This Is Not Your Typical SPAT

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

The Special Power of Appointment Trust, or “SPAT Trust”, has been used by estate planners for many years, but only recently has it been used for asset protection. The SPAT is specifically mentioned in the trust laws of many states, as well as in the Internal Revenue Code. While it has been touted as a “magic bullet” by some planners, it is really just another tool in the toolbox, and can be a useful one.  In other words, it is appropriate in some circumstances and inappropriate in others. However, in many instances a SPAT Trust offers unique benefits you may not achieve otherwise.

A Special Power of Appointment is often used in trusts that require special flexibility. This power is given to an “Appointer”, who has the power to give trust assets to anyone except himself, his creditors, his estate, or creditors of his estate. This power is usually used, of course, to make distributions from the trust to someone other than a beneficiary or the excluded persons we’ve just mentioned.

The bane of domestic asset protection trust planning is that, in most jurisdictions a self-settled trust, by law, is not allowed to protect trust assets from the settlor’s creditors. In other words, if you fund a trust in the traditional manner (by way of gift), and you wish to continue to benefit from those assets, then the trust is “self-settled” and you typically will get no asset protection. On the other hand, if you set up an irrevocable trust, and you are not a beneficiary of the trust, and do not retain improper control over trust assets then a state’s “spendthrift” laws will (subject to fraudulent transfer law) protect trust assets from most creditors.

The beauty of a SPAT trust is that the settlor is not a beneficiary of the trust. However, we may use the special power of appointment as a means to, if desired, give assets back to the settlor at some future point, while also making the trust non self-settled so as to obtain spendthrift protection.  Unlike the Domestic Asset Protection Trust, or “DAPT”, the SPAT Trust may provide meaningful protection in all 50 states.

Because a settlor of a SPAT Trust has no beneficial interest in trust assets, he retains no ownership interest in those assets. This means that he can honestly not list trust assets on a bankruptcy schedule (unless they were transferred within 1-2 years of filing bankruptcy), in a post-judgment debtor’s examination, or in a deposition. This is a benefit that very few, if any, other asset protection structures have. If you place assets in an LLC, for example, you must list your LLC interest on a bankruptcy schedule or in a debtor’s exam. The same goes for corporate stock, partnership interests, or a beneficial interest in a trust (however, unlike many other assets, a beneficial interest in a non-self-settled spendthrift trust is generally not included in one’s bankruptcy estate.)

Finally, one of the greatest appeals of a SPAT Trust is its simplified tax treatment. SPAT Trusts are typically set up as ‘grantor trusts’ under the Internal Revenue Code’s grantor trust tax provisions. In most instances, this means we can set up the trust so that it is disregarded as being separate from its settlor for tax purposes. Trust income is treated as if it were earned directly by the settlor, and is reported on the settlor’s personal income tax return. Not having to file an extra return for the SPAT Trust thus greatly reduces administrative hassles. And, unlike an LLC, the SPAT Trust need not be publicly disclosed, and no annual reports need be filed.

Potential SPAT Trust Drawbacks

SPAT Trusts do have some disadvantages. For example, like most trusts, a SPAT Trust is typically funded by way of a gift (however, for better protection, we may also fund it via installment sale, a strategy we discuss later). Under fraudulent transfer law, gifts are the most easily reversible type of transfer. At any point within 4 years of the transfer, or longer (based on state laws), a judgment creditor may undo a transfer, even if the creditor was not a creditor at the time of the gift, if he can show both of the following to be true:

• The transfer was a gift, or if consideration was received, the consideration was less than fair market value; and
• The debtor is unable or unwilling to pay the creditor (insolvent).

In addition to the foregoing, if frequent distributions are made from the trust back to the settlor, a savvy creditor may argue the settlor is a de facto trust beneficiary, even if he’s not listed as such in the trust document. This may lead a judge to treat the trust as if it were self-settled. However, for a married individual with children, or for a combined trust/LLC structure (described below), it is often not difficult to structure a trust so that its assets chiefly go to the beneficiaries, e.g. the spouse and children, rather than the settlor; this is a strategy we’ll examine shortly.

Finally, we must realize that, absent a provision restricting the special power of appointment, the Appointer may distribute trust assets to anyone other than himself, his estate, his creditors, or creditors of his estate. So as to ensure an improper appointment is not made, we could appoint a Trust Director/Protector, who would have power to veto an Appointer’s actions, or even fire and replace an Appointer, or we could give the trust’s settlor the right to veto trust distributions (but not the power to replace or remove a trustee, protector, or Appointer). Note that, if the settlor retains the power to veto trust distributions, this may cause inclusion of trust assets in his estate for estate tax purposes. This will not be an issue for most individuals, since currently the estate tax is only levied to the extent an estate’s assets exceed $11,580,000 million at the time of one’s death (or $23,160,000 million for a married couple).

Using a SPAT Trust with an LLC

For business assets, SPAT Trusts work best in tandem with a limited liability company (LLC). Because transfers to an LLC are an exchange of equivalent value and not a gift, a combined SPAT Trust/LLC structure (where the trust is a non-managing member of the LLC) would be less susceptible to fraudulent transfer claims, without necessarily having to make installment sales to the trust. A properly structured LLC can mitigate or even eliminate most SPAT Trust shortcomings.

For example, one could manage the LLC and keep assets inside the LLC instead of in the SPAT Trust, with the trust only owning the LLC as a non-managing member. This would mitigate concerns about whether an Appointer would always act in accordance with the settlor’s wishes. One could also receive money from the LLC by charging management fees, or by rendering services to the LLC and charging for those services. Taking out cash in this manner would prevent a creditor from arguing that the settlor is a beneficiary of the trust, since payments are for legitimate services, and are not distributions to the settlor from the trust.

Using a SPAT Trust in combination with an LLC provides more protection than using an LLC by itself. This is because, if one were to own an LLC outright, a creditor could obtain a charging order against the owner’s LLC interest. Although a creditor of an owner may not control an LLC, become a member, attach LLC assets, or force assets out of an LLC, a charging order allows a creditor to attach LLC distributions if and when they are made to the debtor-owner. If the LLC were owned by a SPAT Trust, however, then the debtor would no longer own the LLC, and the creditor could not obtain a charging order. Assuming there are no fraudulent transfer issues, a creditor would thus have no way to attach the LLC interest. He is simply out of luck!

There are instances where a SPAT Trust should not be used with an LLC. For example, case law has shown us that it is generally inappropriate for an LLC to own strictly personal assets, such as a personal residence. In such an instance, we would use a SPAT trust by itself, and perhaps sell the asset to the trust instead funding it by way of gift, so as to minimize the likelihood of a fraudulent transfer claim.

While the SPA trust is not for everyone, it provides an excellent asset protection strategy when the fit is right.