Four levels of asset protection combined with other related statutes make South Dakota one of the most popular and beneficial jurisdictions for Wealth Preservation and Domestic Asset Protection Trusts.
South Dakota Domestic Asset Protection Trusts generally provide for excellent estate planning, wealth preservation and asset protection.
A self-settled trust is one of the more frequently used types of domestic asset protection trusts (DAPT). It is generally a discretionary irrevocable trust where the grantor/settlor is a permissible beneficiary. If properly structured, funded and administered, creditors generally cannot reach the assets in a self-settled trust to satisfy the settlor’s legal obligations. Only seventeen states, including South Dakota, currently have self-settled DAPT statutes. A self-settled trust can be drafted to either keep trust assets within the settlor’s estate or to remove them, which allows a wealthy individual to establish a self-settled trust even though that individual’s gift tax exemption has been fully utilized.
Establishing a DAPT in a top rated trust state like South Dakota is extremely advantageous because of the four levels of asset protection provided for in South Dakota. Offshore asset protection has lost a lot of momentum as a result of these four levels of protection as well as the increased IRS scrutiny and reporting requirements (i.e., FBAR, FATCA, etc.) by the United States government.
Generally, the grantor/settlor places up to 10% to 40% of their financial assets, or possibly other assets, into a DAPT to protect those assets from a possible future lawsuit. The amount and types of assets to be transferred are generally case by case. The settlor is a permissible discretionary beneficiary of the DAPT, but does not generally use the trust for everyday living expenses. This could weaken the asset protection as well as result in possible estate tax inclusion issues if a dynasty DAPT is involved.
Below are the four levels of protection provided with a DAPT: the trust, the limited liability company (“LLC”), a discretionary interest provisions, and a spendthrift provision.
1. Level One – The Trust:
A properly drafted, funded and administered self-settled South Dakota DAPT is an irrevocable trust and allows the grantor/settlor to be a permissible discretionary beneficiary of the trust while generally preventing creditors of the settlor to reach the trust assets.
The key requirements of the Self-Settled DAPT are: no pre-existing understanding or arrangement between the settlor and the trustee; the assets were not transferred fraudulently; creditors of settlor are unable to access trust property interests as defined by state law (i.e. exception creditors); and notice to the transferor’s spouse if marital property versus separate property is transferred after marriage.
Creditors may argue that there was a fraudulent conveyance to the trust. For this claim to prevail, the creditor must prove that there was intent to hinder, delay or defraud. This argument is subject to a “clear and convincing” standard of proof in South Dakota versus a “preponderance of the evidence” standard of proof provided for in many other DAPT states. South Dakota’s statute of limitation for a fraudulent conveyance is two years after which time a cause of action or claim for relief with respect to a transfer of the settlor’s assets to a DAPT is extinguished, and the creditor may not be able to reach the assets. If the creditor is an existing creditor at the time the DAPT is established, that creditor may also have the period of time starting from when the transfer is or reasonably could have been discovered by that creditor to bring its claim which is six months in South Dakota. Some clients may start the discovery period by giving notice to potential creditors. Both the standard of proof (i.e. clear and convincing) and statutes of limitations are key factors to consider when selecting the DAPT situs, which why South Dakota is one of the best DAPT jurisdictions.
Generally two steps would be required to prove a fraudulent conveyance in South Dakota. In South Dakota, step one would be an action to prove with clear and convincing evidence that the transfer to the trust was an action to hinder, delay or defraud the creditor within 2 years. The second step would be to prove with clear and convincing evidence that the transfer of property to the trust was made to defraud that specific creditor.
A creditor may also claim to be an exception creditor, that is, the creditor fits within a defined type or class, so that it may be able to reach the DAPT assets. Exception creditors vary by state statute. Some of the more common exception creditors are tort victims, divorcing spouses/marital property divisions and those receiving alimony or child support, and generally, any judgments in place at the time of the transfer regardless of state.
There are limited exception creditors in South Dakota unlike most other asset protection trust states. South Dakota does not allow for exception creditors for divorcing spouses in regard to marital property for transfers made to the DAPT prior to the marriage; however, if the transfer to the DAPT occurred after marriage with marital property, then notice is required to be given to the spouse. This is not a requirement with separate property. Additionally, child support and alimony are not exception creditors in South Dakota unless the child support or alimony was awarded prior to the transfer to the DAPT.
Most jurisdictions recognize trusts sitused in other jurisdictions in accordance with Conflict of Laws principles unless there is a strong public policy argument not to recognize the trust or there is not a substantial presence or enough ties to the trust situs state. Many advisors claim that lack of notice regarding the transfer of martial property post marriage, without giving the spouse notice for example, could pose a strong public policy issue in the client’s resident state. South Dakota statute avoids this potential issue by requiring notice. This is in contrast with some states which are silent regarding the transfer of marital property post marriage which may prove problematic from a public policy standpoint as seen in recent cases. As such, the South Dakota statute requiring notice for the transfer of marital property (not separate property) to a trust post marriage will likely prevent other jurisdictions from not applying South Dakota due to public policy reasons law if there is a substantial trust administration presence in South Dakota.
2. Level Two – LLC and Limited Partnership (“LP”) Statutes:
The location of trust property is extremely important from an asset protection standpoint. Consequently, many individuals title assets located in other states to a South Dakota LLC or LP, which in turn are titled to a DAPT. Generally, the South Dakota trust is the sole member of the South Dakota LLC to maximize the asset protection. Not all DAPT states have statutes allowing for the trust to be the sole member. Choosing South Dakota’s LLC/LP statutes further ties the trust property to the jurisdiction of the self-settled trust, allowing for increased asset protection. The asset protection afforded by LLC and LP statutes varies by state, and South Dakota is one of the leading jurisdictions. It has “charging order” protection as the sole and exclusive remedy which is generally considered the most desirable. A charging order only gives a creditor the rights of a partnership or LLC interest, and it does not give a creditor any voting rights. A charging order is simply a right to a distribution (if and when one is ever made) and it leaves a creditor without any means to force a distribution. This results in a waiting game between the client and the creditor, often forcing the creditor to settle for significantly less than the original judgment amount.
3. Level Three – Discretionary Interest Statute:
South Dakota was the first state in the U.S. to pass a “Discretionary Support Statute” in 2007. According to many advisors, the Restatement (Third) of Trusts may have blurred the line, allowing for a fully discretionary trust to be attached by a beneficiary’s creditors as a property interest. South Dakota codified the common law and Restatement (2nd), which defines the types of interests a beneficiary has in a trust, and therefore, the rights of a beneficiary’s creditors. Consequently, a discretionary interest in a South Dakota trust is not a property interest nor an entitlement. Additionally, limited powers of appointment and remainder interests are also not property interests or entitlements in South Dakota. This can become extremely advantageous from an asset protection standpoint. Alaska, Nevada and Delaware all passed more limited versions of the South Dakota discretionary interest statute. Most states do not have this additional layer of trust protection.
4. Level Four – Spendthrift Trusts:
As previously mentioned, only seventeen trust jurisdictions, including South Dakota, have self-settled domestic asset protection statutes. However, all fifty states, including South Dakota, offer some asset protection through the incorporation of spendthrift provisions into the trust. A spendthrift clause prevents all but a few exception creditors from attaching a trust. Two key exception creditors to the spendthrift clause are alimony and child support. Consequently a beneficiary may still have an enforceable right to a distribution as an exception creditor, which could remain unprotected by the spendthrift clause. South Dakota has uniquely addressed these potential issues with the enactment of its Discretionary Support Statute so that a discretionary interest in trust is not a property right or an entitlement. This is especially relevant in light of recent cases in Florida and Massachusetts where courts have pierced or referenced the possibility of piercing the spendthrift clause of third party trusts (i.e. not a self-settled trust) to garnish the trusts discretionary interests. This would not be possible in South Dakota.