Domestic Asset Protection Trusts: Why Consider Alaska as a Jurisdiction?
Most advisors are ramping up for busy years in 2024 and 2025 as our high net worth and our moderately wealthy clients will be considering which trust or combination of trusts is appropriate for their situation. Why? Because the exemption (the amount you can transfer without gift tax or generation skipping tax) is set to be cut in half effective January 1, 2026. It is possible that the exemption and other estate planning issues can be impacted by the election. Our clients have a window of opportunity to utilize their higher exemption amount now, or they risk losing half of it.
The estate/gift/generation skipping tax exemption in 2024 is $13.61 million—a married couple has $27.22 million. The increased exemption amounts under the Tax Cuts & Jobs Act (2017) are due to sunset 12/31/25 and we will revert to the exemption amount prior to the TC&JA which was $5.0 million indexed for inflation. Effective 1/1/2026 the exempt amount will be an estimated $6.8 million ($13.6 for a married couple). Thus, our clients are in a season of “using it or losing it.”
Our last newsletter discussed using completed gift Spousal Lifetime Access Trusts (SLATs) as a suitable trust for married couples to consider when gifting. It is a great tool for the moderate estate as we can get the assets out of the estate to achieve a freeze in value and estate-tax-free growth while maintaining access to the assets (through the spouse). If a client isn’t married, has a troubled marriage, and may need access to the funds in the future, the Domestic Asset Protection (DAPT) would be an appropriate trust for their consideration as they can accomplish the same goals, namely: 1). Gifting assets out of the estate to achieve an estate freeze, 2). Having estate-tax-free growth on the assets, 3). Having access to the funds if needed as a discretionary beneficiary through discretionary distributions from the trustee.
For the last 25 years, DAPTs—also known as self-settled spendthrift trusts have become increasingly more common. Alaska was one of the first states to enact DAPT statutes (enacted in 1997). Now there are 18 states with DAPT laws with Alaska, Nevada, South Dakota, and Delaware being the most competitive. Each DAPT state’s statutes differ, but they all operate with the same essence: an irrevocable trust created for the benefit of the settlor and beneficiaries to protect the asset owned by the trust from potential negative effects of events such as attacks by creditors and predators. The assets are legally titled to the trust.
DAPTs created with the settlor as a discretionary beneficiary are called first-party trusts. DAPTs created for the benefit of other beneficiaries, such as children and grandchildren, are called third-party trusts. Thirdparty trusts should be considered when the client has sufficient wealth that they can gift freely to the trust without concern as to their possible future financial needs. Third-party trusts are well supported in the various DAPT states. Of course, Alaska, Nevada or a state with no income tax has advantages.
Clients who are moderately wealthy are more likely to utilize first-party DAPTs where they can make significant gifts now and still have access should they have a need in the future. More care needs to be taken in establishing a first-party trust in which the settlor is going to be a beneficiary. Yes, the settlor can be a discretionary beneficiary of a DAPT and receive discretionary distributions from the trustee. If a first-party DAPT is to be used, Alaska probably should be the state of situs. Some practitioners rely on Private Letter Ruling 200944002, which may allow a client to establish an Alaska DAPT and treat the transfer to the DAPT as a completed gift, thereby eliminating the DAPT assets from the client’s gross estate for estate tax purposes. This will allow appreciation on the DAPT property to accumulate outside of the client’s estate. Alaska is the only state where a Private Letter Ruling has been issued.
As in the case with other irrevocable trusts, the power of the DAPT comes from the discretionary role of the trustee. Typically, the trustee must be a resident of the DAPT state or in the case of a trust company, maintain its principal place of business there. Administration of the trust should take place within the state and some of the assets of the trust must be held in the state as well. A non-resident of a DAPT state may create a trust in that state. For example, a non-Alaska resident may create an Alaska situs trust. The criterion specified in this paragraph should be met.
There are three methods by which a creditor might attack a DAPT:
By undermining the choice of law that a court should apply.
By arguing a fraudulent transfer funded the DAPT.
By claiming illegitimate administration by the trustee or overreach by the settlor.
Knowing these potential threats can serve as guidance when drafting and implementing the DAPT, particularly in selection of jurisdiction.
Let’s take a closer look at the fraudulent transfer issue. Because DAPTs can be susceptible to misuse through fraudulent transfers, state statutes impose limitations and courts will consider certain factors to determine validity. The avoidance of fraudulent transfers is crucial for an effective domestic asset protection trust. Alaska is the only DAPT state not to have enacted the Uniform Fraudulent Transfer Act thereby avoiding the ambiguous provisions of the uniform act with uncertain limitation periods dealing with discovery of the transfer. In order to set aside a transfer to an Alaska DAPT on the grounds that the transfer was fraudulent, the creditor must establish that the settlor had an intent to defraud, and such intent must be established by clear and convincing evidence (not constructive evidence as allowed by other DAPT states). The general statute of limitations period to set aside a transfer to an Alaska DAPT is four years after the transfer was made. Alaska has resisted the temptation to shorten the limitation period in order to maintain a balanced, reasonable approach and increase the probability of enforcement by the courts. Specifically, if a creditor became a creditor subsequent to the transfer, then a fixed four-year limitation period applies. If the creditor was existing prior to the transfer, a claim must be brought within the later of four years after the transfer was made one year after the transfer is or reasonably could have been discovered by the creditor. The discovery exception is found in the Uniform Fraudulent Transfer Act which exists in all other DAPT states as well as in Alaska. This discovery exception creates considerable uncertainty because the discovery could occur many years after a transfer. The Alaska legislation provided certainty in this area by adding provisions which only exist in Alaska. The Alaksa statutes state that the reasonable discovery exception applies only if the creditor 1). Can demonstrate, by preponderance of the evidence, that the creditor asserted a specific claim against the settlor before the transfer, or 2). Files another action against the settlor that asserts a claim based on an act or omission of the settlor that occurred before the transfer, and that the action is filed within four years after the transfer.
Alaska’s discretionary trust provisions qualify and strengthen asset protection against the claims of creditors. As long as the trustee has discretion to make distributions to a beneficiary, then a creditor may not force a distribution, nor can a creditor compel a trustee to make a distribution. Even if a beneficiary has an outstanding creditor, a trustee with discretion may pay income or principal to a third-party for the benefit of the beneficiary. A creditor may not obtain an order of attachment that would prevent a trustee from making a discretionary payment to a third-party on behalf of the beneficiary.
In summary:
Benefits of DAPTs
For holding and controlling lifetime gifts
Exemption gifts $13.61 million
Annual exclusion gifts $18,000/donor/donee.
Asset protection against creditor’s claims against settlor/ beneficiaries
State Income Tax Planning
Protection of a sole asset—business, farm, etc.
Settlor can be a beneficiary for discretionary distributions.
Why Alaska?
Alaska’s strong DAPT statutes
Alaska’s strong fraudulent transfer statutes
Alaska Discretionary Trust statutes
Uses due diligence affidavit.
Trust duration 1,000 years
No income tax
Priv. Ltr. Rul. 9837007
