Domestic Asset Protection Trusts

A Domestic Asset Protection Trust ("DAPT") is a trust established by a settlor to protect his/her assets from potential creditors while receiving some benefit from the trust. Although the common law prohibits the creation of a self-settled creditor protection trust, some US jurisdictions, including South Dakota, authorize self-settled spendthrift trusts. South Dakota law refers to this type of trust as a qualified disposition in trust, or, informally, as a domestic asset protection trust.

What are common asset protection strategies? 

Much of estate planning revolves around the use of traditional asset protection strategies, such as tenancy by the entirety, retirement plans, family limited partnerships and limited liability companies, homesteads, and life insurance policies. Offshore trusts are another asset protection tool.

Must the settlor be a resident of South Dakota to obtain the protection? 

No, the trust must have its situs in South Dakota, but the settlor does not need to be a resident of South Dakota. Situs is generally obtained by invoking South Dakota law, having a resident South Dakota trustee, and siting as much trust administration and custody of assets in South Dakota as possible.

Isn’t that a fraudulent transfer?

All states, including South Dakota, have rules that set aside fraudulent transfers, which are generally defined as any transfer that renders the debtor insolvent with respect to known creditors. That fraud can be actual or constructive, as to either present or future creditors. Actual fraud can be avoided by paying just debts as they become due. Present and future constructive fraud can be avoided by structuring the transfer so the transferor remains solvent. Future actual fraud would generally result in setting aside a self-settled asset protection trust.

What benefits might a domestic asset protection trust offer to clients? 

In addition to creditor protection benefits, DAPTs offer estate planning benefits, income and estate tax benefits.

What are the gift and estate tax effects of a Domestic Asset Protection Trust? 

The DAPT can be structured as a completed gift for gift tax purposes while being excluded from the gross estate of the settlor if the settlor can only receive distributions from the trust in the absolute discretion of an independent trustee. Conversely, a completed gift can be avoided if the settlor retains a special testamentary power of appointment.