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Asset Protection Trust (APT): Definition – Explanation – Pros – Cons

What Is An Asset Protection Trust (APT)?

Asset Protection TrustAn Asset Protection Trust (APT) is a self-settled Trust intended to shield an estate and assets from creditors, lawsuits, or legal judgments.

An asset protection trust (APT) is a type of trust that holds an individual’s assets in order to protect them against creditors. Asset protection trusts provide the most robust defense against creditors, lawsuits, and judgments against an estate. An APT can even assist to discourage costly litigation before it starts.  Or, it can positively affect the outcomes of settlement negotiations.

A foreign asset protection trust is designed to offer effective protection against a court-ordered seizure of assets in the United States.  However, it can expose the assets to potential economic and political dangers connected with the nation in which the offshore account is maintained. The funding of an asset protection trust is where things become more complicated. Depending on the type of assets you intend to transfer to the trust, you may need to form a limited liability corporation before funding. You should also evaluate any potential tax consequences of adding assets to this form of trust.

Asset Protection Trust – A Closer Look

An asset protection trust is a self-settled trust in which the grantor can be named as a permissible beneficiary.  In other words, the person setting up the trust can have access to the trust money. Nevertheless, if the APT is correctly established, the trust’s assets will be inaccessible to creditors. A domestic APT provides asset protection as well as additional benefits.  For example, state income tax savings when located in a no-income-tax state.

APTs must meet stringent regulatory standards, such as being irrevocable. APTs allow for payouts on a sporadic basis, but only at the discretion of an independent trustee. These trusts also have a spendthrift clause.  This states that the beneficiary may not sell, spend, or give away trust assets unless certain conditions are met. For these reasons, an asset protection trust is a complex type of trust that is not suitable for everyone.

Asset Protection Trust – Irrevocable

An irrevocable trust is required to effectively secure your assets. As the name implies, once such a trust is established, it cannot be revoked by modifying its conditions.  Nor, do you have power over the trust’s assets. Instead, the trustee, or person designated to manage the trust, has power over the trust’s assets.  As a result, any modifications or distributions are at the trustee’s discretion. However, if a creditor sues you, the assets in the trust are unlikely to be regarded as yours.  Hence, even if the creditor gets a judgment against you, the assets in the irrevocable trust are much more likely to be preserved.

An irrevocable trust is a trust, that, by its terms, cannot be modified, amended, or revoked. For tax purposes an irrevocable trust can be treated as a simple, complex, or grantor trust, depending on the powers listed in the trust instrument. A revocable trust may be revoked and is considered a grantor trust (IRC § 676). State law and the trust instrument establish whether a trust is revocable or irrevocable. If the trust instrument is silent on revocability, then most states consider the trust revocable. (Source: irs.gov)

Three Types of Asset Protection Trust

There are three primary types of irrevocable trusts that can be used to protect assets. Foreign asset protection trusts, domestic asset protection trusts, and Medicaid APTs.

Domestic APTs

A domestic asset protection trust provides the most adaptable asset-protection trust legislation in the United States. If you choose to use one, you can do so swiftly and easily in the 17 states that allow them.  They are Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. However, as these trusts become more prevalent, an increasing number of state governments recognize their legal existence.

The main disadvantage of domestic trusts is that your assets remain subject to U.S. legal jurisdiction.  This puts them at risk of court orders including liens or judgments, federal bankruptcy laws, and other state regulations. Furthermore, because domestic APTs are new, they lack the legitimacy of proven case law.  This might be disastrous if a lawsuit or judgment is filed against your estate.

Foreign APTs

Because they are frequently held in an offshore account, foreign asset protection trusts are also known as “offshore” trusts. These trusts are set up in jurisdictions other than the United States.  For example, the Cook Islands and the British Virgin Islands. Foreign APTs are typically more expensive than domestic equivalents to create.  However, an overseas asset protection trust has more secure privacy protections than its domestic counterpart.  As a result,  a foreign ATP can provide even more effective asset protection. Another advantage is that governments that portray themselves as offshore tax havens typically do not enforce U.S. judgments against trust assets formed in their jurisdictions.

Medicaid Asset Protection Trust 

A Medicaid Asset Protection Trust (MAPT) is simply a Trust designed to limit or eliminate assets from being included in your overall estate valuation. A large estate could jeopardize your Medicaid eligibility. Typically, if a person intends to use Medicaid benefits for things like long-term care, their own assets must be depleted before any benefits kick in. Having a MAPT may allow you to get Medicaid benefits while still being able to live in your principal residence.  Also, while continuing to earn money from investments. As long as both are contained within the MAPT, the values will not compromise the benefits. This protects not just the individual establishing the Trust, but also future beneficiaries.

APTs Are a Complex Form of Trust

Before establishing an asset protection trust, you should completely grasp APTs and their implications. Most people set up these trusts with the assistance of a financial consultant. An asset protection trust is a form of irrevocable trust that can shield your assets from creditor proceedings such as lawsuits. This form of trust can help you protect wealth for future generations while avoiding probate, but it may not be appropriate for everyone.

Funding an APT

It helps to be affluent, or at least financially comfortable to consider an asset protection trust.  An APT benefits no one unless it is funded with assets. Trust assets often consist of a number of asset classes.  For example, cash, securities, real estate, vehicles, boats, and aircraft.  An APT may also be funded by limited liability companies (LLCs), business assets, intellectual property, inventory, and equipment.

Transferring the Assets

The process of moving assets to the APT is crucial.  It requires the collaboration of a diverse group of qualified and trusted specialists.  They range from financial advisors and lawyers to insurance brokers and many more. Next, several complicated legal hurdles must be overcome.  Each asset considered for transfer into an APT must be analyzed from various perspectives.  For example, its impact on legal protection, taxation, business and growth potential, and future distributions to spouses and heirs.

Asset Protection Trust – Advantages and Disadvantages

The most significant benefit of establishing this type of trust is to protect assets from creditors and lawsuits. Even if you don’t expect to be sued, having this type of trust in place could be beneficial.  Especially, if you do end up facing a lawsuit.

  • Protection for entrepreneurs – If you own a firm, you should think about setting up an asset protection trust. If you default on company loans or lines of credit for any reason, you would be protected from both personal injury claims and creditor litigation. If you have a higher net worth, you may want to explore this type of trust.  It can help to ensure that your assets are protected from creditors for your beneficiaries.
  • Avoids probate – In general, trusts enable your heirs to avoid the probate process after your death. Probate is a legal process in which an executor gathers your assets and pays off any outstanding debts.  The leftover assets then go to your heirs in accordance with your will or state inheritance laws if you die intestate. Probate can be time-consuming and expensive.  However, an asset protection trust allows your heirs to avoid it for the assets in the trust.

Disadvantages

  • Irrevocable once established and funded – The biggest disadvantage of an asset protection trust is that it cannot be revoked. You cannot withdraw assets from the trust after they have been transferred to it. This could complicate estate planning if you change your mind about which assets to include.
  • Different states, different statutes – An APT is intended to have the strongest ties to the state where the trust is established.  The settlor’s state of residency is only a secondary concern.  This is because the location of the trust’s assets could be decisive in a tightly disputed court struggle. As a result, it may be prudent to consider transferring some assets on a case-by-case basis.  For example, stocks and cash accounts, valuable and risky commercial and recreational assets, real estate, and settlor firms, might be better off transferred into an LLC.

Up Next: LIFO Method – What Is Last In, First Out?

LIFO MethodThe LIFO Method of accounting stands for last-in, first-out. It means the latest purchased or produced goods are considered as sold and expensed first.  In other words, the cost of the most recent product acquired (or created) is the first to be expensed as the cost of goods sold (COGS).  As a result, it means that the lower cost of older products is reported as inventory and stays on the balance sheet. This differs from the average cost method which takes the weighted average of all units available for sale.  It then uses that average cost to determine COGS and ending inventory for the accounting period under consideration. Another system is called the FIFO method. FIFO takes the oldest inventory items recorded as sold first to determine COGS and ending inventory.

Companies employ the LIFO method because it is assumed that the cost of the inventory rises over time.  This is a legitimate assumption in times of inflation and rising prices. When utilizing the LIFO method, the most recently acquired inventory will always be more expensive than earlier purchases.  As a result, the final inventory balance will be valued at earlier costs.  However, the most recent expense appears in the cost of goods sold. A corporation can reduce its stated level of profitability and hence defer the recognition of income taxes.  This is a direct result of shifting high-cost inventory into the cost of goods sold. Income tax deferral is usually the primary rationale for employing the LIFO method of inventory valuation.  The LIFO method is prohibited by international financial reporting standards.  However, it is still allowed in the United States under the approval of the Internal Revenue Service.

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