A reminder of how certain asset protection trusts that are properly administered remain effective vehicles to shield valuable assets from one’s creditors was re-confirmed this year in the case of Church Joint Venture, L.P. v. Blasingame, 2020 WL 284527 (6th Cir., Jan. 21, 2020). Obviously the effectiveness of a trust can vary based on multiple factors that can sway a court to conclude that certain laws can be interpreted to allow a creditor to gain access to trust assets when all the surrounding facts warrant such a result. Nevertheless, to design one’s relationship with assets in a way that effectively implements the spendthrift protections that are otherwise afforded under applicable trust law, a debtor can weather a creditor storm much more favorably as a result of assets being in a trust versus alternative forms of ownership. In this regard the Blasingame case describes one such situation in favor of the debtor, and in fact states “asset protection [planning] is a legitimate, legally sanctioned objective” (although the court acknowledges such planning has certain limitations). In this cited case, it was the debtor’s mother who created and funded a trust for the debtor and his family. The court upheld the protection of the trust assets from creditors of the debtor, even though the debtor was a trustee who held distribution powers, including to himself. We refer to such a trust in this blog post as a “business opportunity trust.” Below, we explain the concept of the business opportunity trust.
A business opportunity trust allows one (e.g., a family member) to place property into an irrevocable trust structure whereby you can manage and control the property; use the property (and income and gains from the property) for whatever purposes you desire; have the ability to give the property to whomever you want; and protect the property against lawsuits and taxes (i.e., asset protection).
Business Opportunities. Business opportunity trusts are excellent recipients of “business opportunities.” If you are about to engage in any new business ventures that may rapidly develop into a project of much greater monetary value, you can first sell to the business opportunity trust the “rights” to pursue this new venture at a very low “startup” price. In exchange, you receive an installment note to reflect this low price. You can then develop the new venture so that the new project appreciates in value outside of your taxable estate. If the trust is designed as a “non-grantor” trust, it can also create income tax benefits.
As intimated above, the business opportunity trust would need to be created by someone other than you, such as a parent. The business opportunity trust could then name you as a beneficiary and further designate you as a co-trustee (i.e., manager) with the authority to invest, manage, and develop the trust assets as you see fit without exposing those assets to your creditors or to estate taxes. A foreign (i.e., non-U.S.) situs business opportunity trust has stronger protections than a domestic business opportunity trust, but either way, depending on your particular estate planning objectives, each such trust may serve as an excellent tool to protect assets and having those assets escape taxation in your estate.
Even though the domestic business opportunity trust effectively holds assets outside of your taxable estate, a foreign business opportunity trust might be desired in the event you wanted to even further increase the already highly-asset-protective nature of the business opportunity trust. If the business opportunity trust were designed as a foreign business opportunity trust, such a design could generally still allow the foreign business opportunity trust to be treated as a domestic business opportunity trust for income tax purpose, and therefore avoid the burdensome foreign trust tax filings.
Maintain Control. You can be provided with the same powers over the business opportunity trust assets that you would typically have over assets you own outright, save a few “creditor” sensitive powers to avoid providing easy access to those assets by your future creditors. For example, you cannot exercise the power to make distributions to yourself beyond certain standards (e.g., for your health and medical expenses, educational costs, as well as your accustomed standard of living support needs). Rather, an independent unrelated trustee (e.g., a CPA or professional trustee) is designated by the business opportunity trust to be the individual who is authorized to make distributions to you that may be beyond such standards.
You could hold a power to replace the independent trustee with another independent trustee if such power is highly desired by you. Further, you could be granted the power to veto decisions made by the independent trustee, if you also felt such additional control would be necessary for you to hold. Therefore, you can potentially have strong control over the independent trustee depending on your ultimate goals.
You could also control all major decisions regarding the trust assets, including control over all management decisions over the trust assets and the authority to direct what distributions are made to other beneficiaries of the trust (e.g., a spouse, children). This can be accomplished either (i) under your distribution powers as a trustee, or (ii) through the exercise of a limited power of appointment granted to you under the trust (or by both such trustee powers and your power of appointment). You could also have an effect on what distributions would be made to yourself in that you can replace an independent trustee who may have become inattentive or nonresponsive.
All that being said, you should note that each element of control that you choose to retain could potentially encourage a creditor, in an attempt to “bust open the trust,” to argue that such retained control is excessive and tantamount to ownership.
Exclusion from Taxable Estate. The reason you cannot create this trust for yourself (and hence the need for someone else to create the trust) is to avoid the weaknesses of certain “self-settled” trusts (i.e., weaknesses that may include easier creditor access and estate inclusion for estate tax purposes). In the case of a parent creating the trust, the business opportunity trust is often a receptacle for a partial advancement of the beneficiary’s inheritance. The contributor may be motivated to establish such a trust so that you (as a beneficiary) can truly enjoy the gift without fear of a creditor obtaining a judgment against you and having the judgment satisfied from the trust assets. Also, it is a way of providing you benefits that will never be taxed in your estate. Furthermore, the business opportunity trust assets are fully exempt from the onerous 40% generation-skipping transfer taxes. The assets in the business opportunity trust are not subject to such taxes partly because you do not directly own those assets. Also, if you personally transfer assets to the business opportunity trust (see below), you can do so at a discounted value without paying any gift taxes. Further, the trust can be designed as a “grantor” trust. In such case, you would pay income taxes on all income generated by the business opportunity trust. From a gift tax standpoint, this is an excellent way to effectively make additional gifts to the trust free of any tax.
You can place assets into the business opportunity trust by any means other than as a contribution or gift. For example, you can lend money to the business opportunity trust. Also, once a parent or other person creates a business opportunity trust for you, you can place assets in the trust by means of an installment sale or in exchange for a private annuity. The IRS treats such a sale as a non-taxable event for income tax purposes if the business opportunity trust is designed as a “grantor” trust. This allows you to place further assets into a structure that are protected from your creditors while also removing those assets from your taxable estate. Such a sale may be made on a discounted basis as well. By way of example, if you have assets that you own outright worth $1,000,000, you can place those assets into a properly designed limited liability company (“LLC”) and then sell the membership interests in that LLC to the business opportunity trust at a discounted value (e.g., $650,000 based on an appraisal that shows such discount). As such, the sale effectively reduces your existing estate for estate tax purposes since the installment note or private annuity that you receive will have a significantly lower value than the underlying assets you initially sold to the business opportunity trust. In utilizing this strategy, however, care must be taken so that certain controls over the LLC are not retained if removing the value of such LLC membership interests from your taxable estate is one of the desired goals.