Recently, Alaska and Delaware have enacted statutes which permit self-settled trusts which are protected under Alaska and Delaware statutes, from the reach of creditors while still permitting the grantor to retain certain rights to income and principal from the trust. As a result of this recent legislation, Alaska and Delaware Trusts have become intriguing tools for both asset protection as well as long term wealth transfer planning. This article will outline the two statutes and highlight for estate planner some of the benefits as well as the risks associated with these trusts.
Most trusts include spendthrift provisions that protect trust assets from being attached by a creditor of a beneficiary of the trust. Until recently, however, spendthrift protection has been unavailable in the United States for a settlor of a trust who has retained a beneficial interest in the income or principal of the trust, even if the settlor has no mandatory right to such income. Thus, if the trustee of a self-settled trust could exercise discretion to pay income or principal to the settlor, then the settlor’s creditors could attach the corpus of the trust. This rule stems from the fraudulent conveyance laws of England, including Parliament’s Statute of Elizabeth, enacted in 1571 and related case law. 1 Applicable provisions of Parliament’s Statute of Elizabeth have been codified in the Uniform Fraudulent Transfers Act (UFTA), Federal bankruptcy laws and the Restatements (2d) Trusts, Section 156.22. Historically, estate planners have gone offshore to islands such as Evis, the Cayman Islands, the Cook islands, Belize, the Bahamas, Bermuda and Gibraltar to take advantage of self-settled trusts which enjoy spendthrift protection even for the settlor. These foreign jurisdictions have enabled such self-settled trusts to be established by repealing the Statute of Elizabeth. Before April of 1997, such planning was not possible in the United States. However, U.S. citizens must be willing to pay a high price to establish such off-shore trusts and continue to pay U.S. advisors to handle the somewhat onerous I.R.S. reporting requirements involved with establishing and funding such trusts.
On April 2, 1997, the Alaska Trust Act was passed. This Act has three relevant provisions and relates specifically to irrevocable transfers into trust.
A. Jurisdiction Governing Alaskan Trusts.
1. AS 13.36.035(a) was amended to state that Alaskan courts have exclusive jurisdiction over the administration and distribution of trusts, declaration of rights and the determination of other matters involving trustees and beneficiaries of "Alaska Trusts." 3
2. AS 13.36.035(d) states that matters relating to the validity,
construction and administration of a trust with Alaskan jurisdiction are determined by the laws of Alaska. Such matters within the jurisdiction of the courts of Alaska include the (i) capacity of the settler, (ii) the power, obligations, liabilities and rights of the trustee and the appointment and removal of the trustees; and (iii) the existence and extent of powers conferred or retained, including a trustee’s discretionary powers, the powers retained by a beneficiary of the trust and the validity of the exercise of a power.
3. AS 13.36.035(c) lists the qualifying features of an Alaska Trust.
Specifically, a trust will be covered under the jurisdictional provisions of the statute if: (i) some or all of the assets are deposited in Alaska and are administered by a "qualified person" (being an Alaskan domicillary, an Alaskan Trust Company or an Alaskan Bank)4; (ii) the powers of the trustee include or are limited to maintaining records for the trust on an exclusive or nonexclusive basis; preparing or arranging for the preparation of income tax returns for the trust on an exclusive or nonexclusive basis, and (iii) part or all of the administration occurs in the state of Alaska. Under the 1998 amendment to the act, a non-resident of Alaska and banks and trust companies who are not headquartered in Alaska can act as a co-trustee with a qualified Alaska Trustee and not be considered engaged in business in Alaska solely by reason of serving as co-trustee.5
B. Spendthrift Provisions. Sec. 34.40.110 provides that an Alaskan Trust
prevents a creditor from satisfying a claim out of the beneficiary’s interest in the trust unless:
1. The transfer was in whole or in part to hinder, delay or
2. The trust provides that the settlor may revoke or terminate all
or part of the trust without the consent of an adverse person6. "Revoke or terminate" does not include the power to veto a distribution from the trust; a special testamentary power of appointment or the right to receive discretionary income or principal from the trust. So, provided the right to receive income is within the discretion of a person other than the settlor, this right would not jeopardize the spendthrift provisions.
3. The trust requires that all or part of the trust’s income,
principal or both MUST be distributed to the settlor; or
4. At the time of the transfer, the settlor was in default by 30 or
more days of making a child support payment (under a judgment or order).
C. Challenges to Trusts and Statue of Repose.
1. AS 13.36.310 provides that except as provided in AS 34.40.110
(actual fraudulent transfers or with respect to trusts that are revocable, etc.), Alaskan Trusts with spendthrift provisions are not voidable on the grounds that a transfer into the trust avoids or defeats a right, claim or interest conferred by law on a person by reason of a personal or business relationship with the settlor or by way of a marital or similar right.
2. AS34.40.110(d) provides a statute of repose or elimination
period for claims, which could be brought against an Alaskan Trust. Specifically, if the person is a creditor at the time the trust was created, any action must be brought within the later of four years after the transfer is made or one year after the transfer is or reasonably could have been discovered by the person. If the person becomes a creditor subsequent to the transfer, the action must be brought within four years after the transfer was made. In any event, if a transfer is voided or set aside because it was considered a fraudulent conveyance, the trust can only be set aside to the extent necessary to satisfy the creditor and the attorneys fees allowed.7
3. Other New Provisions – 1998 Act. AS13.36.043 was amended to
make it easier to move a foreign trust to Alaska. Even if a trust was set up prior to April 2, 1997, it will still be valid under Alaska law.
On July 9, 1997, the Delaware Code was amended to permit
spendthrift protection for a settlor of a self-settled trust. The Delaware statute is very similar to the Alaska statute, with a few notable exceptions.8
A. 12 Del. Code Section 3573 states that Delaware spendthrift trust will
not be enforced with respect to:
1. Any person to whom the settlor is indebted on account of a
child support or alimony order or property distribution under
court order in favor of the settlor’s spouse, former spouse or
children to the extent of such debt;
2. A creditor who became a creditor of the settlor in reliance
upon an express written statement of the transferor that any property that was transferred to the trust was available to satisfy a debt owed by the settlor to the creditor;
3. Any person who suffers death, personal injury or property
damage on or before the date of the transfer to trust by the settlor which death, personal injury or property damage is at any time to be determined to have been caused by the settlor or by another party for whom the settlor is vicariously liable; an
4. Actual fraudulent transfers (transfers intended, in whole or in
part, to hinder, delay or defraud creditors under the Delaware fraudulent transfer law).
A. Trustee Provisions. 12 Del. Code Section 3570 (8) defines a trustee to
be, in the case of a natural person, a resident of the state, and in all other cases a Trust Company or Bank authorized under Delaware law to act as trustee. However, under the 1998 amendment, a non-resident can act as an "advisor" to the trustee. Specifically, such advisor can be and investment advisor, a distribution advisor or other advisor. It is important to note, however, that the settlor can not be a distribution advisor if such settlor has a right to income or principal.
B. Spendthrift Provisions. 12 Del. C. Section 2570 (9)(b) states that a
Delaware spendthrift trust must be irrevocable but that the settlor can retain the following rights without the trust being deemed revocable:
1. Settlor can retain a veto right on distributions;
2. Settlor can retain a special testamentary power of
3. Settlor can retain a right to income and principal in the sole
discretion of a trustee who is not the transferor nor a related or subordinate party within the meaning of the Internal Revenue Code Section 672(c)9; and
4. Settlor can retain a right to the income only of a trust or the
income and principal of the trust on the basis of an ascertainable standard.
5.Settlor cannot retain a right to revoke trust with the consent of
an adverse party, as permitted under the Alaska statute.
Tax Planning with Alaska and Delaware Trusts
A. Gift Tax Issues
If your client wishes to make a completed gift in to an Alaskan or Delaware Trust,
the client can not retain a testamentary power of appointment over the assets, a right to revoke the trust or otherwise retain an interest which would be deemed to be a "retained interest" for gift tax purposes. The Alaska Trust Company sought and received Private Letter Ruling 9837007 dated June 10, 1998 on the subject matter of a gift to an Alaskan Trust. In that letter ruling, the donor transferred property to an irrevocably trust in which he maintained a right to receive income and principal only at the discretion of the third party trustee. He did not retain a testamentary power of appointment or a right to change the trustees. Under the trust agreement, any person who is related or subordinate to the donor is prohibited from being the trustee. If the corporate trustee ever ceases to act as trustee, a representative of the Donor will appointment a successor who is not related or subordinate to the Donor. The IRS ruled that such a transfer will be deemed to be a completed gift, citing Section 25.2511-2(b) of the Gift Tax Regulations and Rev. Rul. 77-378, 1977-2 C.B. 348.10 However, the IRS refused to rule on the question of whether the transfer will be included in the estate of the donor. Without that ruling, a client must be willing to make a completed gift, pay the gift tax (or use part or all of the client’s applicable credit amount AND take the risk that the gift will be pulled back into the client’s estate at death under I.R.C. Section 2036 or 2037. The IRS appeared to be particularly concerned about the fact that the donor can not have any prearranged deal with the trustee with respect to distributions.
B. Income Tax Treatment of Trusts
Alaska and Delaware Trusts are "defective trusts" in that they are treated as Grantor trusts for income tax purposes even if transfers are treated as completed gifts for gift tax purposes.11 This gives the Settlor an additional advantage of paying income taxes on the income from the trust without reporting such payments as "additional gifts" to the trust.
Changes to Both Acts Which Make Them More "Friendly" to Foreign Trusts
Both statues have been amended in 1998 to facilitate the transfer of foreign trusts to either Delaware or Alaska. Some of these amendments include a tacking provision which causes an elimination period or statute of repose to commence on the date that the trust was created, not the date of transfer to Delaware or Alaska. Both statutes also permit such trusts which were created prior to the date of enactment of the relevant 1997 statute to be governed by such statute. The states of Delaware and Alaska are clearly seeking to repatriate some foreign trusts to their states. Even though neither of these statutes has been tested yet, these two states have definitely gone to great measures to enact laws to attract business and prevent expatriation of trust dollars.
Challenges to Trusts Which Still Make Them "Risky Business"
Some of the greatest challenges which face these trusts will be constitutional challenges stemming from the supremacy clause and the full faith and credit clause of the U.S. Constitution.12 Under the full faith a credit clause, each state is required to recognize the judgments of the courts of other states. The arguments given in favor of upholding Alaskan and Delaware Trusts against attacks of foreign judgments are based on (i) lack of jurisdiction (i.e., that the out-of-state court never had jurisdiction over the Alaska or Delaware Trust)13 and (ii) no connection because the Alaskan or Delaware Trust was never a party to the original cause of action.14
Under the Supremacy Clause it is difficult to believe that a U.S. Bankruptcy trustee will not be able to pierce an Alaska or Delaware Trust. Finally, there is a discrepancy with the Uniform Enforcement of Foreign Judgments Act which is adopted in the states of Delaware and Alaska and the Alaska and Delaware Trust Acts in those same states. While the Uniform Enforcement of Judgments Act states that such states will enforce foreign judgments, it appears to contradict the Trust Acts in those same states. Clarification by statute is needed in those states.15
While these new statutes are very attractive alternatives to foreign trusts, there are still some unanswered questions concerning their viability as asset protection vehicles and estate planning/asset wealth transfer vehicles. Until more I.R.S. rulings and case law come down, estate planners should use these trusts with caution. First and foremost, estate planners should not consider these trusts for clients who do not have significant wealth because the transfers are irrevocable and the asset protection features are not guaranteed. Second, these trusts can obviously not be used if your client has current creditor issues. Practitioners should take serious the fraudulent transfer issues in evaluating these trusts for clients. Ignoring such issues could expose the practitioner, as well as the client to civil and possibly criminal actions against them. Furthermore, estate planner need to thoroughly explore both off shore and domestic options with their clients who seek asset protection and make sure that their clients fully understand the costs and risks involved with each option. If the client understands the risk and is willing and financially able to assume those risks, it presents a fascinating planning technique for clients who may have exposure due to their professions or business dealings or otherwise and, in the future, may serve as a long term wealth transfer tool.
1 One of the early landmark cases relating to fraudulent transfers is Twyne’s Case, 3 Coke 80b, 76 Eng. Rep. 809 (Star Chamber 1601). See Sullivan, Future Creditors and Fraudulent Transfers: When a Claimant Doesn’t Have a Claim, When a Transfer Isn’t a Transfer, When Fraud Doesn’t Stay Fraudulent, and Other Important Limits to Fraudulent transfers law for the Asset Protection Planner, 22 Del. J. Corp L 955 (1997) for a good background discussion of the history of fraudulent transfer laws in the United States as they relate to estate planning.
2 See Zaluda and Horwood, Planning with the New Alaska and Delaware Trust Acts, Chicago Bar Association Trust Law Seminar, March 12, 1998 for discussion of history of spendthrift trusts.
3 The matters over which Alaska courts have jurisdiction include, but are not limited to (1) appointing and removing a trustee, (2) reviewing trustees’ fees and reviewing and settling interim or final accounts; ascertaining beneficiaries, determining any questions which arise in administering or distributing trust assets including matters of trust construction, capacity, immunity, power, privilege, duty or right, and (4) releasing the registration of a trust. AS 13.36.035(a)
4 The phrase "deposited in this state" in the statute includes, by statute, a checking account, time deposit, certificate of deposit, brokerage account, trust company fiduciary account or similar account or deposit that is located in Alaska. An Alaska Trust Company has stated that simply having a custodial account held in Alaska (but traded or administered elsewhere) or a single Certificate of Deposit would meet this definition.
5 See Amendment to AS13.36.320, Senate Bill 354 with effective date of September 15, 1998
6 An adverse person is one who has a substantial beneficial interest in the trust and the interest would be adversely affected by the exercise of the power held by the settlor to revoke or terminate the trust. AS 34.40.110(b)(2).
7 See Alaska Senate Bill 354, Omnibus Trust and Estate Improvement Act, Effective Date: September 15, 1998
8 12 Del.Code Section 3570, et seq. And House Bill No. 747, passed June 24, 1998 contain the changes to the Delaware Code which permit self-settled spendthrift trusts.
9 Under I.R..C. Section 672(c) related or subordinate party means any non-adverse party who is the grantor’s spouse if living with the grantor; or the grantor’s father, mother, issue, brother or sister, an employee of the grantor; a corporation or any employee of a corporation in which the stock holdings of the grantor and the trust are significant from the view of voting control; and a subordinate employee of a corporation in which the grantor is an executive.
10 Section 25.2511-2(b) of the Gift Tax Regulations provides that a gift is complete as to any property, or part thereof or interest therein, of which the donor has parted with dominion and control as to leave in the donor no power to change its disposition, whether for the donor’s benefit or for the benefit of another. Said regulation contains an example in which a donor retains a testamentary power of appointment of assets and such powers makes the gift incomplete. In Rev. Rul 77-378, the grantor conveyed one-half of the grantor’s income producing property to an irrevocable trust under which the grantor retained a right to discretionary payments of income and principal. The discretion was in the hands of an unrelated third party. The grantor had no power to change or alter the trust terms and the assets went to specific parties at the death of the grantor. The trust was designed as an
asset protection trust. The Service ruled that such transfer was a completed gift.
11 See Internal Revenue Code Section 674 and 677 and regulations thereunder.
12 See Kenneth M. Bloom, The Alaska and Delaware Trusts Acts: Does the U.S. Constitution Foil the Plan?, Chicago Bar Association, Trust Law Seminar, October 19, 1998.
13 See Hanson v. Denckla, 357 U.S. 235 (1958) and Bloom article cited in note 10 above.
14 See Baker v. General Motors, U.S. Supreme Court Case No. 96-653, decided January 13, 1998 and Bloom article cited in note 10 above.
15 Again, see note 10.
Susan Reedy Williams is a Principal of her own firm in Itasca. Her practice is concentrated in Estate Planning and Administration and Taxation. She is a C.P.A. She may be reached at firstname.lastname@example.org.