What is a Utah Domestic Asset Protection Trust (UDAPT)?

  A UDAPT is an irrevocable trust that provides (1) asset protection, (2) control, (3) and access. Hundreds of years of laws previously stated that your creditor can get access assets in your trust to the extent that you can benefit from them. Utah is one of 17 US States that turned the tables allowing creditor protection for a self-settled trust (a trust whose settlor is also a permissible beneficiary).

Who should consider a UDAPT?

  People with high-liability professions, high net-worth, or high-risk aversion who want to take some “chips” off the table and also be a permissible beneficiary. People who want to protect assets such as a residence or other real estate, savings or investment accounts, business interests, or other valuable assets should consider a UDAPT in their asset protection plan.

Pros and Cons of a UDAPT?

Pros:

• Statutory – Blessed by Utah Statutes.
• Control – The Settlor can control the trust assets and investments (however another non-beneficiary co-trustee is required to make distribution decisions).
• Access – The Settlor is a permissible beneficiary.
• Statute of Limitations
  • Non-existing Creditors (Potential Future Creditors): Immediate protection
  • Existing Creditors: Barred from making a claim after the later of 2 years or 1 year after they reasonably should have known about the transfer to the trust. This can be reduced to 120 Days by providing actual notice to known creditors and by publishing notice for unknown creditors.

 Cons:

• Affidavit of Solvency – A strict interpretation of the UDAPT statute appears that every time you make a transfer into the trust, you must sign an affidavit of solvency. If this isn’t followed for each transfer, a potential creditor could attempt to attack the trust on the grounds that the formalities had not been followed (although there are no court cases on this).
• New Law – Only 17 States allow DAPTs. Utah has only allowed the use of a DAPT since 2013. Alaska was the first state and has only allowed this type of trust since 1997. There are very few court cases addressing their effectiveness.
• Liabilities in other States – There is concern that the trust assets are vulnerable to creditors outside of Utah without DAPT statutes.
• Real Estate – Utah requires that deeds to real estate transferred to a UDAPT state that the trust is an “asset protection trust.” This requirement appears in a different part of the Utah statutes (not the UDAPT statute) and is often missed. Some have concerns about whether they lose the protection if they don’t do this. Some prefer not to put the words within an “asset protection trust” on a publicly recorded document.
• Bankruptcy – Federal bankruptcy can reach assets transferred into the trust within 10 years of the bankruptcy. 

How to set up a UDAPT?

  The UDAPT requires specific language and should be prepared by an attorney with extensive knowledge about Utah estate planning and asset protection. At least one trustee of your DAPT must be a Utah resident. The Settlor must sign an Affidavit of Solvency each time assets are transferred into the trust, which means you are certifying that after the transfer of every asset into your DAPT, you still have more assets than liabilities and can cover your obligations.

 When to create an Asset Protection Trust?

  Timing is important with any asset protection. The trust should be established in advance of a creditor problem to avoid fraudulent/voidable transfers (transfers which render the settlor insolvent or are made with the intent to delay, hinder, or defraud known creditors). Any asset protection strategies should be established before the liability wind is blowing so that if the storm comes, you already have a bunker prepared.

Building a Better UDAPT

  McCullough has 30 years of combined experience in creating irrevocable trusts. Understanding a client’s particular situation is key in determining what tools to use. A UDAPT can be created with variations and provisions to provide greater protection and flexibility. This could include (1) appointing a Trust Protector who can remove and replace trustees among other things, (2) limiting the settlor’s beneficial interests (such as to reside in trust owned real estate, if the settlor doesn’t need distributions, or the trust only owns a residence), (3) asset protection planning with more than one trust, and (4) publishing notice (or providing specific notice to creditors) to shorten the statute of limitations period to 120 days.

What is better than a UDAPT?

In many circumstances, a third-party trust (non-self-settled) is a better planning tool. We call our third-party trust a 541 Trust®. A 541 Trust® works in all 50 States. We always consider your specific circumstances when determining which type of asset protection trust is best for you. Asset protection plans require customization by a knowledgeable attorney.

  A UDAPT is a good option if the settlor lives in Utah, the assets the settlor needs protecting are in Utah (or in another DAPT State), and the settlor doesn’t have a likelihood of bankruptcy within 10 years of funding the trust. UDAPTs often work well for unmarried individuals with assets in need of protection. If, however, the settlor has assets or liability exposure in many states other than Utah, a 541 Trust® may be a better solution. 

On July 21, 2019 the U.S. Supreme Court ruled unanimously that North Carolina could not tax the income of a New York trust where the only connection to North Carolina was a discretionary beneficiary who had not received and could not demand distributions. While the court’s opinion was applied narrowly to the facts, it provides support for planning with trusts to avoid or defer state income tax such as NINGs.

FACTS OF THE CASE

Decades ago, a father established a trust for the benefit of his children in New York. Some time later, the trust was subdivided into separate trusts, one for the benefit of his daughter Kimberley and her children and called the trust The Kimberley Rice Kaestner 1992 Family Trust (the “Kaestner Trust”). Kimberly moved to North Carolina at some point.

The North Carolina Department of Revenue assessed a $1.3 million tax for 2005-2008 because The Kaestner Trust was “for the benefit of” a North Carolina resident. The taxing authority relied on North Carolina statutes and a North Carolina Supreme Court case which found that a beneficiary residing in the state was sufficient to assess the tax. The Trustee paid the tax then appealed in the North Carolina courts. The appeal claimed that the Due Process Clause of the U.S. Constitution prevents North Carolina from assessing a tax where the only link to North Carolina was that a beneficiary resided in the state. All of the North Carolina courts agreed, holding “that the Kaestners’ in-state residence was too tenuous a link between the State and the Trust to support the tax.” The North Carolina Department of Revenue appealed to the U.S. Supreme Court.

The North Carolina Department of Revenue’s argument failed again at the highest court in the land. The State argued that a “trust and its constituents” (e.g. a trustee or beneficiary) are “inextricably intertwined,” and supports state taxation, and an in-state beneficiary is sufficient to tax the trust. The court acknowledged that while a beneficiary is central to a trust, there is such “wide variation in beneficiaries’ interests” in any trust and wouldn’t adopt such a hard-line rule to tax solely on that basis. Likewise, the State’s arguments that ruling in favor of the Trust would “undermine numerous state tax regimes” and could “lead to opportunistic gaming of state tax systems” failed.

The US Supreme Court considered the Due Process Clause of the U.S. Constitution. Ultimately, a minimum connection between the State and the trust is required to assess a tax. It was a purely discretionary trust. Distributions to or for the benefit of a beneficiary were in the sole discretion of a Trustee who was not in the State of North Carolina. The ruling was that the mere residence of the beneficiary in North Carolina was not sufficient to tax the trust because: 1. The beneficiary did not receive any income from the trust during the years in question, 2. The beneficiary had no right to demand trust income or to control, possess, enjoy, or receive trust assets, and 3, The beneficiary couldn’t count on receiving distributions from the trust at any known point in the future.

ANALYSIS

What does this case tell us? Although the ruling was limited to the narrow facts of this case, it gives us an excellent view of how the U.S. Supreme Court interprets States’ authority to tax trusts. It supports the idea that a trust can be established in another state and avoid/defer income tax in the state of the trust beneficiary. Establishing a non-grantor trust (a trust which is a separate income tax payer) in a state without state income tax (sometimes called ING Trusts). These types of trusts can be excellent tools in the right situation to minimize tax liabilities so long as they are structured properly.