Don't Be Foolish

In 2009, asset protection specialists watched a major Internal Revenue Service drive to flush out secret foreign bank accounts while a financial crisis brought to light mammoth Ponzi schemes and took down publicly traded companies. But we saw few relevant new laws and rulings in the area. How does the U.S. government's recent emphasis on tax transparency and anti-money laundering impact asset protection?

In 2009, asset protection specialists watched a major Internal Revenue Service drive to flush out secret foreign bank accounts while a financial crisis brought to light mammoth Ponzi schemes and took down publicly traded companies. But we saw few relevant new laws and rulings in the area.

How does the U.S. government's recent emphasis on tax transparency and anti-money laundering impact asset protection? Not at all. Those of us who practice regularly in this area know that, in general, any asset protection trust a client settles will be a grantor trust, whether it's domestic or offshore. And because I, like all responsible lawyers, provide clients with clear guidance on the filing requirements for such trusts (including the disclosure of foreign bank accounts), it's unsurprising that none of my clients asked me to represent them in the recent offshore voluntary compliance initiative that the IRS announced on March 23, 2009.

I was retained by new clients who have foreign bank accounts and, for whatever reason, failed to comply with the tax reporting requirements. But, as it turns out, none of these individuals had gone offshore for asset protection reasons (though they might have had tax avoidance, or evasion, in mind).

The bottom line always has been, and continues to be, that effective asset protection does not depend on the concealment of assets nor on the avoidance of lawful tax obligations. Rather, good asset protection, when effectuated properly, complies with all laws — and merely takes advantage of a particular jurisdiction's statutes to minimize clients' exposure to future creditors or predators.

What has become more evident in these times of economic distress is that clients too often seek asset protection when the horse already is out of the barn.

Take, for example, a young client who consulted with me recently. He was the fortunate beneficiary of his uncle's estate worth $15 million. He was concerned that his inheritance may be in serious jeopardy because he'd made personal guarantees to some banks to secure loans for a real estate development that went awry. Unfortunately, if he disclaimed, the fortune would go to charity, which was not an acceptable alternative for him. He left my office without a viable solution.

Too bad his uncle hadn't left the inheritance for him in a discretionary trust.

Others who have come to me this past year seeking magic bullets have included victims of the Madoff Ponzi scheme as well as directors of publicly held companies that have failed. In all these situations, the individuals had consulted reputable estate-planning attorneys and financial advisors, but these professionals had never advised them about the availability of asset protection strategies. And I'm not simply talking self-settled trusts. In some states, protection could have been as easy as holding assets in tenancy-by-the-entireties or purchasing life insurance.

The estate-planning process traditionally has been driven by concerns about tax minimization without any thought to asset protection. It's people with these types of plans who all too often appear on my doorstep in distress. But by that time, it's usually too late to help them with asset protection.

So, I want to take this opportunity to implore my colleagues at the bar and all wealth management advisors to dialogue with every client about the need for asset protection as part of the estate-planning process. What you'll find is that the need to retain assets in trust is compelling and serves the dual purpose of not only saving on taxes, but also providing security from creditors, divorcing spouses and other misfortunes.

As for the law — there were very few legislative or judicial developments in the asset protection arena in 2009.

New Hampshire became the twelfth state to enact self-settled trust legislation, which became effective Jan. 1, 2009.

A more recent development was the issuance of Private Letter Ruling 200944002, which addressed the issue of whether a discretionary trust for the benefit of a settlor, wherein the settlor retained no rights or powers over, was a completed gift and excluded from the settlor's estate. The ruling involved a trust governed under Alaska's self-settled trust law and a resident of Alaska. The IRS ruled that because under Internal Revenue Code Section 2511, the grantor cannot, in effect, relegate the trust assets to his creditors under Alaska's statute (AS 34.40.110), the gift is a completed gift.

On the issue of whether the trust would be includible in the grantor's estate under IRC Section 2036, the Service, citing Revenue Ruling 2004-64, noted that if a trust's governing instrument or applicable local law gave the trustee the discretion to reimburse the grantor for that portion of the grantor's income tax liability, the existence of that discretion, by itself, would not cause the value of the trust's assets to be includible in the grantor's gross estate provided, further, that such provision would not cause the trust assets to be subject to the grantor's creditors under local law.

Following that premise, unless there is an implied understanding or pre-existing arrangement between the grantor and the trustee demonstrating a retained right, a self-settled trust governed by Alaska law should not be includible in the grantor's estate.

Though many, if not most, self-settled trusts are intended to be incomplete gift transfers (and thus includible in the settlor's estate), this ruling provides planners with the opportunity to provide clients who have been hesitant to make large gifts (for fear of future needs) with a strategy that provides not only asset protection, but also significant potential estate tax savings, while at the same time the comfort of knowing that if the settlor requires some portion of the funds transferred, a trustee can provide for them.?

As for what lies ahead, I expect that we'll see a few more states enacting self-settled trust legislation and greater scrutiny of foreign trusts by the IRS. One possible example of such scrutiny may come from a bill proposed, as of this writing, by the Joint Committee of Taxation that if enacted, would require those who provide “material aid, assistance or advice with respect to carrying out one or more foreign entity transactions” to file returns with the Treasury disclosing the names of the clients establishing foreign trusts or entities. This requirement would impose additional burdens on those practitioners engaged in this arena.

These are certainly challenging and interesting times that will require all professionals practicing in this area to be ever more vigilant to avoid being drawn into the depths by Charybdis.1


  1. Wikipedia explains “Charybdis” as follows: “Charybdis or Kharybdis… was a sea monster, once a beautiful naiad and the daughter of Poseidon and Gaia. She takes form as a huge bladder of a creature whose face was all mouth and whose arms and legs were flippers and who swallows huge amounts of water three times a day before belching them back out again, creating whirlpools. In some variations of the tale, Charybdis is just a large whirlpool rather than a sea monster. Charybdis was very loyal to her father in his endless feud with Zeus; it was she who rode the hungry tides after Poseidon had stirred up a storm, and led them onto the beaches, gobbling up whole villages, submerging fields, drowning forests, claiming them for the sea. She won so much land for her father's kingdom that Zeus became enraged and changed her into a monster.

    “The myth has Charybdis lying on one side of a blue, narrow channel of water. On the other side of the strait was Scylla, another sea-monster. The two sides of the strait are within an arrow's range of each other, so close that sailors attempting to avoid Charybdis will pass too close to Scylla and vice versa. The phrase ‘between Scylla and Charybdis’ has come to mean being in a state where one is between two dangers and moving away from one will cause you to be in danger of the other. ‘Between Scylla and Charybdis’ is the origin of the phrase ‘between the rock and the whirlpool’ (the rock upon which Scylla dwelt and the whirlpool of Charybdis) and may also be the genesis of the phrase ‘between a rock and a hard place.’”

Gideon Rothschild is a partner in the New York law firm of Moses & Singer LLP, where he co-chairs the Trusts and Estates and Wealth Preservation Group