Asset Protection Trusts

<div class="Section1">A qualified disability trust will generally be responsible for filing a tax return in the same manner as any other trust. The filing is made on Form 1041 and must be made if any one of three circumstances applies: (1) the trust has taxable income for the year, (2) the trust had gross income of $600 or more for the year regardless of whether it had taxable income or (3) the trust has a beneficiary who is a non-resident alien. Form 1041 is due at the same time that personal income tax returns are due for the year (a five-month extension may be available upon request).</div>

<div class="Section1" style="text-align: center;"><strong>Invalid Trust or Spendthrift Provision</strong></div><br /> <div class="Section1"><br /> <br /> The first and fairly obvious way a third party may reach a beneficiary's interest in a spendthrift trust is if the trust itself is invalid or the spendthrift provision is invalid. If a trust does not exist, then a spendthrift provision does not protect any of the beneficiary's interests. Furthermore, a spendthrift provision is invalid if it does not manifest the settlor's intent to create the spendthrift trust.<br /> <p style="text-align: center;"><strong>After a Distribution is made to Beneficiary</strong></p><br /> In addition, the interest is only protected while properly held in trust. Once the trustee makes a distribution to the beneficiary, creditors may reach the interest through the same procedures that apply generally to property of the beneficiary.<br /> <p style="text-align: center;"><strong>Supplies &amp; Necessities for the Protection of Beneficiary's Interest in the Trust</strong></p><br /> A claim by someone who renders necessary services or gives necessary supplies to the beneficiary can also access the beneficiary's interest in a spendthrift trust.<a href="#_ftn1" name="_ftnref1">¹</a> To refuse recovery for providing necessities to the beneficiary would frustrate the settlor's purpose of protecting and providing for the beneficiary.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> In addition, a beneficiary may find it difficult to obtain services essential to protecting and enforcing his or her rights under the spendthrift trust if claimants who provided assistance had no means of recovering from the trust.<a href="#_ftn3" name="_ftnref3">³</a> Thus, a claimant who has an enforceable unjust enrichment claim may reach a beneficiary's interest in a spendthrift trust.<a href="#_ftn4" name="_ftnref4">⁴</a> This includes those who provide services or materials for preserving the beneficiary's interest in the trust, or for goods and services that increased the value of the beneficiary's interest.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <blockquote><em>Example:</em> S's will leaves his residuary estate to T upon a spendthrift trust for B for life, remainder to R or R's issue. Shortly before death, S amended the trust by a codicil by which C is added as a life beneficiary to share the benefits of the trust with B. B institutes an action to contest the codicil. C employs attorney A to represent him in the action, and the codicil is upheld. Although subject to a spendthrift restraint, C's interest in the trust can be reached by A in payment for her services in protecting that interest. It is within the discretion of the court to determine how much of each distribution A should receive as a matter of fairness both to her and to C.<a href="#_ftn6" name="_ftnref6">⁶</a></blockquote><br /> <p style="text-align: center;"><strong>Public Policy</strong></p><br /> Occasionally, public policy calls for a spendthrift provision to be invalid. The following examples are not an exclusive list because courts continue to define what exactly violates public policy based on special circumstances and evolving policy. This section will explore common instances.<br /> <p style="text-align: center;"><strong><em>If the Settlor is Also the Beneficiary</em></strong></p><br /> A settlor of a spendthrift trust cannot also be the beneficiary of the trust.<a href="#_ftn7" name="_ftnref7">⁷</a> The most common reason a settlor attempts this is to protect his personal estate from issues concerning a business. However, it is against public policy to allow a settlor to enjoy his own property but not be responsible for the liabilities and debts that he creates.<br /> <br /> A small number of states have recognized a rare exception where a settlor may also be the beneficiary. If a settlor/beneficiary is a prisoner, a few states have recognized it does not violate public policy for such a person to tie up his property because he is not in a position to defraud creditors. Rather, a prisoner has an interest in protecting his estate from those who may try to take advantage of him because of his current incarceration.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <p style="text-align: center;"><strong><em>Spousal or Child Support</em></strong></p><br /> An enforceable claim by the beneficiary's spouse or children for support can invalidate a spendthrift provision.<a href="#_ftn9" name="_ftnref9">⁹</a> On public policy grounds, typically a beneficiary cannot enjoy a favorable interest while neglecting to support his dependents.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <p style="text-align: center;"><strong><em>Alimony</em></strong></p><br /> In states that provide for spousal support, a spendthrift provision may be invalid to protect against an ex-spouse's enforceable claim for support.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <p style="text-align: center;"><strong><em>Federal Tax Obligations of the Beneficiary</em></strong></p><br /> A government claimant can reach a beneficiary's interest to the extent provided by federal law or an applicable state statute.<a href="#_ftn12" name="_ftnref12">¹²</a> Bankruptcy, however, generally respects the spendthrift trust.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <p style="text-align: center;"><strong><em>Tort Claimants</em></strong></p><br /> In some jurisdictions, tort claimants have been able to access a beneficiary's interest within a spendthrift trust. When a tort claimant is an innocent party that has suffered harm, a court is not likely to protect a beneficiary's trust interest, especially when the beneficiary acted willfully or fraudulently.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Restatement (Third) of Trusts § 59 cmt. c (2003).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Restatement (Third) of Trusts § 59 cmt. c (2003).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Restatement (Third) of Trusts § 59 cmt. c (2003) at (d).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Restatement (Third) of Trusts § 59 cmt. c (2003).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  Restatement (Third) of Trusts § 59 cmt. c (2003).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.  <em>Id</em>.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.  Restatement (Third) of Trusts § 58 cmt. b (2003).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.  <em><em>See Booth v. Chadwick</em></em>, 154 S.W.2d 268 (Tex. Ct. App. 1941).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.  Restatement (Third) of Trusts § 58 cmt. b (2003).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.  Restatement (Third) of Trusts § 58 cmt. b (2003).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.  Restatement (Third) of Trusts § 59 cmt. b (2003).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.  <em>Id</em>. at a(1).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.  Restatement (Third) of Trusts § 58 comment a (2003).<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.  Restatement (Third) of Trusts § 59 comment a(2) (2003).<br /> <br /> </div>

<div class="Section1">If a trust is a qualified disability trust, it is entitled to claim a personal exemption under IRC Section&nbsp;151(d) (typically, trusts are not entitled to the personal exemption deduction because they are not individuals). In the case of a qualified disability trust, the trust is treated as an individual and IRC Section&nbsp;67(e) is used to determine its adjusted gross income.<a href="#_ftn1" name="_ftnref1">¹</a> Although the 2017 Tax Act repealed the personal exemption for 2018-2025, qualified disability trusts remain entitled to the personal exemption during this period of suspension ($5,100 in 2025 projected, $5,000 in 2024, $4,700 in 2023 and $4,400 in 2022).<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> Generally, this means that the trust&rsquo;s adjusted gross income is determined in the same manner as if it were an individual, except that deductions for costs and expenses in trust administration that would not have been incurred were the assets not held in trust are allowable.<a href="#_ftn3" name="_ftnref3">³</a> Further, the deduction for trusts that distribute current income only<a href="#_ftn4" name="_ftnref4">⁴</a> and the deduction for trusts that accumulate income or distribute trust principal<a href="#_ftn5" name="_ftnref5">⁵</a> may be allowed, as relevant.<br /> <br /> Because of these provisions, qualified disability trusts are typically much more favorable from a tax perspective than a standard irrevocable trust, which receives a much lower annual exemption than the personal exemption available to individuals. However, in some cases (often depending upon the taxpayer&rsquo;s income tax bracket and the needs of the beneficiary), it may be more advantageous to structure the trust as a grantor trust, where the tax liability &ldquo;flows through&rdquo; to the grantor of the trust.<br /> <br /> For a discussion of the ABLE account rules that allow taxpayers to create savings accounts for disabled individuals without jeopardizing qualification for Social Security and Medicaid benefits, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="386">386</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;642(b)(2)(C)(i).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;67(e).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&nbsp;651.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect;&nbsp;661.<br /> <br /> </div></div><br />

<div class="Section1">A qualified disability trust is a non-grantor trust (meaning that a qualified disability trust generally cannot be a grantor trust) where all of the beneficiaries of the trust are disabled at some point during the year, as determined at the close of the tax year by the Commissioner of Social Security.<a href="#_ftn1" name="_ftnref1">¹</a> The trust must also qualify as one described in Section&nbsp;1917 of the Social Security Act, meaning that it is a trust that was established solely for the benefit of an individual under 65 years of age who is disabled.<a href="#_ftn2" name="_ftnref2">²</a><div class="Section1"><br /> <br /> As a rule, a qualified disability trust will be a discretionary trust, meaning that qualified disability trusts do not require distribution of all income each year.<br /> <br /> A trust will not fail to qualify as a qualified disability trust merely because the trust assets will revert to an individual who is not disabled after the trust no longer has any beneficiaries who are disabled.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9090">9090</a> for a discussion of the tax treatment of qualified disability trusts. For a discussion of the ABLE account rules that allow taxpayers to create savings accounts for disabled individuals without jeopardizing qualification for Social Security and Medicaid benefits, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="386">386</a>. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9074">9074</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9076">9076</a> for a discussion of domestic asset protection trusts generally.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;642(b)(2)(C)(ii)(II).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; 42 USC &sect;&nbsp;1396p(c)(2)(B)(iv).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;642(b)(2)(C)(ii) (flush language).<br /> <br /> </div></div><br />

<div class="Section1">The settlor of an Alaska trust who is also named trust beneficiary is required to sign a sworn affidavit before the assets are transferred to the trust. This affidavit must state that the settlor has full right, title and authority to transfer the assets to the trust, and that the transfer will not render the settlor insolvent. The settlor must also verify that he or she does not plan on filing for bankruptcy relief.</div><br /> <div class="Section1"><br /> <br /> Further, the affidavit must state that the settlor does not intend to defraud any creditors through the transfer, and that no pending or threatened court actions exist (unless the actions are identified and attached to the affidavit). Similarly, the settlor must verify that he or she is not involved in any administrative proceedings unless they are identified and attached to the affidavit.<br /> <br /> The settlor must also verify that the settlor is not in default on child support payments by more than 30 days, and that the assets being transferred were not obtained from unlawful activities.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Alaska Stat. § 34.40.110(j).<br /> <br /> </div>

<div class="Section1">Like a Delaware trust (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9077">9077</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9081">9081</a>), an Alaska trust is a form of domestic asset protection trust that is formed under the favorable trust laws developed by Alaska. If the assets are transferred to the trust pursuant to a written document that provides that the interests of the trust beneficiary in the trust assets cannot be voluntarily or involuntarily transferred before the interests are paid or delivered to the beneficiary, the assets will be protected from the beneficiary&rsquo;s creditors.<div class="Section1"><br /> <br /> This means creditors that exist when the trust is created, or those who become creditors after the trust is created, are unable to satisfy their claims from the beneficiary&rsquo;s interest in the trust in most circumstances.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> This is the case even if the trust beneficiary is also the settlor of the trust.<a href="#_ftn2" name="_ftnref2">²</a> The settlor can also permissibly serve as co-trustee or trust advisor, as long as the settlor does not have authority over discretionary trust distributions.<a href="#_ftn3" name="_ftnref3">³</a> A non-settlor trust beneficiary may serve as sole trustee, co-trustee or advisor without jeopardizing the validity of the transfer restrictions.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> &ldquo;Payment or delivery&rdquo; of trust assets, for these purposes, does not include a beneficiary&rsquo;s use or occupancy of either real property or tangible personal property owned by the trust, so long as the use is in accordance with the trustee&rsquo;s discretionary authority as specified in the trust document.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9083">9083</a> for a discussion of situations where a creditor can reach assets held in an Alaska trust despite proper structuring of the trust. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9074">9074</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9076">9076</a> for a discussion of domestic asset protection trusts generally. The rules governing asset protection trusts established in Delaware are discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9078">9078</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9081">9081</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Alaska Stat. &sect;&nbsp;34.40.110(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Alaska Stat. &sect;&nbsp;34.40.110(a).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Alaska Stat. &sect;&nbsp;34.40.110(f).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Alaska Stat. &sect;&nbsp;34.40.110(g).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; Alaska Stat. &sect;&nbsp;34.40.110(a).<br /> <br /> </div></div><br />

<div class="Section1">A spendthrift is an individual who is prone to using property in an excessive or frivolous manner. Thus, a spendthrift trust serves two important purposes: (1) it protects the beneficiary of the trust from himself or herself; and (2) it prevents the beneficiary&rsquo;s creditors from accessing the beneficiary&rsquo;s interest in the trust.<div class="Section1"><br /> <br /> A spendthrift provision protects the beneficiary by preventing voluntary or involuntary alienation by the beneficiary.<a href="#_ftn1" name="_ftnref1">¹</a> The beneficiary cannot sell, give away, exchange, or otherwise transfer the beneficiary&rsquo;s interest. A settlor typically does this to protect the beneficiary from misfortune or incapacity.<br /> <br /> In addition, the spendthrift provision also allows the settlor to carry out the intent of benefitting the beneficiary, rather than the beneficiary&rsquo;s creditors or assignees. A spendthrift trust does not require that the beneficiary be a &ldquo;spendthrift&rdquo; or declared incompetent under the law.<a href="#_ftn2" name="_ftnref2">²</a> It is enough that the settlor has a concern about the beneficiary&rsquo;s ability to manage their finances in a responsible manner.<br /> <br /> Most states have now codified the law of spendthrift trusts. Some states make all trusts spendthrift trusts unless the settlor specifically provides otherwise. In addition, some states may restrain involuntary, but not voluntary, alienation for all trusts.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9074">9074</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="9076">9076</a> for a discussion of domestic asset protection trusts generally.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; Restatement (Third) of Trusts &sect;&nbsp;58 cmt. a (2003).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; Restatement (Third) of Trusts &sect;&nbsp;58 cmt. a (2003).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Restatement (Third) of Trusts &sect;&nbsp;58 cmt. a (2003).<br /> <br /> </div></div><br />

<div class="Section1">If a beneficiary of a Delaware trust has not acted in bad faith, the beneficiary may retain any distributions from the trust that are made before a creditor brings a claim against the trust assets.<a href="#_ftn1" name="_ftnref1">¹</a> Under Delaware law, it is presumed that the beneficiary (including a beneficiary who is also the transferor) did not act in bad faith, and the creditor has the burden of proving the existence of bad faith.<a href="#_ftn2" name="_ftnref2">²</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Del. Code. Ann. Tit. 12, § 3574(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Del. Code. Ann. Tit. 12, § 3574(c).<br /> <br /> </div>

<div class="Section1">Generally, the beneficiary's interest in an Alaska trust is not considered marital property that is subject to division. However, unless the parties otherwise agree in writing, this general rule does not apply if the settlor is the beneficiary and the assets were transferred to the trust (1) after the settlor-beneficiary's marriage or (2) within 30 days before the settlor-beneficiary's marriage, unless the settlor gives written notice of the transfer to the future spouse.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Alaska Stat. § 34.40.110(l).<br /> <br /> </div>

<div class="Section1">Yes. There are circumstances under which a creditor can reach the assets held in a valid Alaska trust when the creditor is a creditor of the settlor. First, a creditor of the settlor may reach Alaska trust assets if the creditor establishes that the transfer of property to the trust was made with the intent to defraud the creditor (a settlor's expressed intent to protect the assets from the beneficiary's potential future creditors does not show an intent to defraud).<a href="#_ftn1" name="_ftnref1">¹</a> A creditor may reach trust assets under this exception if the creditor was a creditor before the assets were transferred, and an action to prove intent to defraud is brought within either:</div><br /> <div class="Section1"><br /> <ol><br /> <li>four years after the transfer was made, or</li><br /> <li>within one year after the transfer is (or reasonably could have been) discovered by the creditor <em>if</em> (a) the creditor can demonstrate that it brought a specific claim against the settlor before the transfer or (b) the creditor files another action (other than one asserting an intent to defraud) that is based on an act or omission of the settlor that occurred before the transfer, and an action asserting an intent to defraud is filed within four years of the transfer.<a href="#_ftn2" name="_ftnref2">²</a></li><br /> </ol><br /> A creditor who became a creditor subsequent to the asset transfer may only reach the assets if it brings an action claiming intent to defraud within four years of the transfer.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> A creditor who is a creditor of the settlor may also reach trust assets if the trust provides that the settlor may revoke or terminate all or part of the trust without the beneficiary's consent, and the trust interest would be adversely affected if the settlor exercised the power to revoke or terminate. A settlor is not considered to have retained these powers if he or she has the right to veto a trust distribution, or if he or she holds a non-general power of appointment. Retention of the rights to receive income in the circumstances discussed below also does not constitute a power to revoke or terminate trust interests.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> If the trust provides that all or a part of the trust income or principal must be distributed to the settlor, a creditor of the settlor may reach trust assets unless the distribution is one of the following types of distribution:<br /> <ol><br /> <li>a distribution of income or principal from a charitable remainder annuity trust or charitable remainder unitrust;</li><br /> <li>a distribution of a percentage of the value of the trust each year as determined each year under the trust document;</li><br /> <li>actual or potential use of real property held under a qualified personal residence trust;</li><br /> <li>a distribution of income or principal from a grantor retained annuity trust or grantor retained unitrust.<a href="#_ftn5" name="_ftnref5">⁵</a></li><br /> </ol><br /> A creditor of the settlor may also reach trust assets if the settlor is, at the time of transfer, in default for 30 days or more in making child support payments that are due under a valid support judgment or order.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Alaska Stat. § 34.40.110(b)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Alaska Stat. § 34.40.110(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Alaska Stat. § 34.40.110(d)(2).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Alaska Stat. § 34.40.110(b)(2).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  Alaska Stat. § 34.40.110(b)(3).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.  Alaska Stat. § 34.40.110(b)(4).<br /> <br /> </div>