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Is There Stronger Protection in DAPTs?
By Rick Kahler MS CFP® ChFC CCIM http://www.KahlerFinancial.com
Most financial advisors and attorneys who specialize in asset protection trusts have probably never visited South Dakota. Yet it’s one of their favorite places. A change made by the legislature this year has made them like it even more.
The reason asset protection experts are so fond of our state is that South Dakota is one of a few states (Nevada, Delaware, and Alaska are the others) to offer some of the strongest protections available for Domestic Asset Protection Trusts (About Domestic Asset Protection Trusts).
House Bill 1056
House Bill 1056, passed by the legislature and signed into law by Governor Dennis Daugaard, includes a small change in wording that makes DAPTs even stronger. The relevant section amends South Dakota Codified Law 55-16-15 by adding the five words shown here in all caps:
“Notwithstanding the provisions of §§ 55-16-9 to 55-16-14, inclusive, this chapter does not apply in any respect to any person to whom AT THE TIME OF TRANSFER the transferor is indebted on account of an agreement or order of court for the payment of support or alimony in favor of the transferor’s spouse, former spouse, or children, or for a division or distribution of property in favor of the transferor’s spouse or former spouse, to the extent of the debt.”
This change is not intended to allow divorcing spouses to hide assets from one another, cheat ex-spouses out of alimony, or avoid paying child support. Someone who owes alimony or child support to a former spouse cannot get out of that obligation by contributing assets to a DAPT. Any amounts owed at the time the trust is established must be paid. Attempting to avoid legitimate obligations through a DAPT would be fraud.
On Definitions and Meanings
What the new wording means is that, once a divorce settlement has been agreed upon, former spouses cannot come back later and make new claims against an ex-wife or ex-husband’s protected assets.
For many people, this change is irrelevant. Many divorcing couples, probably the majority, don’t have many financial assets and have never heard of a DAPT. They work out a financial settlement, go their separate ways, and that’s that.
Yet there are cases where this new law could make a huge difference.
Here are just two examples:
Suppose that at the time a couple divorce, the husband had just started a construction company. It had more debt than assets and wasn’t making any money yet. Several years later, business is booming and he is well on his way to becoming wealthy. Even though his ex-wife was not involved in building the company, she might try to benefit from his post-divorce success by suing for a share of his assets. He could protect those assets by contributing them to a DAPT.
Or suppose a divorce settlement required the wife to pay her husband a one-time cash amount in exchange for his share of their house and acreage. Several years after the divorce, he isn’t doing so well financially. She’s still living in the house, however, and the value of the property has increased significantly. He might sue to amend the original agreement in an effort to claim part of the real estate. His attempt to change the agreement after the fact couldn’t touch that property if she had contributed it to a DAPT.
Assessment
Until now, Nevada was the only state whose DAPT laws did not make an exception for former spouses. This change in the South Dakota law makes the two states very comparable in their DAPT provisions. It’s one more reason for asset protection professionals to find South Dakota a great place to do business.
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Filed under: Estate Planning, Risk Management | Tagged: DAPTs, Dennis Daugaard, Domestic Asset Protection Trusts, rick kahler |
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More on A-B Trusts?
Married couples have several ways to potentially avoid any estate tax liability when they leave assets to each other.
Because of the unlimited marital deduction, no estate taxes are due when one spouse dies and leaves his or her assets to the survivor (as long as the surviving spouse is a U.S. citizen). However, this may merely postpone taxes that would be due until the death of the second spouse. Why? Federal estate taxes would be owed on the portion of the estate that exceeds the applicable estate tax exemption ($5.34 million in 2014).
One basic method to maximize the exemption for both spouses has been an A-B trust (also known as a bypass trust), which preserves the estate exemption of the first spouse to die and also enables the last-surviving spouse to utilize the exemption — essentially doubling the amount exempted from the estate tax.
However, with enactment of the American Taxpayer Relief Act of 2012, some couples may no longer need an A-B trust to maximize the estate tax exemption for both spouses. But before you make a decision about the use of a bypass trust, there are a number of issues to consider.
History
First, a little background on the changes in the estate tax as a result of the American Taxpayer Relief Act of 2012. The law permanently extended the higher applicable exemption amount ($5 million, indexed for inflation after 2011) and raised the federal estate tax rate to 40 percent from 35 percent. The increased threshold alone eliminates many people from being subject to the federal estate tax. The act also made permanent “portability” of the exemption to the surviving spouse, which allows surviving spouses to use their spouse’s unused exemption plus their own, enabling a couple to exempt up to $10.68 million from federal estate taxes in 2014.
However, many states have their own estate or inheritance taxes, or both, and none currently has any portability provisions. This means that when married couples leave all their assets to their spouses, the surviving spouse will be able to use only his or her state estate tax exemption. A trust may preserve a married couple’s state estate tax exemption. Additional considerations favoring a trust are the ability to shelter appreciation of assets placed in the trust, to protect assets from creditors, and to benefit children from a previous marriage.
How an A-B Trust Works
Using a living trust with an A-B provision (aka A-B trust), you ensure that both you and your spouse can take advantage of the exemption — once upon the death of the first spouse to die and then again upon the death of the second spouse.
When the first spouse dies, two separate trusts are created. The assets of the surviving spouse are transferred to the A trust, and an amount up to the estate tax exemption of the deceased spouse’s assets is transferred to the B trust. This then creates two taxable trusts, each of which is entitled to use the exemption.
The B trust is subject to estate taxes. However, because of the applicable exemption, no taxes will be owed. The surviving spouse maintains control of the assets in the A trust and receives income from the B trust. Then, upon the death of the second spouse, only the A trust is subject to federal estate taxes because the B trust was taxed at the first death. After the death of the surviving spouse, the B trust can continue for the benefit of the grantors’ family, often the children. The trust assets can be divided into separate equal trusts for the benefit of the grantors’ children, who will receive net income; and then, at some specified age, they will receive the principal.
There are many considerations involved with A-B trusts, including upfront costs and administrative fees. As the use of trusts involves a complex web of tax rules and regulations, you should consider the counsel of an experienced estate planning professional and your legal and tax advisers before implementing such strategies.
However, the A-B trust can be an effective way to help reduce estate taxes and preserve family assets.
Ralph
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DAPTs
I have found a b trust and testamentary trust to be great tools to help people in my area. Unfortunately I do not reside or work with any clients in these states that allow for the trust mentioned in the article above and that does sound pretty awesome.
Making things even more simple I have found that educating clients around the various types of joint ownership between their spouse and/or children takes care of a lot of their general planning needs particularly early in their career before they’ve accumulated wealth that creates state tax problems. The more simple versions of wills, medical directives, and powers of attorney allow their plans to stay on track with any hiccups along the way or an unexpected premature death. It is typically those more mature medical professionals that are in their high earning years that really need to start taking a look at trust as a way to ensure their wealth is used in the most effective way.
It is always a good idea to consult an estate planning attorney and a tax professional in concert with your CERTIFIED MEDICAL PLANNER® before setting up this type of entity.
JOE
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