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What is a 541 Trust®?

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We use the 541 Trust® name to refer to an irrevocable asset protection trust built upon a foundation of generations of proven legal precedent. A 541 Trust® is a domestic, irrevocable, non-self-settled trust carefully designed to provide the best asset protection while at the same time affording maximum flexibility. The 541 Trust® is not a new school of thought nor is it based on foreign laws. We have carefully researched generations of legal precedent right here in the U.S. to find strategies that have always worked and design our trusts in compliance.

Assets owned by you are within reach of your creditors. Likewise, absent a fraudulent transfer, assets not owned by you cannot be reached by your creditors. If asset protection is a key goal in your estate planning, you must somehow remove the assets from your personal ownership. The best way to remove assets from your ownership is through the use of a properly crafted irrevocable trust. Because our trusts are drafted in compliance with U.S. laws, and are supported by generations of legal precedent, they provide the best possible protection.

Public policy and generations of legal precedent are clear: you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. Offshore Trusts and Domestic Self-Settled Asset Protection trusts (DAPTs) are self-settled, which is a fatal chink in the supposed armor of these types of trusts. Even though some states and offshore jurisdictions purport to allow self-settled asset protection trusts, it is important to see what the courts have made clear–the only court cases dealing with Offshore Trusts or DAPTs have shown that they fail to protect the assets.[i] Despite an abundance of promotion and marketing, self-settled trusts (DAPTs and Offshore Trusts) have zero wins when challenged in court. The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[ii] In other words, if a settlor who is also a beneficiary has access to trust cash, property, vehicles, etc., so does a creditor. It is hard to argue that an Offshore Trust or a DAPT is the best solution based on their dismal record when challenged in court.

Generations of legal precedent have made clear that the only type of trust which has withstood the test of time as a proven method of asset protection is a non-self-settled trust (a.k.a. a third party trust or our 541 Trust®). This means that the settlor of the trust creates the trust for beneficiaries other than him/herself.[iii] 

Our 541 Trust® protects assets from a person’s potential future liabilities by removing the assets from the person’s legal and personal ownership. Rather than employing new strategies which have not been tested or strategies which rely on the laws of foreign jurisdictions, the 541 Trust® is designed using methods which have been successfully tested in lawsuits, bankruptcy, and IRS audits in the U.S. legal system. The 541 Trust® has been proven to work better than offshore trusts and other asset protection strategies. Frankly, the name of the trust is of little importance. The important part of the 541 Trust® is its craftsmanship. Our years of experience and dedication to building trusts upon a tried and tested legal foundation is the key value to our asset protection trusts. After all, what good is a trust if it fails when challenged? The legal precedent speaks for itself.

 [i] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011), Waldron v. Huber (In re Huber), 2013 WL 2154218 (Bk.W.D.Wa., Slip Copy, May 17, 2013), Dexia Credit Local v. Rogan 624 F. Supp 2d 970 (N.D.Ill. 2009), 11 U.S.C. 548(e), More offshore self-settled trust cases HERE.

[ii] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[iii] “By establishing an irrevocable trust in favor of another, a settlor, in effect, gives her assets to the third party as a gift. Once conveyed, the assets no longer belong to the settlor and are no more subject to the claims of her creditors than if the settlor had directly transferred title to the third party.” In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

Why Self-Settled Asset Protection Trusts Don’t Protect Assets

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Don’t Self-Settle for Inadequate Asset Protection

Why Self-Settled Asset Protection Trusts Don’t Protect Assets

By: Randall Sparks, JD LL.M. and Lee S. McCullough, III, JD MAcc

Click HERE for pdf verison

Self-Settled Asset Protection Trusts are all the rage. They come in two main flavors: (1) The Domestic Asset Protection Trust (“DAPT”) and (2) the Offshore Trust, aka Foreign Asset Protection Trust (“FAPT”). To boost in-state trust business, about a dozen states have passed or are actively improving their self-settled asset protection trust statutes … and that number is growing. Although self-settled trusts are heavily promoted by asset protection attorneys across the county, all of the relevant court cases indicate that if asset protection is your goal, you should find a more viable option.

If self-settled trusts are inadequate for asset protection, why do attorneys go to such lengths to sell them? The answer is simple: Money. Asset protection promoters market them heavily promising maximum protection and make big profits in the process. They do this despite zero court authority in existence that upholds self-settled asset protection trusts. Promoters also ignore the many court cases showing that self-settled trusts simply don’t afford the promised asset protection benefits.

What is a Self-Settled Asset Protection Trust?

There are three parties to any trust agreement: (1) a Settlor, who creates the trust and funds it with assets, (2) a Trustee, who holds legal title to the assets in trust for the beneficiaries, and (3) the Beneficiaries, who are eligible to receive benefits from the trust. In most trusts, the Settlor and Beneficiary are different people. In a self-settled trust, the Settlor is also a Beneficiary. In concept, the idea is incredible: contribute any amount of property to the trust and while creditors can’t touch it, you can enjoy it as much as you want. The reality is that these arrangements just don’t work as advertised.

Public policy has long been clear that you cannot settle a trust for your own benefit and at the same time shield the trust assets from your potential creditors. The Uniform Trust Code states that a creditor of a settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.[1] In other words, if a Settlor/Beneficiary has access to trust cash, property, vehicles, etc., so does a creditor.

Offshore jurisdictions were the first to market self-settled trusts by promising protections in a foreign jurisdiction that is not bound by the laws of the United States. In 1997, Alaska was the first state to enact a DAPT statute. Since then, over a dozen United States jurisdictions have enacted DAPT statutes. However, creditor attorneys have developed successful techniques to pierce these trusts. By frequently siding with creditors in these cases, courts have rebuffed the zeal of offshore and domestic jurisdictions to establish and promote self-settled trusts as superior asset protection tools.

Court Cases Defeating Domestic Asset Protection Trusts (DAPTs)

When it comes to self-settled trusts, there is an elephant in the room and that elephant has a name: Bankruptcy. In states that don’t recognize self-settled trusts, a debtor’s interest in a self-settled trust is subject to bankruptcy.[2] The Mortensen case made clear that Federal Bankruptcy Law can even defeat a self-settled trust in states that recognize, protect, and advocate self-settled trusts.[3] In Mortensen, an Alaska resident created a self-settled trust under Alaska’s DAPT statute under ideal circumstances: he was solvent and there were no judgments against him. Several years later he ended up in a bankruptcy court sitting in Alaska. The court applied Federal Bankruptcy Law instead of Alaska law ruling that the trust assets were reachable by the creditors in the bankruptcy under Section 548(e) of the Federal Bankruptcy Code.[4]

Another problem with a DAPT is a potential lawsuit arising in a state that does not recognize or protect self-settled trusts. In Dexia Credit Local v. Rogan, the Seventh Circuit Court ruled that despite the debtor’s trust having been created in a DAPT state, Illinois law applied instead.[5] Another huge blow to DAPTs came on May 17, 2013 in Waldron v. Huber where, among other things, Washington State law applied rather than Alaska law where the DAPT was formed.[6] The result was that the trust assets were not protected. Based on the Dexia Credit and Huber cases, one shouldn’t expect that a self-settled trust will be upheld in a state that does not allow them. Numerous other cases indicate that a court can apply the law of the state where the court is located and not recognize the laws of the state where an entity was formed.[7]

If self-settled trusts don’t work in bankruptcy and don’t protect against laws of DAPT unfriendly states, then you can just avoid declaring bankruptcy and avoid contacts outside of your DAPT friendly state, right? Not so fast. Unfortunately, even if you are careful not to get sued in the wrong state and manage to avoid voluntary bankruptcy, your creditors could file an involuntary bankruptcy petition against you. The court cases and the bankruptcy code have shown that even though a self-settled trust is created pursuant to a DAPT statute, the trust is still vulnerable.

Court Cases Defeating Offshore Trusts, aka Foreign Asset Protection Trusts (FAPTs)

Many asset protection promoters claim that offshore trusts are impermeable, in contrast to the absence of a single court case to support their claims. Why do they sell a product that has such an abominable record? It’s a calculated risk that the resulting liability of a few failed trusts that are actually challenged will be vastly overshadowed by those that are never tested. In other words, they know that the majority of their clients will never get sued or go bankrupt. For those who are sued or face bankruptcy however, if the trust is self-settled, its assets are not protected.

Although promoters of FAPTs claim foreign laws protect you because the trust is not subject to the jurisdiction of U.S. Courts, there are many court cases showing how offshore trusts fail. For example, it is well established that an offshore trust cannot protect onshore assets.[8] Numerous other cases show that even though a court in the United States may not have jurisdiction over the FAPT, they have jurisdiction over the debtor and can order the debtor to repatriate the trust assets or face incarceration for contempt. In In re Lawrence the debtor was jailed for over six years for refusing to repatriate assets, in Bank of America v. Weese the debtors paid settlement of over $12,000,000 in order to avoid incarceration, and in U.S. v. Plath the debtor was held in contempt for refusing to obey the court order to disclose details about offshore accounts despite the fact that there was no fraudulent transfer.[9] These are just a few lowlights of the long list of failed FAPT strategies.

For a time, offshore trust peddlers used US v. Grant as the one court case that supported their strategy, because it was the single case where a court did not hold the debtor in contempt. The purported steel bulwark of the Grant opinion came crashing down when, in the Spring of 2013, a Florida court ruled against the very strategy FAPT promoters touted, dealing a huge blow to the offshore asset protection industry.[10] In Grant, Raymond Grant created two self-settled trusts offshore (FAPTs), one for his own benefit and one for the benefit of his wife. Raymond funded both FAPTs at a time when he was solvent and had no known claims against him, once again ideal circumstances. Years later, Raymond died and the IRS obtained a $36 million dollar judgment against Raymond’s wife Arline. The U.S. moved to hold Arline in contempt of court for failing to repatriate the assets in the offshore trusts to pay the tax liability. Initially, the court refused to do so because Arline had never exerted control or received benefits from these trusts. But later when it was proven that Arline had received funds from the trust through her children’s accounts, the court issued a permanent injunction prohibiting Arline and her children from ever receiving any benefits from the trusts. Ultimately a very expensive “asset protection” strategy kept the assets protected from creditors, but also out of reach of those the trust was created to benefit. If your goal is to protect assets from both creditors and yourself, an offshore trust may be a great fit. If, however, you seek any self-settled benefits at all, look elsewhere.

Solution – Non-Self-Settled Trust

The alternative to the self-settled trust is simple, remove the one aspect of the trust that creates all of its vulnerability; make the trust non-self-settled. A non-self-settled trust, aka third party trust, has the support of state and federal statutes, the federal bankruptcy code, and an overwhelming number of court cases. Since the Settlor is not a beneficiary, the creditors of the Settlor cannot reach the trust assets, even in bankruptcy.[11] A properly drafted third party trust can still benefit the settlor without disrupting the asset protection. The settlor could potentially benefit from the trust through a spouse who is a beneficiary. For example, the settlor could live in a trust owned residence free from rent so long as the spouse is a beneficiary.[12] The settlor could be an income only beneficiary and still protect the trust principal.[13] The settlor could also maintain flexibility by appointing a trust protector or through the use of a special power of appointment.

If the trust has discretionary spendthrift language, the assets are also shielded from the creditors of the beneficiaries. If Raymond Grant had created a non-self-settled discretionary spendthrift trust for his wife Arline, instead of creating the two FAPTs that failed, the assets would have been protected from the IRS judgment and Arline and other trust beneficiaries could still have benefitted from the trusts. For example, the trust could have purchased a home for Arline to live in and paid Arline’s credit card bills.[14]

If true asset protection is the goal, consumers and especially promoters should remember the old adage that pigs get fat and hogs get slaughtered. The court cases make it clear that a non-self-settled trust provides proven asset protection, whereas a self-settled trust lays out the welcome mat, flips on the light, and leaves the front door wide open to creditors. If you self-settle, you settle for an inferior trust.

[1] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2), and Restatement (Third) of Trusts Section 58(2).

[2] Federal Bankruptcy Code 11 U.S.C. 541. See also In re Simmonds, 240 B.R. 897 (8th Cir. BAP (Minn.) 1999).

[3] In re Mortensen, Battley v. Mortensen, (Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011).

[4] 11 U.S.C. 548(e).

[5] Dexia Credit Local v. Rogan 624 F. Supp 2d 970 (N.D.Ill. 2009).

[6] Waldron v. Huber (In re Huber), 2013 WL 2154218 (Bk.W.D.Wa., Slip Copy, May 17, 2013).

[7] American Institutional Partners, LLC v. Fairstar Resources, Ltd. (where Utah law applied against a Delaware-formed LLC), 2011 WL 1230074 (D.Del., Mar. 31, 2011), Malone v. Corrections Corp. Of Am., 553 F.3d 540, 543 (7th Cir. 2009) (a district court in diversity applies the choice-of-law rules of the state in which it sits).

[8] In re Brooks, 217 B.R. 98 (D. Conn. Bkrpt. 1998) (where the offshore trust was disregarded because it was self-settled and the onshore assets were seized).

[9] In re Lawrence, 279 F.3d 1294 (11th Cir. 2002), Bank of America v. Weese, 277 B.R. 241 (D.Md. 2002), and U.S. v. Plath, 2003-1 USTC 50,729 (U.S. District Court, So. Dist. Fla. 2003).

[10] US v. Grant, 2013 WL 1729380 (S.D.Fla., April 22, 2013).

[11] Uniform Trust Code Section 505, Restatement (Second) of Trusts Section 156(2) and Restatement (Third) of Trusts Section 58(2), In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002), Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997).

[12] Revenue Ruling 70-155, Estate of Allen D. Gutchess, 46 T.C. 554 (1966), PLR 9735035.

[13] In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002).

[14] United States v. Baldwin, 391 A.2d 844 (1978) or U.S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) (where the trust assets were not subject to tax lien because the trust was not self-settled).

Dean v. United States – Irrevocable Trust Protects Against Federal Tax Lien

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987 F.Supp. 1160

Joanne R. DEAN, et al., Plaintiffs, v. UNITED STATES of America, Defendant.

No. 96-0652-CV-W-5.

United States District Court, W.D. Missouri, Western Division.

December 4, 1997.

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Edward J. Essay, Colorado Springs, CO, for Plaintiffs.

Anita L. Mortimer, U.S. Atty’s Office, Kansas City, MO, Carol E. Schultz, U.S. Dept. of Justice, Tax Div., Civil Trial Section, Washington, DC, for Defendant.

ORDER

LAUGHREY, District Judge.

This case was tried to the Court on November 4 and 5, 1997. Plaintiffs, as the Trustees of the George and Catherine Irrevocable Trust, assert that a wrongful levy was made on trust assets by the Internal Revenue Service (“IRS”). The government claims that the levy was proper because George and Catherine Mossie are delinquent taxpayers and the George and Catherine Irrevocable Trust is merely the alter ego of these delinquent taxpayers. The trustees claim that the trust is not the alter ego of George and Catherine Mossie, therefore, the seizure of trust property by the IRS was wrongful and the property should be returned to the trust.

The Court makes the following findings of fact and conclusions of law.

FINDINGS OF FACT

  1. In 1950, George W. Mossie married Catherine P. Mossie.
  2. In 1967, George W. Mossie and Catherine P. Mossie separated and lived apart from one another and continue to do so. During this separation, the Mossies continued to perform their respective functions in the various family businesses and were amicable in their relationship with each other.
  3. Prior to their separation, the Mossies had four children, Tom Mossie, Joanne R.

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Mossie (Dean), Janet A. Mossie and Linda L. Mossie.

  1. In 1987, the Mossies decided to equally divide part of the real property owned in their individual names. The division was done because of their long-term separation and upon the advice of their estate planning counsel. On February 23, 1987, deeds were prepared and the property was conveyed into their respective 1987 revocable trusts.
  2. In September of 1987, George W. Mossie was severely injured in an automobile accident and thereafter underwent multiple surgeries which rendered him disabled. In 1988, Catherine P. Mossie suffered a life-threatening illness from which she was not expected to recover. She also had surgery in 1989. Because of these illnesses, George and Catherine Mossie decided to transfer their assets into an irrevocable trust for the sole benefit of their children. This was done on advice of their estate planning counsel.
  3. In November of 1989, the Mossies executed the George and Catherine Irrevocable Trust (hereinafter 1990 Irrevocable Trust) naming Joanne Mossie Dean and Janet A. Mossie as the trustees. The following assets were to be transferred into the irrevocable trust.
  4. 20,000 shares of Summit Structural Steel.
  5. Fifteen duplex units, which had been acquired in 1975 in the name of George and Tom Mossie.
  6. Lake investment property which was used for family vacations.
  7. The foregoing assets were not transferred into the trust until December 4, 1990. The delay was caused by the ill health of George and Catherine Mossie.
  8. When the Mossies transferred their assets into the trust on December 4, 1990, they did not know that their 1988 tax return was being audited by the IRS. At that time, they did not know that they would be assessed back taxes by the IRS. Eventually, the IRS audited the Mossies’ 1987, 1988, 1989, and 1990 jointly-filed tax returns and did assess back taxes against them.
  9. At the time the assets were transferred into the 1990 Irrevocable Trust, the Mossies had a net worth sufficient to cover their current liabilities and the tax liability that was eventually assessed against them by the IRS.
  10. After a proceeding in the United States Tax Court to determine the tax deficiency owed by the Mossies for their jointly-filed returns for tax years 1987, 1988, 1989, and 1990, the IRS assessed back taxes and penalties against the Mossies in the amount of $281,093.95.
  11. On February 8, 1993, the Internal Revenue Service assessed a trust fund recovery penalty in the amount of $109,125.71 against George W. Mossie, Tom Mossie and Summit Structural Steel, relating to the unpaid employment taxes withheld from the wages of the employees of Summit Structural Steel pursuant to I.R.C. § 6672. This assessment was made against George W. and Tom Mossie because they were persons required to collect and truthfully account for and pay over to the United States the federal social security and income taxes withheld from the wages of the employees of Summit Structural Steel, Inc., for the taxable quarter ending June 30, 1992.
  12. On May 4, 1994, two additional real estate holdings were transferred into the 1990 Irrevocable Trust.
  13. The west 70 feet of Lot 2, Highway Lane Addition, a subdivision in Lee’s Summit, Missouri.
  14. Lot 85, Braeside Addition, a subdivision in Lee’s Summit, Jackson County, Missouri, also known as 311 Lincolnwood.
  15. Log 4, Ziegler Addition, a subdivision in Lee’s Summit, Jackson County, Missouri.

These properties were titled in the name of Alamo Real Estate Company, a company owned by George and Catherine Mossie, which was dissolved in 1994 because of financial difficulty.

  1. In 1995, notices of a federal tax lien were filed with the Recorder of Deeds for Jackson County, Missouri, and Morgan County, Missouri, against property held in the names of Joanne R. Dean and Janet A. Mossie, as co-trustees of the 1990 Irrevocable Trust. These liens were levied against

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the trustees as the nominees or alter egos of George W. Mossie and Catherine P. Mossie.

  1. The 1990 Irrevocable Trust is not the nominee or alter ego of delinquent taxpayers George W. Mossie and Catherine P. Mossie.
  2. The assets of the 1990 Irrevocable Trust are controlled by the Plaintiff trustees and not George W. Mossie and Catherine P. Mossie.
  3. Except for a brief period at the beginning of the trust when Catherine Mossie used old checks to pay for rental property expenses, all trust checks are signed by the trustees. Catherine Mossie used the old checks because she did not want to waste them.
  4. All deeds and other transfer documents are signed by the trustees.
  5. All tax returns are executed by the trustees.
  6. All promissory notes are executed by the trustees.
  7. All management decisions concerning the trust and its property are made by the trustees, not Catherine or George Mossie.
  8. George and Catherine Mossie do receive some benefits from the trust.
  9. The trustees permit Catherine Mossie to live at 311 Lincolnwood Drive, which has been the family home for the last 33 years. Catherine Mossie does not pay rent to live at 311 Lincolnwood Drive. Catherine Mossie does pay the utilities at 311 Lincolnwood Drive.
  10. The trust also provides a car to Catherine Mossie and George Mossie which is available for their personal use.
  11. The trustees would permit George and Catherine Mossie to stay at the family vacation home, but only Catherine has gone there since 1990 and only once or twice.
  12. George Mossie did not significantly benefit when the trust loaned $275,000 to Summit Structural Steel to pay employment taxes and penalties for the period ending June 30, 1992. At the time of the loan, the majority shareholder of Summit Structural Steel was the 1990 Irrevocable Trust, and the minority shareholder was Tom Mossie. When the employment taxes of Summit Structural Steel were paid off, the trust and Tom Mossie, as owners of the corporation, were the primary beneficiaries. It would be illusory to say that the loan was, therefore, for the benefit of George Mossie merely because he was also liable as an officer of the corporation.
  13. George and Catherine Mossie receive no money from the trust except reimbursement for minimal expenses incurred on behalf of the trust and for gasoline and auto maintenance.
  14. George and Catherine Mossie have provided benefits to the trust.
  15. Catherine Mossie presently manages fifteen duplex rental units which are owned by the trust. She also managed the units when they were owned by her husband and her son. She receives no compensation from the trust for her management of the rental units. She received no compensation for managing the rental property when it was owned by her husband and son.
  16. Catherine Mossie is the bookkeeper for the trust and is not paid for this service.
  17. George Mossie infrequently helps with the rental units by picking up parts needed for repairs.
  18. After the transfer of the rental units to the trust, Catherine Mossie’s responsibilities were decreased and were assumed by the trustees. Tom Mossie and the trustees now are actively involved in the maintenance, cleaning and repair of the rental units. The trustees make the ultimate management decisions concerning the rental property.
  19. Other than to recommend the bank and to introduce the trustees to the bank officers, neither George nor Catherine Mossie helped the trustees to get a loan from the LaMonte Bank to pay employment taxes owed by Summit Structural Steel.

CONCLUSIONS OF LAW

Pursuant to § 6321 and 6322 of the Internal Revenue Code (26 U.S.C., “the Code”) a tax lien in favor of the United States attaches to all properties and rights to property of a delinquent tax payer from the date the tax liability is assessed. Glass City Bank of Jeanette, Pa. v. United States, 326

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U.S. 265, 267-68, 66 S.Ct. 108, 110-11, 90 L.Ed. 56 (1945). The federal tax lien continues until the tax liability is fully satisfied or becomes unenforceable due to lapse of time. 26 U.S.C. § 6322; Guthrie v. Sawyer, 970 F.2d 733, 735 (10th Cir.1992).

The United States may also file tax liens against property held by a third party, (i.e., person other than the taxpayer) where the third party is the nominee or alter ego of the taxpayer. When such a lien has been filed, the United States may levy upon the property. See, e.g., G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-51, 97 S.Ct. 619, 627-28, 50 L.Ed.2d 530 (1977); F.P.P. Enters. v. United States, 830 F.2d 114, 117-18 (8th Cir.1987); Loving Saviour Church v. United States, 728 F.2d 1085, 1086 (8th Cir. 1984).

A third party who claims an interest in the property seized by the government may challenge the seizure in a wrongful levy action in the United States District Court pursuant to Code § 7426. In such an action, the initial burden is on the Plaintiff to prove (1) an interest in the property and (2) the tax assessment is for taxes owed by another taxpayer. The burden then shifts to the government to produce substantial evidence showing a nexus between the property and the taxpayer. The Plaintiff has the ultimate burden of proving that the levy was wrongful and should be overruled. Xemas, Inc. v. United States, 689 F.Supp. 917, 922 (D.Minn. 1988), aff’d, 889 F.2d 1091 (8th Cir.1989), cert. denied, 494 U.S. 1027, 110 S.Ct. 1472, 108 L.Ed.2d 610 (1990).

It appears that state law controls the question of whether a third party is the alter ego of the taxpayer. Aquilino v. United States, 363 U.S. 509, 513, 80 S.Ct. 1277, 1280, 4 L.Ed.2d 1365 (1960); Morgan v. Comm’r of Internal Revenue, 309 U.S. 78, 82, 60 S.Ct. 424, 426, 84 L.Ed. 585 (1940). “[I]n the application of a federal revenue act, state law controls in determining the nature of the legal interest which the taxpayer had in the property … sought to be reached by statutes.” Id. at 82, 60 S.Ct. at 426. While Aquilino and Morgan seem to clearly indicate that state law controls in a wrongful levy case such as this, there has been confusion over the issue. It appears that some federal courts have considered more than state law to determine whether a third-party is the alter ego of the taxpayer, e.g., James E. Edwards Family Trust by Edwards v. United States, 572 F.Supp. 22, 24-25 (D.N.M. 1983); Loving Saviour Church, 728 F.2d at 1086; Valley Finance, Inc. v. United States, 629 F.2d 162 (1980) (“Given the diversity of corporate structures and the range of factual settings in which unjust and inequitable results are alleged, it is not surprising that no uniform standard exists for determining whether a corporation is simply the alter ego of its owner.” Id. at 172.) One court has held, however, that the question of whether state or federal law controls is of little importance because the standards are so similar. “The issue under either state or federal law depends upon who has ‘active’ or ‘substantial control.’” Shades Ridge Holding Co., Inc. v. United States, 880 F.2d 342 (11th Cir.1989). While the Court believes that Aquilino and Morgan require application of state law in this case, the Court’s conclusion would be the same even if the additional factors suggested by the government and considered in other federal cases were also taken into account.

While the Missouri courts have never considered the alter ego doctrine in the context of a trust, the doctrine has been applied in the corporate context where an effort is being made to pierce the corporate veil. Collet v. American Nat’l Stores, Inc., 708 S.W.2d 273, 283 (Mo.App.1986). In such cases, the Missouri courts use a three-part test. An individual will be deemed to be the alter ego of a corporation when:

1) The individual completely dominates and controls the finances, policy and business practice of the other corporation.

2) Such control was for an improper purpose such as “fraud or wrong, or … unjust act in contravention of [a third parties’] legal rights.”

3) The alter ego’s control of the corporation caused injury to the third party. National Bond Finance Co. v. General Motors Corp., 238 F.Supp. 248, 256 (W.D.Mo. 1964), aff’d, 341 F.2d 1022 (8th Cir.1965); K.C. Roofing Center v. On Top Roofing, Inc., 807 S.W.2d 545 (Mo.App.1991). The alter

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ego doctrine, however, will only apply where a corporation has “no separate mind, will or existence of its own.” Thomas Berkeley Consulting Eng’r, Inc. v. Zerman, 911 S.W.2d 692, 695 (Mo.App.1995).

Because there is no Missouri law applying the alter ego doctrine to trusts, the court assumes that the same standard applied in the corporate context would be applied to trusts. At a minimum, Missouri law would require a showing that the alter ego of the trust so dominated it that the trust had “no separate mind, will or existence of its own.” Thomas Berkeley, 911 S.W.2d at 695. Applying this standard to the 1990 Irrevocable Trust, it is clear that the trust is not the alter ego of George and Catherine Mossie.

Like thousands of aging adults, George and Catherine Mossie created a trust for the benefit of their children, making it irrevocable as their health deteriorated. They did not rely on a mail order product peddled by tax protesters. They set up their trust with an estate planner from a sophisticated law firm. They executed the documents necessary to transfer the legal title of their assets to the trust, and, other than a brief period when Catherine Mossie wrote checks for the rental property using old personal checks rather than trust checks, the trustees executed all documents requiring signatures by the owner of the trust property. Tax returns were executed by the trustee. Checks were signed by the trustees. The trustees decided how to spend trust assets, when to make repairs on the rental property, and the rent to be paid by tenants. The trustees borrowed and repaid money in the name of the trust. In other words, the legal control of the trust assets has consistently been exercised by the trustee, not the taxpayer. These trusts were not a sham and did “coincide with economic reality.” F.P.P. Enters., 830 F.2d at 117. Also see James Edwards Family Trust, 572 F.Supp. at 24. While it is true that there is a family relationship between the trustees and the taxpayers, the taxpayers had forever given up the right to control the disposition of the trust property and whatever advice the taxpayer gives to the trustee can be ignored. The government minimizes the importance of legal title and legal control, but the ancient law of trust is grounded in just such distinctions.

The government is correct that practical control is an important consideration, but the Court finds that the balance weighs in favor of the taxpayer on this question as well. After the trusts were created, the behavior of the trustees and settlors changed. The trustees made the decisions about the assets and also became more actively involved in the cleaning, maintenance and rental of the duplexes. While Catherine Mossie continues to be involved in the maintenance of the rental property, it is clear that she does not control the decision-making. George Mossie is no more involved in the rental property than any parent who occasionally helps their children with business advice or runs an errand for them to pick up supplies. It is not unusual for parents to continue to help their children, even after the parents’ assets are placed in trust. Indeed, even where a parent’s assets are transferred in fee simple presently to the children, most parents continue to help. Indeed, even if parents have never transferred any property to their children, parents help children with their property. That is how families do function and should function. It would substantially undermine trust law if such behavior was sufficient to characterize the settlor as the alter ego of the trust and negate the validity of the trust.

The trust does not support George and Catherine Mossie. They receive no money from the trust except reimbursement for minimal expenses incurred on behalf of the trust. It is true that they both drive cars owned by the trust for their personal use and Catherine Mossie lives in the family home. But these facts alone are insufficient to characterize the trust as the alter ego of the taxpayers. A beneficiary of the trust could sue the trustees for failing to comply with a term of the trust, but small deviations from the trust are not enough to invalidate the whole trust.

The government attempted to show that the $275,000 loan made to Summit Structural Steel, Inc. was for the benefit of George Mossie because he was chairman of the board and, in that capacity, was liable for the

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past-due employment taxes of the corporation. Tom Mossie, however, owned 49 per cent of the stock of Summit Structural Steel and, as president of the corporation and a stockholder, was also liable for the employment taxes. More importantly, the trust owned 51 per cent of the stock and would be directly liable if the taxes were not paid. Any benefit to George Mossie under these circumstances is illusory and is certainly not enough evidence that the trust had “no separate mind, will, or existence of its own.” Thomas Berkeley, 911 S.W.2d at 695.

The fact that the trustee’s parents were permitted to use the family vacation property is de minimis given that they had little or no contact with the vacation property, did not use it even when it was in their own name and such sharing would be expected. It is also significant that at the time the property was placed in trust, the taxpayers had sufficient assets to meet their tax liability and to provide for their own personal expenses. There is no evidence that the trust was created for an improper purpose.

The cases cited by the government in support of their argument that the alter ego doctrine is applicable to this case are not persuasive because they are factually distinguishable. The government’s authority falls into two categories. The first group of cases involve trusts established by or with the assistance of tax protestors. The so-called “family” trusts give the settlor complete access to the trust property so that the settlor can use it for self-support. This is because the trustee is completely controlled by the settlor. Loving Saviour Church, 728 F.2d at 1086. (The taxpayer transferred all assets to a trust and the trust transferred the assets to a church which was established and controlled by the taxpayer. The taxpayer/settlor received all his support from the church which received all the income from the taxpayer’s chiropractic practice); F.P.P. Enters. 830 F.2d at 117 (The trust lacked the essential elements of a trust. The trust failed to identify beneficiaries and the taxpayer, not the trustee, exercised control over the trust property. The taxes on the trust property and the expenses paid to maintain the trust property were deducted from the personal income tax of the taxpayer.)

In the second group of cases cited by the government, corporations have been found to be the alter ego of the taxpayer because the taxpayer controls the corporate entity. Wilcox v. United States, 983 F.2d 1071 (6th Cir.1992) (Table); 1992 WL 393581 (unpublished per curium opinion) (The corporation and trust were the alter ego of taxpayer/anesthesiologist because the taxpayer commingled corporate, individual and pension property and as the only shareholder and officer of the corporation and as the only trustee of the pension had complete control over the disposition of corporate and pension property. Wolfe v. United States, 798 F.2d 1241 (9th Cir.1986), cert. denied, 482 U.S. 927, 107 S.Ct. 3210, 96 L.Ed.2d 697 (1987) (Wolfe was deemed to be the alter ego of corporation/taxpayer because Wolfe was the sole shareholder of the corporation and, as the director and president of the corporation, made all corporate decisions without consulting with the other directors. Corporate expenses, including personnel costs, were paid from a sole proprietorship operated by Wolfe and all income of the corporation was put into the sole proprietorship’s bank account); Ames Investment, Inc. v. United States, 819 F.Supp. 666 (E.D.Mich.1993), aff’d, 36 F.3d 1097, 1994 WL 529863 (6th Cir.1994) (A corporation was formed to purchase and manage real estate. The first property purchased was a house which was used as the personal residence of the taxpayer who was a shareholder and director of the corporation. This house was the most valuable asset of the corporation. It was never rented or used as an office. There were never any corporate meetings and there was no capitalization of the corporation or any profit from the corporation.)

The common thrust of all these cases is that the alter ego doctrine will apply when the delinquent taxpayer is really in control of the corporation or trust and so dominates it that the corporation or trust form exists, but there is no substance to it. As already discussed, the 1990 Irrevocable Trust is a valid trust instrument, created for a valid purpose, comports with economic reality, and the trustees, in most aspects, have respected the terms of the trust. To permit the alter ego doctrine to apply in such a case would require

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an expansion of the alter ego doctrine which the Court is unwilling to do without clearer direction from Congress or the Missouri courts. The Court, therefore, finds that the levies by the IRS against the assets of the George and Catherine Irrevocable Trust of December 4, 1990, was unlawful. The property seized by the IRS pursuant to the levies shall be returned to the trustees and all tax liens related to the unlawful levies shall be released. The Plaintiffs’ request for damages and attorneys’ fees is denied.

One troubling aspect of this case is the fact that the family home was deeded to the trust but Catherine Mossie has continued to control and occupy the home since the formation of the trust. The trustees acknowledged at trial that they and the Mossies have always understood that Catherine Mossie would continue to occupy the house until her death. Catherine Mossie also holds a deed of trust against the house which secures a promissory note in favor of Catherine Mossie. That promissory note is in default and has been since the property was transferred into trust. Catherine Mossie has the beneficial interest in the property during her lifetime and holds the key to the legal title at any time that she chooses to foreclose on the property. While it is true that the trust holds legal title until foreclosure, effectively Catherine Mossie controls the future disposition of the family home. While an argument could be made that the house was never a part of the trust, even though legal title was transferred to it, the government has insisted during this litigation that the house was properly placed in trust and is subject to the trust. The government’s position, therefore, forecloses a finding that the house is subject to the IRS levy because it is the property of the delinquent taxpayer, Catherine Mossie, not the property of the trust. The Court’s decision in this case, however, does not preclude the IRS from levying on property owned by Catherine Mossie, such as the promissory note and deed of trust on the property at 311 Lincolnwood. The only issue before this Court, however, is whether the levy by the IRS against the assets of the trust was wrongful. The Court has rejected the government’s argument that the 1990 Irrevocable Trust is the alter ego of George and Catherine Mossie and, therefore, the IRS levy on the trust property was wrongful and the trust property must be returned to the trust and the liens released from the trust property.

CONCLUSION

Accordingly, it is hereby ORDERED that:

  1. Judgment be entered in favor of Plaintiff trustees.
  2. The property of the 1990 Irrevocable Trust which has been seized by the IRS to satisfy the tax liability of George and Catherine Mossie shall be returned to the trustees.
  3. The 1995 tax liens filed with the Recorder of Deeds for Jackson County, Missouri, and Morgan County, Missouri, against property held in the name of Joanne R. Dean and Janet A. Mossie as co-trustees of the 1990 Irrevocable Trust shall be forthwith release.
  4. The Plaintiffs’ request for damages and attorneys’ fees is denied.

Law and Precedent Supporting the 541 Trust®

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STATEMENT OF THE LAW

Our 541 Trust® is built on two irrefutable legal principles:

1.         With respect to an irrevocable trust, a creditor of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit (Essentially, if the trust is self-settled, it is vulnerable).  See Uniform Trust Code Section 505; RESTATEMENT (SECOND) OF TRUSTS Section 156(2) and RESTATEMENT (THIRD) OF TRUSTS Section 58(2). This principle has been adopted in hundreds of cases throughout the country and many states have enacted statutes with this identical language. For example, see Alabama Code Section 19-3B-505; Ariz. Rev. Stat. Ann. §14-7705; Cal. Prob. Code § 15304; Ga. Code Ann. § 53-12-28(c); Florida Trust Code Section 736.0505(b); Ind. Code Ann. § 30-4-3-2; Kan. Stat. Ann, §33-101; La. Rev. Stat. Ann.§2004(2); Michigan Code Section 7506(c)(2), Mo. Ann. Stat. § 456.080.3(2); Mont. Code Ann. § 72-33-305; N.Y. Civ. Prac. L. & R. § 5205(c); Ohio Code Section 5805.06; Okla. Stat. Ann. tit. 60, §175.25G; Pennsylvania Code Title 20 §7745; R.I. Gen. Laws § 18-9.1-1; Tex. Prop. Code Ann. §112.035(d); Utah Code Section 75-7-505(b); Virginia Code Section 55-545.05 ); W. Va. Code §36-1-18 (1985); Wis. Stat. Ann. §701.06(1).

2.         A settlor can retain a special power of appointment without subjecting the trust to the claims of creditors.   See RESTATEMENT (THIRD) OF PROPERTY: WILLS AND OTHER DONATIVE TRANSFERS Section 22.1; US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681; Delaware Code Section 3536; Georgia Code Section 23-2-111; New York Code 10-7.1; Also see cases set forth below.

APPLICATION OF LAW TO THE 541 TRUST®

The 541 Trust® is an irrevocable trust that includes the following features:

1.         The settlor is not a beneficiary and no distributions can be made to or for the settlor’s benefit.

2.         The settlor retains a “special power of appointment” which allows the settlor to change the trustees, the beneficiaries, or the terms of the 541 Trust® at any time (except that the assets cannot be distributed to or for the settlor’s benefit). In addition, the settlor can appoint assets to any other person at any time.

Creditors have no claim against the 541 Trust® because no distributions can be made for the settlor’s benefit. The cases and statutes set forth below show that these powers of appointment do not give creditors any claim against the 541 Trust®.  There are no statutes, cases, secondary sources or commentaries to the contrary.

COURT CASES

In re Jane McLean Brown, D. C. Docket No. 01-14026-CV-DLG (11th Cir. 2002) – Defendant funded irrevocable trust and retained an income interest and a special power of appointment over principal. 11th Circuit analyzes creditor’s access to an irrevocable trust. The trust principal was not included in the defendant’s bankruptcy estate. To read the case, follow this link: In re Jane McLean Brown

In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH)) – Assets of an irrevocable trust were not subject to the creditors of the settlor despite the fact that the trustees and beneficiaries had power to appoint the assets to the settlor.

Shurley v. Texas Commerce Bank, 115 F.3d 333 (5th Cir. 1997) – 5th Circuit Court holds that the portion of the trust that was not self-settled is not included in the bankruptcy estate, and assets subject to a special power of appointment are excluded from the bankruptcy estate. To read this case, click Shurley v. Texas Commerce Bank                 

In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982) – A court cannot compel the exercise of a special power of appointment and the assets of the trust were not included in the bankruptcy estate of a permissible appointee. To read this case, click In-re-Hicks

In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994) – The interest of a contingent beneficiary was included in the bankruptcy estate, but the interest of a permissible appointee of a power of appointment was too remote to be property and was not included in the bankruptcy estate. To read this case, click In re Knight

In re Colish, 289 B.R. 523 (Bankr.E.D. N.Y. 2002) – The interest of a contingent beneficiary was included in the bankruptcy estate. The court distinguished this from Knight and Hicks where the interest of a permissible appointee under a power of appointment was not included. To read this case, click Colish-v-United-States

Cooley v. Cooley, 628 A.2d 608 (1993) – A special power of appointment is not a part of the marital estate that can be awarded in a divorce action. As one of the possible objects of the defendant’s power, the plaintiff possesses no more than a mere expectancy. To read this case, click Cooley-v-Cooley

 Cote v. Bank One, Texas, N.A., No. 4:03-CV-296-A, 2003 WL 23194260 (N.D. Tex. Aug. 1, 2003) – Permissible appointee is not an “interested person” with standing to sue the trust. This is relevant because if the permissible appointee has no standing to sue the trust, neither should a creditor of a permissible appointee.

Avis v. Gold, 178 F.3d 718 (1999) – Permissible appointee had no interest which could be included in the bankruptcy estate, or to which an IRS tax lien could attach, prior to the time the power was exercised in favor of the debtor.

Horsley v. Maher, U.S. Bankruptcy Ct. Case No. 385-00071 (1988) – debtor was a permissible appointee of Trust A and a beneficiary of Trust B. Trust A was not included in the bankruptcy estate because “the debtor holds no interest in Trust A.” The assets of Trust B were included in the bankruptcy estate.

  1. S. v. O’Shaughnessy, 517 N.W.2d 574 (1994) – Assets subject to discretionary special power of appointment not subject to tax lien

Spetz v. New York State Dep’t of Health, 737 N.Y.S. 2d 524 (Sup. Ct. Chautauqua Co, Jan. 15, 2002) – New York Supreme Court holds that special power of appointment does not cause trust assets to be taken into account for purposes of Medicaid qualification

Verdow v. Sutkowy, 209 F.R.D. 309 (N.D.N.Y. 2002) – Assets subject to special power of appointment not taken into account for purposes of Medicaid qualification

United States v. Baldwin, 391 A.2d 844 (1978) – Assets subject to special power of appointment not subject to tax lien

Estate of Ballard v. Commissioner, 47 BTA 784 (1942), aff’d, 138 F.2d 512 (2nd Cir. 1943) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Kneeland v. COMMISSIONER OF INTERNAL REVENUE, 34 BTA 816 – Board of Tax Appeals (1936) – Assets of trust not included in husband’s estate merely because wife had the power to return the assets to the husband.

Helvering v. Helmholz, 296 US 93 (Supreme Court 1935) – Assets of trust not included in wife’s estate merely because the beneficiaries had the power to terminate the trust and return the assets back to the wife.

Price v. Cherbonnier, 63 Atl 209 (1906) – Creditors of the donee of a special power of appointment cannot reach the assets subject to the power.

Gilman v. Bell, 99 Ill. 194 (1881) – Assets subject to power of appointment not subject to claims of creditors.

Jones v. Clifton, 101 US 225 (1879) – Assets subject to power of appointment not subject to claims of creditors.

Holmes v. Coghill, 33 Eng. Rep 79 (1806) – Assets subject to power of appointment not subject to claims of creditors.

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For an excellent summary of the law supporting this kind of trust (from an unrelated law firm), see Asset Protection Planning with Trusts – A Practical Overview by Alexander A. Bove, Jr. published in Journal of Practical Estate Planning (CCH Inc., April-May 2002).

How to Attack an Asset Protection Trust and How to Defend Against Such an Attack

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If you read all the asset protection cases out there, you will find that there are really only three ways to attack a well crafted asset protection trust: (1) attempt to prove that the transfers to the trust were fraudulent transfers, (2) attack a self-settled asset protection trust by using the laws of a state or jurisdiction that doesn’t recognize self-settled trusts, or (3) attack the trust based on several related theories referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory. For purposes of this article, the third category will be referred to as “veil piercing.”

Fraudulent Transfers

It is easy to completely avoid and prevent an attack based on a fraudulent transfer theory. You simply transfer your assets to your asset protection trust in advance of a problem, lawsuit, or bankruptcy. Note that the courts analyze fraudulent transfers based on if a prudent person in your situation might or could have foreseen liability given the circumstances. 

For example, in Albee v. Krasnoff,[1] Mr. Krasnoff was a fifty percent owner of an investment partnership with hundreds of investors. Mr. Krasnoff conveyed a home to an irrevocable trust for his wife. Five years later it was discovered that Mr. Krasnoff’s partner had embezzled money from the partnership. All the investors lost money and sued the partnership as well as Mr. Krasnoff and his partner. The investors argued that the transfer to the trust was fraudulent because it occurred after the investment had been made, but the court ruled that the transfer was not fraudulent because it was done for estate planning purposes and Mr. Krasnoff had no knowledge of the fraud or the potential claim when the transfer was made.

In another court case called, In the Matter of Damrow,[2] the court examined two separate transfers by the same person, and the court found that one of them constituted a fraudulent transfer, and the other did not. When the first transfer was made, in January of the year 2000, Mr. Damrow had guaranteed significant loans to several lenders, but he was not behind on payments. When the second transfer was made, in November of 2001, Mr. Damrow was behind on payments and several creditors had initiated collection activities. The court found that the second transfer was fraudulent because Mr. Damrow was insolvent when he made it, and the first transfer was not fraudulent because he was not insolvent when the first transfer was made.

If you make a transfer with actual intent to hinder, delay, or defraud a creditor, or if you make a transfer at a time and under circumstances that appear to be a fraudulent transfer, then a creditor can obtain a judgment against the trust regardless of how well the trust is designed and drafted. Countless court cases make it unmistakably clear that no asset protection trust, domestic or offshore, can be relied upon to protect assets if the transfers are made at a time and under circumstances that are likely to result in a fraudulent transfer.

Even if you do have a current lawsuit or judgment against you, you may be able to make a transfer to an asset protection trust that is not a fraudulent transfer if you retain sufficient assets in your name to satisfy the pending judgment. The test that is used to determine if a transfer is fraudulent is based on your specific facts and circumstances. If you have any question whether a transfer could be considered fraudulent, you should consult legal counsel regarding your specific situation.

In summary, the best way to defend against a fraudulent transfer attack is to create and fund your asset protection trust at a time when you are not insolvent, the transfer does not render you insolvent, you have no judgments against you, you are not behind on payments, and you have no reason to believe that substantial liabilities or judgments are imminent. If you do so, the fraudulent transfer attack is avoided and you can move on to the next phase of the analysis.

Self-Settled Trusts

The common law rule in the United States has always been that if a settlor is also a beneficiary of a trust, the settlor’s creditors can reach the maximum amount which the trustee can pay to the settlor. (See Restatement (Second) of Trusts, Section 156 and Uniform Trust Code Section 505). Over the past thirty years, several domestic and offshore jurisdictions have passed statutory laws providing that the assets of a self-settled trust (a trust in which the settlor is also a beneficiary) are protected from creditors. Almost all offshore and domestic asset protection trusts are based on these new laws which provide asset protection for a self-settled trust.

If you create a self-settled asset protection trust in a supportive jurisdiction, a creditor could attack your trust by arguing that the law of a different jurisdiction applies. For example, if you create a Delaware asset protection trust, a creditor from New York may argue that New York law applies instead of Delaware law because the offense occurred in New York and the offended party is a resident of New York. Because the laws of the State of New York do not allow a debtor to protect assets in a self-settled trust, the New York courts could potentially allow a New York resident to obtain a judgment against the trust. Similarly, it is possible that a federal court (including a bankruptcy court) could refuse to recognize the laws of a jurisdiction that provides asset protection for a self-settled trust. Because domestic self-settled asset protection trusts have only been around for 13 years, there are no court cases on this issue at the present time. There are however, two federal bankruptcy cases where the bankruptcy court has refused to recognize the self-settled trust laws of a foreign jurisdiction because it is against the policy of the federal bankruptcy courts.[3]

In the Portnoy case cited above, Judge Brozman of the Federal Bankruptcy court said, “I think it probably goes without saying that it would offend our policies to permit a debtor to shield from creditors all of his assets because ownership is technically held in a self-settled trust.”[4]

In Dexia Credit Local v. Rogan,[5] Dexia sued Peter Rogan for fraud, conspiracy, and other torts and obtained a judgment against him for $124,000,000. Rogan had established a trust under Bahamian law which protects the assets of a self-settled trust from the creditors of the grantor. The Illinois court said that it would not honor the laws of a jurisdiction where doing so would violate the public policy of the State of Illinois.

You can avoid an attack based on a self-settled trust theory by simply not using a self-settled trust. If you create an irrevocable trust for your spouse and children and you are not included as a beneficiary, the risk of an attack based on a self-settled trust theory is completely eliminated.

There are other ways that you can potentially receive benefits from a trust without being included as a beneficiary. For example, you could receive a salary for managing companies owned by a trust. Or, the trust could provide distributions to your spouse, which your spouse could later transfer to you as a gift or allow you to enjoy as a collateral benefit of being married to a wealthy spouse. Another option is to grant your spouse or some other person a special power of appointment. This is a power to appoint the assets of a trust to anyone except for the person who holds the power (or their estate or their creditors). The special power of appointment could be used to provide benefits to you if necessary, even though you are not a beneficiary of the trust. Many statutes and cases support the fact that a special power of appointment does not create creditor rights.[6]

In summary, you can avoid an attack based on a self-settled trust theory by not using a self-settled trust. However, this creates other risks because it means that you are left out as a beneficiary. The best way to solve this problem is to include a special power of appointment in the trust, and design a system of trustees and trust protectors that ensures that no person has power to abuse the trust.

Veil Piercing

The only other way to attack an asset protection trust is to argue that the trust is not to be respected as a separate legal entity from the debtor. This attack is often referred to as reverse veil piercing, alter-ego, constructive trust, or the sham transaction theory. There are many court cases discussing and applying these theories to determine if a creditor can pierce an irrevocable trust.

For example, in Dean v. United States,[7] George and Catherine Mossie established an irrevocable trust for the benefit of their children for estate planning purposes. They transferred assets to the trust on December 4, 1990. At the time the transfer was made, they were not aware that their tax return from 1988 was being audited. Later the IRS, audited all their returns from 1987 to 1990 and assessed back taxes and penalties against the Mossies in the amount of $281,093.95. The IRS placed a federal tax lien on the assets of the trust by claiming that it was the alter-ego of the Mossies, and the trustees sued to have the lien removed.

It is interesting to note the following facts pertaining to the alter-ego analysis:

  1. Except for a brief period at the beginning of the trust when Catherine Mossie used her personal checking account to pay rental expenses for the trust property, all trust checks were signed by the trustees and not the Mossies.
  2. All deeds, transfer documents, tax returns, and promissory notes pertaining to the trust were signed by the trustees.
  3. All management decisions concerning the trust were made by the trustees.
  4. The trustees did allow Catherine Mossie to live in a home owned by the trust without rent.
  5. The trust owns a car which it makes available for the personal use of George and Catherine Mossie.
  6. The trust owns a vacation home which it has made available to Catherine without rent, once or twice.
  7. George and Catherine Mossie have received no money from the trust, except for reimbursement for nominal trust expenses paid by the Mossies.
  8. The trustees were two of the Mossie’s four daughters.

The court recited the general rule for applying the alter-ego doctrine which is that a separate entity will be respected unless it was so dominated that it had “no separate mind, will or existence of its own.” The court found that the Mossies had established the trust for legitimate estate planning purposes and that the legal control of the trust assets had shifted to the trustees. It is true that the trustees had allowed the Mossies to receive some collateral benefits from the trust but the court said that is how families do function and should function and small deviations from the trust are not enough to invalidate the whole trust. In the end, the court ordered the IRS to return the trust property to the trustees and release the tax liens against the trust property.

Another example is the case called, In re Vebeliunas.[8] In the Vebeliunas case, a wife established an irrevocable trust for her husband (the “debtor”), naming herself as the sole trustee. The court found that the creditor was not able to pierce the veil of the trust, despite the following facts: (1) the debtor was indicted for fraud, (2) the debtor filed for bankruptcy to obtain relief from his creditors, (3) the bankruptcy court sought to have the debtor declared the alter ego of the trust and to have the trust assets treated as part of debtor’s bankruptcy estate, (4) the debtor’s family received and retained rent proceeds from trust, (5) the debtor and his family lived on property owned by the trust without paying rent to the trust; (6) the debtor granted easements on property owned by the trust, (7) the debtor and his wife deducted from their personal tax returns real estate taxes and interest expenses relating to the trust, (8) the debtor granted mortgages on property owned by the trust, (9) the debtor pledged the trust property in order to obtain bail in his criminal case; and (10) the debtor represented to several banks that his revocable trust owned the property which was actually owned by the irrevocable trust. Although the debtor probably pushed the limits of dominion and control over the trust in this case, this case illustrates the fact that a court will generally uphold an irrevocable trust as a separate and distinct legal entity unless the debtor exerts so much dominion over the trust that it has no separate identity.

Similarly, in Miller v. Kresser,[9] a mother created a trust for her son and named another son as the trustee. The beneficiary son was sued for over $1,000,000. The trial court found that the beneficiary son exerted significant control over the trust by taking money out without the trustee’s knowledge, dominating investment decisions, and keeping possession of the trust checkbook. The Florida 4th District Court of Appeals upheld the creditor protection provided by the trust even though “the facts in this case are perhaps the most egregious example of a trustee abdicating his responsibilities . . . the law requires that the focus must be on the terms of the trust . . . and the trust did not give the beneficiary any authority whatsoever to manage or distribute trust property.”

We think these cases demonstrate the fact that a court will generally uphold the separate existence of a trust, just as they generally uphold the separate existence of a corporation, unless the facts are so egregious as to indicate a total disregard of the legal entity so that it becomes the alter-ego of the debtor.

The solution to avoiding these attacks is really quite simple: (1) the trustee should demonstrate control over the trust and abide by the terms of the trust instrument, (2) the presence of an independent trustee is not required, but it goes a long way to show that the trust is a separate legal entity from the grantor or the beneficiaries, (3) the grantor and beneficiaries should not exert so much control or dominion so that they appear to be the owners of the trust assets, (4) the benefits of the trust should be reserved for the beneficiaries, and (5) transactions with the trust should be on the same terms as would be expected between unrelated parties.

Another way to defend against the veil piercing type of attack is to locate the trust in a state with greater asset protection laws. Currently, the best states are Nevada, Alaska, and South Dakota. A person in any state can create a trust in one of these locations by appointing a trustee in the state where they want the trust to be located. Consider the language of these Nevada Statutes which are designed to protect against a veil piercing attack:

NRS 163.4177 Factors which must not be considered exercising improper dominion or control over trust. If a party asserts that a beneficiary or settlor is exercising improper dominion or control over a trust, the following factors, alone or in combination, must not be considered exercising improper dominion or control over a trust:

  1. A beneficiary is serving as a trustee.
  2. The settlor or beneficiary holds unrestricted power to remove or replace a trustee.
  3. The settlor or beneficiary is a trust administrator, general partner of a partnership, manager of a limited-liability company, officer of a corporation or any other manager of any other type of entity and all or part of the trust property consists of an interest in the entity.
  4. The trustee is a person related by blood, adoption or marriage to the settlor or beneficiary.
  5. The trustee is the settlor or beneficiary’s agent, accountant, attorney, financial adviser or friend.
  6. The trustee is a business associate of the settlor or beneficiary.

NRS 163.418 Clear and convincing evidence required to find settlor to be alter ego of trustee of irrevocable trust; certain factors insufficient for finding that settlor controls or is alter ego of trustee of irrevocable trust. Absent clear and convincing evidence, a settlor of an irrevocable trust shall not be deemed to be the alter ego of a trustee of an irrevocable trust. If a party asserts that a settlor of an irrevocable trust is the alter ego of a trustee of the trust, the following factors, alone or in combination, are not sufficient evidence for a court to find that the settlor controls or is the alter ego of a trustee:

  1. The settlor has signed checks, made disbursements or executed other documents related to the trust as the trustee and the settlor is not a trustee, if the settlor has done so in isolated incidents.
  2. The settlor has made requests for distributions on behalf of a beneficiary.
  3. The settlor has made requests for the trustee to hold, purchase or sell any trust property.
  4. The settlor has engaged in any one of the activities, alone or in combination, listed in NRS 163.4177.

Conclusion

In our experience, most properly designed asset protection trusts are never discovered in the first place. If you are sued or subject to some kind of unexpected liability, the creditor will ask for your personal financial statements. Because you have no ownership in the trust or its assets, they should not be included on your personal financial statements. If your trust is funded more than two years before you file bankruptcy, the trust is usually not discovered through a typical bankruptcy proceeding.

Although an asset protection trust is not discovered in the majority of cases, one should never rely solely on secrecy to defend against every attack. A sophisticated creditor can always get you under oath and ask enough of the right questions to discover the trust. If that happens to you, you should always answer honestly and with confidence that your trust was established for appropriate purposes and that it will hold up on its own merits. The best asset protection trust has the following characteristics: (1) it is funded in advance of a problem, (2) it is created for legitimate estate planning purposes, (3) it is an irrevocable trust that does not include the grantor as a beneficiary, (4) it includes an independent professional trustee in the State of Nevada (although it is possible to use a family member or friend in your home state as long as the parties respect the trust as a separate legal entity), and (5) it includes a special power of appointment which provides flexibility to the trust despite the fact that the trust is irrevocable.

[1] 566 SE 2d 455 (Ga.Ct. Appeals 2002).

[2] Case No. BK02-43392 (Bankr.Neb. 3/13/2007) (Bankr.Neb., 2007).

[3] See In re Portnoy, 201 B.R. 698, and In re Brooks, 217 B.R. 98.

[4] In re Portnoy at 700.

[5] 624 F. Supp. 2d 970 (N.D. Illinois 2009).

[6] See US Bankruptcy Code Section 541(b)(1), California Probate Code Section 681, Delaware Code Section 3536, In Estate of German, 7 Cl. Ct. 641 (1985) (85-1 USTC Par 13,610 (CCH), In re Hicks, 22 B.R. 243 (Bankr. N.D.Ga.1982), In re Knight, 164 B.R. 372 (Bankr.S.D.Fla.1994), RESTATEMENT OF THE LAW (SECOND) PROPERTY, Section 13.6.

[7] 987 F. Supp. 1160 (December 4, 1997).

[8] 332 f. 3D 85 (Ct. Appeals 2nd Cir. 2003).

[9] 2010 Fla. App Lexis 6152.

Why You Can’t Rely on a Wyoming LLC for Asset Protection Purposes

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For many years, asset protection planners have believed and promoted the idea that an out-of-state resident could take advantage of the strong charging order laws in another state by filing their LLC in another state.  Recent cases show that this does not work.

In American Institutional Partners, LLC v. Fairstar Resources, Ltd., 2011 WL 1230074 (D.Del., Mar. 31, 2011), a Utah resident established several Delaware LLCs with the hope that they could take advantage of the better charging order statute in the State of Delaware. When the Utah resident was sued in a state court in Utah, the Utah court stated “that Utah law applies to all execution proceedings in this matter, including the foreclosure of a member’s interest in a limited liability [company], whether such company is domestic or foreign.” In other words, the Utah court used their own law and ignored the law of the state where the LLC was filed.

This means that you shouldn’t believe those who heavily advertise the use of a Wyoming LLC for asset protection purposes, because if you are sued in a state outside of Wyoming, the court will probably use their own law and you won’t get the benefits of a Wyoming LLC.