An ongoing series of informational articles
An ongoing series of informational articles
7 Common Questions about Domestic Asset Protection Trusts.
7 Common Questions about Domestic Asset Protection Trusts.
October 10, 2017
- What exactly is a Domestic Asset Protection Trust?
A “domestic asset protection trust,” or DAPT, is a type of trust entity, authorized under the statutes of about 15 states, which under appropriate circumstances allows a person to remover his or her assets from the reach of creditors.
2. I am comfortable, but not rich. Is it worthwhile for me to set up a DAPT?
A domestic asset protection trust is not just for the wealthy. Many persons of moderate wealth, who are engaged in business or activities which can lead to excessive creditor exposure, can benefit greatly from setting up one of these trusts, if done properly.
3. Will setting up a domestic asset protection trust protect my assets from debt I already owe?
Clients first must recognize that under the laws of all states a transfer of assets, whether to a trust or corporation, or simply to a relative or friend, specifically for the purpose of avoiding collection by a creditor, is an unlawful fraudulent conveyance and will not stand. Whether a debt is sufficiently known by the debtor so as to result in the finding of a fraudulent conveyance can be a matter of nuance, and a client should obtain the advice of competent counsel with regard to his or her specific situation.
4. Can I use the DAPT laws of a state in which I don’t reside?
Generally the answer is “yes.” A few DAPT laws require that the assets of the trust be physically located within the state under which the trust is formed, but this is the exception rather than the rule.
5. Does it matter under the laws of which state I set up the trust?
Being creatures of statute, rather than the common law, these trusts have very specific features, limitations and qualifications, which differ from state to state. Thus, not all domestic asset protection-friendly states, or their statutes, are created equal.
For example, In addition to the fundamental rule against fraudulent conveyances, many of the DAPT states have statutes of limitation as to creditors’ claims, ranging from one year to five years. That is to say, there is a waiting period of such term before the assets become fully secure from the reach of creditors – for example, divorcing spouses – whether or not the transfer of assets into the trust was made purposely to try to avoid the debt.
Some DAPT states have a state income tax that would be applicable to the trust, so depending on the type of asset conveyed, a client might want to avoid a DAPT created under the laws of one of these states.
In all cases a client should get competent advice as to which states’ laws are the best for his or her situation.
6. Are DAPTS upheld in court?
A few negative court opinions have caused some commentators to raise the question as to whether these trusts are really effective, or are a waste of money. However, our view is that even though it might be a truism that not all such trusts will be upheld in court, it is also a truism that not all of them are going to be struck down. Thus, the very existence of a domestic asset protection trust holding a substantial part of a debtor’s wealth, can be effective in inducing a creditor to settle a debt for far less than the full amount. Accordingly, it can be said that all DAPTS are useful, if not necessarily bullet proof.
7. Will I have access to money I put in a domestic asset protection trust?
This is probably the most common question clients have with regard to DAPT trusts. The short answer is “yes,” but certain types of trusts are designed to allow more access than others. Not coincidentally, asset protection trusts which make it a little more difficult for the grantor to gain access – for example, which allow payments only to spouses or children – are more apt to withstand court scrutiny.
WHAT IS A BUY SELL AGREEMENT AND DO I NEED ONE?
WHAT IS A BUY SELL AGREEMENT AND DO I NEED ONE?
February 14, 2017
An effective and well-conceived buy-sell agreement is critical to the successful estate planning of any owner of a closely-held business – i.e., a non-public corporation, LLC, partnership or limited partnership.
Often the largest portion of a person’s estate is tied up in a family or other small business. But what happens to the business if one of the owners can no longer continue? More often than not, people leave their estates (i.e., their business interests, and any real and personal property and savings) to family members, in wills or living trusts. However, surviving owners generally want to ensure a continuity of ownership and management without having the departing owner’s spouse or child thrust upon them.
They also generally do not want to unduly compromise the liquidity needs of the business by having to fund a significant buyout of the departing owner’s interest. Yet naturally, owners want to ensure their families are compensated fairly for their inherited of the business. The purpose of a buy-sell agreement is to address these competing concerns, before the inevitable happens.
A properly drafted buy-sell agreement can:
- Provide that upon the occurrence of a specified “triggering event,” (i.e., death, disability, and sometimes retirement or simply the desire to sell), owners are guaranteed that their interest in the business can and will be purchased;
- Provide that the owner’s interest must be sold to the company, the remaining owners, or a combination of the two;
- Provide a mechanism whereby the purchase price may be determined by market conditions in existence upon the occurrence of the event;
- Provide a funding source, such as through insurance policies, so that the liquidity needs of the business or its owners will not be onerous; and
- Establish a valuation of the departing owner’s interest in the business for estate tax purposes.
An integral part of any buy-sell agreement is to specify what type of situations will cause a mandatory or optional buyout of an owner’s interest by the other owners or the entity itself. The most common of these triggering events are described below.
- Death or disability. This event is almost universally provided for in the buy-sell agreement. Terms of this buyout will include the determination of disability, the time for payment to the owner or the owner’s estate, whether the entity or the surviving shareholders have the obligation to purchase the interest, and whether a funding mechanism, such as life or disability insurance, should be maintained by the entity or the owners personally.
- Desire to sell. The agreement should provide that the terms of the potential sale be presented to the other owners, and that they be given the option of:
- matching the offer made by the outsider;
- purchasing the shares in accordance with the valuation method and payment terms provided for within the agreement;
- having the entity repurchase the shares issued in accordance with the valuation method provided for within the agreement; or
- allowing the sale to be effectuated to the third party.
- Retirement of an owner. While a sale to a third party would provide the other owners an optional right to purchase the selling owner’s interest, an owner’s retirement will generally trigger a mandatory buyout. Of course, the conditions under which an owner may have the right to retire so that the remaining owners, or the entity, would be compelled to buy that owner out are often a point of negotiation. Once again, valuation methods and payment terms will be important issues, because there are no outside funding mechanisms, such as life or disability insurance, available to bear the cost.
- Owner’s divorce or bankruptcy. Either of these events can subject the business to interference from outsiders. To prevent this, the other owners should have the option to compel the affected owner to sell his shares to the remaining owners or the entity itself, in accordance with the payment terms and valuation methods (to be discussed later.)
Types of Funding Upon an Owner’s Death
NOTE: The following all have their own particular tax ramifications. Advice from a tax specialist should always be obtained before deciding on a particular avenue.
- Entity redemption arrangement. Under this plan, the business entity is obligated to purchase the owner’s interest. To minimize the impact this might have on the entity’s liquidity needs, the entity can purchase life insurance policies on each owner. The business names itself as the beneficiary of each policy, and the face amount of the policy will be equal to the agreed-upon purchase price set in the buy-sell agreement. The proceeds should be received by the entity free of ordinary income taxes, pursuant to IRC section 101. This would be followed by a purchase of the owner’s interest by the entity with the life insurance proceeds.
- Cross-purchase arrangements. Under this plan, each surviving owner of a business becomes personally obligated to purchase the departing owner’s interest. To provide the surviving owners with liquidity, each owner would own an insurance policy on the lives of the other owners. The proceeds of the life insurance policy would be received tax-free by the survivor and then used to purchase the deceased owner’s interest so that the survivor’s ownership interest remains the same in relation to the other surviving owners. This method generally addresses the disadvantages associated with the entity redemption arrangement, including shielding the insurance policies and proceeds from the entity’s creditors, not subjecting the insurance amounts to the corporate AMT, and giving the acquiring owners additional basis for the total purchase price of the deceased owner’s shares.
- Wait-and-see. This situation, also known as a “mixed agreement,” attempts to give the entity and its owners maximum flexibility at the time of the triggering event (e.g., retirement, disability, death). Generally, the entity has the initial option to purchase the shares from the departing owner in an entity redemption format. The entity may or may not carry life insurance on its owners. Should the advantages of an entity redemption listed above outweigh the disadvantages, then the entity shall exercise its right to purchase the owner’s interest. If the entity fails to exercise its option, or purchases only part of the owner’s interest, then the surviving owners have an option to purchase the departing owner’s interest in a cross-purchase format. The owners may or may not carry insurance for this purpose. To the extent that this second option does not result in a complete purchase of the departing owner’s interest, then the entity must complete the purchase.
- Book value or net asset value method. This is based on the net worth (assets -- liabilities) of a business on a company’s books and records for accounting purposes. While this method is easy and relatively inexpensive to ascertain, book values are based on historical-cost principles, which frequently become unrealistic over time, especially for assets such as real estate, patents, and goodwill. Economic book value requires an experience appraiser.
- Capitalization of earnings. This sets a value for a business by estimating an acceptable rate of return on a purchaser’s investment in light of the risk associated with the particular business, and then applying such a rate of return to the anticipated earnings stream of the business, based on its average net earnings (after operating expenses) over the last few years.
- Discounted cash flow. This method seeks to adjust earnings for any non-cash expenses (e.g. depreciation, amortization, gains and losses), and subtract a reasonable amount for future capital expenditures (e.g., equipment replacement), and liability payments to project the future net cash flow over a period of time. Then, using present-value concepts, based on an estimated discount rate over the term, an acceptable purchase price is determined for that future cash flow.
- Sales-multiple valuation. This method, commonly used in establishing a fair price for a service business where tangible assets are not significant, attaches an industry multiplier to an average stream of revenue over several years. The multipliers used are industry specific, with certain rules of thumb based on the performance of the “average” business within an industry. The problem with these formulas, however, is that they don’t take company-specific situations into account.
Executing a carefully planned buy-sell agreement can assure owners in a closely held business that their interest in the business they built is secure regardless of any unforeseen circumstances. In many cases this can be accomplished without putting excessive strain on the business’s cash flow, ensuring that the business and its remaining owners continue to succeed as well.
Competent and experienced legal counsel should draft the agreement and advise each owner regarding their individual interests.
This article is not intended as legal advice for any particular person, business or situation.
DO I NEED A POWER OF ATTORNEY?
DO I NEED A POWER OF ATTORNEY?
April 10, 2017
LawBridge International™ 2011-2018
A power of attorney is a formal legal instrument in which you (the “principal”) give authority to another person (your “agent”), to make financial decisions for you. In some jurisdictions, particularly in the United States, the term is also used with regard to a person whom you have chosen to make medical decisions for you if you are unable to speak for yourself. This is usually called a “medical power of attorney.” It is not to be confused with a “living will,” otherwise known as an “advance medical directive,” which is a document wherein you decide in advance whether artificial means of support shall be used to keep you alive if you have a terminal illness. (If you have both a medical power of attorney and a living will, it is critical that the two do not conflict with one another.) The “attorney,” or agent, in a power of attorney does not have to be anyone with specialty in legal training.
In the United States, most states have statutes governing powers of attorney, which are very broadly used for many purposes. Thus, there is unfortunately more potential for abuse, particularly among the elderly.
Critically, not all countries recognize powers of attorney. Some version of the concept exists in a number of jurisdictions, and some have ratified the Hague Convention of 13 Jan 2000 on the International Protection of Adults. (The US has not.) However, even among those that do recognize and approve of the concept there can be enormous and important differences in the law.
In the United States, an inter vivos, or “living” trust can be used very effectively in place of a power of attorney, and these trusts have other benefits as well for persons with property in several jurisdictions. But here again, these trust instruments are not uniformly recognized elsewhere in the world.
Thus, if you have roots and property in more than one country, and wish to arrange so that your affairs can be dealt with if you become incapacitated in some way, it is very important to consult counsel for specific advice. It may be necessary to use different approaches or different instrument in the different jurisdictions.
This article is not intended to provide specific legal advice to any reader.
What Does a Pet Trust Do?
What Does a Pet Trust Do?
March 15, 2017
We have many clients whose furry, feathery or scaly friends are as important as any other member of the family. It is therefore not surprising that many want to be certain their wills or trusts contain provisions to insure that, after their death, the loved one who is caring for their pet does not have to face the choice of sacrificing money needed for supporting the family in order to pay for the pet’s emergency surgery, or having a precious pet put to sleep. Even worse is the fear that nobody will step up to take care of the pet in the event of the client’s disability or death. This is a real concern: more than 500,000 pets are orphaned every year when their human companions become disabled or die. Many of them are put to sleep because the pounds just can’t take care of them.
Leaving money for your pet’s care after your death, is not only wise, but a popular bequest to make. Our animals become members of our families and just as we would provide for our loved ones, our pets need provisions as well. You can, of course, leave your pet to a caregiver in your Will, but in Colorado and elsewhere, you may establish a pet trust, which can do so much more.
Because a trust is a legal entity, the terms of the trust are enforceable by law. A trust sets up a system of checks and balances, and the trustee of the trust (not necessarily the same as the caregiver) will make reports to the court of the trust’s activity. Should the court find any misappropriations or questionable practices, it can step in and investigate.
A pet trust provides assurance of care should you become disabled or incompetent to continue caring for your pet. A Will is only active when you pass away, but a pet trust can become active from the date you sign the document. Once you fund the trust, your pet is protected even if you should become ill for an extended period of time.
A pet trust can be very specific about your pet’s care. If your pet has an illness, you can require regularly scheduled visits to the vet. You can set forth what type of diet the pet must have. You can also stipulate whether your pet is kept indoors or outdoors, or even the times they are to be outdoors. You can also use the trust to stipulate how and where your pet should be buried when it dies. The trust is your voice when it comes to your pet’s care.
Making use of a pet trust ensures that your pet will continued to be cared for long after you pass away. For more information or to set up a pet trust, contact our office today.
Statute Text – Pet Trusts in Colorado:
(1) Honorary trust. Subject to subsection (3) of this section, and except as provided under sections 38-30-110, 38-30-111, and 38-30-112, C.R.S., if (i) a trust is for a specific, lawful, noncharitable purpose or for lawful, noncharitable purposes to be selected by the trustee and (ii) there is no definite or definitely ascertainable beneficiary designated, the trust may be performed by the trustee for twenty-one years but no longer, whether or not the terms of the trust contemplate a longer duration.
(2) Trust for pets. Subject to this subsection (2) and subsection (3) of this section, a trust for the care of designated domestic or pet animals and the animals' offspring in gestation is valid. For purposes of this subsection (2), the determination of the "animals' offspring in gestation" is made at the time the designated domestic or pet animals become present beneficiaries of the trust. Unless the trust instrument provides for an earlier termination, the trust terminates when no living animal is covered by the trust. A governing instrument shall be liberally construed to bring the transfer within this subsection (2), to presume against the merely precatory or honorary nature of the disposition, and to carry out the general intent of the transferor. Extrinsic evidence is admissible in determining the transferor's intent. Any trust under this subsection (2) shall be an exception to any statutory or common law rule against perpetuities.
(3) Additional provisions applicable to honorary trusts and trusts for pets. In addition to the provisions of subsection (1) or (2) of this section, a trust covered by either of those subsections is subject to the following provisions:
(a) Except as expressly provided otherwise in the trust instrument, no portion of the principal or income may be converted to the use of the trustee, other than reasonable trustee fees and expenses of administration, or to any use other than for the trust's purposes or for the benefit of a covered animal or animals.
(b) Upon termination, the trustee shall transfer the unexpended trust property in the following order:
(I) As directed in the trust instrument;
(II) If the trust was created in a nonresiduary clause in the transferor's will or in a codicil to the transferor's will, under the residuary clause in the transferor's will; and
(III) If no taker is produced by the application of subparagraph (I) or (II) of this paragraph (b), to the transferor's heirs under part 5 of this article.
(d) The intended use of the principal or income can be enforced by an individual designated for that purpose in the trust instrument, by the person having custody of an animal for which care is provided by the trust instrument, by a remainder beneficiary, or, if none, by an individual appointed by a court upon application to it by an individual.
(e) All trusts created under this section shall be registered and all trustees shall be subject to the laws of this state applying to trusts and trustees.
(g) If no trustee is designated or no designated trustee is willing or able to serve, a court shall name a trustee. A court may order the transfer of the property to another trustee, if required to assure that the intended use is carried out and if no successor trustee is designated in the trust instrument or if no designated successor trustee agrees to serve or is able to serve. A court may also make such other orders and determinations as shall be advisable to carry out the intent of the transferor and the purpose of this section.
Repealed and reenacted by Laws 1994, S.B.94-43, § 3, eff. July 1, 1995. Amended by Laws 1995, S.B.95-43, § 15, eff. July 1, 1995.