Recent bankruptcy case a blow to DAPTsArticle added by Julius Giarmarco on November 15, 2011
Julius Giarmarco

Julius Giarmarco

Troy, MI

Joined: July 07, 2008

Does Section 548(e) merely increase the statute of limitations in bankruptcy for transfers to a DAPT to 10 years (while still requiring an actual intent to hinder, delay or defraud creditors), or does Section 548(e) effectively eliminate the benefits of a DAPT created within that 10-year period (because a DAPT’s express purpose is to protect assets from creditors)?

A dozen states now offer what are called domestic asset protection trusts, which allow a trust grantor to shelter trust assets from creditors while retaining the right to distributions from the trust. While Michigan does not provide for the formation of DAPTs, Michigan residents can avail themselves of the laws of states that do by using a trustee located in that jurisdiction. In July, 2010, Forbes ranked the twelve DAPT states based on the following criteria: (1) imposition of a state income tax; (2) statute of limitations for commencing an action; and (3) whether “exception” creditors (i.e., spousal support, child support, and preexisting torts) are permitted to attach trust assets. Only four states received an “A” grade: Nevada (A+), Alaska (A), South Dakota (A-), and Delaware (A-).

In October, 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which contains a provision specifically targeting DAPTs. Section 548(e) of BAPCPA provides that transfers by a debtor to a DAPT within 10 years of filing for bankruptcy may be set aside if the debtor made such transfer with actual intent to hinder, delay or defraud a creditor. This begs the question: Does Section 548(e) merely increase the statute of limitations in bankruptcy for transfers to a DAPT to 10 years (while still requiring an actual intent to hinder, delay or defraud creditors), or does Section 548(e) effectively eliminate the benefits of a DAPT created within that 10-year period (because a DAPT’s express purpose is to protect assets from creditors)?

To date, only one bankruptcy court has opined on this issue. On May 26, 2011, the Alaska Bankruptcy Court voided a transfer of real property to an Alaska DAPT. In re Mortensen, A09-90036-DMD. The court held that, under Section 548(e), any transfer to a DAPT for less than full and adequate consideration is, by definition, with the intent to “hinder, delay or defraud” creditors, despite state law providing otherwise, and that DAPT assets are part of the bankruptcy estate if made within the 10-year look-back period of Section 548(e).

Although Mortensen was decided by the bankruptcy court in Alaska, there is no reason to doubt the decision would be any different in the other 11 DAPT states (since the decision is based on federal, not state, law). However, the Mortensen decision is only applicable in bankruptcy. So, grantors of DAPTs who can stay out of bankruptcy may still be safe.

There are certainly more of these cases coming, and eventually the law will be settled. Until then, grantors concerned about asset protection may be well advised to consider an offshore asset protection trust. But, for those grantors who wish to stay on shore, it’s a good idea to establish an estate planning justification for the DAPT (in lieu of asset protection planning). For example, a DAPT created for gift tax planning purposes, with the transfers treated as completed gifts, might survive a fraudulent transfer attack under Section 548(e).

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.

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