Alaskan self-settled trusts.

Today's highly litigious society has led many to consider the potential benefits of asset protection planning. Although many techniques are as simple as properly tiding assets, having money in protected pension plans, purchasing life insurance, etc., more sophisticated methods are increasingly being considered.

The recent past has seen the frequent use of offshore asset protection trusts established in creditor-friendly jurisdictions. These jurisdictions are countries that tend to have bank secrecy laws and no income, gift or estate taxes. Contrary to the laws in most states, these jurisdictions permit self-settled trusts; thus, the person establishing the trust (i.e., the grantor) can be a potential beneficiary. Although the trusts will be grantor trusts during the lifetime of the settlor under Sec. 679, they may become exempt from income tax after the grantor's death. The common law rule against perpetuities (which limits the life of a trust) is often repealed by these jurisdictions. Therefore, after a grantor's death, these trusts have unlimited life without income taxation, until the assets are repatriated to the US.

Potential abuses have brought the attention of Congress. Recent legislation has been designed to control the use of these trusts. Requiring specialized attorneys as drafters and trust companies as fiduciaries, these trusts are expensive to establish and operate. Further, the political and economic stability of countries with these statutes is always a concern.

Effective as of April 2, 1997, Alaska permits self-settled trusts to be free of the reach of creditors. The drafters of the Alaska law intended to provide a vehicle for asset protection and estate planning. (Missouri and Delaware have established similar statutes.) The initial issue of whether Alaskan self-settled trusts can provide similar asset protection features to those provided by offshore trusts has received a basically negative response from the professional community. Many commentators believe, however, that even if the asset protection statutes are ineffective, estate planning advantages can be obtained through the use of Alaskan trusts.

The Alaska law may not pass muster under those portions of the US. Constitution that protect the right to contract, provide for "full faith and credit" (requiring recognition of court judgments of other states) and ensure that a state cannot legislate against Federal law. In addition, conflict-of-laws matters (i.e., which jurisdiction's laws will be applied in a given case) must be considered. Many offshore jurisdictions will only apply their own law, not recognize U.S. judgments and not allow nonjurisdictional attorneys or contingency fee arrangements. While another state's court within the U.S. may treat an Alaskan trust as a sham or alter ego of the settlor, many foreign courts will not. And, although Alaska has not instituted the Uniform Fraudulent Conveyance Act or the Uniform Fraudulent Transfers Act and has not acknowledged or defined "badges of fraud" by statute, there is significant Alaska case history to encourage creditors to litigate such issues.

If, after analyzing these issues, it is decided that Alaskan trusts will not provide, asset protection, should these trusts be disregarded and not used? Surprisingly, an analysis of the rules on completed gifts may lead to the conclusion that Alaskan trusts may still be effective for gift and estate tax purposes.

Although Sec. 2036 includes the value of any transferred property over which the transferor retained the right of possession, enjoyment or income for a period not ascertainable without reference to his life, Rev. Rul. 77-378 held that if "the (settlor) cannot require that the trust's assets be distributed to the (settlor) nor can the creditors of the (settlor) reach any of the trust's assets, the parting with dominion and control creates a completed gift." Also, Rev. Rul. 76-103, involving a case in which trustees decided to move the situs of a trust to another state where "creditors [could not] reach the trust's assets," held that a completed gift took place.

Letter Ruling 9332006 applied these rulings to a foreign asset protection trust. This ruling indicated that funding of the trust creates a completed gift, because whether or not to distribute trust principal or income was solely in the trustee's discretion.

Because an Alaskan creditor will not be successful against an Alaskan trust of an Alaskan debtor (when Alaska law prevails), the revenue rulings discussed will presumptively apply. As such, placing assets into an Alaskan trust (without fraudulent intent or effect) will be treated as a completed gift.

The relative tax benefits of inter vivos gifts versus testamentary transfers can be accelerated by the use of Crummey powers. If relevant, proper drafting and allocation of exemptions can leverage generation-skipping transfer tax benefits. Furthermore, an Alaskan trust may allow certain benefits during the settlor's lifetime. Although Sec. 679 generally requires that offshore asset protection trusts be structured as grantor trusts for income tax purposes, an Alaskan trust can be drafted as either a grantor or a nongrantor trust. The decision will be based on the entire family's tax situation.

In summary, although an Alaskan self-settled trust may lack considerable asset protection benefits (in comparison to an offshore trust), they still should be considered within an entire wealth preservation plan.