The Hybrid DAPT

By: Randall A. Denha, J.D., LL.M.

A primary estate planning goal for most people is to hold on to as much of their wealth as possible to pass on to their children and other loved ones. To achieve this, you must limit estate tax liability and protect assets from creditors’ claims and lawsuits. Let’s look at some asset protection planning facts and lawsuit statistics. Did you know:

• 78% of lawsuit defendants never thought it would happen to them
• The US has 80% of the world’s lawyers.
• 96% of all lawsuits are filed in the U.S.
• A new lawsuit is filed every 30 seconds, on average
• The self-employed and small business owners have a 33% chance of becoming a defendant in a lawsuit
• There are over 100,000 students in law school today
• FBI reports that a quarter million criminals make their living through lawsuits
• Asset Protection is not just for the wealthy. Recent studies show that the average income bracket for targeted lawsuits is under $200,000 a year.

Having sufficient liability insurance coverage is important, but in situations where greater inherent exposure of liability exists, it could make sense to consider creating a domestic asset protection trust (DAPT), which is designed to provide an extra layer of protection between you and your future creditors. A DAPT is an irrevocable trust in which the settlor is generally a discretionary beneficiary set up in one of the 17 jurisdictions that allows a settlor to be a beneficiary without creditors of the settlor being able to access the trust assets. This will now allow a settlor to retain certain benefits while creating an important additional blanket of possible legal protection for the financial assets placed in these trusts. In the past, this level of protection could only be accomplished if the trust creator (settlor) gave up complete control plus all economic benefit derived from any assets transferred into such a trust.

The Tax Cuts and Jobs Act reduces or eliminates federal gift and estate taxes for most people (at least until 2026). The gift and estate tax exemption is $11.58 million for 2020. One benefit of this change is that it allows you to focus your estate planning efforts on asset protection and other wealth-preservation strategies, rather than tax minimization. One estate planning vehicle to consider is a “hybrid” domestic asset protection trust (DAPT).

What is a Hybrid DAPT?

As my friend, Steve Oshins, a leading asset protection and estate planning lawyer in Nevada has said, “the hybrid DAPT is the most important tool in the asset protection industry. Period. It has no equal.” I couldn’t agree more! The benefit of a standard DAPT is that it offers creditor protection even if you’re a beneficiary of the trust. But there’s also some risk: Although many experts believe they’ll hold up in court, DAPTs are relatively untested, so there’s some uncertainty over their ability to repel creditors’ claims. A “hybrid” DAPT offers the best of both worlds.

A Hybrid DAPT is a third-party irrevocable trust generally set up for the benefit of the settlor’s spouse and descendants in which the settlor isn’t an initial beneficiary, but which gives the settlor the power to appoint a trust protector who has the power to add and remove beneficiaries, including the power to add or remove the settlor. This type of trust can only be set up in one of the 17 DAPT jurisdictions. Initially, you’re not named as a beneficiary of the trust, which virtually eliminates the risk described above. But if you need access to the funds down the road, the trustee or trust protector can add you as a beneficiary, converting the trust into a DAPT.

Do you need this trust type?

Before you consider a Hybrid DAPT, determine whether you need such a trust at all. The most effective asset protection strategy is to place assets beyond the reach of creditors by transferring them to your spouse, children or other family members, either outright or in a trust, without retaining any control. If the transfer isn’t designed to defraud known creditors, your creditors won’t be able to reach the assets. And even though you’ve given up control, you’ll have indirect access to the assets through your spouse or children (provided your relationship with them remains strong).

If, however, you want to retain access to the assets in the future, without relying on your spouse or children, a DAPT may be the answer.

How does a hybrid DAPT work?

As stated above, a hybrid DAPT is initially set up as a third-party trust — that is, it benefits your spouse and children or other family members, but not you. Because you’re not named as a beneficiary, the trust isn’t a self-settled trust, so it avoids the uncertainty associated with regular DAPTs. Put another way, in a “hybrid” domestic asset protection trust, the settlor is not initially listed as a beneficiary, but the trustee has the power to add that person at some future date. Should the settlor encounter liability issues, these assets would not be in consideration if the settlor has not yet been added as a permissible trust beneficiary.

There’s little doubt that a properly structured third-party trust avoids creditors’ claims. If, however, you need access to the trust assets in the future, the trustee or trust protector has the authority to add additional beneficiaries, including you. If that happens, the hybrid account is converted into a regular DAPT subject to the previously discussed risks.

A flexible tool

The hybrid DAPT can add flexibility while offering maximum asset protection. It also minimizes the risks associated with DAPTs, while retaining the ability to convert to a DAPT should the need arise.

Combining the DAPT with a limited liability company (LLC) formed in Nevada or Michigan, in which the assets are considered to be owned by the entity rather than the individual may add another wall around the assets. If a creditor were able to pierce the DAPT, they should only be entitled to a pro-rata share of any member distributions from the LLC, if applicable; but because the debtor has control over any distributions, he or she would decline to distribute.