A shifting trust provides ease of understanding and asset protection.

By Alan R. Eber

Excerpted from Asset Protection Strategies & Forms

A shifting trust provision is particularly helpful after you have suggested to your client an excellent asset protected and extremely flexible trust (a non-self-settled, discretionary, spendthrift trust, with a letter of wishes and a protector), but the client is not able to understand the benefits and states: “All I want is to give each of my two children half of my estate in equal parts when they turn 25, 30, and 35 and do so in a way they will be asset protected.”

The shifting trust allows you to give the client ease of understanding while preserving considerable (but not total) asset protection and flexibility.

The trust states that the distributions are to occur at ages 25, 30, and 35 UNLESS creditors, divorce, a lawsuit, or an IRS lien, or other adverse circumstances (about which the client has concern) are present. If these circumstances are present the trust shifts from being mandatory to being discretionary.

Note:

If the client says, “Better, but how do I know the trustee will comply?” then you could make the trust a “support trust.” However, there are risks with support trusts. [See §4:100.]

§4:81       How a Shifting Trust Works

Like the “shape shifter” of Star Trek fame, this type of trust shifts its purpose, its terms, and/or its beneficiaries if either a creditor tries to penetrate it, or the law changes.

Because of this flexibility, a premium is placed on drafting the needed language into the trust.

Whether the shift is effective to avoid creditors depends on the nature of the interest retained by the beneficiary. The greater the equity of the claim, the less the beneficiary can retain in order to protect trust property. Where the beneficiary has no interest after the shift, the interest is spared creditor attachment. Under many circumstances, the beneficiary can retain a limited power of appointment over the interest. [For limited power of appointment, see §4:181.]

It is critical that language allowing the shift be based on the settlor’s intent to have his trust benefit certain persons and not others. The basis of the trust has nothing to do with the protection of the beneficiary but rather with implementing the donor’s intent and protecting his right to choose the objects of his bounty.

With a shifting trust that terminates a beneficiary’s interest on the occurrence of a specified event, the beneficiary’s interests are sometimes characterized as being subject to a condition subsequent.

Note:

If the beneficiary has any voice in exercising a shift, we would have to run the full gamut of a fraudulent transfer analysis.

§4:82       The Shift Language

The shift language for a shifting trust may be tied to any of the following:

  • Notice or belief by the trustee that the interest of the beneficiary may be diverted from the stated trust purpose
  • A creditor attempting to attach a beneficiary’s interest
  • The beneficiary initiating bankruptcy, or becoming insolvent
  • Any other criteria drafted to evidence the settlor’s intent

[See, e.g., Miller v. Miller, 31 S.E.2d 844 (W. Va.1944) (interest shifted upon filing for bankruptcy). See also Industrial Nat’l Bank v. Budlong, 264 A.2d 18; Jones v. Coon, 295 N.W. 162. Cf.Riggs Nat’l Bank, 57 AFTR 2d 86-1358, 636 F Supp 172, 86-1 USTC ¶9398.]

§4:83       Shifting Trusts Are Safe From Attachment by Creditors

Forfeiture of a trust interest on any attempted alienation or attempted attachment by creditors or upon the beneficiary’s insolvency or bankruptcy is generally valid, even in jurisdictions that do not recognize spendthrift trusts.

This termination of a beneficiary’s interest shields the trust interest from creditor claims. The effectiveness of this device applies against the most tenacious claims.

Example:

In re Fitzsimmons, 896 F.2d 373 (9th Cir. 1990). In this case, the debtor was a beneficiary of a trust against which a tax lien was asserted. The trust provided that the termination of the beneficiary’s interest prevented the IRS from satisfying its tax claim. The Ninth Circuit held that the forfeiture was valid and “[b]ecause the beneficiary’s interest had terminated no interest was left in him which would be reached by the assignee in bankruptcy for the benefit of creditors.”

§4:84       Protection for Trust Interests in Bankruptcy

Trusts that are exempted from creditor attachment under local law are excluded from the debtor’s estate in bankruptcy.

Therefore, to the extent that shifting trusts provide protection under local law, they also provide protection in bankruptcy.

§4:85       Protection When Interest Is Retained

Termination of a beneficiary’s interest is the surest way of protecting trust assets from the reach of creditors.

However, shifting trusts can also protect against creditors even if the beneficiary retains some interest in the trust, if the retained interest is so tenuous that he cannot force the trustee to make distributions.

Example:

Industrial National Bank v. Budlong, 106 RI 780, 264 A2d 18 (1970). In this case, the court was faced with a trust that provided that if the beneficiary attempted to assign her right to income, the trust would shift to a discretionary trust. The court held that the attempted shift to a discretionary trust was ineffective because it did not extend the trustee’s discretion to distribute to persons other than the original beneficiary. However, the court stated that it is possible to shift to a discretionary trust with more than one current beneficiary, which would be exempt from creditor attachment, but only if the trust’s terms “are sufficiently elastic to permit the trustee at his discretion to pay income, not only to the original beneficiary, but to others as well.” This agrees with the definition of “discretionary trust.” A beneficiary holds an interest not subject to attachment since the trustee’s broad discretion can be exercised to preclude or make any distribution to the beneficiary.

§4:86       Suspension of Distributions on Specific Conditions

Some trust provisions suspend the beneficiary’s right to receive distributions on the occurrence of various events (such as financial hardship) and reinstate that interest after those problems have passed.

Such trusts will be effective if the trustee’s discretion can be exercised so as to indefinitely suspend such distributions. The breadth of the discretion prevents it from being treated as a condition limited to merely the time of payment, which would result in the interest being subject to creditor attachment when the designated time has arrived.

Trust provisions that suspend a beneficiary’s interest are valid if the trust provides that subsequent distributions to the beneficiary are subject to the trustee’s discretion to either withhold or make such distributions.

Example:

A trust may provide that the trustee should withhold distributions if the beneficiary is taking drugs, or is in litigation, or is experiencing other difficulties that would make it unlikely that the trust assets would be used as the settlor intended. This broad discretion will tend to counter a public policy argument that the trust arrangement is being misused to allow a beneficiary to avoid creditors.

§4:90       Disclaimer Can Keep Property From Creditors

Disclaimers are used to try to keep property from being taken by creditors of the disclaimant.

Generally, whether a disclaimer will be successful for that purpose depends on state law. [But see Drye v. United States, 528 U.S. 49 (1999) (holding that a disclaimer cannot defeat an existing tax lien on inherited property, regardless of how the disclaimer is characterized under state law).]

In the following jurisdictions, a disclaimer is not a fraudulent transfer:

  • California [Cal Prob C §283.]
  • Illinois [In re Atchison, 925 F.2d 209 (7th Cir. 1991), cert. denied (beneficiary’s disclaimer did not constitute a transfer under Illinois law).]
  • Missouri [In re Popkin & Stern, 223 F.3d 764 (8th Cir. 2000) (a disclaimer was effective under Missouri law).]
  • Federal [Mapes v. United States, 15 F.3d 138, 140 (9th Cir. 1994) (renunciation by legatee of interest defeated an IRS claim).]

A disclaimer is not affected by the presence or absence of a spendthrift provision. [Comment to UTC §502.]

§4:91       Disclaimers Can Avoid Taxes

No one can be forced to accept an asset against his will.

By not accepting the bequest, the would-be recipient allows the asset to be enjoyed by other recipients named by the donor (generally members of the disclaimant’s family whom he wishes to benefit).

Disclaimers for tax planning purposes are an important part of the estate planning arsenal. However, because of perceived abuses, Congress created the concept of “Qualified Disclaimers” in 1976. If the disclaimer is a qualified disclaimer, the resulting shift in property interests does not constitute a transfer for gift, estate, or GSTT purposes. The disclaimant is regarded as never having had the interest he disclaimed. [Treas. Reg. §25.2518-1.]

Basically, a “Qualified” disclaimer has to be irrevocable in writing, and made within 9 months from the time that the person disclaiming had a vested right in the asset. With the exception of certain disclaimers by spouses, the disclaimant may receive no benefit from the asset, and may not control its disposition in any way. However, it is important to distinguish between federal disclaimer rules for tax purposes and state disclaimer rules.

The fact that a disclaimer may be voidable by the disclaimant’s creditors has no effect on the determination of whether it constitutes a qualified disclaimer. However, a disclaimer that is wholly void or that is voided by the disclaimant’s creditors cannot be a qualified disclaimer. [Treas. Reg. §25.2518-1.]

Different standards apply in determining whether a disclaimer will be recognized for income tax purposes. Generally, the holder of a power to vest any portion of trust income or principal in himself generally is treated for income tax purposes as the owner of such portion. However, this does not apply to a power that has been “renounced or disclaimed within a reasonable time after the holder of the power first became aware of its existence.” [IRC §678(a).]

However, a disclaimer cannot be used to defeat the imposition of an existing tax lien on inherited property, regardless of how the disclaimer is characterized under state law. [Drye v. United States, 528 U.S.49, 120 S. Ct. 474, 99-2 USTC ¶60,363 (1999).]

Example: Avoiding the Gift Tax

Dad is already wealthy. Then, his father left him $2 million, but provided that if Dad predeceased him, then the $2 million would pass to Dad’s sons. Dad wishes his sons to have the $2 million, but does not want to pay transfer taxes. If he gives the property to his sons, he will incur a gift tax. If he wills it to them, an estate tax will be imposed. However, if he disclaims, the money is generally deemed to have passed directly to his sons, thereby saving taxes.

Caveat: Generation skipping taxation must still be considered. [See §4:120.]

Form 4-11:    Shifting Trust: Terminates Interest and Creates a Discretionary Interest

DownloadShifting Trust: Terminates Interest and Creates a Discretionary Interest in Microsoft Word.

Form 4-12:    Shifting Trust: Converts From Spendthrift to Discretionary Trust

DownloadShifting Trust: Converts From Spendthrift to Discretionary Trust in Microsoft Word.

Form 4-13:    Disclaimer Clause

DownloadDisclaimer Clause in Microsoft Word.

Form 4-14:    Disclaimer Clause Into Credit Shelter Trust

DownloadDisclaimer Clause Into Credit Shelter Trust in Microsoft Word.


Alan R. Eber is a pioneer in the asset protection field and a highly sought after speaker on estate and wealth planning and protection.  Since 1974, Mr. Eber has assisted clients in establishing a wide variety of wealth preservation structures. Currently, Mr. Eber is presenting seminars on Advanced Asset Protection and Techniques and Domestic and International Trusts for the National Business Institute (NBI), the Lorman Group, and numerous other groups.  He is the author of Asset Protection Strategies & Forms, from which this article is excerpted.