Using trusts to shield assets from potential liability
Money Matters
By David B. Snyder, JD, CLU, September 3, 2018
Given the nature of liability in the U.S. legal system, dermatologists would do well to consider planning tools that can provide protection against potential lawsuits. Whether the concern is medical malpractice, employee claims, HIPAA violations, slips/falls, or the car accidents of teenage drivers, asset protection planning should be part of nearly all dermatologists’ wealth planning. Trusts are important tools frequently utilized in asset protection planning.
What is a trust?
A trust is essentially a legal arrangement where one person holds property for the benefit of another. Within this basic structure, the following definitions and classifications should help you understand a trust and how it functions.
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Grantor: The grantor is the person who sets up the trust. They are usually the person who transfers property into the trust. A grantor may also be called the trustor or settlor.
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Trustee: The trustee is the legal owner of the trust property. The trustee is responsible for administering and carrying out the terms of the trust. They owe a fiduciary duty to the beneficiaries — an utmost duty of care that they will follow the terms of the trust document and properly manage the trust property. A trustee may be a person, such as a family member or trusted friend. The trustee can also be an institution, such as a professional trust company or the trust department of a bank. When there is more than one trustee, they are called co-trustees.
The trustee is the legal owner of any assets owned by the trust and has legal title to these assets. For example, assume that a father wants to set up a trust for his son and daughter. The father wants his brother, the children’s uncle, to serve as trustee. If the father transfers his house into the trust, the title to that house will be with the uncle, as trustee. -
Beneficiary: The beneficiary (or beneficiaries) is the person (or people) for whom the trust was set up. (In the example above, the beneficiaries would be the son and daughter.) While the trustee has legal title to assets owned by the trust, the beneficiary has equitable title or the right to the trust property. The beneficiary can sue the trustee if the trustee mismanages the trust property or disobeys specific instructions in the trust. The beneficiary may be the same person as the grantor and can possibly be the same person as the trustee. For asset protection purposes, the trustee, beneficiary, and grantor cannot all be the same person.
Revocable living trusts: Illusory asset protection
Revocable living trusts (also called “family trusts” or “A-B trusts”) allow the grantor of the living trust the flexibility to make changes to an estate plan and are valuable estate planning tools because they typically avoid the time and expense of probate, the court process for settling an estate using a will.
During your lifetime, however, living trusts provide absolutely no asset protection because they are revocable. In other words, if you wanted to unwind a revocable trust and use the funds for yourself, you could do so. Thus, if your creditors want to seize assets owned by a revocable trust, they need only petition the court to “step into your shoes” and direct the funds of the trust back to you, where they can be levied.
Irrevocable trusts: The asset protectors
While revocable trusts offer no asset protection, irrevocable trusts are outstanding for this purpose. Once you establish an irrevocable trust, you forever abandon the ability to undo the trust and reclaim property transferred to the trust. With an irrevocable trust, you lose both control of the trust assets and ownership.
Because an established irrevocable trust cannot be altered or undone, your creditors cannot “step into your shoes” and undo the trust any more than you can. Assets in an irrevocable trust are immune from creditor attack, lawsuits, and other threats against the grantor (the person who created the trust), so long as the trust was not established (or assets transferred to it) after liability was foreseeable.
For many dermatologists, an irrevocable trust may be too harsh a medicine to utilize. In essence, you have to give away the asset (at least most of it, even if to family members) in order to protect it. If estate planning is also a high-level concern, then such trusts become more attractive. There are many to consider, with acronyms like QPRT, GRAT, GRUT, CRT, and others. Some of these trusts allow an income stream to come back to the grantor each year, even if the main asset has been given away. We will briefly describe one irrevocable trust here because it actually allows you to have access to the trust assets, unlike every other type of irrevocable trust.
Domestic asset protection trusts (DAPTs)
DAPTs are unique irrevocable trusts in that you can be both the grantor and a beneficiary of the trust. When there is no lawsuit concern, you can get to the trust assets as beneficiary — but if you have lawsuit claimants pursuing you, the trust can be written so that the trustee cannot make distributions to you while you are “under duress.” In this way, a DAPT can allow you both access to the trust assets when the “coast is clear” and protection when lawsuits and creditors are near. As such, it can be very attractive for physicians who live and practice in states with DAPT trust legislation. These states are: Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Rhode Island, South Dakota, Tennessee, Utah, and Wyoming.
Some dermatologists may be advised to consider using a DAPT in a foreign state if their home state does not allow DAPTs. In our view, there is significant risk to this approach. There is no guarantee that a court in one’s home state will recognize the protections of the out-of-state DAPT, when the state in which you live (and likely where you will be sued) has not passed such legislation. We advise clients to ask questions about the evidence that such protections work in their home state before moving forward.
Conclusion
If asset protection is part of your wealth planning, trusts may be one type of tool you utilize. As part of your advisory team, be sure to work with an experienced asset protection professional who can educate you on potential trusts for your situation.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.
