against a spendthrift trust more burdensome for the creditor;
- (2) qualifying as a creditor with standing to attack a trust more difficult;
- (3) the time within which a trust can be attacked more precisely determined;
- (4) retention of certain controls possible; and
- (5) a beneficiary’s use or occupancy of property not a reason for loss of protection of the property from the beneficiary’s creditors.
In most state fraudulent transfer/conveyance acts, cases and the Bankruptcy Code, the settlor’s intent to hinder, delay or defraud creditors is a basic element defining which transfers or conveyances are fraudulent. Taking a giant step for settlors, the 2003 Bill limits actionable transfers solely to those made with the intent to defraud. Thus, transfers made to an Alaska trust with the intent to hinder or delay a creditor are tacitly condoned and no longer actionable.
That is, a settlor has the permission of the Alaskan legislature to make collection more difficult without the possibility of giving the creditor a remedy. As any self-settled trust is meant, at least in part, “to hinder or delay” a creditor — who is not designated as a beneficiary of the trust — the 2003 Bill seriously weakens a creditor’s standing to complain about a transfer, and curtails the use of “badges of fraud” in proving a transfer to be fraudulent, and thus actionable.
Following the lead of a number of offshore jurisdictions, the 2003 Bill limits standing to attack a transfer to a trust solely to the particular creditor who was harmed by the specific complained of transfer. A creditor can no longer cite the effect the settlor’s actions had on another creditor in establishing the fraudulent transfer claim for it/him/herself. In addition, Alaska made its statute of limitations slightly more attractive.
Most states allow a fraudulent transfer action to be brought within the later of x years from the time of transfer (time certain), or y time from the time the transfer is or reasonably could be discovered (a time uncertain). Alaska narrowed the availability of that time uncertain. Under the 2003 Bill a qualified pre-existing creditor can take advantage of the “one year after the transfer is or reasonably could have been discovered” provision, only by
- (1) demonstrating, by a preponderance of the evidence, the assertion of a specific claim against the settlor before the transfer; or
- (2) having, within four years after the settlor transferred assets to the trust, filed an action against the settlor based on a claim grounded on an act or omission by the settlor occurring before the transfer (such as breach of contract). Under the amended provisions, a settlor should be able to rest assured after four years that all creditors are known.
Although this provides a settlor with more comfort than most other states’ statute of limitation laws, the comfort falls short of that offered by offshore jurisdictions with even shorter statutes of limitations, especially where the settlor is solvent before and after the transfer to the trust.
Further enhancing Alaska’s position as a domestic asset protection situs, the 2003 Bill specifically prohibits a court from ordering a trustee to violate a trust’s spendthrift provisions absent a finding of fraudulent transfer as to the complaining creditor. In other words, under the 2003 Bill, a court no longer has the authority to compel a trustee to exercise its discretion to turn over the maximum potential benefit it could give to a discretionary beneficiary- settlor!
Time will tell how this provision withstands the test of the supremacy clause in the face of a settlor’s bankruptcy, or public policy attacks by judges sitting in other jurisdictions. Also, the 2003 Bill does not prevent a court from ordering the trust protector to amend the trust to remove a current trustee and appoint a creditor-friendly trustee — perhaps one outside Alaska’s jurisdiction and friendly to the creditor.
Going even further for settlors of trusts, Alaska expanded its typical spendthrift provision to provide that such protection for a beneficiary who is a settlor of the trust. Also, it went a step further to provide that: [p]ayment or delivery of the interest to the beneficiary [including a settlor-beneficiary] does not include a beneficiary’s use or occupancy of real property or tangible personal property owned by the trust if the use or occupancy is in accordance with the trustee’s discretionary authority under the trust instrument.
Thus, for example, a settlor who has assigned his/her interest in a time share to a trust, may be permitted by a trustee exercising its discretion to use the very interest in the transferred time share, and there would be no right of the creditor to reach it. Beneficial use can be enjoyed without creditor threat according to the 2003 Bill. However, should the settlor be under the jurisdiction of another state or a federal court enforcing federal law — such as collecting penalties under a RICO statute — the settlor might otherwise be prevented from using the property of the trust.
The 2003 Bill allows a settlor to retain controls that would heretofore, under Alaska and most other states laws, cause the loss of the spendthrift protection. For example, spendthrift protection will not now be lost by the settlor:
- (1) serving as a co-trustee or as an advisor to the trustee, provided the settlor does not have a trustee power over discretionary distributions, or
- (2) having authority to appoint a trust protector or a trust advisor.
A settlor transferring assets to a trust created on or after July 10, 2003, in order to reap the benefits afforded by the 2003 Bill, must provide a sworn affidavit. This affidavit attests to the settlor’s:
- (1) ownership of assets,
- (2) solvency,
- (3) lack of intent to defraud a creditor,
- (4) lack of undisclosed pending or threatened court actions or administrative proceedings,
- (5) not being in default of a child support obligation by more than 30 days,
- (6) not contemplating filing for Bankruptcy relief, and
- (7) not having derived the assets from unlawful activities. Affidavits of this type have long been required by stable offshore trustees and ethical U.S. practitioners as part of their due diligence.
In an effort to ease the fears of other parties involved with the trust, the 2003 Bill delineates which trust protector and trust advisor powers may be granted by the trust instrument without causing the trust protector or trust advisor to become a fiduciary. The 2003 Bill does not, however, prevent a court from ordering a protector to exercise his/her powers, as provided in the trust instrument (absent a duress clause) to do things which might benefit a creditor, such as name a creditor-friendly trustee.
Turning to legislation enabling estate freezes (that is, in freezing the value of the estate for estate tax purposes) with trusts, the business that states purport to seek in passing this type of legislation, Alaska is clearly making headway. In effectuating an estate freeze the settlor must make a completed gift.
Practitioners have been concerned that despite a trust being structured as a completed gift, the fact that a creditor may be able to satisfy their claim out of the trusts assets would cause the gift to be deemed incomplete for estate tax purposes, thus adding it to the settlor’s estate. While there remains the exception in Alaska to protection for transfers made at a time when the settlor is in default by 30 or more days of making a payment due under a child support judgment or order, a settlor should be aware of that at the time of creating a trust, and transfers to a properly structured Alaska trust should thus qualify as completed gifts.
New AS 34.40.110(j) provides that (j) A settlor whose beneficial interest in a trust is subject to a transfer restriction that is allowed under [the spendthrift provision] may not benefit from, direct a distribution of, or use trust property except as may be stated in the trust instrument. An agreement or understanding, express or implied, between the settlor and the trustee that attempts to grant or permit the retention of greater rights or authority than is stated in the trust instrument is void.
This provision was meant to assure that if the trust is structured as a completed gift, it will not be included in the settlor’s estate under §2036 because of an implied agreement (alleged by the IRS) between the settlor and the trustee as to the use of the assets by the settlor.
In conclusion, while Alaska has taken significant steps in providing for helpful estate planning techniques for practitioners, it still fails to provide the ultimate protection afforded by an offshore trust — that is, at the critical time, not having the trustee or the trust’s assets subject to any U.S. (state or federal) court’s jurisdiction. Only an offshore trust can provide this ultimate protection.
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