TABLE OF CONTENTS
I. Introduction ....................................................................................................... 1
II. Transfers in Trust .............................................................................................. 2
III. The Beneficiary Controlled Trust Concept ....................................................... 5
IV. Designing the Beneficiary Controlled Trust ..................................................... 6
V. Support Trusts Versus Discretionary Trusts ................................................... 11
VI. What is a Property Interest? ............................................................................ 20
VII. Spendthrift Provisions..................................................................................... 21
VIII. Distribution Standard and the Current Beneficial Interest .............................. 24
IX. Remainder Interest .......................................................................................... 27
X. Conflicting Distribution Language ................................................................. 29
XI. Hybrid Trust .................................................................................................... 31
XII. The Uniform Trust Code ................................................................................. 32
XIII. Creditor Remedies Prior to the UTC .............................................................. 33
XIV. Current Distribution Analysis – Non-UTC State ............................................ 34
XV. Remainder Interest Analysis - Non-UTC State .............................................. 35
XVI. Remainder Interest in Trust Subject to Division in Divorce! ......................... 37
XVII. Understanding the UTC .................................................................................. 42
XVIII. The Cornerstone of the Common Law Discretionary Trust ........................... 43
XIX. Ohio – A Tale of What Not to Do................................................................... 43
XX. Uniform Trust Code and Restatement Third .................................................. 46
XXI. Asset Protection for Discretionary and Support Trusts Now the Same? ........ 48
XXII. Continuum of Discretionary Trusts More Protective? .................................... 50
XXIII. Expansion of Exception Creditors? ................................................................ 50
XXIV. Restatement (Third) of Trusts ......................................................................... 55
XXV. Special Needs Trusts ....................................................................................... 56
XXVI. Beneficiary as Sole Trustee ............................................................................ 56
XXVII. Domestic Relations Case and Imputed Income .............................................. 57
XXVIII. End Round to Force A Distribution For Any Creditors .................................. 59
XXIX. Planning Around the Restatement Third and UTC ......................................... 59
XXX. The Inheritor’s Trust™ ................................................................................... 60
XXXI. Opportunity Shifting ....................................................................................... 61
XXXII. Corporations, Limited Liability Companies and Limited Partnerships ............. 65
XXXIII. Creditor Protection through Charging Orders................................................... 66
XXXIV. Alternative Asset Protection Structures .......................................................... 74
XXXV. The Inheritor’s Trust™/FLP Combo .............................................................. 75
XXXVI. Sale of Voting Interest to Inheritor’s Trust™ ................................................. 77
XXXVII. The Dual Spousal Trust Structure ................................................................... 79
XXXVIII. The Dual Spousal Trust and FLP Structure .................................................... 81
XXXIX. Asset Protection and Individual Retirement Accounts ................................... 81
XL. Other Creditor Protection Strategies – Tenancy by the Entirety (Craft) ........ 84
XLI. Other Creditor Protection Strategies – Disclaimers (Drye) ............................ 86
Asset Protection other than Self-Settled Trusts: Beneficiary
Controlled Trusts, FLPs, LLCs, Retirement Plans and other
Creditor Protection Strategies1
Steven J. Oshins
Oshins & Associates, LLC
Las Vegas, NV
A. With the spiraling divorce rate of over fifty percent in the United States, as
well as the increasing number of lawsuits, creditor protection is often the
most important objective of our clients.
B. An irrevocable trust set up by someone other than a beneficiary provides
the ultimate in creditor protection. As the asset protection maxim goes --
"If you don't own it, nobody can take it away from you."2
C. Historically, the general rule has been that the creator of the trust can
dictate who may receive the beneficial enjoyment of the property and the
extent and circumstances under which this enjoyment may be obtained. As
a result, unless trust property is distributed to a beneficiary, it will
generally be protected from the beneficiary's creditors.
D. The general rule is that through accepted legal remedies a creditor of a
debtor stands in the shoes of the debtor and may exercise any property or
other right that the debtor may exercise. So does this mean that a creditor
may attach a beneficiary’s trust interest or force the trust to make a
distribution to the creditor in satisfaction of a beneficiary’s debt? Further,
could a creditor lien or attach a remainder interest? If this is the general
rule, does an estranged spouse have more rights to attach a beneficial
interest under domestic relations law than an ordinary creditor? Does a
The author would like to thank Heidi C. Freeman and Kristen E. Simmons, attorneys at Oshins &
Associates, LLC, for their assistance in editing this outline. The author would also like to thank Mark
Merric, attorney at Merric Law Firm, LLC, for co-authoring the portions of this outline relating to the
Uniform Trust Code. More extensive materials can be read online at http://www.oshins.com.
Howard D. Rosen, 810 T.M., Asset Protection Planning, BNA Tax Management Portfolio at A-1.
discretionary trust provide stronger creditor protection than a support trust?
This outline will answer these questions and others.
II. Transfers in Trust
A. For transfer tax purposes and creditor protection purposes, properly
structured inherited wealth is a far more valuable commodity than wealth
earned and saved. Although it is generally true that neither our transfer tax
system nor our property law system distinguishes between wealth a
transferee taxpayer owns and retransmits and wealth that is earned and
subsequently transferred, proper planning can dramatically alter these
general rules. The vehicle that is generally used to achieve and maintain this
differential is an irrevocable trust, particularly a dynasty trust.
B. In the typical family setting, the trust is created by a senior family member
for the benefit of his or her descendants (and perhaps also for the spouse of
the trust creator). For the greatest flexibility, the permissible distributees
would also encompass spouses of descendants, 3 including the surviving
spouse of a deceased descendant (who was living with the descendant at the
time of his death or was unable to do so for health reasons), as well as trusts
under which the potential individual recipients are beneficiaries, whether set
up by a trustee under the original trust or by a third party.4
C. In order to achieve the maximum transfer tax savings, the trust should be
wholly exempt from the generation-skipping transfer tax ("GST tax"). This
will perpetually avoid the imposition of transfer taxes for successive
D. This outline has as a basic premise the philosophy that any gift or bequest
should be made in trust unless the size of the transfer does not justify the
expense of setting up a trust. The transfer of a gift or bequest in a trust can
confer more benefits upon a beneficiary than the beneficiary would have
received if the property had been conveyed outright. This outline generally
addresses the concept that trusts should be the vehicles of choice for all
dispositions to individuals, and in most instances should form the centerpiece
of the estate and creditor protection plan.
E. For mature, competent family members who would receive the property
outright were it not for the benefits that can be derived through the receipt of
For example, if a descendant was being sued or going through bankruptcy, a distribution to the descendant's
spouse could finesse attachment by the descendant's present or potential creditors, yet still provide indirect
benefits to the descendant.
See Malcolm A. Moore, New Horizons in the Grant and Exercise of Discretionary Powers, 15 U. Miami Inst.
on Est. Plan., Ch. 6 (1981).
property in a trust, the trust would be designed to give the primary
beneficiary the functional equivalent of outright ownership, including
undisturbed control over the property. Indeed, many candidates for this type
of planning would be unwilling to create such a structure unless the trust
benefits are coupled with the ability of the primary beneficiary or
beneficiaries to obtain control over the trust property virtually tantamount to
F. A portion of this outline will focus on such a trust that will be referred to as a
"Beneficiary Controlled Trust." This ability to improve a gift or bequest by
arranging that the transfer be made in trust, particularly a flexible
Beneficiary Controlled Trust, is too often dismissed without a careful and
skilled analysis of the enhanced benefits obtainable through the trust vehicle.
G. Notwithstanding the dual tax and creditor protection benefits that trusts can
provide, many planners and their clients eschew the opportunity to take full
advantage of trusts in the estate planning process.5 To the knowledgeable,
experienced estate planning and creditor protection planner, it is evident that
most clients, and many of their advisors, are not fully aware of how trusts
work, nor are they aware that if drafted skillfully, trusts are not the inflexible
vehicles that restrict the beneficiary's enjoyment of the property that many
H. To the contrary, in the hands of a proficient draftsman, trusts are extremely
flexible arrangements that can help the family cope with various problems,
both anticipated and unanticipated, that have occurred or may occur in the
future. Customized design of the trust can in almost every instance achieve
the client's goals, even where it is desired that virtually all major decisions be
lodged in the hands of the trust beneficiaries.
I. Sophisticated drafting in this instance includes incorporating provisions that
are often counterintuitive to most estate planning and creditor protection
practitioners. This approach often involves, among other things, negating the
prudent person rule and expanding the permissible investments to include
virtually everything imaginable that the beneficiary/trustee would acquire
individually. Traditional trust language usually precludes the types of
investments that a Beneficiary Controlled Trust encourages.
J. A surprisingly large number of wealthy estate owners and persons who are
otherwise astute in business and finance do not recognize the wealth
planning and creditor protection opportunities available to them, nor do they
realize the potential diminution of family assets that can be unnecessarily
and irretrievably lost through exposure to both the wealth transfer system
See Malcolm A. Moore and Jeffrey N. Pennell, Survey of the Profession II, U. Miami 30th Inst. on Est. Plan,
Ch. 15 (1996).
and the failure to use creditor protection strategies. A properly structured
irrevocable trust can avoid this exposure.6 To maximize the goal of keeping
wealth within the family unit, the trust should be a dynasty trust, designed,
funded and managed in a manner that will enable the trust to grow rapidly
and avoid transfer taxes and creditors, including divorcing spouses, for
several generations, preferably into perpetuity. This philosophy should be
followed provided it is consistent with the objective of providing
comfortably for the trust beneficiaries. Under this tax avoidance and creditor
protection strategy, the trustee should be encouraged to acquire assets for the
"use" of the beneficiaries rather than funding the individuals' personal
acquisition of assets.7
K. The trust should be designed in such a way that distributions are permissible,
but operationally it is anticipated that they should not be made in the absence
of a compelling reason to make them. By retaining property in trust, the
assets will not be subject to creditors of the trust beneficiaries or
diminishment in a divorce. The trust corpus can form a "family bank" or
"asset pool" for the use of the descendants (and, if desired, the spouse) of the
creator. As a result, the beneficiaries will have the use and enjoyment of the
property without transfer tax problems or exposure to creditors. The
beneficiaries individually (or by utilization of assets in trusts not protected
by the GST tax exemption) should be expected to absorb most family
expenditures such as food, schooling and vacations. Additionally, the exempt
funds should generally not be expended on consumable assets, such as
clothing, automobiles, etc., since use of protected funds in this manner would
L. In addition to providing tax savings, trusts are extremely useful and under-
utilized for non-tax purposes as well. It has been stated that, "[i]t is indeed a
rare client who should not at least seriously consider the use of a trust for
some circumstances, even if only to cover contingencies that ought to be
Note that the Mississippi Supreme Court ruled in Sligh v. First National Bank of Holmes County, No. 96-CA-
00033-SCT, 1997 Westlaw 620799 (Miss. Oct. 9, 1997), that a beneficiary's tort creditors could reach a
spendthrift trust for damages arising from gross negligence. Mississippi thus became the only state to recognize
a common law exception to the spendthrift trust doctrine, although a few states, such as Louisiana and Georgia,
have certain statutory exceptions. See Charles D. Fox IV and Rosalie Murphy, Are Spendthrift Trusts
Vulnerable to a Beneficiary's Tort Creditors?, Trusts & Estates (Feb. 1998). However, soon after this case was
decided, it was reversed by the enactment of a new state statute.
See Richard A. Oshins, MegatrustsSM--Representation Without Taxation, 48 INST. ON FED. TAX’N § 19 (1990);
Richard A. Oshins and Lawrence Brody, Representation Without Taxation – MegatrustsSM and
MegainsurancetruststSM, University of Southern California 42nd Institute on Federal Taxation; Richard A.
Oshins and Jonathan Blattmachr, The MegatrustSM: An Ideal Family Wealth Preservation Tool, Trusts &
Estates (Nov. 1991).
See Edward C. Halbach, Jr., Trusts in Estate Planning, The Probate Lawyer (Summer, 1975).
III. The Beneficiary Controlled Trust Concept9
A. Most of our clients want to leave their property to their loved ones outright,
provided that at the time of the gift or bequest the desired recipient is
capable of managing the property wisely. For these clients, trusts, possibly
combined with various estate planning maneuvers to increase the size and
growth of GST tax exempt trusts, are generally recommended in place of
straightforward, outright transfers. For those clients who want to pass on
their wealth so that the preferred beneficiaries (typically members of the
oldest then living generation) obtain the enjoyment of the property in a
manner as close to outright ownership as possible, with possible trade-offs
in order to increase flexibility, tax and creditor benefits, a Beneficiary
Controlled Trust should be considered.
B. The Beneficiary Controlled Trust is designed to provide the primary
beneficiary with all of the rights, benefits and control over the trust property
that he would have had if he owned it outright, in addition to tax, creditor
and divorce protection benefits that are not obtainable with outright
ownership. The ability to derive more benefits in a trust than one would
obtain with outright ownership without giving up control leads one to
wonder why trusts are not the vehicle of choice in virtually every estate plan
and why Beneficiary Controlled Trusts are not used instead of outright
transfers in almost every instance in which the transferor otherwise would be
inclined to gift or bequeath the property outright.
C. The Beneficiary Controlled Trust concept is fairly simple. It is a trust in
which the primary beneficiary either is the sole trustee or has the ability to
fire any co-trustee and select a successor co-trustee. Typically, control of the
trusteeship is coupled with a broad special power of appointment that can
have the effect of eliminating any potential interference by remote
beneficiaries. Because the primary beneficiary/trustee possesses the ability to
eliminate all participation in the enjoyment of the trust assets by secondary
and more remote beneficiaries, the latter will not be inclined to interfere
because their rights could be eliminated.10
D. From a beneficiary's perspective, the beneficiary can be given more benefits
in a trust than he could obtain with outright ownership. For the client who
would transfer property to the objects of his bounty outright, it is difficult to
reconcile not making the transfer to a trust that the primary beneficiary
See Frederick R. Keydel, Trustee Selection, Succession, and Removal: Ways to Blend Expertise with Family
Control, 23 U. Miami Inst. on Est. Plan., Ch. 4 (1989).
Congress is well aware of the fact that a trust can be designed in such a manner whereby "...the intervening
generation could be given the equivalent of absolute ownership of trust assets through powers of appointment
and trust powers." George Cooper, A VOLUNTARY TAX? NEW PERSEPCTIVES ON SOPHISTICATED ESTATE TAX
AVOIDANCE, 56 (Studies of Government Finance: Second Series 1979), referring to testimony given by Prof. A.
James Casner to the Ways and Means Committee.
controls, since the primary beneficiary can control the trust virtually without
limitation and interference from any secondary beneficiaries and still receive
the tax and creditor protection benefits of the trust vehicle. A trust designed
with control in the hands of the primary beneficiary (and secondary
beneficiaries who become primary beneficiaries upon the demise of the
primary beneficiary), coupled with a special power of appointment that
would enable the primary beneficiary to cut out a complaining secondary
beneficiary, should be free of interference and thus is the singularly most
important component of the estate and creditor protection plan.
E. Obviously, not all clients share the foregoing philosophy, and sometimes
circumstances preclude or suggest that all power not be lodged in a
beneficiary. For such clients, the estate plan should be designed to take into
account and reflect the specific variations and desires of the client to
accomplish his objectives. Illustrations of circumstances where the client
would not select a Beneficiary Controlled Trust include situations where the
beneficiary is either legally (e.g., a minor) or practically (e.g., inexperienced,
disabled, lacking judgmental skills, etc.) incapable or unable to assume
managerial responsibility; where the client wants to limit the beneficiary's
enjoyment of the property, enabling others to enjoy and share in the wealth;
or where the client wants to limit the beneficiary's power of disposition over
the property. In such instances, a trust, although not a Beneficiary Controlled
Trust, should be considered, even for transfers in which tax considerations
are not a substantial factor.11
IV. Designing the Beneficiary Controlled Trust
A. Once it has been decided that a trust should be used, the design of the trust to
achieve and maximize the desired results becomes important. In its simplest
structure, the trust could be designed whereby the beneficiary would be the
sole trustee and have the right to any or all of the income, plus access to
principal limited to health, education, support and maintenance, plus a broad
special power of appointment during life and/or at death to anyone other than
the beneficiary, his creditors, his estate, or the creditors of his estate.
B. However, in most instances this trust variation is not recommended because
greater flexibility, tax benefits and creditor protection can be obtained using
a discretionary Beneficiary Controlled Trust with multiple trustees. By using
friendly, independent trustees (or special trustees who could act under
Interestingly, when queried as to whether or not a trust should be considered for a young couple with a young
child or two and few assets which, including life insurance, might total between $100,000 and $200,000, most
clients and advisors respond that a trust is inappropriate. The author respectfully submits that the majority
answer is incorrect; even here a trust is the best vehicle. The real question is whether the cost of setting up the
trust and the remote possibility that the trust would be used justify its creation. Certainly, if the parents were to
die prematurely with young children, having a trust in place would be preferable to any other alternative.
appropriate circumstances), certain powers can be woven into the trust
agreement that could not exist if there were no independent trustees. This is
so because powers that are rather innocuous in the hands of an independent
trustee would cause tax and creditor problems if lodged in the hands of a
C. The primary factors that should be considered in designing the Beneficiary
Controlled Trust are:
a. Most trust scriveners draft trusts that pay out all of the
income. This course of action moves the income from a tax
and creditor protected area to one that is exposed.
Distributions from the trust restrict the growth of the
protected trust and are counterproductive from both a tax and
creditor protection perspective. Distributions will increase the
beneficiary's estate for both transfer tax and creditor purposes.
b. In addition, the retention of income in the trust will help the
trust beneficiaries in accomplishing their own estate planning
and creditor protection goals. If income is retained in the trust,
the trust will grow and create a large accessible fund for the
primary beneficiary of the trust that is creditor and divorce
protected. Based upon the security of the expanded trust fund,
the primary beneficiary can establish an aggressive gifting
posture and defund his own estate more rapidly and to a
c. In fact, as a result of the assets being beyond the reach of
creditors, the trust offers greater comfort and security than
outright ownership affords. From a creditor protection
perspective, a trust that provides for a mandatory payout of
the income may give creditors the ability to access the right
to receive the income.12 Therefore, although trust corpus is
generally shielded from creditors, some of the asset
protection benefits inherent in the trust vehicle will be lost. In
such instance, depending on state law, a court could either
direct a sale of such right to income or direct that the income
be paid to the creditor until the debt is discharged. 13 By
eliminating a beneficiary's enforceable rights, his creditor's
rights are also eliminated.
See IRS v. Orr, 84 AFTR2d 99-5390, 1999 WL 486613 (CA-5, 1999).
Scott, 2 Trusts 147-147.2 (2d ed. 1956).
d. Alternatively, for maximum creditor protection, a
discretionary trust should be used. The use of a discretionary
trust, where distributions are subject to the absolute discretion
of an independent trustee, has been described as "... the
ultimate in creditor and divorce claims protection - even in a
state that restricts so called ‘spendthrift trusts' - since the
beneficiary himself has no enforceable rights against the
e. Use of an independent co-trustee is generally acceptable
when one realizes that the grantor may have broad removal
and replacement powers as long as the replacement trustee is
not a "related or subordinate party" as defined in IRC
§672(c),15 or, alternatively, such powers may be lodged in the
hands of the beneficiary.16
f. Many clients will not accept anyone other than the intended
beneficiaries as a fiduciary, notwithstanding the benefits and
flexibility that a non-beneficiary fiduciary can offer, even if
the "stranger" is their best friend. In such instance, the
primary beneficiary should be the sole trustee subject to an
ascertainable standard since there is no proscription in the
estate tax laws that prevents a Beneficiary Controlled Trust
from being designed in this manner. This route should be
selected rather than the alternatives of selecting an outright
disposition or a trust that distributes all the income. However,
as discussed later in this outline, a discretionary trust with an
independent trustee making the discretionary distribution
decisions is far superior to a trust with the beneficiary as
trustee with distributions subject to an ascertainable standard
(a “support trust”), so the support trust design should only be
a secondary alternative.
g. The support trust alternative could authorize the
beneficiary/trustee to distribute income and principal to
himself based on the ascertainable standard of health,
education, support and maintenance without taking into
account his other assets. Under IRC §2041(b)(1)(A), the use
of the ascertainable standard would prevent estate tax
inclusion as a general power of appointment. If this option is
selected, the draftsman should also include a clause
prohibiting the beneficiary/trustee from making distributions
Keydel, fn. 9, supra, at §409.1.
Rev. Rul. 95-58, 1995-36 I.R.B. 16.
that would discharge his legal obligations. The trust also
should include special powers of appointment for maximum
flexibility. An inter vivos power would enable the
beneficiary/trustee/powerholder to make distributions to
secondary beneficiaries by exercise of the power, thus
avoiding gifts of his interests in the trust.
2. "Use" concept.
a. The basic philosophy of this outline is that a transfer of
property in trust improves the value of the property to the
trust beneficiaries. The corollary of that thesis is that
distributions from the trust, in the absence of a compelling
reason to make distributions, such as onerous income tax
consequences, should be avoided. The consequence of
making distributions would be to move wealth from a tax and
creditor protected environment into one that is exposed.
b. It is anticipated that the investment pattern would be
designed to enable the trust to realize and optimize its goal of
avoiding transfer taxes and creditor exposure for multiple
generations. The trustee should be encouraged to acquire
assets that are expected to appreciate in value for the "use" of
the beneficiaries, rather than funding the individual's personal
acquisition of the assets. The right to "use" the trust assets
may be for any purpose and need not be limited by an
ascertainable standard without coming within the general
power of appointment proscription contained in IRC §2041
even though the decision to allow the use is in the hands of a
person acting in the dual capacity of beneficiary and trustee.
Rather than being a power of appointment, use of the trust
assets would be akin to a life estate.
c. The trust instrument, particularly where a Beneficiary
Controlled Trust is the vehicle of choice, should contain
specific language that permits investment in assets such as
homes, artwork, jewelry, and business and investment
opportunities (whether speculative or not), that have
significant appreciation potential. This course of action is
generally viewed by purists as being the antithesis of
traditional trust investments, but is consistent with the
philosophy of the Beneficiary Controlled Trust in that the
trust wrapper is employed solely as an enhancement to
provide benefits to the trust beneficiary without meaningful
restrictions. Since the beneficiary would have had
unrestricted investment power had he received the assets
outside of the trust, it would be consistent with coming as
close to outright ownership as possible to permit broad
investment powers inside of the trust.
d. The beneficiaries individually (or by utilization of assets in
trusts not protected by the GST tax exemption) are expected
to absorb most family expenditures such as food, schooling
and vacations. Additionally, trust funds should generally not
be expended for consumable assets since use of protected
funds in this manner would be wasteful from both a transfer
tax and a creditor protection standpoint.
e. If the trust were to acquire and own assets such as the
beneficiaries' businesses and homes, it would indeed be rare
that an otherwise functional beneficiary could not fund the
foregoing family expenditures and consumables with
property outside of the trust. In fact, it is reasonable to
conclude that if a beneficiary could not so provide, the trust
alternative would be even more desirable as a creditor
protection shield. In order to further protect the beneficiary,
rather than making distributions to the beneficiary, the trustee
should make secured loans to the beneficiary so that the trust,
rather than the beneficiary's creditors, would have priority in
case of bankruptcy.
3. Special power of appointment.
a. A broad special power of appointment is often given to the
primary beneficiary of a trust, particularly if it is a
Beneficiary Controlled Trust. A power of appointment is a
desirable ingredient in most trusts because it adds flexibility,
and permits the trust to be modified in order to deal with
changes in the law or family circumstances. Its importance
increases when the trust is dynastic because there is a greater
possibility of change in family circumstances, laws,
particularly tax laws, etc. For many clients, the power of
appointment is, and should be, an essential ingredient of the
plan. They may not be inclined to proceed with their planning
in its absence because of a concern of interference by a
b. The use of a special power of appointment enhances the
objective of using a Beneficiary Controlled Trust in that it
provides added control in the hands of the primary
beneficiary. For example, by giving the trustee broad latitude
in investing, including high risk/reward opportunities, it can
be anticipated that some transactions will fail. If there were
no trust, there would be no accountability to more remote
descendants. By coupling the power of appointment with
broad discretionary powers in the hands of the
trustee/beneficiary, the result would be that the
trustee/beneficiary would have the functional equivalent of
no accountability with respect to the trust. As Professor Ed
Halbach has often stated, "[a] power of appointment is also a
power of disappointment."
c. If the creator of the trust desires to provide the beneficiary
with rights that are as close to outright ownership as possible,
the powerholder can be given the power to appoint the
property in favor of anyone, in trust or outright, other than
himself, his estate, his creditors or the creditors of his estate17
without causing estate inclusion.
d. A concern often voiced by dynasty trust candidates and some
of their advisors is that they don't want to be irrevocably
locked into a trust arrangement forever. A power of
appointment that can be exercised by making outright
distributions, thus terminating the trust, can easily finesse that
V. Support Trusts Versus Discretionary Trusts
A. A trust is generally drafted as either: (1) a mandatory distribution trust, (2)
a support trust (i.e., distributions pursuant to an ascertainable standard), or
(3) a discretionary trust. Additionally, since many attorneys tend to
combine the language of a support trust with the language of a
discretionary trust, a handful of states have created a fourth type of trust
called a hybrid trust.
1. Mandatory Distribution Trust
a. A mandatory distribution trust is a trust in which the trustee
must make the distribution required by the terms of the trust
b. The trustee may not withhold or accumulate a mandatory
c. Some examples of mandatory distribution trusts include
marital deduction trusts, grantor retained annuity trusts,
charitable remainder trusts and charitable lead trusts. The
trusts in these examples require mandatory distributions in
order to qualify for certain tax benefits.
d. However, many trusts are drafted with mandatory
distributions even though there is no tax reason to do so.
This often makes some or all of the trust assets available to
the beneficiary’s creditors and divorcing spouses for no
reason but that the trust scrivener was using a trust “form”
which was inadequate for planning purposes.
2. Support Trust
a. A support trust is created by the grantor to support one or
b. A support trust directs the trustee to apply the trust’s
income and/or principal as is necessary for the support,
maintenance, education, and welfare (or other standard) of
c. The beneficiary of a support trust can compel the trustee to
make a distribution of trust income or principal merely by
demonstrating that the money is necessary for the
beneficiary’s support, maintenance, education, or welfare,19
or whatever other standard is contained in the trust.
d. Following is the most common example of language
creating a support trust: “The Trustee shall make
distributions of income or principal for the beneficiary’s
health, education, maintenance and support.”
e. Implicit in this support language are two components: (1) a
command that the trustee “shall” make distributions, and (2)
under what standard or circumstances (i.e., health,
education, maintenance and support) distributions are to be
First National Bank of Maryland v. Dept. of Health and Mental Hygiene, 399 A.2d 891 (Md. 1979);
RESTATEMENT (SECOND) OF TRUSTS, Section 154.
Chenot v. Bordeleau, 561 A.2d 891 (R.I. 1989); Eckes v. Richland County Social Services, 621 N.W. 2d
851 (ND 2001); RESTATEMENT (SECOND) TRUSTS, Section 128, comments d and e.
f. A support trust typically includes mandatory language that
the trustee “shall” make distributions.20 However, there are
a few cases in which a trust has been classified as a support
trust even though the discretionary word “may” or the
words “discretion,” and even “sole discretion,” were used
instead of the mandatory word “shall.”
g. The standard for distributions often contains words such as
“health, education, maintenance and support.” However,
the standard may also include terms such as “comfort and
h. A support trust gives the trustee discretion only with
respect to the time, manner, or size of distributions needed
to achieve a certain purpose, such as support of the
i. For example, in McElrath v. Citizens and Southern Nat.
Bank, the language “[t]he Trustee shall use a sufficient
amount of the income to provide for the grandchild’s
support, maintenance and education” [emphasis added] was
held to be a support trust.23
j. Similarly, in In re Carlson’s Trust, the language “[t]he
trustee shall pay…[to the grantor’s] daughters such
reasonable sums as shall be needed for their care, support,
maintenance, and education” [emphasis added] was
determined to be a support trust.24
k. Finally, in McNiff v. Olmsted County Welfare Dept., the
court decided that the language “[t]he trustee shall
administer the trust estate for the benefit of my wife and
my said daughter, or the survivor of either, and the trustee
Lineback by Hutchens v. Stout, 339 S.E.2d 103 (NC App. 1986).
For estate tax purposes, under IRC §2041, the “welfare” standard would result in the trust failing the
definition of an ascertainable standard and thereby being deemed a general power of appointment.
However, for the definition of a support trust, it is included within the ascertainable standard. Further, in
some cases, language such as “comfort and general welfare” will also take the trust language outside that of
a general support trust. Lang v. Com., Dept of Public Welfare, 528 A.2d 1335 (PA 1987); RESTATEMENT
(SECOND) OF TRUSTS, Section 154 and comments thereto. But see Bohac v. Graham, 424 N.W.2d 144 (ND
Eckes v. Richland County Social Services, 621 N.W.2d 851 (ND 2001).
McElrath v. Citizens and Southern Nat. Bank, 189 S.E.2d 49 (GA. 1972).
In re Carlson’s Trust, 152 N.W.2d 434 (SD 1967).
shall apply the income in such proportion together with
such amounts of principal as the trustee, it its discretion,
deems advisable for the maintenance, care, support and
education of both my wife and my said daughter”
[emphasis added] created a support trust.25
3. Discretionary Trust
a. A discretionary trust allows the trustee complete and
uncontrolled discretion to make allocations of trust funds if
and when it deems appropriate. 26 Because the trustee is
given such broad powers, the beneficiary can only compel
the trustee to distribute funds if it can be shown that the
trustee is abusing its discretion by failing to act, acting
dishonestly, or acting with an improper purpose in regard to
the motive in denying the beneficiary the funds sought.27
b. Following is an example of language creating a
discretionary trust: “The Trustee may distribute as much or
more of the net income and principal as the Trustee, in its
sole and absolute discretion, deems appropriate to or
among any beneficiary or beneficiaries. The Trustee, in its
sole and absolute discretion, at any time or times, may
exclude any of the beneficiaries or may make unequal
distributions among them.”
c. Implicit in this magical discretionary language are three
components: (1) a discretionary statement that the trustee
“may” make a distribution, (2) the trustee has the “sole and
absolute” discretion to determine whether a distribution
shall be made and, if so, how much shall be distributed, and
(3) the ability to exclude distributions from other
d. A discretionary trust generally uses permissive language
such as the word “may” instead of the word “shall.” 28
However, as noted below, there are a few cases where the
courts have held that the word “shall” when combined with
McNiff v. Olmsted County Welfare Dept., 176 N.W. 2d 888 (Minn. 1970).
First National Bank of Maryland v. Dept. of Health and Mental Hygiene, 399 A.2d 891 (Md. 1979).
Town of Randolph v. Roberts, 195 N.E.2d 72 (Mass. 1964); Lineback, 339 S.E. 2d at 106 (NC App.
1986); Ridgell v. Ridgell, 960 S. W. 2d 144 (Tex. App. 1997); RESTATEMENT (SECOND) OF TRUSTS, Section
187, comment e.
State ex. rel. Secretary of SRS v. Jackson, 822 P2d 1033 (KS 1991).
the words “sole and absolute” discretion still resulted in a
e. The permissive word “may” is still generally further
qualified by granting the trustee unfettered discretion using
words such as “sole and absolute discretion,” “absolute and
uncontrolled discretion” or “unfettered discretion.”
f. In some cases, explicit language that permitted the trustees
to exclude or discriminate between beneficiaries when
making distributions was a major factor the court
considered when determining whether a trust was a
g. For example, in In re Matter of Leona Carlisle Trust, the
court determined that the language “[t]he Trustee shall
expend such sums from the principal of the trust for the
benefit of [appellant]…as the trustee, in its full discretion,
deems advisable,” [emphasis added] and it “is expressly
understood the trustee is under no obligation to make any
expenditures,” created a discretionary trust.31 Furthermore,
the trust language provided that the trustee shall not make
any distributions for appellant’s “basic necessities as
provided or to be provided by any governmental unit,” and
the trustee “shall make distributions only to supplement and
not to supplant such public assistance available for
maintenance, health care or other benefits.”32
h. Similarly, in Zeoli v. Commissioner of Social Services, the
court found that the language “[t]o pay or apply so much of
the net income to or among either one or both of my
daughters as shall be living from time to time during the
term of such trust, and in such proportions and amounts as
my trustee shall determine in his absolute and uncontrolled
discretion...” [emphasis added] created a discretionary trust.
The language in that case continued, “[m]y trustee shall not
be required to distribute any net income of such trust
currently and may, in his absolute and uncontrolled
discretion, accumulate any part or all of the net income of
Myers v. Kansas Dept. of Social and Rehabilitation Services, 866 P.2d 1052 (Kan. 1994).
McNiff v. Olmstead County Welfare Dept., 176 N.W.2d 888 (Minn. 1970).
In re Matter of Leona Carlisle Trust, 498 N.W.2d 260 (Minn. App. 1993).
such trust, which such accumulated net income shall be
available for distribution to the beneficiaries as aforesaid.33
i. As yet another example, in Simpson v. State Dept. of Social
and Rehabilitation Services, the trustees were required to
distribute trust income and assets to any one or more of the
group of beneficiaries as the trustees “in their absolute
discretion” may determine from time to time. The
instrument further provided that “the Trustees shall have
the absolute discretion, at any time and from time to time,
to make unequal payments or distributions to or among any
one or more of said group and to exclude any one or more
of them from any such payment or distribution.” 34
4. Hybrid Trust or “Discretionary Support Trust”
a. There are three states and possibly a fourth (Iowa,
Nebraska, North Dakota, and possibly Pennsylvania) that
have taken the position that there is an additional type of
trust – a “discretionary support trust”.
b. This type of trust includes elements of both a support trust
and a discretionary trust.35 A discretionary support trust is
created when the grantor combines the explicit
discretionary language “with language that, in itself, would
be deemed to create a pure support trust.”36
c. Under the case law of these three or four states, the hybrid
trust covers the middle ground between a classic support
trust and a classic discretionary trust.37 If a trust is neither a
traditional support trust nor a traditional discretionary trust,
these courts have followed one or the other of the following
two approaches. They have either (a) allowed extrinsic
evidence to determine the classification as either a
discretionary or a support trust, or (b) required the trustee
to carry out the purposes of the trust based on a “good
Zeoli v. Commissioner of Social Services, 425 A.2d 553 (Conn. 1979).
Simpson v. State Dept. of Social and Rehabilitation Services, 906 P.2d 174 (Kan. App. 1995).
Eckes v. Richland County Social Services, 621 N.W.2d 851 (ND 2001).
Elvelyn Ginsberg Abravanel, Discretionary Support Trusts, 68 Iowa L. Rev. 273, 279, n. 26 (1983).
Bohac v. Graham, 424 N.W.2d at 144 (ND 1988).
faith” standard and required the trustee to make minimal
d. For an example of a court allowing extrinsic evidence to
make the determination, in Bohac,38 the provisions of the
trust allowed the trustee to distribute principal as the
“Trustee may deem necessary” for the beneficiary’s
“support, maintenance, medical expenses, care, comfort,
and general welfare.” [Emphasis added.] The court noted
that the trust provisions created a hybrid trust, but decided
that extrinsic evidence must be admitted to determine the
grantor’s intent with respect to whether the trust was a
support trust or a discretionary trust. Even though the court
noted that the words “comfort and general welfare” may
result in the classification of the trust as a discretionary
trust, the court held the trust was a support trust.
e. As another example, in Kryzsko v. Ramsey County Soc.
Services 39 the trustee was given sole discretion to invade
trust principal for the “proper care, maintenance, support,
and education” of the beneficiary. The court held that the
trustee did not have unfettered discretion and must follow a
standard of providing proper support. The court noted that
unlike a discretionary trust, which fixes no standard on the
trustee’s absolute discretion as to whether to pay income or
principal to a beneficiary, a support trust gives the trustee
discretion only as to the time, manner, and size of the
payments needed to achieve a certain purpose such as
support of a beneficiary.
f. As yet another example, in Lang v. Com., Dept. of Public
Welfare,40 the terms of the trust provided that “the trustee
shall pay the income periodically to or for the support,
maintenance, welfare, and benefit of my son or may, in the
trustee’s discretion, add part or all of the income or
principal to be invested as such.” [Emphasis added.] The
trust continued, “[t]he trustee may distribute such part of
the income not necessary for the support of my son, in
equal shares to my children.” After looking at extrinsic
evidence suggesting that it was the grantor’s intent to
preserve trust assets, particularly where public benefits
Id. at 146.
607 N.W.2d 237 (ND 2000).
528 A.2d 1335 (PA 1987).
were available to the beneficiary, the court held that the
trust was discretionary.
g. In contrast, in Smith v. Smith, 41 the Nebraska Supreme
Court held that the trustee of a discretionary support trust
can be compelled to carry out the purpose of the trust in
good faith. The trust provided that “[T]he trustee shall pay
over to, or for the benefit of one or more of the living
members of a class composed of my son Richard and his
issue, so much of the net income and principal of the trust
as the Trustee shall deem to be in the best interests of each
such person, from time to time. Such distributions need not
be made equally unto all members of the class. In
determining the amount and frequency of such distributions,
the Trustee shall consider that the primary purpose of the
trust is to provide for the health, support, care, and
maintenance of my son Richard during his life.” [Emphasis
added.] The court determined that the above language
constituted a “hybrid trust” where the trusts were not only
created to support the primary beneficiary, but also to grant
the trustee greater liberty in decision-making than that of a
trustee of an ordinary support trust.
h. A few courts have held that the effect of a discretionary
support trust is to establish the minimal distributions a
trustee must make in order to comport with the grantor’s
intent of providing basic support, while retaining broad
discretionary powers in the trustee. 42 In these cases, the
courts held that the minimum distribution may be reached
by a creditor.43
i. In Bureau of Support in Dep’t of Mental Hygiene &
Correction v. Kreitzer,44 the Ohio Supreme Court, without
using the term “hybrid trust,” found the trust language to
517 N.W.2d 394 (Neb 1994).
In Strojek ex re. Mills v. Hardin County Bd. of Supervisors, 602 N.W. 2d 566 (Iowa App. 1999); In re
Sullivan’s Will, 12 N.W.2d 148 (Neb. 1943); Elvelyn Ginsberg Abravanel, Discretionary Support Trusts,
68 Iowa L. Rev. 273, 290 (1983); 3 Austin Wakeman Scott & William Franklin Fratcher, The Law of
Trusts §187 at Page 15 (4th ed. 1988).
In Strojek ex re. Mills v. Hardin County Bd. of Supervisors, 602 N.W. 2d 566 (Iowa App. 1999); Elvelyn
Ginsberg Abravanel, Discretionary Support Trusts, 68 Iowa L. Rev. 273, 290 (1983); Lawrence A Forlik,
Discretionary Trusts for a Disabled Beneficiary: A Solution or a Trap For the Unwary?, 46 U. Pitt L. Rev.
335, 342 (1985).
243 N.E. 2d 83 (Ohio 1968).
create neither a purely discretionary trust nor a purely
support trust. Therefore, the court held that the trust should
be governed by a “reasonableness” standard that would not
permit the beneficiary to become destitute. The result was
that the governmental agency could recover against the
trust assets under the exception for necessary expenses of a
beneficiary. Further, the Ohio Supreme Court seemed to
lean further toward becoming a “hybrid trust” state when it
stated in a subsequent case that “[a] trust conferring upon
the trustees power to distribute income and principal in
their absolute discretion, but which provides standards by
which that discretion is to be exercised with reference to
the needs of the trust beneficiary for education, care,
comfort, or support is neither a purely discretionary trust
nor a strict support trust.”45
j. This Ohio Supreme Court ruling is particularly troubling
because it used a “reasonableness” standard. For over a
hundred years, the strong majority view has been that the
appropriate standard is bad faith or abuse (i.e., the trustee
acts dishonestly with an improper motive or fails to act).46
Martin v. Martin, 374 N.E. 2d 1384 (Ohio 1978).
Different courts define the term “bad faith” slightly differently. As used in this outline, the term bad faith
means the trustee (1) acts dishonestly, (2) acts with an improper motive, or (3) fails to use his or her
judgment. In Re Jones, 812 P.2d 1152 (Colo. 1991) (citing SCOTT ON TRUSTS, Section 130 at Page 409 (4th
ed. 1989)). Also see the detailed analysis of Scott on Trusts, Section 187 at Page 15 where it is noted that if
the distribution standard includes enlarged or qualifying adjectives such as “sole and absolute discretion”
combined with “no fixed standard by which the trustee can be determined is abusing his discretion…the
trustee’s discretion would generally be deemed final.” Furthermore, Section 187.2 provides, “[e]ven though
there is no standard by which it can be judged whether the trustee is acting reasonably or not, or though by
the terms of the trust he is not required to act reasonably, the court will interfere where he acts dishonestly
or in bad faith, or where he acts from an improper motive.” This analysis by SCOTT ON TRUSTS remains
consistent through the 2003 supplemental volume.
George Taylor Bogert also seems to hold relatively the same definitional analysis as Scott in THE LAW OF
TRUSTS AND TRUSTEES, 2nd Edition 1980, Supplement through 2003. Section 560 of the Supplement at
Page 183 provides that if a settlor has given a discretionary power (without qualification), the court is
reluctant to interfere with the trustee’s use of the power…Hence, in the absence of one or more of the
special circumstances mentioned hereinafter, the court will not upset the decision of the trustee. These
special circumstances (at Page 196) are (1) a trustee fails to use his judgment; (2) an abuse of discretion; (3)
bad faith; (4) dishonesty; (5) an arbitrary action. Regarding the issue of “arbitrary action,” Bogert provides,
“[i]f the trustee has gone through the formality of using his discretion, but has not deliberately considered
the arguments pro and con, and thus has made a decision for no reason at all, his conduct may be
characterized as arbitrary and capricious, as amounting to a failure to use his discretion. In this respect,
Bogert suggests that the “arbitrary” action is a subset of a trustee failing to act.
Also, both Scott and Bogert note that a few states have statutes where unless the trust agreement contains
language such as the “sole and absolute discretion” of the trustee, the trustee may not act arbitrarily. Bogert
2003 Suppl. at 199, footnote 85; Scott, Section 187.2, Page 39, footnote 12; CALIFORNIA PROBATE CODE
§1608, ENACTED 1986 C.820; MONTANA CODE §72-23-306 (1983); NORTH DAKOTA CENT. CODE §59-02-
12; SOUTH DAKOTA CODIFIED LAWS §55-3-9 (1967).
Further, the purpose of a discretionary trust is to prevent
the courts from reviewing the “sole and absolute”
discretion of the trustee. With a discretionary trust, the
grantor has chosen to put his faith in the trustee rather than
the courts. However, a support trust takes the opposite
approach. With a support trust, the grantor wants the
beneficiary to have a right to enforce the ascertainable trust
terms if the trustee does not follow the standard drafted into
the trust agreement.
k. By using a standard less than that of bad faith and closer to
reasonableness, the Ohio Supreme Court has now given the
beneficiary of this hybrid type of trust the right to sue the
trustee for unreasonably not making a distribution or not
distributing enough. Furthermore, this legal right will most
likely be a property right (i.e., a right enforceable under
state law) that can cause the creditor to stand in the shoes of
VI. What is a Property Interest?
A. If the beneficiary of a trust comes under the attack of a creditor, most
courts first determine whether the beneficiary has a property interest in the
trust under state law.47 Rather than using a property analysis, some courts
will find that the beneficiary’s interest has no ascertainable value. 48 In
essence, the analysis is the same. In the latter approach, there is no interest
or enforceable right that a creditor may attach because the beneficial
interest has no value.
B. Assuming the property analysis approach is used, the initial step in
determining whether a creditor may recover against an interest in a trust is
to determine whether the interest is a property interest under state law.
C. If the beneficiary’s interest in the trust is not a property interest, then the
analysis proceeds directly to whether the beneficiary held too much
control over the trust, followed by any state nuances under domestic
Carlisle v. Carlisle, 194 WL 592243 (Superior Ct. Connecticut 1994); Lauricella v. Lauricella, 565 N.E.
2d 436 (Mass. 1991).
Miller v. Department of Mental Health, 442 N.W.2d 617 (Mich. 1989); Henderson v. Collins, 267 S.E.2d
202 (Ga. 1980); In re Dias, 37 BR 584 (D. Idaho 1984).
A creditor cannot recover against a beneficial interest that is not a property interest. Magavern v. U.S.,
550 F.2d 797 (2nd Cir. 1977) (reversing the state court, but still discussing the property interest issue).
However, due to some state domestic relations statutes, a value may be assigned to a discretionary interest
in a trust to determine what the other spouse should receive upon the divorce.
D. On the other hand, if the beneficiary holds a property interest, does the
creditor stand in the shoes of the beneficiary, and may the creditor enforce
the beneficiary’s property right? The answers to these questions depend
upon whether the trust has a spendthrift provision and how much creditor
protection the spendthrift provision provides.
E. State law determines what constitutes a property interest. While state law
may vary, “property” is generally defined as everything that has an
exchangeable value or which goes to make up wealth or estate.50
F. An “equitable interest” in trust property is regarded as a property interest
of the same kind as trust res and is more than a mere chose in action.51
Simply, there are two methods for determining whether something
constitutes property: (1) something that may be sold or exchanged, or (2)
an enforceable right.
G. With regard to the first type of property, such property is freely alienable,
and as such has a fair market value that may be determined by a market
H. However, beneficial interests in trusts are generally restricted by
spendthrift provisions that prevent the transfer of any beneficiary’s interest.
In this respect, there is no fair market value because the property cannot be
sold. On the other hand, under the second test, in many situations, a
beneficiary has an enforceable right (i.e., a property interest).
I. For example, with support trusts, a current beneficiary has a right to sue
the trustee to force a distribution pursuant to a standard in the trust. Also,
if a beneficiary has a vested remainder interest, the beneficiary will most
likely receive property at some time in the future.
VII. Spendthrift Provisions
A. A spendthrift provision is a provision in a trust agreement that provides
that the beneficiary cannot sell, pledge or encumber his beneficial interest,
and a creditor cannot attach a beneficiary’s interest.
Graham v. Graham, 194 Colo. 429; 574 P.2d 75, 76 (Colo. 1978) (citing Black’s Law Dictionary, 1382
Senior v. Braden, 295 U.S. 422 (1935); Brown v. Fletcher, 235 U.S. 589 (1915); II W. Fratcher SCOTT
ON TRUSTS, Section 130 at 406 (1987).
B. At common law, the purpose of a spendthrift trust was to protect a
beneficiary other than the grantor of the trust from his own spending
habits. The idea was to provide for someone who could not provide for
himself, and to keep such beneficiary from becoming dependent on public
assistance. Therefore, if a spendthrift clause was added to a trust, the
common law developed a legal principle that a creditor could not recover
from the beneficiary’s interest. 52 If the mere insertion of such a clause
could protect a beneficiary’s interest, why not include such a provision in
almost all trusts? Today, this is in fact the case.53
C. A beneficiary of a discretionary dynasty trust does not need to rely on a
spendthrift provision because neither the current distribution interest nor
any subsequent interest is a property interest under state law. Therefore, in
a non-UTC state, neither the beneficiary nor the creditors of the
beneficiary have any right to force a distribution from the trust. However,
as a matter of course, trust scriveners should nearly always include
spendthrift provisions.54 This is especially true should the UTC become
law in the applicable state.
D. However, the same analysis is not true for a trust that is classified as a
support trust. In this case, beneficiaries in many states may force a
distribution from the trust pursuant to the standard provided in the trust
E. So the question becomes, can a creditor stand in the shoes of the
beneficiary and force such a distribution? The language of a spendthrift
provision on its face generally prohibits a creditor from doing so.
F. However, under what circumstances will courts make exceptions to
spendthrift protection? Except for certain types of creditors, a spendthrift
provision protects the trust’s assets from attachment.55
G. The Restatement Second, Section 157 carves out the following four key
exceptions 56 to spendthrift protection, where a creditor may attach the
assets of a support trust:
The U.S. Supreme Court followed the common law view of spendthrift protection in Nichols v. Eaton, 91
U.S. 716 (1875).
Even though almost all scriveners include a spendthrift provision in a trust, the trust instrument must still
be examined to make sure that this is indeed the case. If a spendthrift clause is not included, a creditor
stands in the shoes of the beneficiary and may enforce any right that he has - mandatory distribution,
ascertainable standard distribution or a remainder interest. In re Katz, 203 B.R. 227 (E.D. Pa. 1996);
Chandler v. Hale, 377 A.2d 318 (Conn. 1977).
This is particularly true should the governing state law of the trust ever adopt the UTC or the
RESTATEMENT (THIRD) OF TRUSTS.
In Re Graham 726 F.2d 1268 (C.A.8. Iowa 1984); In re Stephens, 47 B.R. 85 (Bkrtcy. D. Vt. 1985).
RESTATEMENT (SECOND) OF TRUSTS, Section 157.
1. Alimony or child support - Almost all, if not all, recent cases hold
that a spouse may reach a beneficiary’s interest for alimony or
child support.57 Therefore, if a trust is classified as a support trust,
an estranged spouse may almost always reach the assets of the trust
to satisfy a maintenance or child support claim. However, this
exception does not apply to a division of marital property pursuant
to a divorce.
2. Necessary services or supplies rendered to the beneficiary - Most
cases in this area arise when a federal or state institution is
attempting to attach a beneficiary’s interest for medical services
rendered on behalf of the beneficiary.58 Furthermore, in almost all
of these cases, the drafting attorney conflicted the magical words
found in a discretionary trust with those of a support trust.
3. Services rendered and materials furnished that preserve or benefit
the beneficial interest in the trust - These are generally claims by
attorneys for fees incurred to either sue the trust or protect a
beneficial interest. Fortunately, while the other three exceptions of
the Restatement Second are almost universally applied by the
states, this one is not. In other words, attorneys are frequently not
allowed to recover their fees from the trust.
4. A claim by the U.S. or a state to satisfy a claim against a
beneficiary - Generally, these are tax liens. The Internal Revenue
Service may often reach a beneficiary’s interest in a support trust
for payment of a tax lien.59 In First Northern Trust Co. v. Internal
Revenue Service,60 the court noted that it is a well established legal
principle that the income from a spendthrift trust is not immune
from federal tax liens notwithstanding any state laws or recognized
exemptions to the contrary.61
In re Threewitt, 20.B.R. 434 (Bkrtcy. D. Kan. 1982); Payer v. Orgill, 191 N.E.2d 373 (Ohio 1963).
Department of Mental Health and Development Disabilities v. First Nat. Bank of Chicago, 432 N.E. 2d
1086 (Ill. App. 1 Dist., 1982); Department of Mental Health and Developmental Disabilities v. First Nat.
Bank of Chicago, 432 N.E. 2d 1086 (Ill. App. Dist. 1982); State v. Rubion, 308 S.W. 2d 4 (Tex. 1957);
Lang v. Com., Dept of Public Welfare, 528 A.2d 1335 (Pa. 1987); Sisters of Mercy Health Corp. v. First
Bank of Whiting, 624 N.E. 2d 520 (Ind. App. 3 Dist. 1993).
Bank One Ohio Trust & Co., 80 F.3d 173 (6th Cir. 1996).
622 F.2d 387 (8th Cir. 1980).
But see U.S. v. Riggs Nat. Bank, 636 F. Supp 172 (D.D.C. 1986).
H. In summary, there are four exception creditors that can reach a support
trust’s assets to satisfy their claim. In a non-UTC state, these exception
creditors, including the federal government, would have no claim against
the trust assets if the trust had been drafted as a discretionary dynasty trust.
VIII. Distribution Standard and the Current Beneficial Interest
A. Almost all courts will classify a beneficiary’s interest as being (1) a
mandatory distribution, (2) a support distribution, or (3) a discretionary
distribution. However, as previously noted, there is a problem when a
scrivener conflicts the elements of a discretionary trust with those of a
1. Mandatory Distribution Trust
a. When the terms of a trust require a mandatory distribution
to be made, there is no question that the beneficiary has an
enforceable right to this distribution. The beneficiary
unquestionably may sue the trustee to force a distribution.
Therefore, a fixed interest, which is an interest that creates
an enforceable right in the beneficiary, is a property interest.
For example, in In re Question Submitted by the United
States Court of Appeals for the Tenth Circuit, the Tenth
Circuit held that a beneficiary’s future right to receive
$1,000 per month was a property interest.62
b. With respect to a mandatory distribution right, the creditor
is not attaching the trust’s assets. Rather, the creditor is
attempting to attach to the mandatory distribution stream.63
Since this interest is a property right, the only question is
whether a spendthrift provision provides some type of
protection for a mandatory distribution received from a
2. Support Trust
a. The common law purpose of a support trust is to provide
support for a beneficiary based on a “standard.”
b. The most common standard used is that of health,
education, maintenance and support.
In re Question Submitted by the United States Court of Appeals for the Tenth Circuit, 191 Colo. 406,
411; 553 P.2d 382, 386 (1976).
RESTATEMENT (THIRD) OF TRUSTS, Section 56, comment a; UNIFORM TRUST CODE, Section 501.
c. Such a support standard must be definite enough for a court
to be able to determine whether a trustee is following the
support standard. In this respect, magical words such as
health, education, maintenance and support have been
determined by courts to be definite.
d. Words such as comfort and welfare may or may not be
sufficiently definite depending on state law.
e. On the other hand, words such as joy and happiness are not
capable of interpretation on a reasonable basis, and may
easily result in a trust not being classified as a support trust.
f. If a trust is classified as a support trust, a beneficiary of a
support trust can compel the trustee to make a distribution
of income or principal merely by demonstrating that the
money is necessary for the beneficiary’s support,
maintenance, education, or welfare, 64 or whatever other
standard is used in the trust agreement.
g. In other words, a beneficiary has a right to sue the trustee
for failing to make a distribution from a support trust. If a
beneficiary has the right to sue the trustee, the beneficiary
most likely has a property interest under state law.65
h. If this is the case, does the creditor stand in the
beneficiary’s shoes and have the power to sue the trustee to
force the payment of the beneficiary’s debt? Absent
spendthrift provisions, this would definitely be the case.
i. Therefore, whether a creditor (including an estranged
spouse) may recover must be determined under the analysis
in the spendthrift portion of this outline.
3. Discretionary Interest
a. Under the Restatement Second and almost all of the case
law to date, a discretionary beneficiary has no contractual
or enforceable right to any income or principal from the
Chenot v. Bordeleau, 561 A.2d 891 (R.I. 1989); Eckes v. Richland County Social Services, 621 N.W. 2d
851 (ND 2001); RESTATEMENT (SECOND) OF TRUSTS, Section 128, comments d and e.
Each state law must be analyzed in this respect. However, there is at least one case where state law held
that a beneficiary of a support trust did not have a property right (i.e., an enforceable right) to force the trust
to make a distribution pursuant to the support standard.
trust, and therefore the beneficiary cannot force any action
by the trustee.66
b. This is because a court may only review a discretionary
trust for abuse and bad faith. There is no reasonableness
standard of review by a court with respect to a discretionary
trust. Further, the discretionary interest is not assignable.67
c. In this respect, a discretionary beneficiary’s interest is
generally not classified as a property interest. Rather, it is
nothing more than a mere expectancy.68 If a beneficiary has
no right to force a distribution from a trust, then the same
rule applies to the beneficiary’s creditor. The creditor may
not force a distribution.
d. Similarly, whether the assets of a discretionary trust are
protected does not depend on spendthrift provisions with
respect to the current beneficial interest. As discussed in the
spendthrift section of this outline, the creditor protection
features of a discretionary trust are much stronger than
those of a support trust or a mandatory distribution trust
that must rely on spendthrift protection.
4. Hybrid Trust or “Discretionary Support Trust”
a. If a judge does not classify a trust with conflicting language
as either a discretionary trust or a support trust, the case law
in Iowa, Nebraska, North Dakota, and possibly
Pennsylvania, has indicated that it is a hybrid trust. In
general, a beneficiary of a hybrid trust only has the right to
sue the trustee for a minimal distribution.69
b. This being the case, the hybrid trust does not provide the
same degree of protection as a discretionary trust. Rather, it
is more similar to a support trust than a discretionary trust,
In re Marriage of Jones, 812 P.2d 1152 (Colo. 1991); G. Bogert, Trusts and Trustees, Section 228 (2nd
U.S. v. O’Shaughnessy, 517 N.W. 2d 574 (Minn. 1994); In re Marriage of Jones, 812 P.2d 1152 (Colo.
In Strojek ex re. Mills v. Hardin County Bd. of Supervisors, 602 N.W. 2d 566 (Iowa App. 1999); In re
Sullivan’s Will, 12 N.W.2d 148 (Neb. 1943); Elvelyn Ginsberg Abravanel, Discretionary Support Trusts,
68 Iowa L. Rev. 273, 290 (1983); 3 Austin Wakeman Scott & William Franklin Fratcher, The Law of
Trusts Section 187, at 15 (4th ed. 1988).
and an analysis of the spendthrift provisions must be done
to determine whether the trust assets are protected.
IX. Remainder Interest
A. A remainder interest has a slightly different analysis than that of a current
beneficial interest. While divorce cases tend to use the word “property” in
determining a remainder interest,70 the rule under the Restatement Second,
Section 160 requires a determination as to whether there are “inseparable
B. In essence, the “inseparable interest” rule functions quite similar to the
property analysis used for a current beneficial interest. Further, the
Restatement adds to the analysis an “indefinite” or “contingent” interest
analysis as another hurdle a creditor will most likely need to cross. If the
remainder interest is not a property interest, or if a creditor cannot
overcome the indefinite or contingent interest rule, then the analysis
proceeds directly to whether the debtor/beneficiary retained too much
C. According to the Restatement Second, if a beneficial trust interest is “so
indefinite or contingent that it cannot be sold with fairness to both the
creditors and the beneficiary, it cannot be reached by creditors.” 71 There
are two parts to this rule. First, is the remainder interest indefinite? Second,
can the remainder interest be sold with fairness to both the creditors and
1. Indefinite and Contingent Interests
a. A vested interest is not a contingent interest. A vested
interest is one where the debtor/beneficiary or the
debtor/beneficiary’s estate will take at some point of time
in the future.
b. The clear majority rule appears to be that a vested
remainder interest may be sold at a judicial foreclosure sale
unless it cannot be sold with fairness to both the creditors
and the beneficiary, or unless the trust contains spendthrift
Balanson v. Balanson, 25 P.3d 28 (Colo. 2001); Davidson v. Davidson, 474 N.E. 2d 1137 (Mass. App.
Ct. 1985); Trowbridge v. Trowbridge, 114 N.W.2d 129, 134 (Wis. 1962).
RESTATEMENT (SECOND) OF TRUSTS, Section 161.
Henderson v. Collins, 267 S.E.2d 202 (Ga. 1980) [vested remainder interest in a discretionary trust may
be sold at judicial foreclosure sale]; Burrell v. Burrell, 537 P.2d 1 (Alaska 1975); Moyars v. Moyars, 717
N.E. 2d 976 (Ct. App. Ind. 1999); Benston v. Benston, 656 P.2d 395 (Or. App. 1983); Lauricella v.
c. These cases follow the general property rule that a
remainder interest in property may be sold even though it is
a future interest.73
d. Many estate planners consider a remainder interest to be a
contingent interest where either (1) one party must outlive
the other party in order to take, or (2) the trust property is
subject to complete divestment due to a special power of
appointment. However, Restatement Second, Section 162,
Illustration 1 indicates that the mere fact that a child must
survive a parent in order to take the trust property is not too
contingent, and, therefore, unless the remainder interest
cannot be sold with fairness to both the creditors and the
beneficiary, absent spendthrift protection, a creditor would
be able to judicially foreclose on the remainder interest.74
2. Sold With Fairness
a. Would a willing buyer or willing seller pay much for an
interest in trust that is contingent on a child outliving his
parent? Most likely, the interest would be highly
b. However, what if the interest was subject to a special
power of appointment that could divest the child of the
entire remainder interest? In this case, a purchaser at a
judicial foreclosure sale would likely pay little for the
interest when compared to the amount that would
ultimately be received by the remainder beneficiary.
Lauricella, 565 N.E. 2d 436 (Mass. 1991) [under all of these cases, a vested remainder interest was
considered marital property for division purposes].
Mid American Corp. v. Geisman, 380 P.2d 85 (Okla. 1963) [A debtor received a remainder interest under
a will. Once the death of the will maker had occurred, the remainder interest was vested. It was not in trust,
and a simple future property analysis provided for the property to be received under the will to be sold at a
judicial foreclosure sale.].
In Re Neuton, 922 F.2d 1379 (9th Cir. 1990) [where the fact that the debtor would need to outlive his
mother in order to take the trust property was not so contingent as to prevent the judicial foreclosure sale of
a 25% of the debtor’s interest by a bankruptcy trustee]; Balanson v. Balanson, 25 P.3d 28 (Colo. 2001);
Davidson v. Davidson, 474 N.E. 2d 1137 (Mass. 1985); Benston v. Benston, 656 P.2d 359 (Or. App. 1983);
Trowbridge v. Trowbridge, 114 N.W. 2d 129 (Wis. 1962) [Under all of these cases, vested remainder
interests were not too indefinite to be classified as marital property for purposes of division.]; but see Loeb
v. Loeb, 301 N.E. 2d 349 (Ind. 1973) where the contingency of outliving the debtor’s mother was
considered too indefinite for purposes of equitable division in a divorce.
c. There are very few reported cases where anyone other than
a former spouse attaches the remainder interest. 75 Most
creditors do not attempt to judicially foreclose on a
remainder interest because in almost all cases the “sold
with fairness rule” would apply. Even if the “sold with
fairness rule” does not apply, several states have passed
state statutes preventing the forced sale of remainder
X. Conflicting Distribution Language
A. With respect to the current distribution interest, a discretionary trust
generally provides the strongest asset protection features because the
discretionary distribution interest is generally not a property interest under
state law. If a beneficiary does not hold a property interest, then a creditor
cannot attach it. Unfortunately, there is a tension between the asset
protection features of a discretionary trust and who can be a trustee
without possible estate tax inclusion issues.
B. Clients generally wish to have a family member, such as a spouse or child,
serve as the trustee. If distributions are limited to an ascertainable standard,
there are times when a spouse/beneficiary or a child/beneficiary may serve
as the sole trustee of a trust without an estate tax inclusion issue.77 On the
other hand, if the spouse or child is the sole trustee and a beneficiary of a
discretionary trust, the spouse or child will be considered to hold a general
power of appointment, thereby resulting in estate inclusion.78
C. Many estate planners attempt to get the best of both worlds. These
planners would like a trust that would be considered discretionary for state
law purposes so that a creditor of a beneficiary cannot attach the trust.
They also would like the trust to be deemed to have an ascertainable
standard for estate and gift tax purposes, giving the client greater selection
over who can be a trustee.
Mid America Corp. v. Geisman, 380 P.2d 85 (Okla. 1963) [In a one paragraph holding, the Supreme
Court of Oklahoma reversed the appellate court decision to sell the remainder interest, noting the proper
remedy was a lien. The Supreme Court thought the remedy was too drastic a measure as related to the
RESTATEMENT (THIRD) OF TRUSTS, Section 56, comment e.
For example, if the beneficiary children are adults (i.e., the spouse has no support obligation) and the
distribution is pursuant to an ascertainable standard, the spouse may be the sole trustee without IRC §2041
As a trustee, the spouse or child would have unlimited power to distribute any amount of the trust assets
to himself as a beneficiary of the trust.
D. In an attempt to accomplish both of these objectives, these planners draft
distribution language that uses magical words from both a support trust
and a discretionary trust. For example, the trust document may read:
“The Trustee may, in his sole and absolute discretion, make distributions
of income or principal based on health, education, maintenance and
support to any beneficiary.”
E. The magical discretionary words “may,” and “discretion” have been
conflicted with the trust support words “health, education, maintenance
and support.” Furthermore, the discretionary language allowing the
trustee to make distributions to one beneficiary and not the others has been
F. Naturally, the Service would like to argue that this language creates a
discretionary trust because the distribution trustee would have a general
power of appointment at death and would therefore have estate inclusion
under IRC §2041.79
G. Conversely, the taxpayer would like to argue that distributions are
pursuant to an ascertainable standard in order to avoid the estate inclusion
H. Furthermore, if it is a governmental agency that is the creditor of the
beneficiary and is seeking to recover payment from the trust, the
governmental agency will argue that distributions are pursuant to an
ascertainable standard and that the trust should be classified as a support
trust. The client will argue that the distributions are discretionary.
I. The court will almost always find that the trust is either (1) a “support”
trust (i.e., ascertainable standards) or (2) a discretionary trust.
J. Almost all non-UTC courts will decide one way or the other, but not both
K. By attempting to accomplish the best of both worlds, the estate planner
typically does more damage than good. The planner either creates a
possible estate inclusion issue or allows a creditor to recover from the trust
assets. For this reason, the trust scrivener should avoid conflicting trust
Estate of Carpenter, 45 AFTR 2d 80-1784, 80-1 USTC 13,339 (D. Wis. 1980); Independence Bk.
Waukesha (N.A.) v. U.S., 761 F.2d 442 (7th Cir. 1985) – tangential reference to “without court approval”;
analogy – PLR 9118017; but see Best v. U.S., 902 F. Supp. 1023 (D. Neb. 1995) where “sole and absolute”
language was not argued by the Service.
The only exceptions are Iowa, Nebraska, North Dakota, and possibly Pennsylvania, each of which has
taken the position that there is a third type of trust – a “discretionary support trust.”
language and should draft either a purely discretionary trust or a support
trust (i.e., distributions based on ascertainable standards).81
XI. Hybrid Trust
A. In the few states that recognize a hybrid trust, 82 the hybrid trust is by
definition a conflicting language trust.
B. The problem with this is that most of the states require the trustee to make
a minimal distribution for the beneficiaries’ needs. This being the case, a
creditor for necessary expenses of the beneficiary most likely becomes an
C. Furthermore, what about child support and alimony? One could easily
argue that child support is a necessary expense.
D. Similarly, are taxes a necessary expense of a beneficiary?
E. At present, the answers to these questions are unknown. However, in the
few states that recognize a hybrid trust, it seems that such a trust provides
little more protection than that of a support trust.
F. Support Trust Conflicting Language - The following court decisions noted
that the language of the trust used both discretionary and support language,
but held that the trust was a discretionary trust:
*Myers v. Kansas Depts of SRS, 866 P.2d 1052 (Kan. 1994).
*Roorda v. Roorda, 300 N.W. 294 (1941).
*Lineback by Hutchens v. Stout, 339 S.E.2d 103 (NC App. 1986).
*Chenot v. Bordeleau, 561 A.2d 891 (RI 1989).
One would hope that various judges throughout the states would agree whether similar conflicting
language constituted a discretionary trust or one based on an ascertainable standard. Unfortunately, this is
generally not the case. The judges appear to be equally confused on the issue. Further, even if in one state
the judges would be consistent on what similar conflicting language meant, what if the trust jurisdiction
changes to another state or nation? Will the new jurisdiction agree with the old jurisdiction’s interpretation
of the conflicting language?
Iowa, Nebraska, North Dakota, and possibly Pennsylvania. Also, as previously discussed, Ohio imposes
a reasonableness standard as to whether the trustee must make distributions to a beneficiary, but Ohio does
not use the term “hybrid trust.”
In Strojek ex re. Mills v. Hardin County Bd. of Supervisors, 602 N.W. 2d 566 (Iowa App. 1999); Elvelyn
Ginsberg Abravanel, Discretionary Support Trusts, 68 Iowa L. Rev. 273, 290 (1983); Lawrence A Forlik,
discretionary Trusts for a Disabled Beneficiary: A Solution or a Trap For the Unwary?, 46 U. Pitt L. Rev.
335, 342 (1985).
G. Discretionary Trust Conflicting Language - The following court decisions
noted that the language of the trust used both discretionary and support
language, but held that the trust was a support trust:
*Bohac v. Graham, 424 NW 2d. 144 (ND 1988).
*Button by Curio v. Elmhurst Nat. Bank, 522 N.E.2d 1368 (Ill. App. 1988).
*Kryzsko v. Ramsey County Social Services, 607 N.W.2d 237 (ND 2000).
*Bureau of Support in Dept. of Mental Hygiene and Correction v. Kreitzer,
243 N.E. 2d 83 (Ohio 1968).
*McNiff v. Olmsted County Welfare Dept., 176 N.W.2d 888 (Minn. 1970).
XII. The Uniform Trust Code84
A. Presently, nine states - Kansas, Maine, Missouri, Nebraska, New
Hampshire, New Mexico, Tennessee, Utah and Wyoming - have enacted
the UTC. The UTC is under review in numerous other states. The District
of Columbia has also enacted the UTC.
B. On the other hand, Arizona enacted the UTC in May of 2003. Within a
year, due to the public outcry and the estate planning attorneys’ strong
opposition to the UTC, it was repealed by unanimous vote of both the
House and the Senate.
C. The UTC was also defeated in the Colorado legislature and killed in a
Senate Committee in Oklahoma despite the support of both Bars. After
intensive study in Texas, Minnesota, and Indiana, some minor portions of
the UTC were adopted, but most of the provisions of the UTC were
rejected. Furthermore, the Texas Bar is currently drafting anti-Restatement
(Third) of Trusts legislation.
D. One of the principal reasons the UTC was repealed in Arizona and is
receiving strong resistance in several other states is the radical departure
that the UTC and Restatement Third take from common law regarding the
traditional asset protection afforded by discretionary dynasty trusts as well
as spendthrift trusts in general.
E. For well over four hundred years, trust law has been based on the property
concept that a donor may make a gift subject to whatever restrictions he
wishes. While there are some limited public policy exceptions to this rule,
such as restrictions on marriage, the common law has generally allowed
Most of the material in this outline related to the UTC and support trusts versus discretionary trusts is
based on the analysis made in the three-part article titled The Effect of the UTC on the Asset Protection of
Spendthrift Trusts, Estate Planning (Aug., Sept. and Oct. 2004), co-authored by Mark Merric and Steven J.
Oshins. That article is based on extensive research done by Mark Merric. The article can be read at
trusts to follow the grantor’s intent. The UTC and the Restatement Third
are both built on the opposite assumption.
F. As related to discretionary trusts, the UTC and Restatement Third are built
on the assumption that the beneficiaries should have a much greater right
to challenge the grantor’s wishes through litigation than prior law has
G. In addition to changing the fundamental property assumption behind trust
law, both promulgations overturn one hundred twenty-five years of well-
established trust law by equating the asset protection features of a
discretionary trust with those of a support trust.
H. For this reason, in the area of traditional asset protection through non-self-
settled trusts, should a state legislature adopt the UTC or should a court
decide to follow the Restatement Third, a completely separate analysis of
asset protection is provided below.
XIII. Creditor Remedies Prior to the UTC
A. To the extent a trust beneficiary has a “property right,” even if the trust
includes a spendthrift clause, certain “exception creditors” may attach the
beneficiary’s interest. These “exception creditors” are generally the
following exception creditors specifically listed in the Restatement Second
1. Alimony and child support;
2. Necessary expenses of a beneficiary (i.e., governmental claims for
medical expenses); and
3. Governmental claims.85
B. There is a fourth exception creditor listed in the Restatement Second - a
creditor for expenses incurred to preserve a beneficial interest (i.e.,
attorneys’ fees). 86 However, most states have not adopted this fourth
C. Exception creditors are allowed to attach the beneficial interest of a trust
pursuant to the distribution standard in the support trust (e.g., health,
education, maintenance and support). As discussed later in this outline, in
a non-UTC state or non-hybrid trust state, exception creditors may only
RESTATEMENT (SECOND) OF TRUSTS, Section 157.
recover against a trust that is classified as a support trust, not against a
trust that is classified as a discretionary trust.
D. Since the beneficiary has a right to force a distribution pursuant to the
distribution standard, the exception creditor also succeeds to such a right.
In this respect, the exception creditor is able to reach part or all of the
assets necessary to satisfy the creditor’s claim directly from the trust
XIV. Current Distribution Analysis – Non-UTC State
A. In general, a current distribution interest is an interest where the trustee
may make a current mandatory distribution, discretionary distribution, or
distribution based on a support standard. Generally, if the beneficiary does
not have a property interest (i.e., an enforceable right 87), a creditor has
absolutely no right of recovery. The theory is that if the beneficiary does
not have a right of recovery that he may enforce, the creditor can obtain no
more rights than the beneficiary has over the trust assets. This rule that
prevents recovery by a creditor is not dependent upon spendthrift
provisions. Rather, a creditor cannot compel the trustee to pay anything
because the beneficiary cannot compel a payment.88 Therefore, so long as
the governing law of the trust is not that of a state that has adopted the
UTC, absent control issues, or, in a few states, certain divorce issues, if a
beneficiary has no property interest, the analysis is generally concluded
and the creditor has no right of recovery.
B. However, not all state courts use a direct property analysis in determining
whether a creditor may reach a beneficial interest. Rather, some courts
will examine whether the beneficiary’s interest has an ascertainable
value.89 In essence, the analysis is the same. If the beneficiary’s interest
has no value, then there is no interest or enforceable right that a creditor
C. On the other hand, if the beneficiary has a property interest, then the trust
must be reviewed to determine whether it contains a spendthrift clause.
Rather than using a property analysis, some courts will find that the beneficiary’s interest has no
ascertainable value. Miller v. Department of Mental Health, 442 N.W.2d 617 (Mich. 1989); Henderson v.
Collins, 267 S.E.2d 202 (Ga. 1980); In re Dias, 37 BR 584 (D. Idaho 1984). In essence, the analysis is the
same - there is no interest or enforceable right that a creditor may attach because under this analysis the
beneficial interest has no value.
RESTATEMENT (SECOND) OF TRUSTS, Section 155, comment b.
Miller v. Department of Mental Health, 442 N.W.2d 617 (Mich. 1989); RESTATEMENT (SECOND) OF
TRUSTS, Section 157; Henderson v. Collins, 267 S.E.2d 202 (Ga. 1980); In re Dias, 37 BR 584 (D. Idaho
Almost all trusts have such a clause. In general, a spendthrift clause
protects a beneficiary’s interest from attachment by a creditor.
D. However, under the Restatement Second, there are four types of creditors
that may attach a beneficiary’s interest regardless of the spendthrift
provisions. These creditors are referred to as exception creditors. Most
states have adopted three of the four exception creditors. The exception
creditor for expenses required to protect a beneficial interest (i.e., attorney
fees) has not been adopted by many states.
E. In addition, even if a the creditor is not an exception creditor, or even if
the trust is a discretionary trust, if the beneficiary holds too much control
over the trust, a creditor will still be able to attach to the beneficiary’s
interest and reach the trust’s assets. For example, if the beneficiary is the
sole trustee and sole beneficiary of a trust, then the trust assets may be
available to a creditor.90
F. With respect to alimony and child support claims, a former spouse and
minor children are exception creditors, and the former spouse may attach a
current beneficial interest of a support trust on behalf of minor children.
However, except for states that have adopted the UTC or Restatement
Third, a spouse generally does not have any claim against a discretionary
XV. Remainder Interest Analysis - Non-UTC State
A. Absent spendthrift provisions, a beneficiary may transfer the remainder
interest, and a creditor may attach such interest.91 This would include an
estranged spouse as well as any other creditor.92
B. On the other hand, if spendthrift provisions are present, ordinary creditors
may not attach a remainder interest. This is true even in bankruptcy court.
C. The Federal Bankruptcy Court is required to look to state law to apply
property rules.93 For example, in In Re Neuton, a California state statute
provided that spendthrift provisions protected 75% of the remainder
In re Bottom, 176 B.R. 950 (N.D. Fla. 1994).
RESTATEMENT (SECOND) OF TRUSTS, Section 161; Henderson v. Collins, 267 S.E.2d 202 (Ga. 1980)
[noting that in this case a remainder interest was a future property interest].
Martin v. Martin, 374 N.E.2d 1384 (Ohio 1978); Miller v. Department of Mental Health, 442 N.W. 2d
617 (Mich. 1989).
However, in the highly controversial case U.S. v. Craft, 122 S. Ct. 1414 (2002) the Supreme Court
overturned 50 years of well-established property law when it stated that federal law determined property
interest. 94 The debtor’s ordinary creditor could not recover against the
amount protected by state law.
D. However, if the creditor is one of the four exception creditors and the
“sold with fairness” rule does not apply, the creditor may attach and/or
judicially foreclose and sell the remainder interest.95
E. The remainder interest analysis varies from the current distribution
analysis in a few key areas. First, similar to a current beneficial interest,
one must first determine whether the interest is a property interest.
However, the Restatement Second adopts a different approach than that
which is used in the current beneficial interest analysis. If an interest is
created for a group of persons, it is inseparable and a creditor cannot reach
it.96 For example, a dynasty trust is a trust in which an interest never vests
in anyone. Hence, an interest in a dynasty trust would not be a property
interest and would be “inseparable” as defined in the Restatement Second.
F. The Restatement Second also provides that if an interest of a trust “is so
indefinite or contingent that it cannot be sold with fairness to both the
creditors and the beneficiary, it cannot be reached by his creditors.” 97 If
this is the case, a creditor should not be able to recover from the trust.
However, if this is not the case, then the analysis shifts to whether the trust
has a spendthrift provision.
G. Similar to the analysis for a current distribution interest, spendthrift
protection must be analyzed within the confines of the four exception
creditors. Here again, a former spouse is an exception creditor who may
attach a remainder interest for child support or alimony.
H. The control issue analysis is substantially identical for a current beneficial
interest and a remainder interest. Even if a the creditor is not an exception
creditor or even if the trust is a discretionary trust, if the beneficiary holds
too much control over the trust, a creditor will still be able to attach to the
beneficiary’s interest and reach the trust’s assets.
I. In the domestic relations area, courts have granted a former spouse greater
rights than an ordinary creditor or an exception creditor. As noted above, a
spouse is an exception creditor, but only for the purposes of alimony or
child support. However, in many states, courts have allowed a spouse to
attach a remainder interest as part of a property settlement.
In Re Neuton, 922 F.2d 1379 (9th Cir. 1990).
Miller v. Department of Mental Health, 442 N.W. 2d 617 (Mich. 1989).
RESTATEMENT (SECOND) OF TRUSTS, Section 161.
RESTATEMENT (SECOND) OF TRUSTS, Section 162.
XVI. Remainder Interest in Trust Subject to Division in Divorce!
A. Until recently, in the event of divorce, almost all asset protection planners
thought that a remainder interest was free from division of marital
property. Most Colorado estate planners went into shock when the
Colorado Supreme Court handed down the In re Balanson decision.98 The
Colorado Supreme Court had held that the appreciation on a vested
remainder interest subject to complete divestment was marital property
eligible for equitable division. Colorado law holds that an inheritance is
exempt from the definition of marital property, and any appreciation on
inherited property is considered marital property. Prior to this, Colorado
had held that remainder interests in trusts were indivisible.99
B. The disturbing facts of Balanson began when the daughter married. A few
years later, Mom and Dad create the standard estate plan that creates a
marital trust and credit shelter trust upon the death of the first spouse.
Several years later, Mom died and the first $1 million of her assets funded
the credit shelter trust, and the remainder funded the marital trust. Dad was
the sole trustee of both trusts. All income of the marital trust was required
to be distributed to Dad. However, distributions of income of the credit
shelter trust and any corpus of either trust were based on an ascertainable
C. Dad was in good health and could easily live many more years.
Furthermore, Dad had a testamentary general power of appointment over
the marital share that would allow him to completely extinguish the
daughter’s interest should he desire by appointing all of the trust property
to his son.
D. Several years after Mom dies, Daughter filed for divorce.
E. Son-in-law claimed that Daughter’s vested remainder interest was marital
property eligible for division in the divorce.
F. Daughter’s remainder interest was contingent since she had to outlive Dad.
Also, Daughter’s interest was subject to complete divestment because Dad
could exercise his special power of appointment solely in favor of his son.
G. However, the Colorado Supreme Court ruled that even if a vested
remainder interest is subject to complete divestment, such an interest is still
In re Balanson, 25 P.3d 28 (Colo. 2001).
In re Marriage of Rosenblum, 602 P.2d 892 (1979).
a property interest that can be valued for the purpose of division in a
H. The logic behind the decision was that the Court frequently values interests
that are hard to value such as retirement plans and businesses and that,
therefore, each side needs to merely bring in its experts since it is only a
I. In Balanson, the Colorado Court cited two other cases – Davidson v.
Davidson (a Massachusetts case) and Trowbridge v. Trowbridge (a
Wisconsin case) 100 and held that a vested remainder interest subject to
complete divestment is eligible for marital property division.
J. At first blush, following in Massachusetts’ footsteps, the Colorado
Supreme Court appears to be crossing new legal ground. However, this
does not quite appear to be the case. Rather, it appears that this is a national
trend rather than being just a few states with isolated occurrences.
K. The following courts, listed alphabetically by state, have found a remainder
interest to be a marital asset eligible for division in a divorce:
1. Alaska - Burrell v. Burrell101 - In 1975, the Alaska Supreme Court
found a vested remainder interest subject to division.
2. Colorado - Balanson v. Balanson 102 - In 2001, the Colorado
Supreme Court held that any appreciation on a vested remainder
interest subject to complete divestment was eligible for division as
a marital asset.
3. Connecticut - Carlisle v. Carlisle103 - In 1994, the Superior Court
of Connecticut found remainder interests in a credit shelter trust,
marital trust, and an irrevocable trust to be marital property.
4. Indiana – Moyars v. Moyars104 - In 1999, the Court of Appeals of
Indiana distinguished Loeb v. Loeb. 105 Loeb had held that a
contingent remainder interest was too remote to be considered
Davidson v. Davidson, 474 N.E. 2d 1137 (Mass. App. Ct. 1985); Trowbridge v. Trowbridge, 114
N.W.2d 129, 134 (Wis. 1962).
537 P.2d 1 (Alaska 1975).
25 P.3d 28 (Colo. 2001).
194 WL 592243 (Superior Ct. of Conn. 1994).
717 N.E.2d 976 (Ct. App. Ind. 1999).
301 N.E. 2d 349 (Ind. 1973).
marital property because if the husband predeceased his mother the
entire trust property would pass to the husband’s siblings. In
Moyars, the husband owned a vested one-third remainder interest
in real estate. The remainder interest was not contingent on him
outliving his mother’s life estate. Rather, the remainder interest
would pass to his estate if he predeceased his mother. Therefore,
the Court of Appeals held that a vested remainder interest was
5. Massachusetts - Davidson v. Davidson 106 - In 1985, the
Massachusetts Supreme Court held that neither uncertainty of
value nor inalienability of a husband’s vested remainder interest in
a discretionary trust were sufficient to preclude division.
6. Montana - Buxbaum v. Buxbaum 107 - In 1984, the Montana
Supreme Court held that a husband who had benefited from his
future interests, which were vested interests, by using them as
collateral, could not construe them as a mere expectancy and
preclude them from property division.
7. New Hampshire - Flaherty v. Flaherty 108 - In 1994, the New
Hampshire Supreme Court held that an anti-alienation clause and
circumstances that the defendant’s contingent remainder interest
will not have value until his last parent dies did not preclude the
treatment of the interest as marital property.
8. North Dakota - van Ossting v. van Ossting109 - In 1994, the North
Dakota Superior Court held that when the present value of the
husband’s vested credit trust was subject to contingencies and was
too speculative to calculate, the proper method of distribution was
to award the wife a percentage of future payments.
9. Ohio - Martin v. Martin 110 - In 1978, the Ohio Supreme Court
found that a future interest, whether contingent or executory, is
474 N.E. 2d 1137 (Mass. 1985). See also Lauricella v. Lauricella, 565 N.E. 2d 436 (Mass. 1991) where
a vested remainder interest in an irrevocable trust subject to a term of years was subject to division as
692 P.2d 411 (Mont. 1984).
638 A.2d 1254 (N.H. 1994).
ND Sup Ct., No 940003 (1994).
374 N.E. 2d 1384 (Ohio 1978).
10. Oregon - Benston v. Benston 111 - In 1983, the Oregon Appeal
Court found that a vested, as well as a contingent, remainder
interest is subject to division.
11. Vermont - Chikott v. Chilkott112 - In 1992, the Vermont Supreme
Court held that techniques of actuarial valuation of pension
interests were applicable to determining the present value of the
husband’s vested, defeasible trust interest for the purposes of
property division at dissolution.
12. Wisconsin - Trowbridge v. Trowbridge113 - In 1962, as dictum, the
Wisconsin Supreme Court held that remainder interests in trust
subject to conditions of survivorship, depletion of corpus, and
spendthrift clause, were part of a marital estate subject to division
L. To date, twelve states have held that a vested remainder interest is
property that is eligible for division in a divorce. Some of these states
require the property to be vested, but most of them hold that a vested
remainder interest, even if subject to complete divestment, is a marital
asset. In this respect, the Balanson case is not the shock that many people
first suspected. Rather, it appears to be a common finding in many courts
when all or part of a remainder interest is considered marital property.
M. One may ask why more states have not found a vested remainder interest
to be property eligible for division. First, as noted above, a handful of
states still follow the theory that a vested remainder interest is not divisible,
or that it is a mere expectancy, or that it is too remote to be classified as
N. However, the primary reason more states have not found that a remainder
interest is marital property is because in most states an inheritance,
including any appreciation on the inheritance, is separate property.
O. On the other hand, many of the aforementioned states that have concluded
that a remainder interest is marital property have state statutes that in
general are based on one of the following types:
1. An inheritance is classified as a marital asset.
2. An inheritance is classified as separate property. However, the
appreciation on an inheritance is considered a marital asset.
656 P.2d 395 (Or. App. 1983).
607 A.2d 883 (Vt. 1992).
114 N.W. 2d 129 (Wis. 1962).
3. There is a test using certain factors for dividing all property owned
by either spouse at the time of dissolution. More specifically, based
on the applicable state statute, the judge has complete authority to
give the separate property of one spouse to the other spouse for
various reasons such as the length of the marriage, the
contributions to the marriage of the receiving spouse, the needs of
the spouse who has custody of the children, and the lower income
level of the receiving spouse.
P. In the states that hold that a remainder interest is property eligible for
division on the dissolution of a marriage, an estranged spouse has greater
rights than an ordinary creditor.
Q. Under the Restatement Second, an ordinary creditor cannot generally
attach the remainder interest until it is distributed because the interest is
either contingent or subject to a spendthrift provision.114
R. However, a spouse is an exception creditor for purposes of child support
and alimony, not with respect to the division of marital property.115
S. Furthermore, it appears from the older cases that the general rule was that
a spouse attempting to receive a property settlement has a standing no
better than that of any other creditor.116
T. Unfortunately, in all but one of the cases cited above, the courts did not
discuss the spendthrift issue.
U. In one case, Davidson v. Davidson, however, the Supreme Court of
Massachusetts did mention the spendthrift provisions. Later in the opinion,
without discussing the spendthrift provisions, the Court stated that it
rejected the contention that “the content of estates of divorcing parties
ought to be determined by the wooded application of the technical rules of
the law of property.” The opinion continued, “[w]e [the Supreme Court of
Massachusetts] think an expansive approach, within the marital
RESTATEMENT (SECOND) OF TRUSTS, Section 162; Henderson v. Collins, 267 S.E. 2d 202 (Ga. 1980)
[noting that a remainder interest was future property].
Some state statutes on domestic relations issues do not separate alimony and property settlements.
Rather, these states view the two as integrated in a divorce settlement. In these states, the spouse would be
an exception creditor.
Loeb v. Loeb, 301 N.E. 2d 349 (Ind. 1973) [where a wife’s interest under a trust in which she is not a
beneficiary can never be greater than her beneficiary-husband’s interest]; Buckman v. Buckman, 200 N.E.
918 (Mass. 1936) [where a former spouse attempting to enforce alimony stood “no better than any other
creditor”]. Note that Buckman appears to have been reversed by the holding in Davidson v. Davidson, 474
N.E. 2d 1137 (Mass. 1985). However, while the Davidson court cited Buckman, it did not specifically state
that such holding was reversed.
partnership concept, is appropriate.”117 Therefore, as applied to remainder
interests, a former spouse in many states has greater rights to a remainder
interest than an ordinary creditor.
V. In light of these issues, it is shocking that more estate planners do not
create discretionary multigenerational dynasty trusts 118 as a matter of
course. Presumably, this is either because most attorneys’ formbooks do
not have this option, or simply because many attorneys do not strive to do
the best job possible for their clients.
W. Regardless, it should be inexcusable for a planner not to recommend a
multigenerational trust, and if the client chooses not to use one, then at a
minimum the attorney should make note in the client’s file that this option
was discussed, and probably should obtain a signed waiver from the client.
XVII. Understanding the UTC
A. The UTC and the Restatement Third are interrelated. In fact, the
comments from the UTC have over one hundred specific references to the
Restatement Third’s text, comments, and reporter notes. Additionally, the
comment under Section 106 of the UTC implies that the Restatement
Third should even be given a preference over common law when
interpreting the UTC.
B. Furthermore, the committees of both the Restatement Third and the UTC
worked hand in hand to draft several areas of new trust law. While there
are minor differences in the asset protection issues between the two
pronouncements, for the most part the two pronouncements read as though
they were written by the same authors. With respect to traditional asset
protection, the Restatement Third is for the most part not a restatement of
trust law at all. Rather, it is a new and untested approach to trust law. The
same is also true for Article 5 of the UTC, which appears to be an
abbreviated version of the Restatement Third, Sections 50 and 56-60.119
C. Finally, if one is to read Article 5 of the UTC without reading
corresponding Restatement Third Sections, such person might easily
conclude that the UTC is incredibly confusing and poorly drafted.
However, if one reads the Restatement Third prior to reading Article 5 of
the UTC, even though it is still poorly drafted, Article 5 of the UTC begins
to make some sense. Therefore, in order to understand Article 5 of the
Davidson v. Davidson, 474 N.E.2d 1137 (Mass. 1985).
RESTATEMENT (SECOND) OF TRUSTS, Section 161; Henderson v. Collins, 267 S.E. 2d.
RESTATEMENT (THIRD) OF TRUSTS.
UTC, the reader may wish to first read the aforementioned Sections of the
XVIII. The Cornerstone of the Common Law Discretionary Trust
A. Under the common law, a court would only interfere with a trustee’s “sole
and absolute” discretion of a discretionary trust if the trustee (1) acts
dishonestly, (2) acts with an improper motive, or (3) fails to use his or her
B. A beneficiary had little if any standing to sue for a distribution or question
the amount of a distribution unless the beneficiary could prove one of the
above factors was present.
C. In almost all states, there was no reasonableness or good faith standard for
a discretionary trust that used qualifying adjectives such as the trustee’s
“absolute,” “unlimited” or “uncontrolled” discretion. In fact, Section 187
of the Restatement Second held that such qualifying adjectives dispensed
with the standard of reasonableness.
D. Since the beneficiary had such a high threshold to meet, the beneficiary
had virtually no enforceable right (i.e., property interest). This lack of an
enforceable right is the fundamental cornerstone for the asset protection
behind a discretionary trust. The principle is simple. A creditor cannot
compel the trustee to pay anything because the beneficiary cannot compel
E. This is the common law asset protection difference between a support trust
and a discretionary trust. A support trust has a reasonableness judicial
standard of review, whereas the judicial review of a discretionary trust is
typically limited to the trustee acting dishonestly, acting with an improper
motive, or failing to use his or her judgment (i.e., “bad faith” standard).
XIX. Ohio – A Tale of What Not to Do
A. The following analysis of Ohio law demonstrates the beginning of the
problems that occur with the judicial standard of review is dropped to
Ohio’s possible definition of abuse, good faith or reasonableness.
B. In Ohio, it appears that the standard of review of a discretionary trust has
gradually been shifting from a bad faith type of concept to more of a
RESTATEMENT (SECOND) OF TRUSTS, Section 155, comment b.
C. In 1945, the Ohio Supreme Court held that “[w]here the terms of a trust
provided that the trustee shall pay to a beneficiary only so much of the
income and principal, or either, as the trustee in his uncontrolled discretion
shall see fit to pay, the beneficiary cannot compel the trustee to pay him
any part of the income or principal.” 121 This would mean that the
beneficiary would have little, if any, standing in court. However, by 1955
it appears that the standard was shifting to one of “good faith” in Ohio.122
D. Adding more confusion, in 1962, in Culver v. Culver 123 the Appellate
Court stated that “[o]f course the courts have supervision over
discretionary trusts; but the sole inquiry is whether the discretion exercised
by the trustee has been abused; if the bank, in the exercise of good faith,
failed to exercise its discretion, or having exercised it, was guilty of bad
faith, 124 then the courts can interfere, but not before.” Here the Court
appears to be stating that both a good faith standard and an abuse standard
E. In 1968, in a supplemental needs case, the Ohio Supreme Court held that
even if a discretionary distribution standard utilized the qualifying
adjectives of “sole and absolute” discretion, if the distribution language
was coupled with an enforceable standard, it was an abuse of discretion if
the trustee did not make minimum distributions to a destitute
beneficiary.125 The Court did not discuss what abuse standard Ohio had
adopted or what category of abuse into which the above situation would
fall. Rather, the Court merely held that the fact pattern constituted abuse.
Further, the Court held that because of the enforceable standard, the trust
was neither purely a discretionary trust nor purely a support trust. The
standard was “care, comfort, maintenance, and general wellbeing.”
F. The result of this analysis was that the governmental agency was able to
recover directly from the trust assets by forcing a distribution pursuant to
the standard. This would not be the case in almost all common law states
that retain the discretionary/support dichotomy.
G. In 1978, the Ohio Supreme Court extended the concept of Kreitzer to
allow a spouse to recover for child support from a discretionary trust that
McDonald v. Evatt, 62 N.E. 2d 164 (Ohio 1945).
Caswell v. Lenihan, 126 N.E.2d 902 (Ohio 1955); Huntington Natl. Bank v. Aladdin Crippled
Children’s Hosp. Assn., 157 N.E.2d 138 (Ohio App. 1959).
Culver v. Culver, 169 N.E.2d 486 (Ohio App. 1960).
It is uncertain how the Court is using the term “bad faith” in this case.
Bureau of Support in the Department of Mental Hygiene and Correction v. Kreitzer, 243 N.E.2d 83
was coupled with a standard. Further, the Ohio courts for the most part
consistently continued to apply the Kreitzer analysis, with the result that
Medicaid and governmental agencies would recover from a discretionary
H. The unreported 1997 and 2001 cases of In the Matter of Trust Created by
Item III of Will of Zemuda127 and Buoscio v. Estate of Buoscio128 added
further confusion to what review standard Ohio has for a discretionary
trust. In these decisions, the courts used a standard of abuse requiring that
the trustee act unreasonably, unconscionably, or arbitrarily.
I. Finally, in 2001, an Ohio Appellate Court held that a discretionary trust
was an available resource and it was proper that the beneficiary was
denied Medicaid eligibility.129 The Ohio Appellate Court reasoned that the
beneficiary had an enforceable right under Kreitzer. As such, the Ohio
Department of Human Services was correct in denying benefits since the
discretionary trust was an available resource under Ohio’s definition of
J. In the 1989 case In re Estate of Winograd130 the Ohio Appellate court used
a “reasonableness” standard in reviewing a discretionary trust. Unlike the
Kreitzer line of cases where the Ohio definition of “abuse” or the “good
faith” standard allowed the governmental Medicaid and special needs
creditors to either recover from the trust or deny benefits, Winograd
attacks the basis of a beneficiary controlled trust.131
K. One of the key ideas behind a beneficiary controlled trust is that the reason
a beneficiary is happy to receive his share of an inheritance in trust is
because should the beneficiary need the funds, the trustee may distribute
all of the trust funds to him. In other words, the trustee may completely
exclude any other beneficiaries from any distributions, and all amounts
may be paid to the primary beneficiary if needed. In applying a
The following are unreported appellate cases that follow the Kreitzer analysis: Matter of Gantz, 1986
WL 12960; Samson v. Bertok, 1986 WL 14819 (however, the creditor did not recover because it was not a
governmental claim); Matter of Trust of Stum, 1987 WL 26246; Schierer v. Ostafin, 1999 WL 493940
(however, the creditor did not recover because it was not a governmental claim).
No. L-96-073 (Ohio App. 6 Dist. 1997).
2001 WL 1123960 (Ohio App. 7 Dist).
Metz v. Ohio Dept. of Human Services, 762 N.E. 2d 1032 (OH App. 2001).
582 N.E.2d 1047 (Ohio 1989).
For more information about the beneficiary controlled trust concept, see Richard A. Oshins and Steven
J. Oshins, Protecting & Preserving Wealth into the Next Millenium, Trusts & Estates (Sept. and Oct. 1998)
reasonableness standard, the Ohio Appellate Court held that the trustee
abused his discretion by distributing all of the income to the primary
L. The Court came to this conclusion even though the trust had specific
language stating that the trustee could make distributions of income “to or
for the benefit of any one or more to the exclusion of any one or more” of
the beneficiaries, and the trustee should consider the primary beneficiary
first and the primary beneficiary’s descendants second in making
distributions. Unfortunately, Ohio is not alone in destroying one of the
fundamental aspects of a beneficiary controlled trust. The Restatement
Third also takes the same position as the appellate court in Winograd.132
XX. Uniform Trust Code and Restatement Third
A. Both the UTC and the Restatement Third expand the approach used in
Ohio that caused so many problems from an asset protection perspective.
The UTC makes it clear that a “good faith” standard applies, and the
Restatement Third makes it clear that a “reasonableness” standard applies.
B. Whereas comment b of the Restatement Third provides that “judicial
intervention is not warranted merely because the court would have
differently exercised its discretion,” Section 50, comment b provides that
“a court will not interfere with a trustee’s exercise of a discretionary
power when that exercise is reasonable and not based on an improper
interpretation of the terms of the trust.”133 The comment continues, “[a]
court will also intervene if it finds the payments made, or not made, to be
unreasonable as a means of carrying out the trust provisions.” [Emphasis
C. The UTC does not impose a reasonableness standard. Rather, Section
814(a) provides a good faith standard. According to that Section,
“[n]otwithstanding the breadth of discretion granted to a trustee in the
terms of the trust, including the use of such terms as “absolute,” “sole,” or
“uncontrolled,” the trustee shall exercise a discretionary power in good
faith in accordance with the terms and purposes of the trust and the
interests of the beneficiaries.”
D. The Restatement Third, Section 50, comment c, has a similar construction
whereby it provides that words such as “absolute,” “unlimited,” “sole” and
“uncontrolled” discretion “are not interpreted literally.” Rather, the trustee
must still accomplish the purposes of the discretionary power. In essence,
RESTATEMENT (THIRD) OF TRUSTS, Section 50, comment c., last paragraph.
RESTATEMENT (THIRD) OF TRUSTS, Section 60, comment a.
both the UTC and the Restatement Third use a relatively equivalent
standard of review by a court, and this standard of review provides a much
lower threshold for a beneficiary than the bad faith standard of prior
E. When drafting discretionary trusts, many attorneys also include a broad
standard for making distributions. According to the Restatement Third, an
abuse of discretion depends upon “the proper construction of any
accompanying standards, and on the grantor’s purpose in granting the
discretionary power.” In other words, if a discretionary trust states that the
trustee may make distributions in the trustee’s sole and absolute discretion
for health, education, maintenance, support, comfort, general welfare,
happiness and joy, each separate standard listed may well need to be
examined to determine whether the trustee’s discretionary decision to
distribute or not to distribute was reasonable.
F. On the other hand, the Restatement Third also goes to great lengths to
prevent attorneys from drafting out of this problem. Many attorneys
suggest that a discretionary trust should not even include a distribution
standard. By eliminating any distribution standard, it would be unlikely
that a judge would conclude that the trust is anything other than a
discretionary trust since the judge could not mistake the trust as a support
G. Furthermore, it would be unlikely that a judge would question the trustee’s
distribution decisions. Unfortunately, Section 50, comment b of the
Restatement Third provides “[i]t is not necessary, however, that the terms
of the trust provide specific standards in order for a trustee’s good-faith
decision to be found unreasonable and thus constitute an abuse of
discretion.” If a standard is omitted, the court will still apply a
reasonableness or good-faith judgment “based on the extent of the
trustee’s discretion, the various beneficial interests created, the
beneficiaries’ circumstances and the relationships to the grantor, and the
general purposes of the trust.”135
H. Once the threshold for the judicial standard of review has been reduced to
reasonableness or good faith, in almost all cases, the beneficiary should
have an enforceable right to a distribution.
For purposes of this outline and under case law, the term “bad faith” is not defined as the antithesis of a
good faith standard. Rather, bad faith means the trustee is acting dishonestly, acting with an improper
motive, or failing to use his or her judgment.
RESTATEMENT (THIRD) OF TRUSTS, Section 50, comment d.
I. This being the case, may a creditor stand in the beneficiary’s shoes under
the UTC or the Restatement Third? Even if a creditor may not stand in the
beneficiary’s shoes, similar to the Metz case in Ohio, may a governmental
agency deny benefits by considering a discretionary trust as an available
resource? Also, would the discretionary trust be considered an equitable
factor in determining child support, alimony, and possibly an equitable
division of marital property? Finally, should a beneficiary be imputed
income from a trust for the purpose of computing child support and
alimony? All of these issues are discussed in the following material.
XXI. Asset Protection for Discretionary and Support Trusts Now the Same?
A. The traditional trust analysis has explained in detail the enhanced degree
of asset protection provided by a discretionary dynasty trust. The asset
protection under common law afforded by a discretionary dynasty trust is
based on a property analysis (i.e., regardless of whether there is an
enforceable right). On the other hand, for a support trust, the asset
protection is based on spendthrift protection, subject to the four exception
B. In addition to changing the standard of review, both the UTC and the
Restatement Third eliminate the discretionary trust property analysis. The
provisions in the Restatement Third make it clear that asset protection will
be based solely on the same spendthrift protection analysis. 136 In other
words, there is no property analysis for a discretionary trust under the
Restatement Third or the UTC.137 For a number reasons, this is quite a
dramatic change from an asset protection perspective.
RESTATEMENT (THIRD) OF TRUSTS, Section 60, comment a.
However, it should be noted that due to the incredibly confusing language in Article 5 of the UTC, some
estate planners claim that the discretionary analysis may have only been abolished for the exception
creditor for child support or alimony.
First, Section 503 provides that all exception creditors may pierce a spendthrift provision. No distinction is
made between a discretionary trust and a support trust. The second paragraph of the comments under
Section 503 of the UTC references Section 59(a) of the RESTATEMENT (THIRD) OF TRUSTS. The fifth
paragraph of the comments under Section 503 of the UTC references Section 59(b) of the RESTATEMENT
(THIRD) OF TRUSTS. General comment (a) of the Restatement Third specifically states that “certain
categories of creditors [i.e., the exception creditors] can reach beneficial interests in spendthrift trusts…,
including discretionary interests in those trusts.”
Second, Section 60 provides as to discretionary trusts that a spouse, former spouse, or a spouse acting on
behalf of a child may reach the trust assets for child support or alimony. So at first blush, it appears that the
UTC may be eliminating the discretionary/support distinction for only this purpose. However, the first
paragraph of the comments under Section 60 provides that “[t]his section, similar to the Restatement Third,
eliminates the distinction between discretionary and support trusts, unifying the rules for all trusts fitting
within either of the former categories.” If the rules have been unified (i.e., the discretionary property
analysis has been eliminated), then the argument that alimony and spousal support is the only exception to
a discretionary trust has little merit.
1. First, third-party Medicaid trust planning or special needs trust
planning is based on meeting the definition of a discretionary trust
under state law. Whereas a governmental agency, as an exception
creditor, may recover from a support trust, a governmental agency
cannot recover from a discretionary trust. Unfortunately, under the
UTC and the Restatement Third, the change of the standard of
judicial review, equating a discretionary trust to a support trust,
and the probable expansion of exception creditors as discussed
below, may soon make it possible for a governmental medical
agency to recover directly from a discretionary trust.
2. Second, claims of the U.S. or state governments, including the
Internal Revenue Service, have never been enforced against a
discretionary trust. Again, this is because a beneficiary has no right
of recovery. Therefore, a creditor does not receive greater rights
than the beneficiary.
3. Third, except for the one Massachusetts Court of Appeals case,
which appears to have relied on a draft of the Restatement Third
for its holding, a former spouse has no right of recovery against a
discretionary trust, even for alimony or child support.
4. Fourth, attorney fees incurred on behalf of a beneficiary suing a
discretionary trust for a distribution would most likely not be
recovered from the trust.
C. Therefore, under the Restatement Third and the UTC, virtually all of the
asset protection of a discretionary trust is lost, and the discretionary trust is
forced to rely on the much lesser protection afforded by a spendthrift
Third, adding more confusion to an already confusing Article 5, Section 503(c) provides no limit to any
state or federal claim to the extent the statute provides. By the literal terms of this Section, this means that
all of these types of federal claimants may directly access the trust assets, regardless of whether it is a
federal or state claim. Therefore, this also appears to support the argument that the discretionary/support
distinction has been completely eliminated.
Fourth, again adding more confusion to Article 5, there is no definition of a discretionary trust or a support
trust provided by the UTC. Both Section 504 of the UTC and Section 60 of the RESTATEMENT (THIRD) OF
TRUSTS say that they apply to discretionary interests. But unlike the RESTATEMENT (SECOND) OF TRUSTS,
there is no definition.
RESTATEMENT (THIRD) OF TRUSTS, Section 60, comment a goes to some length to explain a continuum
of discretion under a reasonableness standard. Unfortunately, when courts are given a factor test, a
balancing test, or a continuum to choose from, it is usually nothing more than a blank check for a court to
decide the case almost any way it chooses. For an example of such, in the divorce case apparently using a
Restatement (Third) of Trusts analysis with a discretionary trust, see Dwight v. Dwight, 756 N.E.2d 17
(Mass. Ct. of App. 2001).
XXII. Continuum of Discretionary Trusts More Protective?
A. One might argue that under the UTC and Restatement Third all trusts
should now receive greater asset protection because all trusts are now on a
“continuum of discretionary trusts.” However, this conclusion is incorrect.
The reason that a creditor could not force a distribution from a
discretionary trust was because the beneficiary could not do so. This was
because the beneficiary had very little standing in court under the bad faith
B. Under the UTC the review standard has been changed to good faith, and
under the Restatement Third the review standard has been changed to
C. The issue is whether the beneficiary has an enforceable right if the
beneficiary can force a distribution. Unfortunately, the case law from Ohio
proves this to be the case.
XXIII. Expansion of Exception Creditors?
A. Similar to the Restatement Second, both the UTC and the Restatement
Third have a list of exception creditors.
B. Some have argued that, at least in the short term, since the UTC list of
exception creditors is smaller than that of the Restatement Second, the
UTC is more protective for support trusts (but not for discretionary trusts).
In the short term, this may be the case.
C. However, since the Restatement Second was promulgated almost fifty
years ago, only three of the four exception creditors have generally been
adopted by state courts. On the other hand, when legislators have been
given the ability to determine exception creditors, the magnitude of the
exception creditors appears to be much more expansive than the judicial
exception creditors. Therefore, this greater asset protection for a support
trust may last for only a relatively short period of time.
D. Restatement (Second) of Trusts - The Restatement Second lists the
following four exception creditors:
1. Alimony and child support;
A beneficiary could only bring an action if the trustee acted dishonestly, with an improper motive, or
failed to act.
2. Reasonable needs of a beneficiary;
3. Expenses to preserve a beneficial interest; or
4. Any federal or state claim.
The exception for expenses to preserve a beneficial interest (i.e., attorney
fees for a beneficiary, or an exception creditor standing in the shoes of the
beneficiary suing the trust) never gained much acceptance in the state
courts. It is for this reason, in the fifty-year period since its promulgation,
only three of the four exception creditors have gained acceptance by the
E. Uniform Trust Code - From an asset protection perspective, at first glance
it appears that the UTC is an improvement over the Restatement Second
since it reduces the number of exception creditors to three exception
creditors. The exception creditor for “necessary expenses of the
beneficiary” appears to have been deleted.
1. “...a beneficiary’s child, spouse, or former spouse who has a
judgment or court order against the beneficiary for support or
2. a judgment creditor who has provided services for the protection of
a beneficiary’s interest in the trust, may obtain from a court an
order attaching present or future distributions to or for the benefit
of the beneficiary.”140
3. “A spendthrift provision is unenforceable against a claim of this
State or the United States to the extent a statute of this State or
federal law so provides.”
However, for the most part, this is not really the case. The UTC has
actually combined most of the necessary expenses of a creditor cases (i.e.,
Medicaid and special needs trust cases) with the third exception for claims
by the federal or state government. Whereas exception creditors had no
claim against a discretionary trust under common law, all exception
creditors would be allowed to directly attach the assets of a discretionary
trust under the UTC or Restatement Third. Furthermore, future exception
creditors may now be added both judicially and legislatively.
UNIFORM TRUST CODE, Section 503.
F. At first glance, the UTC appears to be an improvement for Medicaid and
special needs trusts over the common law of most states. This is because a
state or federal government must now pass a statute in order to recover
from a Medicaid or special needs trust. Governmental agencies that
provide benefits are no longer automatically considered an exception
creditor (i.e., the necessary expenses of a beneficiary under the
G. Once the state government agencies realize that they no longer may
recover from this type of trust, it may be only a matter of time before the
state or federal government is able to convince the state legislators to add
them as an exception creditor. At this time, a state or federal governmental
agency would be able to recover from all trusts in a UTC state, including
third party discretionary Medicaid or special needs trusts. In almost all
states, the UTC is retroactive. It applies to all trusts regardless of whether
they were created before or after the effective date of the UTC.
H. Under UTC §504(d), a beneficiary is never limited “to maintain a judicial
proceeding against a trustee for an abuse of discretion or failure to comply
with a standard for distribution.” The term “abuse” has been redefined to
mean “good faith” under the UTC or “reasonableness” under the
Restatement Third. Therefore, even with respect to a discretionary trust,
the beneficiary now has a right to reach the underlying assets pursuant to a
good faith or reasonableness standard.
I. Under §541 of the Bankruptcy Code,141 upon the filing of a bankruptcy,
the bankruptcy estate receives all of the assets of the debtor. Due to the
decrease in the review standard to good faith, all beneficiaries of a
discretionary trust have an enforceable right that is also most likely
considered to be a property interest under state law. Therefore, this
discretionary beneficial interest is now part of the bankruptcy estate.
J. Further under §541, the bankruptcy trustee stands in the shoes of the
debtor for all purposes. Does this mean that the bankruptcy trustee may
now exercise the beneficiary’s rights to force a distribution pursuant to
UTC §504(d)? Under §541(c)(1), any contract clause or other arrangement
calling for the termination of rights upon the filing of a bankruptcy may be
voided by the Bankruptcy Court. Prior to the UTC and the Restatement
Third, this was not an issue with a discretionary trust because the
beneficiary of a discretionary trust did not have a right to force a
K. Furthermore, the list of exception creditors may easily be expanded under
the UTC. For example, for many years, the trial bar has attempted to
11 U.S.C. §541.
create an exception for tort creditors. The Mississippi Supreme Court
actually adopted this view in Sligh v. First National Bank of Holmes
County.142 Approximately a year from the Supreme Court rendering this
landmark decision, the Mississippi legislature specifically overturned the
Mississippi Supreme Court by statute due to the anticipated loss of trust
business that would migrate to other states with more favorable trust
legislation. 143 Under the UTC, the state legislature may easily do this
statutorily by simply appending an unnoticed exception as part of any
other bill that passes through the legislature.
L. In addition to the tort creditor exception, what if the federal bankruptcy
code one day references the UTC exception creditor list? Section 503(c)
provides that “[a] spendthrift provision is unenforceable against a claim of
this State or the United States to the extent a statute of this state provides.”
The federal bankruptcy code could take advantage of this loophole by
enacting a statute such as, “[t]he Federal Bankruptcy Trustee is an
exception creditor pursuant to Section 503(c) of any State that has adopted
this provision of the Uniform Trust Code.”
M. All a creditor need do is file an involuntary bankruptcy against the debtor,
assuming the requirements for such a filing are met, and the creditor
would have easy access to the trust assets. In essence, this would mean all
judgment creditors - not just alimony, child support, necessary expenses of
the creditor, federal claims, state claims and tort creditors - but anyone
who had a debt greater than $11,625. 144 Should federal bankruptcy law
ever allow recovery against a trust in a UTC state, there is virtually no
asset protection provided by a spendthrift provision. In other words, all
credit card companies as well as any other creditors could easily recover
from any spendthrift trust through this possible bankruptcy end run
N. Many asset protection attorneys have indicated that, with a spendthrift
trust, all the trustee need do to avoid attachment and still support the
beneficiary is to pay the debtor/beneficiary’s expenses directly rather than
making a distribution to the beneficiary.145 Both the UTC and Restatement
Third end this possibility. Section 501 of the UTC provides that a creditor
may attach “present or future distributions to or for the benefit of the
704 So 2d 1020 (Miss. 1997).
Miss. Code Ann. Section 91-9-503 (Family Trust Preservation Act 1998).
If there are twelve or less creditors, any one creditor with a claim greater than $11,625 may file an
involuntary bankruptcy. If there are more than twelve creditors, then any three with claims aggregating
greater than $11,625 may file an involuntary bankruptcy. 11 U.S.C. §303(b).
Duncan v. Elkins, 45 A.2d 297 (NH 1946).
beneficiary.” Section 60, comment c and Illustration 4 of the Restatement
Third provide that, “[i]f the trustee has been served with process…, the
trustee is personally liable to the creditor for any amount paid to or applied
for the benefit of the beneficiary in disregard of the rights of the creditor.”
O. The inability of the trustee to pay the expenses of a beneficiary is much
more expansive that one might think. This is how most special needs trusts
pay beneficiaries’ expenses so that a distribution is not considered an
available resource. Also, the interpretation of UTC §501 may lead to the
unfortunate conclusion that all creditors may attach present or future
P. This is because UTC §501 provides that “[t]o the extent a beneficiary’s
interest is not protected by spendthrift provisions, the court may authorize
a creditor or assignee of the beneficiary to reach the beneficiary’s interest
by attachment of present or future distributions to or for the benefit of the
beneficiary…” Pursuant to the Restatement Second, 146 any distributions
received by a beneficiary are not protected by spendthrift provisions.147
The result is that spendthrift provisions only protect assets while held in
trust. Therefore, if spendthrift provisions only protect assets that are held
in trust, does UTC §501 allow attachment by any creditor? If UTC §501 is
interpreted this way, it for the most part almost completely defeats the
asset protection benefits of using a trust since any creditor could attach
and merely wait for satisfaction of his or her claim.
Q. The UTC does not limit the courts from adding judicially created
exception creditors. Furthermore, the Restatement Third encourages the
expansion of exception creditors. Comment a(2) specifically provides that
“[s]pecial circumstances or evolving policy may justify recognition of
other exceptions, allowing the beneficiary’s interest to be reached by
certain creditors in appropriate proceedings….[p]ossible exceptions in this
case require case-by-case weighing of the relevant considerations and
R. In essence, this part of the Restatement Third gives the courts a blank
check to create an exception at the court’s whim. So while the UTC
exception list is incredibly troublesome from an asset protection
perspective, interpretation of the UTC by the Restatement Third is much
RESTATEMENT (SECOND) OF TRUSTS, Section 152, comment j.
See also Lundgren v. Hoglund, 711 P.2d. 809 (Mont. 1985); Guidry v. Sheet Metal Workers, Int’l Ass’n,
10 F.3d 700 (10th Cir. 1993).
S. Furthermore, this portion of the Restatement Third continues, “[i]n some
circumstances, to permit attachment despite the spendthrift restraint may
not undermine, and may even support, the protective purposes of the trust
[emphasis added] or some policy of law.” Since it is inconceivable that a
client would ever ask the trust scrivener to draft the trust so that creditors
of the beneficiaries can recover from the trust, it is unlikely that this could
ever be a “purpose” of the trust.
T. Under the Restatement Second, it appeared that when attorneys sued the
trust for fees to protect a beneficial interest, the courts seldom adopted the
exception. The UTC takes the opposite position of common law by
codifying this exception for attorney’s fees.148 The comment under Section
503 provides that “[t]his exception allows a beneficiary a modest means to
overcome an obstacle preventing the beneficiary’s obtaining services
essential to the protection or enforcement of the beneficiary’s rights under
the trust.” However, almost all discretionary trusts are created with the
purpose that the beneficiaries have virtually no right to challenge the trust.
Hence, the terms “sole,” “absolute,” “unfettered” and “uncontrolled”
discretion were used to mean exactly what they say.
U. Under the UTC and the Restatement Third, a reasonableness standard (or
good faith standard) is now imposed on the trustee. Does the attorney fee
exception under the UTC now mean that the trust is obligated to pay for a
challenge by the beneficiary where most likely such challenge is against
the grantor’s wishes? Furthermore, does this mean that an exception
creditor may challenge a discretionary trust when suing under the
distribution standard, and that the trust is obligated to pay for it?
Unfortunately, with the first situation this may easily be the case, and,
with the second situation, neither the statutory language of the UTC nor its
Comments clearly establish whether this is in fact the case.
XXIV. Restatement (Third) of Trusts
A. The Restatement Third adopts a substantially similar approach to that of
the UTC by imposing a reasonableness standard of review. In this respect,
the Restatement Third is in no sense a restatement of the current law of
trusts at all. As related to the common law of almost all states, the
Restatement Third is a complete rewrite of history in this area.
B. At first blush, the Restatement Third appears to have narrowed the
exception creditors to three:
1. Support of a child, spouse, or former spouse;
UNIFORM TRUST CODE, Section 503.
2. Services or supplies provided for the necessities; or
3. For the protection of the beneficiary’s interest in the trust.149
C. However, comment a(1) specifically provides that governmental claimants,
and other claimants as well, may reach the interest of a beneficiary of a
spendthrift trust to the extent provided by federal law or an applicable
XXV. Special Needs Trusts150
A. With respect to Medicaid or special needs trusts, the UTC and
Restatement Third create two big concerns. First, will a federal or state
government be able to attach the beneficial interest? Second, will the
Medicaid or special needs trust be considered an available resource of the
B. For states that pass the UTC, it may only be a short period of time before
third party 151 Medicaid or special needs type planning will be greatly
curtailed and eventually eliminated. If the discretionary trust and support
trust distinction no longer exists, then the federal government or state
legislature can pierce any trust by enacting a statute saying that the
government may attach the beneficiary’s interest and reach some or all of
the trust assets.
C. In states that do not follow the UTC or Restatement Third, an interest in a
discretionary trust is not a property interest (i.e., an enforceable right).
Both Medicaid trust and special needs trust planning depend on the
dichotomy between discretionary and support trusts related to this
D. In fact, the federal or state government need not necessarily attach a
beneficiary’s interest. The federal or state government may merely
consider the trust as an “available resource” and deny benefits.152
XXVI. Beneficiary as Sole Trustee
RESTATEMENT (THIRD) OF TRUSTS, Section 59.
See also Mark Merric and Douglas W. Stein, A Threat to All SNTs, Trusts & Estates, November 2004, at
A third party Medicaid or special needs trust is a trust where the parents or grandparents have created
the trust for the benefit of a child. It is not the self-settled trust under 42 U.S.C. §1396p(d)(4)(A) (many
times commonly referred to as a "d4A Trust").
Metz v. Ohio Dept. of Human Services, 762 N.E. 2d 1032 (Ohio App. 2001).
A. In the event a creditor cannot attach the trust assets under one of the
aforementioned theories of recovery, then a creditor may attempt to
recover under the theory that the debtor/beneficiary held too much control.
B. The purpose of a spendthrift provision is to protect the beneficiary from
his own improvidence. If the sole beneficiary is the sole trustee, he cannot
protect himself from his own improvidence.
C. In In re Bottom, the spendthrift provision protection was not upheld since
the sole beneficiary was the sole trustee,153 and the creditor was able to
reach the assets of the trust. On the other hand, at least two courts have
held that the beneficiary/trustee did not control a trust in which the
beneficiary was a co-trustee and there were multiple beneficiaries.154
D. Many attorneys draft trusts with an ascertainable standard for distributions
and the primary beneficiary (i.e., the child) as the sole trustee of the trust.
The trust has both the primary beneficiary and the primary beneficiary’s
children as beneficiaries. One court has directly addressed this issue, and a
second court that mentioned the issue as dicta.
E. Unfortunately, under the Restatement Third, Section 60, when a
trustee/beneficiary is the sole trustee, any creditor, not just an exception
creditor, may reach the maximum amount that the trustee may properly
take.155 The Restatement Third departs from common law.
F. Originally, the UTC was silent on this issue. However, after opponents to
the UTC expressed their concern over this issue, the UTC was amended in
August of 2004 so that a sole trustee/beneficiary’s interest would not be
subject to creditor attachment if such interest is limited by an ascertainable
XXVII. Domestic Relations Case and Imputed Income
A. In Dwight v. Dwight,156 upon dad’s death, sixty percent of the estate went
to his two daughters outright, and the other forty percent of the estate went
to the son in a discretionary trust.157 The trust was created approximately
In re Bottom, 176 B.R. 950 (N.D. Fla. 1994).
In re Hersloff, 147 B.R. 262 (M.D. Fla. 1992); In re Schwen, 43 Collier Bankr. Cas. 2d 255 (D. Minn.
RESTATEMENT (THIRD) OF TRUSTS, Section 60, comment g.
756 N.E. 2d 17 (Mass. Ct. of App. 2001).
For an excellent analysis of Dwight v Dwight, see Another Look at “Dwight” and Spendthrift Trusts,
Alexander A. Bove Jr. and Melissa Langa, Massachusetts Lawyers Weekly, December 10, 2001.
two years after this second son was divorced. The trust was discretionary,
and the distribution provisions provided that the trustee may make
distributions of income and principal as the trustee deems to be necessary
or desirable for the support, comfort, maintenance or education of the
beneficiaries. The court concluded that this was a discretionary standard.
The beneficiaries were the son and the son’s issue.
B. During the nine years prior to the Massachusetts Appellate Court decision,
the trust made one discretionary distribution of $7,000 to the son. During
this period of time, the trust corpus grew from $435,000 to a value of
C. The trial court judge stated that it was highly likely that the principal
reason the son received his inheritance in trust rather than outright was in
order to defeat a claim for alimony. The trial court further found that the
son had access to additional funds at anytime he desired based on two
1. The broad purposes for which the trustee may make payments to
the son; and
2. A statement the son made to the trustee that he did not need any
D. The trial court found that the son’s earnings should be imputed from the
discretionary trust for purposes of alimony. The Massachusetts Court of
Appeals agreed with the trial court.
E. Without any discussion, the Appellate Court dismissed the son’s
contention that the trust was a discretionary trust. Rather, the opinion cites
the Restatement of Trusts (Third), Section 59 (Ten. Draft No. 2, 1999) as
authority for dismissing the son’s claim.
F. Under the Restatement Third as well as the UTC158 a spouse can reach the
assets of a discretionary trust for alimony and child support. Furthermore,
a judge may determine what amount the trustee should “reasonably”
distribute or what amount should distributed in “good faith.”159 The broad
standards for the purpose of the distributions must be analyzed to
determine whether distributions should have been made (and therefore be
part of the alimony computation). Here, the court determined that
defeating an alimony claim was not an acceptable purpose. Therefore,
under both the UTC and the Restatement Third, the court was within its
UNIFORM TRUST CODE, Section 504.
RESTATEMENT (THIRD) OF TRUSTS, Section 50, comment b.; UNIFORM TRUST CODE, Section 814(a).
authority to impute income to the husband for the basis of alimony, even
though he only received a token of what was imputed to him.
G. Although Dwight v. Dwight relied on the Restatement Third in reaching its
conclusion, the case was decided before the Restatement Third was even
finalized. Furthermore, Massachusetts has not yet adopted the UTC.
However, if Massachusetts had adopted the UTC, to add insult to injury, it
appears that the former spouse would also be able to recover legal fees
from the trust.
XXVIII. End Round to Force A Distribution For Any Creditors
A. Any creditors may attach an “overdue” or “mandatory” distribution under
UTC §506. Unfortunately, the terms “overdue” and “mandatory” are both
undefined. Further problems are created when one refers to the Third
Restatement for interpretation of a mandatory distribution under the newly
created theory of a “continuum of discretionary trusts.”160 This is because
a judge must now interpret the distribution language of the trust to
determine where the trust should be classified on this new undefined
continuum of discretionary trusts.
B. Once this determination has been made, the judge would then determine
when and how much should be periodically distributed to the beneficiary.
This is the amount that would become an overdue distribution in the event
it was not timely paid.
C. For example, distribution language such as “the trustee may make
distributions, in the trustee’s sole and absolute discretion, for health,
education, maintenance, and support” may create a scenario in which the
judge concludes that the trustee should periodically make distributions to
the beneficiary. If this is the result, then these deemed distributions would
be subject to attachment by any creditor.
XXIX. Planning Around the Restatement Third and UTC
A. Both the UTC and the Restatement Third seem to have gone to great
lengths to greatly reduce the asset protection provided by creating a
reasonableness or good faith standard, even if the terms of the trust
provide for the opposite.
B. Therefore, the trust scrivener should consider providing absolutely no
standard whatsoever when drafting a discretionary trust. For example, the
trust could be drafted such that “the trustee may make distributions in his
sole and absolute discretion to any beneficiary.”
RESTATEMENT (THIRD) OF TRUSTS, Section 60 comment e and e(1).
C. While this will provide some help to mitigate the asset protection
problems posed by the Restatement Third, it may not solve the problem.
This is because, under Section 50, comment d, when no standard is
provided, the Restatement of Trusts Third provides that “even then a
general standard of reasonableness, or at least a good-faith judgment, will
apply to the trustee, based on the extent of the trustee’s discretion, the
various beneficial interests created, the beneficiaries’ circumstances and
relationships to the grantor, and the general purposes of the trust.”
D. Regardless, not including a standard of distribution will make it more
difficult for a judge to conclude that the intent of the grantor was to create
an enforceable right in the beneficiary for a distribution.
E. Although any exception creditors may generally attach a remainder
interest, it appears that a remainder interest in a dynasty interest would not
be able to be attached because it is an interest that does not vest with
anyone. In this respect, drafting trusts with multigenerational interests
should still avoid many creditor issues and should be a matter of course
for most clients, not just a technique for the ultra-wealthy.
XXX. The Inheritor’s Trust™161
A. Estate planners often fail to realize the opportunity to plan in
contemplation of an inheritance, even if the expected inheritance will not
be received for many years.
B. Instead, the emphasis is often focused on planning with existing wealth
rather than future wealth, thereby missing numerous planning
C. This is perhaps one of the most missed planning opportunities since most
planners fail to ask their clients whether they expect to receive any
D. The Inheritor’s Trust™ is a special type of dynasty trust that is designed
by the inheritor to receive an inheritance that would otherwise have been
passed outright to the inheritor as a result of inferior single generation
planning by the attorney for the future decedent.
Inheritor’s Trust™ is a trademark of Steven J. Oshins, Richard A. Oshins and Noel Ice. See The
Inheritor's Trust™: The Art of Properly Inheriting Property, Estate Planning, Vol. 30, Nos. 9 and 10 (Sept.
and Oct. 2003), co-authored by Richard A. Oshins and Noel C. Ice at
http://www.oshins.com/estate%20planning%209.03%20and%2010.03.htm. Also see The Inheritor's
Trust™: Planning in Contemplation of an Inheritance, Lawyers Weekly USA (Jan. 2004), authored by
Steven J. Oshins, at http://lawyersweekly.p2ionline.com/Sections/trusteeandestate2004/p14s1m.htm.
E. By receiving the inheritance in trust rather than outright, the inheritance is
not unnecessarily subjected to estate tax, creditors and divorcing spouses
even though the inheritor controls the trust.
F. Essentially, the Inheritor’s Trust™ concept is to plan for our clients in the
same manner and with the same high level of sophistication that we
provide for our clients’ descendants.
G. This works particularly well in the situation where our client’s parents
want to use their own estate planning attorney to draft their will or
revocable trust, but they are willing to make a simple amendment to their
trust to pour our client’s inheritance into the Inheritor’s Trust.
H. In many cases, our client is able to use all of the parents’ GST tax
exemptions since our client’s siblings will receive their share of the
inheritance outright thereby not using any GST tax exemption. This
benefits our clients’ children and other descendants.
XXXI. Opportunity Shifting162
A. One of the best, yet often overlooked, techniques to avoid the transfer tax
system is the shifting or deflecting of the opportunity to earn income or
generate wealth from the client to others, including trusts.
B. In addition to the transfer tax benefits, opportunity shifting also provides a
means of creditor protecting additional wealth. Those who utilize this
strategy often focus primarily on the transfer tax savings. However, arguably
the creditor and divorce protection benefits are even more valuable than the
transfer tax savings.
C. The opportunity shifting strategy protects future wealth much in the same
way as the Inheritor’s Trust™ does. The difference is that each strategy
protects a different kind of future wealth. The Inheritor’s Trust™ protects
future wealth derived from an inheritance. Opportunity shifting protects
future wealth derived from business and investment opportunities.
D. For both transfer tax planning purposes and creditor protection purposes, it is
far simpler, less risky and more tax efficient to shift the opportunity to create
wealth at the inception of an undertaking than to move wealth to a protected
spot once value has matured and has become substantial. The shifting of an
opportunity does not involve a transfer and therefore finesses the transfer tax
See Steven J. Oshins, Opportunity Shifting: A Life Insurance and Estate Planning Technique, Journal of
Financial Service Professionals (May 1999) at http://www.oshins.com/journal_5_99.htm.
and avoids a transfer with a retained interest that would open the property to
creditors of the transferor.
E. In its simplest form, if a person were to refer business, customers or clients
to another person, or give some gratuitous advice to the other person, no one
would think a transfer subject to the gift tax has occurred. Those activities
happen frequently. Similarly, the shifting of a business or investment
opportunity is not an event that gives rise to the imposition of a gift tax, even
if the result is detrimental to the referring party.
F. Thus, when a new business is formed, a new product is being developed, a
new location is being considered, or the family has an investment
opportunity, a new entity should also be formed, and some or all of the
equity interests offered in the new entity should be placed in irrevocable
trusts. In many instances, the "seed" money is negligible to enable the
recipient of the opportunity to acquire a significant interest in a venture that
can reasonably be predicted to explode in value.
G. This exploding value will occur in an irrevocable trust set up by somebody
other than a beneficiary so that all of the value will be held in a trust that is
transfer tax protected, and creditor and divorce protected.
H. Moreover, a referring family member can determine how much of the
opportunity to shift, and can structure the entity accordingly. Thus, the entity
design can include a scenario whereby the opportunity provider obtains
complete control of the new venture even though he or she owns only a
small sliver of it.163 For example, control of the general partner of a limited
partnership or holder of the only share of voting interest in a corporation or
limited liability company will obtain such a result.
I. A capital structure whereby the opportunity shifter receives control of the
entity will subject to the transfer tax system only the interest owned and not
the opportunity "transferred." In addition, at such time as the retained
interest is ultimately transferred, it should be taxed at a mere fraction of what
the interest really means to its owner.
J. An often-cited illustration of the opportunity shifting strategy occurred
where the senior members of the Lauder family, which owned the Estee
Lauder Company, shifted the opportunity to develop the successful Clinique
and Aramis products down a generation.164
Cooper, fn. 10, supra, at p. 19; Owen G. Fiore, Ownership Shifting to Realize Family Goals, Including Tax
Savings, 37 NYU Inst. on Fed. Tax., Sec. 38 (1979); Owen G. Fiore, Estate and Value Opportunity Shifting
Through Installment Sales, Private Annuities and Interest-Free Loans, U. Miami 13th Inst. on Est. Plan., Ch. 7
Cooper, fn. 10, supra, at p. 20.
1. Had the senior Lauder family members desired control, the new
entity could have been structured whereby the senior Lauders owned
a 1% controlling interest in the entity.
2. Moreover, additional tax and creditor protection benefits could have
been obtained had the wealth shifting opportunity been given to
trusts for the benefit of their children, Leonard and Ronald, and their
descendants rather than to them outright.
3. The Lauder-type plan is not an isolated instance, but only one
illustration of the opportunity shifting concept.
K. These opportunities to shift wealth into a place where it is protected from
estate taxes, creditors and divorce occur often.
L. The problem is that very few of these potential value-shifting possibilities
are exploited in the real world. This inaction is probably due to several
factors, including that many opportunity shifting situations are not
recognized; to a large degree there is indifference on the part of many
planners and their clients; and also possibly because the concept is more one
of common sense than being a technical legal planning device that would
likely be the subject of articles, speeches and other professional training.
Further, since this is a strategy for moving wealth outside the scope of the
transfer tax system, it is usually also not the subject of cases or rulings unless
an error was made.
M. The reason little attention is given by the IRS to this type of undertaking is
that in most instances where opportunity shifting occurs there is no reporting
of the transaction since there is no "transfer" that necessitates the filing of a
N. Thus, it is reasonable to assume that much of this planning is not a result of
strategizing, but rather it is the result of wealthy people just using some
common sense without recognizing that their actions have favorable estate
planning and creditor protection results. Hopefully, they will recognize the
beneficial implications of such actions and that the recipient of the wealth
generating activity should be an irrevocable trust.
O. There are a number of situations in which this type of tax-free, intrafamily
diversion of wealth is often overlooked. For instance, assume that a child
wishes to go into the same business as his parents, just like the Lauder
children. Rather than join the parents, irrevocable trusts can be set up to hold
a newly formed entity, and the parents can refer some of their companies'
business to the trust-owned entity.
P. A striking illustration of this occurs in the situation where both the parents
and the children are developers, and the parents wish to retire during the next
few years and pass the business to their descendants.
1. A direct transfer often has costly tax implications.
2. With proper advance planning, the tax bite can be mitigated or
negated through the process of referrals by the parents to the
children's trust-owned entity.
3. This will have the dual effect of ballooning the value of the trust
while concomitantly reducing the value of the parents' entity, perhaps
over time even to zero, negating the necessity of selling or gifting the
parents' entity to the trust.
4. For creditor protection purposes, this has the effect of protecting one
hundred percent of each referral.
Q. An impressive variation of the opportunity shifting strategy exists where the
child's trust owns a collateral business to which the parents may refer
R. To illustrate, assume that the owner of a retail business wants to shift wealth
that would inure to his own benefit if the estate and business planning
process is not undertaken.
1. The business owner could set up trusts for the benefit of his
descendants (and perhaps his spouse) that forms an entity to do
installation, repairs and warranty work on products sold by the retail
2. The business owner would refer customers to the trust-owned entity
for the service work.
3. Additional sources of collateral fees could be generated by having a
trust-owned entity (separate from the installation and repair shop for
liability purposes) acquire, own and lease furniture, equipment, or an
office building to the business.
S. The fact patterns under which opportunity shifting strategies can be
employed are extensive and are virtually limited only by the imagination of
the planner as long as the planner and/or client have been sensitized to the
existence of the technique and its effectiveness as a tax avoidance and
creditor protection device.
T. Estate planners tend to look down generations for planning purposes.
Typically, the only upstream inquiries made as to the economic situation of
the parents are (i) whether the client anticipates an inheritance that should be
taken into account in planning the client's estate, and (ii) whether the client
may need to provide support for a parent in case of an unusual order of
U. Planners often overlook inquiring as to whether the client's parent has the
ability and inclination to fund a trust for the client's benefit. Even persons of
somewhat modest means can often come up with, and are willing to part
with, sufficient seed money for a predictably "hot" investment or business
venture, such as a new business entity that will be designed to receive
referrals from a present successful business, or another opportunity shifting
V. An extraordinary opportunity exists by looking up a generation as part of the
planning process. When the client is about to embark on a new venture or
has an investment opportunity with significant potential, consideration
should be given to having the client's parent(s) create and fund a trust for the
client. This is the same concept as that used in the context of the Inheritor’s
Trust™ discussed above.
W. Money placed in a dynastic Beneficiary Controlled Trust funded by the
client's parent(s) would provide the "seed" money for any such anticipated
business venture or investment.
X. As long as the client is not the original source of the "seed" money (which
course of action would result in the transaction being recast as a trust created
by the client under the step transaction or agency theories), the normal rules
of taxation should apply and the existence of the trust should be respected for
both tax and asset protection purposes.
Y. Thus, the client can control the trust by being trustee, and can benefit from
the trust assets as the primary beneficiary.
XXXII. Corporations, Limited Liability Companies and Limited Partnerships
A. In addition to using trusts, various business entities should also be used to
provide an additional layer of creditor protection. The entities do not
necessarily have to own a business. Business entities are often used to
protect investment assets as well.
B. There are two types of business entity creditors – (1) internal creditors and (2)
C. Internal creditors are those creditors who sue the business entity itself. The
goal is often to keep minimal assets at risk in the business entity and to use a
business entity that will shield the owners from personal liability.
1. Both a corporation and a limited liability company, if operated
properly, protect the business owners’ personal assets (i.e., those
assets outside of the business entity) from liability against a claim
arising against the business entity itself.
2. A limited partnership does not protect the general partners from
personal liability. However, if the general partner is a corporation or
limited liability company, then the liability of that general partner is
limited to its assets.
3. However, it is generally not advisable to use a corporation as the
general partner since the corporate general partner is exposed to the
creditors of the owners of the corporate general partner because the
corporation does not get charging order protection, as described
below. Thus, a creditor who attaches the corporate stock would gain
control of the entire limited partnership as well.
D. External creditors are creditors of individuals who own interests in the
business entity, but who are not creditors of the entity itself. The goal is to
protect the business entity from the owner’s personal creditors.
1. A corporation does not provide any statutory protection from the
owner’s personal creditors since the creditor may attach the corporate
stock to satisfy a judgment against the owner of the stock.
2. Depending on the choice of state law, limited liability company
assets and limited partnership assets may be protected from the
3. In certain states, the “charging order” is the exclusive remedy of a
judgment creditor against a limited liability company interest or a
limited partnership interest. In most states the charging order is not
the exclusive remedy.
4. Those clients who reside in states where the charging order is not the
exclusive remedy should forum shop by forming their entities in a
XXXIII. Creditor Protection through Charging Orders
A. A charging order is a statutorily created means for a creditor of a judgment
debtor who is a partner of a limited partnership or a member of a limited
liability company to reach the debtor’s beneficial interest in the
partnership or limited liability company, without risking dissolution of the
entity. The court grants an order instructing the entity to distribute the
partner's or member’s share to the creditor instead of to the debtor. In
effect, it is a court ordered lien on the partnership interest or membership
interest of the debtor.
B. A charging order gives the creditor only the rights of an assignee. Essentially,
it is only an economic interest. The creditor only receives distributions from
the entity if the entity makes distributions. The creditor does not have any
right to inspect the entity’s records or to vote the charged interest.
C. If there are no distributions made, then the creditor may never get his
judgment satisfied. The threat of possibly receiving nothing often encourages
a favorable settlement with the debtor.
D. Many practitioners believe that the creditor having the charged interest will
be responsible for the income taxes attributable to that interest based on
Revenue Ruling 77-137.165 This concept is often referred to as “KO by the
K-1”. However, there is strong authority to the contrary.166 Regardless of the
income tax outcome, just the threat of having to pay tax on income never
received is generally enough to force the creditor into a favorable settlement
for the debtor.
E. In Revenue Ruling 77-137, a partner assigned his interest to a third party
assignee, and the assignee was held to be taxable on the distributive share
of income attributable to the assignor's partnership interest. However,
Revenue Ruling 77-137 did not deal with the situation where there is a
judgment creditor and a debtor partner, so a strong argument can be made
that it does not apply to a debtor/creditor scenario.
F. Following are many of the existing charging order cases. 167 This list is not
intended to be exhaustive, and there is no guarantee that the cases listed
below do not have any more current developments.
*Reynolds v. Colonial Bank, No. 1020186 (Ala. 08/15/2003).
*Reynolds v. Colonial Bank, No. 1020186 (Ala. 06/20/2003).
Rev. Rul. 77-137, 1977-1 C.B. 178. GCM 36960 (Dec. 20, 1976).
See Christopher M. Riser, Tax Consequenses of Charging Orders: Is the K.O. by K-1 K.O.’d by the
Code? Asset Protection Journal (Winter 1999) at http://www.riserlaw.com/publications/ap/credtax.htm.
See http://www.assetprotectionbook.com/chargingorderscases.htm, authored by Attorneys Jay Adkisson
and Chris Riser. Also see another web site of theirs, http://www.chargingorders.com.
No known cases
*Chandler Medical Building Partners v. Chandler Dental Group,
855 P.2d 787, 175 (Ariz.App.Div.1 05/25/1993).
*Addis v. Addis, 288 Ark. 205, 703 S.W.2d 852 (Ark. 02/18/1986).
*Warren v. Warren, 12 Ark.App. 260, 675 S.W.2d 371 (Ark.App.
*Riegler v. Riegler, 243 Ark. 113, 419 S.W.2d 311 (Ark.
*Beach Park Associates v. Heron, No. H023320 (Cal.App. Dist.6
*Heron v. Kelley West Santa Clara Associates, No. H024719
(Cal.App. Dist.6 08/25/2003).
*Brown Wood Products v. Interlab Robotics, No. H022232
(Cal.App. Disk.6 04/22/2002).
*Sonju v. Dawson, No. G024324 (Cal.App. Dist.4 12/19/2001).
*Great Western Bank v. Kong, 90 Cal.App.4th 28, 108 Cal.Rptr.2d
266 (Cal.App. Dist.5 06/22/2001).
*Northern Trust Bank v. Pineda, 58 Cal.App.4th 603, 68
Cal.Rptr.2d 357 (Cal.App. Dist.2 10/16/1997).
*In re Hilde, 120 F.3d 950 (9th Cir. 07/15/1997).
*Hellman v. Anderson, 233 Cal.App. 3d 840, 284 Cal. Rptr. 830
(Cal.App. Dist.3 08/26/1991).
*Long Beach Unified School District v. California, 225 Cal. App.
3d 155, 275 Cal. Rptr. 449 (Cal.App. Dist.2 11/15/1990).
*Union Colony Bank v. United Bank of Greeley National
Association, 832 P.2d 1112 (Colo. 05/14/1992).
*Berge v. Berge, 522 P.2d 752, 33 Colo. App. 376 (Colo.App.
*Merchants Bank & Trust Co. v. Chestnut Tree Hill Partnership,
et. al, CV 900033304S (Conn. 06/06/2003).
*Cadle Company v. Robert A. Ginsburg, CV 950076811S (Conn.
*Michael Kononver, et. al v. Tig-Rfa, Inc., et. al, CV 980583516
*P.G.S. Realty Company v. ZPP&W (Bloomfield) Associates, et. al,
CV 930531233 (Conn. 02/16/2001).
*Statewide Grievance Committee v. Joseph S. Dey, III, CV
980063144S (Conn. 09/29/1998).
*PB Real Estate, Inc. v. Dem II Properties, et. al, 50 Conn.App.
741; 719 A.2d 73 (Conn.App. 06/09/1998).
*Madison Hills Ltd. v. Madison Hills, Inc., 1994.CT.11663, 644
A.2d 363 (Conn.App. 06/06/1994).
*Robert F. Jeffreys v. Gerald Exten Topside, 1988 DE 626 (DE
*Felicia MacDonald v. Robert B. MacDonald, and HKM
Associates, L.P., 1986 DE 412 (DE 05/09/1986).
*Givens v. National Loan Investors, L.P., 724 So.2d 610 (Fla.App.
*Donald Gache' and D.G. Enterprises v. First Union National
Bank Florida, 1993.FL.50698 ; 625 So. 2d 86 (Fla.App.
*Stewart v. Lanier Park Medical Office Building, Ltd., 578 S.E. 2d
572, (Ga.App. 02/26/2003).
*Prodigy Centers/Atlanta No. 1 L.P. v. T-C Associates, 147 F.3d
1324 (11th Cir. 07/29/1998).
*Prodigy Centers v. T-C Associates, Ltd., 269 Ga. 522, 501 S.E. 2d
209 (Ga. 06/08/1998).
*Nigri v. Lotz, 1995.GA.24411, 453 S.E.2d 780, 216 Ga. App. 204
No known cases
*Tudor Engineering Company v. John B. Mouw, 1985 ID 15345;
709 P.2d 146; 109 Idaho 573 (Idaho 10/31/1985).
*Max F. (Rip) Sewell v. Neilsen, Monroe, Inc., 1985 ID 15280 ;
706 P.2d 81; 109 Idaho 192 (Idaho App. 08/29/1985).
*J.K. Merrill & Son v. R.G. Carter, 1985 ID 15198 ; 702 P.2d 787;
108 Idaho 749 (Idaho 06/17/1985).
*In re Marriage of Todd J. Chapman and Florence Adele
Chapman, 297 Ill. App. 3d 611;697 N.E.2d 365 (Ill.App.
No known cases
No known cases
*City of Arkansas City v. Anderson, 752 P.2d 673, 242 Kan. 875
No known cases
No known cases
No known cases
*Keeler v. Academy of American Franciscan History, Inc., No.
DKC 2001-0888 (D.Md. 02/14/2002).
*Green v. Bellerive Condominiums LP, 135 Md.App. 563, 763
A.2d 252 (Md.Sp.App. 11/03/2000).
*Lauer Construction Inc. v. Schrift, 123 Md.App. 112, 716 A.2d
1096 (Md.Sp.App. 09/02/1998).
*91st Street Joint Venture v. Goldstein, 691 A.2d 272, 114
Md.App. 561 (Md.Sp.App. 03/28/1997).
No known cases
No known cases
*Windom National Bank of Windom and Others v. Charles H.
Klein and Another, 1934.MN.136, 254 N.W. 602, 191 Minn. 447
No known cases
*Geraldine Deutsch, et. al v. Eugene Wolff, et al, 7 S.W.3d 460
No known cases
*Linda Novak v. Gerald H. Novak, 1994.NE.143, 513 N.W.2d 303,
245 Neb. 366 (Neb. 03/18/1994).
No known cases
29. New Hampshire
*The Cadle Company v. Maurice Bourgeois, 149 N.H. 410
*Baybank v. Catamount Construction, 1997 N.H. 36 (N.H.
30. New Jersey
*Zavodnick v. Leven, 340 N.J.Super. 94, 773 A.2d 1170
31. New Mexico
*Galef v. Buena Vista Dairy, 117 N.M. 701, 875 P.2d 1132
32. New York
*Iser Abramovitz v. Kew Realty Equities et. al, 652 N.Y.S.2d 737
(N.Y.App. Div. 01/23/1997).
33. North Carolina
*Herring v. Keasler, 563 S.E.2d 614 (N.C.App. 06/04/2002).
34. North Dakota
No known cases
*In the Matter of The Estate of Richard C. Lanning, No. 00 CA
110 (Ohio.App. 03/13/2003).
*Geoffrey E. Webster v. Dalcoma Limited Partnership Four,
*Monroe v. Berger, No. C-980269 (Ohio App. Dist.1 09/05/2001).
*Larson v. Kaley, No. 2000-P-0041 (Ohio App. Dist.11
*Banc One Captial Partners v. Robert Russell, No. 74086
*Major Real Estate & Investment Corp. v. Republic Financial, 695
P.2d 893, 1985 OK CIV APP 6 (Okla.App.Div.1 02/12/1985).
*Shinn v. Vaughn, 83 Or.App. 251, 730 P.2d 1290 (Or.App.
*Carol Diament v. John Diament, 2003 PA Super 19; 816 A.2d
256 (Pa. 01/23/2003).
*Advanced Telephone Systems, Inc. v. Com-Net Professional
Mobile Radio LLC, 59 PA D.&C.4th 286 (Pa. 05/15/2002).
*Rugg v. Green Acres Contracting Co., Inc., 55 PA D.&C.4th 149
39. Rhode Island
No known cases
40. South Carolina
No known cases
41. South Dakota
No known cases
No known cases
*Liptak v. Richard E. Colgin I, Ltd., No. 05-99-00583-CV
(Tex.App. Dist.5 03/12/2002).
*Angelo Dispensa v. University State Bank, 1997 TX 2375
(Tex.App. Dist.6 08/13/1997).
*Rosedale Partners v. 131st Judicial District Court, No. 04-93-
00732-CV (Tex.App. Dist.4 01/12/1994).
*Aspenwood, LLC v C.A.T., LLC, 73 P.3d 947 (Utah App.
No known cases
*Ainslie v. Inman, 265 Va. 347, 577 S.E.2d 246 (Va. 02/28/2003).
*Koh v Inno Pacific Holdings Ltd, 114 Wash App 268, 54 P.3d
(Wash App Div 1 10/07/2002).
48. West Virginia
No known cases
No known cases
*Robert Christensen v. John Oedekoven, 1995.WY.3 (Wyo.App.
XXXIV. Alternative Asset Protection Structures
A. One of the objectives of this outline is to describe some creditor protection
alternatives to a self-settled asset protection trust structure.
B. Many of the creditor protection alternative structures are superior to the
typical self-settled asset protection trust/family limited partnership
structure because of the ability to combine creditor protection planning
with estate tax planning.
C. The typical self-settled asset protection trust structure is set up as follows:
1. The grantor sets up an irrevocable trust for the benefit of himself
and certain family members such as his spouse and his descendants.
An independent trustee has the discretion to make distributions to
the grantor or to any of the other beneficiaries. The trust is
established in either an offshore jurisdiction or in one of the five
domestic jurisdictions that allows self-settled asset protection trusts,
such as Nevada.168
The five domestic jurisdictions that have a full self-settled creditor protection statute are Alaska,
Delaware, Nevada, Rhode Island and Utah. Nevada is generally considered the best of the five states
because it has the shortest statute of limitations period.
2. The grantor and the trustee of the self-settled asset protection trust
set up and fund a family limited partnership. Usually, the grantor
will own a 1% general partnership interest, and the asset protection
trust will own a 99% limited partnership interest. This basic
structure gives the grantor 100% of the management and control
over the partnership assets, yet 99% of the assets are protected in
the asset protection trust.
3. If the family limited partnership has been domiciled in a
jurisdiction in which the state law makes the charging order the
exclusive remedy of a judgment creditor, then even if the trust does
not work (such as a situation where the state of limitations has not
yet run prior to the creditor filing a lawsuit), the charging order
protection provides a second layer of defense, although not quite as
protective as the asset protection trust would have been (since the
debtor cannot access the assets).
4. It is clear that completed gifts may be made to a domestic self-
settled asset protection trust, but it is unclear whether the gifted
assets will also be excluded from the grantor’s taxable estate.
D. Certain more sophisticated alternative structures can provide similar and
often better protection, often with estate tax benefits as well.
E. Some examples, already discussed above, include the dynasty trust, the
Inheritor’s Trust™ and opportunity shifting. But each of those concepts
relates to protecting future wealth. How can we structure our clients’
existing assets to protect those assets from creditors? The following
Sections of this outline lay out some alternative structures.
XXXV. The Inheritor’s Trust™/FLP Combo
A. Assume that you client has a $1 million publicly traded securities portfolio
that is currently owned outright and therefore is exposed to the client’s
creditors, including a spouse in the context of divorce.
B. Consider setting up an Inheritor’s Trust™ and, rather than waiting for the
parent (or grandparent or other third party) to die, have the client’s parent
fund it now with a gift of $10,000.
C. Since the trust is funded with a gift from a third party, it is creditor
protected and, if designed correctly, estate tax protected.
D. The client/primary beneficiary is named as investment trustee, and such
primary beneficiary selects a close friend as distribution trustee with the
trust drafted where the independent trustee has absolute discretion over
both income and principal distributions.
E. As investment trustee, the primary beneficiary forms a family limited
partnership with himself individually (or his revocable trust) as the other
F. The client, on behalf of the Inheritor’s Trust™, contributes its $10,000 to
the partnership for a 1% general partnership interest, and the client
individually contributes $990,000 worth of his marketable securities
portfolio for a 99% limited partnership interest.
G. These relatively simple maneuvers create the following results:
1. The client still has access to 100% of the $1 million worth of assets.
2. The client controls 100% of the assets as the investment trustee of
the Inheritor’s Trust™ which holds the 1% general partnership
3. If the family limited partnership is established in one of the states
in which the charging order is the exclusive remedy of a judgment
creditor, then the best case scenario for a creditor, short of settling
the lawsuit, is to obtain a charging order over the 99% limited
4. The 1% general partnership interest is protected from creditors
since it is owned by a trust that was set up and funded by a third
5. Upon the death of the client, the 99% limited partnership interest is
reported on his estate tax return. The 1% general partnership is not
reported on his estate tax return since it is owned by the Inheritor’s
Trust™, not by the client. Therefore, the limited partnership
interest is valued on the estate tax return at a discount from pro rata
value to reflect minority and marketability discounts. Assuming a
30% valuation discount, this saves the heirs almost $150,000.
H. What do we do if the client has a $10 million asset to protect rather than a
$1 million asset?
1. Although there is no statutory prohibition against the Inheritor’s
Trust™ contributing $10,000 for a 0.1% general partnership
interest and the client contributing $9,990,000 for a 99.9% limited
partnership interest, it would be safer to create a less thinly
capitalized general partnership interest to take away the argument
that this structure is a sham.
2. Assuming the client’s parent is not willing and able to make a gift
of $100,000 to the trust in order to increase the trust’s ability to
buy in for a larger interest, one alternative is for the grantor to gift
$10,000 to the trust, and then have the client loan the other
$90,000 to the trust in exchange for a low interest promissory note.
Using this additional step, the trust now has enough money to
make its capital contribution to the partnership.
I. Another option to decrease the required capital contribution obligation of
the Inheritor’s Trust is to create a limited liability company to own the 1%
general partnership interest. The limited liability company would be
structured with a 1% voting membership interest and a 99% non-voting
interest so that the real control of the assets is lodged in the hands of
whoever owns the 1% voting interest of the LLC (which owns the
controlling interest of the partnership). Thus, the capitalization needed by
the Inheritor’s Trust™ is 1% of 1% of the total assets. This strategy is
especially useful when we are dealing with $100 million and $1 billion or
larger estates where even 1% is a high number.
J. Each of the strategies outlined in this section also work with a limited
liability company structured with a 1% voting membership interest and a
99% non-voting interest, or with a corporation structured with 1% voting
stock and 99% non-voting stock. If a corporation is used, then if it is a
Subchapter S corporation, the Inheritor’s Trust™ would need be a
qualified owner of such stock.
XXXVI. Sale of Voting Interest to Inheritor’s Trust™
A. Assume that the client owns a business worth $1 million. The business
may be owned as a corporation, a limited liability company or a limited
partnership. Regardless of the form of ownership, the following strategy
may be utilized to create the same end result as the Inheritor’s
Trust™/FLP combo outlined above, but with some slightly different steps,
and with some additional issues which can be handled as discussed below.
1. First, recapitalize the business entity into 1% voting and 99% non-
2. Next, have the business owner’s/client’s parent (or other third
party) set up and fund an Inheritor’s Trust™ for the benefit of the
client and the client’s family. Assume that the grantor gifts
$20,000 to the trust.
3. After that, have the client sell the 1% voting interest to the trust in
exchange for cash (or in exchange for a promissory note in the case
where the trust does not have enough cash to pay for the voting
interest). The fair market value of the voting interest should reflect
a small control premium so that the sales price will be a little
higher than 1% of the value of the business.
4. This moves the voting interest to the Inheritor’s Trust™ where it is
protected from creditors. This is especially valuable for our clients
who own their businesses in corporate form since their personal
creditor can take their corporate stock if it is not insulated in a
creditor protected structure.
5. If the Inheritor’s Trust™ is designed and funded so that the
primary beneficiary is treated as the owner of the trust for income
tax purposes under §678 of the Code, then the sale to the trust will
not have any income tax consequences.169
B. Similar to the results obtained using the Inheritor’s Trust™/FLP combo as
explained in the previous section of this outline, the following results are
1. The client still has access to 100% of the business assets.
2. The client controls 100% of the business as the investment trustee
of the Inheritor’s Trust™ which holds the 1% voting interest.
3. The 1% voting interest is protected from creditors since it is owned
by a trust that was set up and funded by a third party.
4. Upon the death of the client, the 99% non-voting interest is
reported on his estate tax return. The 1% voting interest is not
reported on his estate tax return since it is owned by the Inheritor’s
Trust™, not by the client. Therefore, the non-voting interest is
valued on the estate tax return at a discount from pro rata value to
reflect minority and marketability discounts.
C. How do we protect against an undervaluation or an overvaluation of the
1% voting interest for purposes of the sale?
1. To protect against an undervaluation or overvaluation, we structure
the sales agreement as a part sale and part trust distribution using a
Rev. Rul. 85-13, 1985-1 C.B. 184.
defined value clause170, and then we intentionally have the trustees
of the Inheritor’s Trust™ “overpay” for the interest.
2. For example, assume an appraiser concludes that the 1% voting
interest has a pro rata value of $10,000 and a fair market value of
$14,000 to reflect a 40% control premium.171
3. The parties might execute a part sales agreement/part discretionary
distribution agreement using a defined value formula whereby both
the investment trustee (i.e., the client) and the distribution trustee
of the Inheritor’s Trust™ sign on behalf of the trust agreeing to
pay $20,000 to the client (i) to purchase the 1% voting interest, and
(ii) to make a discretionary distribution to the client for any
amount of the $20,000 that exceeds the purchase price. The
investment trustee is signing the agreement to make the purchase
of the voting interest, and the distribution trustee is signing the
agreement to approve any “overpayment” as a discretionary
4. As long as the purchase price does not exceed $20,000, this
defined value clause and intentional “overpayment” should protect
the client from inadvertently making a transfer with a retained
interest into the trust. A transfer with a retained interest would
cause both estate tax problems172 and creditor problems173.
XXXVII. The Dual Spousal Trust Structure
A. It is well established that an irrevocable trust set up by a third party is
generally protected from the creditors of the beneficiaries of the trust
subject to certain exceptions examined elsewhere in this outline. This rule
holds true even when the grantor’s spouse is a beneficiary of the trust.
See McCaffrey and Kalik, Using Valuation Clauses to Avoid Gift Taxes, 125 Trusts & Estates 47
(October 1986); see also McCaffrey, Some Tips on Tax Tuning Gifts, 137 Trusts & Estates 87 (August
1998). These articles do an excellent job of explaining defined value clauses, although the context of the
clauses in these articles are somewhat different than that which is being used in this outline.
Note that if the fair market value is going to be very small, it may not be economically feasible to hire a
business valuation appraiser to determine the control premium. In such a case, the transaction should be
structured with a much greater “overpayment” to reflect the additional amount of uncertainty involved.
Unless the trust were set up under the law of one of the five states that allows self-settled asset
protection trusts, and unless the trust terms qualified under the requirements of such law, this self-settled
trust would be open to creditors to an extent because the client would be treated as having made a transfer
without fair and adequate consideration to a trust in which he is a beneficiary.
B. However, if each spouse sets up nearly identical trusts for each other, for
estate tax purposes they run the risk of violating the reciprocal trust
C. The reciprocal trust doctrine may be applied when two grantors create
nearly identical trusts at approximately the same time, generally for each
other’s benefit. The seminal case defining the reciprocal trust doctrine was
the Estate of Grace.174
D. However, in Estate of Levy175, the decedent and his wife had each created
a trust for the other on the same day. The trusts were identical except that
the trust Mr. Levy set up for Mrs. Levy gave her a special power of
appointment, whereas the trust Mrs. Levy set up for Mr. Levy did not give
Mr. Levy a special power of appointment. The court found that because a
power of appointment was granted in one trust, but not in the other, they
had substantially different interests in the trusts and, consequently, the
trusts were not interrelated for purposes of the reciprocal trust doctrine.
E. For estate tax purposes, the Levy case would seem to stand for the absolute
minimum degree of differences that may be acceptable in planning around
the reciprocal trust doctrine. However, in the opinion of the author, the
cautious planner should do much more to avoid the doctrine than simply
creating that one difference between the two trusts.
F. In creating a Dual Spousal Trust Structure, the planner should consider
creditor protection planning objectives as well as estate tax planning
objectives, which is the reason the reciprocal trust doctrine has been
G. The Dual Spousal Trust Structure involves each spouse setting up a trust
for the other spouse’s benefit. Each trust will be sufficiently different from
the other in order to avoid the reciprocal trust doctrine.
H. The assets gifted and/or sold on an installment basis to the trusts are
protected from creditors and estate taxes.
I. This is a very simple yet effective creditor protection structure. The only
drawback to this structure is that each spouse loses access to the assets that
spouse transferred in trust for the other. As long as the beneficiary/spouse
is still living, the grantor/spouse has indirect access to the transferred
assets. But after one spouse dies, the surviving spouse only has access to
the trust the deceased spouse set up since the other trust would be for the
benefit of the descendants at that time.
395 U.S. 316 (1969).
52 T.C.M (P-H) P 83,453 (1983).
J. However, this negative attribute can be minimized to a large extent by
combining the Dual Spousal Trust Structure with a family limited
XXXVIII. The Dual Spousal Trust and FLP Structure
A. The Dual Spousal Trust and FLP structure involves the creation of two
spousal trusts and a family limited partnership. Each spouse might own a
1% general partnership interest, and each spousal trust might own a 49%
limited partnership interest. Because this ownership structure is identical
(in this example), it is of utmost importance that every precaution be taken
to avoid the reciprocal trust doctrine. The trusts should be very, very
different from each other.
B. The advantage to using the family limited partnership structure is that the
survivor of the spouses will inherit the decedent spouse’s general
partnership interest and therefore still control the partnership. Although
the survivor would lose access to 49% of the partnership, the retention of
the control will enable the survivor to access some of the income as a
C. The ability to obtain such strong creditor protection, as well as the ability
to get paid a management fee is often an acceptable trade-off versus the
loss of 49% of the partnership distributions.
D. Therefore, in the right situation this structure works very well.
XXXIX. Asset Protection and Individual Retirement Accounts176
A. This portion of the outline deals with the state and federal exemptions that
may apply to an Individual Retirement Account (IRA).
B. Potential Federal Exemption
1. For a debtor who lives in a state that has exercised its right to opt
out of the Bankruptcy Code (Code) exemptions contained in
§522(d), the Code exemptions discussed below are not available.
However, if a debtor lives in a state that has not exercised its right
to opt out of the Code exemption, either the Code exemptions or
the state law exemptions are available.
2. The elect out provisions are contained in Code §522(b)(1).
The author would like to thank Rod Goodwin MST, Anderson & Dorn, Ltd., Attorneys, Reno, NV, for
his extensive research and assistance in preparing this section of the outline.
3. The states currently electing out are: Alabama, Arizona, Arkansas,
California, Colorado, Delaware, Florida, Georgia, Idaho, Illinois,
Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland,
Mississippi, Missouri, Montana, Nebraska, Nevada, New
Hampshire, New York, North Carolina, North Dakota, Ohio,
Oklahoma, Oregon, South Dakota, Tennessee, Utah, Virginia,
West Virginia, and Wyoming.177
4. In these states, the federal exemptions, including Code
§522(d)(10)(E), discussed immediately below, would not be
available and the state exemption statues would control.
5. Code §522(d)(10)(E) exempts “…a payment under a stock bonus,
pension, profitsharing (sic), annuity or similar plan or contract…”
The Supreme Court addressed the application of Code
§522(d)(10)(E) to an IRA in Patterson v. Shumate. 178 The
Patterson Court first noted that “pension plans that qualify for
preferential tax treatment under 26 U.S.C. section 408 (individual
retirement accounts) are specifically excepted from ERISA's anti-
alienation requirement.” Because the IRA was excepted from
ERISA’s anti-alienation requirement, the Court found that the
exceptions provided in Code §541(c)(2) were inapplicable.
However, the Court recognized that the exceptions provided in
Code §541(c)(2) were much more narrow than the exemptions
provided in Code §522(d)(10)(E). Therefore, the Court held that
an IRA is excluded from a Bankruptcy Court proceeding under the
broader provisions of Code §522(d)(10)(E).
6. Patterson was followed by Appeals Court decisions in: (i) In re
Carmichael, 179 which held that the debtor’s IRA was exempt as “a
similar plan or contract” under Code §522(d)(10)(E), (ii) In re
Dubroff,180 similar holding, (iii) In re Mckown,181 similar holding,
and (iv) In re Dubroff, 182 similar holding. However, in In re
Rousey, 183 the court held that IRAs are not exempted by Code
§522(d)(10)(E) because the court was bound by precedent in the
Spero, Asset Protection: Legal Planning, Strategies and Forms: Warren Gorham & Lamont 2001,
updated to 2004, 12-63.
504 U.S. 753 (1992).
100 F.3d 375, (5th Cir. 1996).
119 F.3d 75, 78 (2nd Cir. 1997).
203 F.3d 1188, 1190 (9th Cir. 2000).
119 F.3d 75, 78 (2nd Cir. 1997).
347 F.3d 689 (8th Cir. 2003).
8th Circuit. Rousey is currently before the Supreme Court,184 and
we must await the final determination.
C. Pre-bankruptcy Planning: The Transfer of IRA Funds to a Qualified Plan,
or Other Exempt Asset, as Allowable or Treated as a Fraudulent
1. The transfer of a non-exempt or limited exemption IRA balance to
a completely exempt ERISA qualified plan, or to another exempt
asset, may be an acceptable pre-bankruptcy planning option,
depending upon the jurisdiction in which the debtor files.
2. In the 9th Circuit two cases have examined this issue.
3. In Schwartzman v. Wilshinsky,185 the court held that the conversion
of non-exempt assets to exempt assets was a permitted action
under the relevant statutes:
“The very purpose of the exemption is to permit a judgment debtor
to place funds beyond the reach of creditors, so long as they
qualify for the exemption under the law. (See Yaesu Electronics
Corp. v. Tamura, supra, 28 Cal.App.4th at p. 13.) Thus, a transfer
which might otherwise be fraudulent is permitted if the funds
qualify for an exemption. There is nothing in the statute, however,
which would permit denial of an exemption on the ground that
unrelated funds are ineligible and have been fraudulently
4. The 9th Circuit Court of Appeals made an even stronger statement
regarding the ability of a debtor to convert non-exempt funds into
exempt funds as part of pre-bankruptcy planning. In In re
Stern, 186 the Court of Appeals dealt with a debtor who had
transferred $1.4 million from an IRA to a qualified plan as part of
the pre-bankruptcy planning. At issue was whether the transfer to
the qualified plan was fraudulent. The court cited a prior case,
Wudrick v. Clements, 187 which held “that the purposeful
conversion of non-exempt assets to exempt assets on the eve of
bankruptcy is not fraudulent per se.” Relying on this precedent, the
court found that a mere inference that “non-exempt assets were
converted to exempt assets immediately prior to bankruptcy . . . . is
insufficient as a matter of law to establish a fraudulent transfer.”
cert. granted, 124 S. Ct. 2817 (2004).
50 Cal. App. 4th, 619, 629 (1996).
317, F.3rd 1111 (9th Cir. 2003).
451 F2d 988, 989 (9th Cir. 1971).
5. Contrasting with this strong policy towards allowing conversions,
is the 11th Circuit’s decision in In re Levine.188 The issue in Levine
again was whether the conversion of funds from non-exempt to
exempt status constituted a fraudulent transfer under Florida
Statute § 726.105. Relying on the precedent of a previous case, In
re Gefen, 189 the Court found that the conversion of the debtor’s
IRA into exempt-status annuities was made with the intent to
hinder, delay or defraud a known creditor, and that the transferred
funds were includable in the debtor’s bankruptcy estate.
6. The determination of the conversion of IRA balances to exempt, or
more exempt qualified plans or annuities, is ultimately governed
by the policy of the jurisdiction at issue regarding the ability to
convert as an acceptable pre-bankruptcy planning step. As such, it
is necessary for the planner to check the fraudulent transfer
decisions in the relevant jurisdiction as to how the courts apply the
standards to conversions from non-exempt to exempt assets.
XL. Other Creditor Protection Strategies – Tenancy by the Entirety (Craft)
A. A tenancy by the entirety is a form of property ownership whereby a
husband and wife own property as a marital unit. Similar to a joint tenancy,
the tenancy by the entirety offers survivorship, so that upon the death of
one spouse the property automatically passes to the surviving spouse in
fee simple. However, unlike a joint tenancy, a tenancy by the entirety is
not severable unilaterally. Instead, the tenancy by the entirety may be
severed only by divorce or by the consent of both parties.
B. Although the tenancy by the entirety developed out of common law, only
about half of the states retain this form of ownership.
C. Property held as tenants by the entirety is generally thought to be protected
from creditors because the marital unit, not the individual debtor spouse,
owns the property. Additionally, because both spouses are required to
approve any conveyance of the property, a creditor cannot compel the
distribution of tenancy by the entirety property. This generalization holds
true for claims brought under state law, such as tort actions.
35 B.R. 368 (Bankr.S.D.Fla.1984) (holding that a the cash value of an IRA may be withdrawn by a
creditor when the transfer from the IRA to a deferred annuity had the legal effect of defrauding, delaying or
D. In United States v. Craft, 190 the Supreme Court limited the scope of
protection afforded by a tenancy by the entirety, deciding that a federal tax
lien against a husband could attach to his share of property held with his
wife as tenants by the entirety.
E. Don Craft, after failing to file federal income tax returns for eight years,
accrued almost $500,000 in unpaid income tax liabilities. After he failed
to pay his debt to the government, a federal tax lien attached to “all
property and rights to property, whether real or personal, belonging to”
him.191 At the time the lien attached, Don and his wife, Sandra Craft,
owned a piece of real property in Michigan as tenants by the entirety.
F. After Don Craft received notice of the federal tax lien, he transferred his
interest in the Michigan real property to his wife for consideration of one
dollar. Years later, when Sandra Craft attempted to sell the Michigan
property, a title search returned with a cloud from the lien. The IRS agreed
to allow the sale by releasing the lien, provided that one-half of the
proceeds be held in escrow until a determination of the Government’s
interest in the property.
G. Sandra Craft brought an action to quiet title to the escrowed proceeds of
the sale. The Government argued that the federal tax lien attached to all
property and rights to property owned by Don Craft, including his interest
in the tenancy by the entirety. The District Court granted summary
judgment for the Government, finding that the lien attached when the
tenancy by the entirety terminated, specifically, when the husband
transferred his interest in the Michigan property to his wife.
H. On appeal, the Sixth Circuit Court of Appeals found that the tax lien did
not attach to the Michigan real property because under Michigan state law,
Don Craft had no separate interest in the property held as tenants by the
entirety. After remand, the case was appealed to the United States
I. The central issue before the Supreme Court was whether Don Craft’s
interest in the entirety property qualified as “property” or “rights to
property” under IRC § 6321. Relying on the reasoning of Drye v. United
States192 (see discussion below), the Court found that it must first analyze
state law in order to determine what rights the taxpayer has to the property
subject to the lien, and secondly it must analyze federal law in order to
determine whether the rights held by the taxpayer under state law qualify
as “property” or “rights to property” under the federal tax lien statute. The
535 US 274 (2002).
IRC § 6321.
528 U.S. 49 (1999).
Court ruled that the first prong of the determination, the analysis of state
law, required examination of the substance of the rights provided by state
J. Michigan law treats property in tenancy by the entirety as owned by the
marital unit, and therefore under state law, Don Craft had no separate
interest in the property. However, the Supreme Court looked beyond the
language of the law. Specifically, because Don Craft had the right to use
the property, to exclude others from the property, to become a tenant in
common upon divorce and to unilaterally block the sale or encumbrance
of the property, the Court found that he had a right to the property under
the definition of IRC § 6321.
K. In concluding that the husband’s interest in the tenancy by the entirety
property was “property” or a “right to property,” the Court also focused on
the fact that if an interest in entireties property were not so categorized,
then no one would own the property for purposes of IRC § 6321. Because
the entireties property was “property” or a “right to property” under IRC §
6321, the Court found that a federal tax lien against one spouse could
properly attach to the tenancy by the entirety property.
L. As a result of the Craft case, the strength of asset protection afforded by a
tenancy by the entirety is weakened. Although it appears that entireties
property retains its protection from state creditors, it is no longer protected
from federal creditors.
XLI. Other Creditor Protection Strategies – Disclaimers (Drye)
A. A person may disclaim an interest in inherited property within nine
months of a decedent’s death. The effect of a disclaimer is to treat the
person disclaiming as though he had predeceased the decedent. As a result,
the disclaimant’s share of the inheritance passes according to will or to the
decedent’s state’s intestacy statutes. The disclaimer has long been used as
a method of making tax-free gifts to the eventual beneficiary of the
property. In addition, those who may be subject to attack from creditors
may utilize a disclaimer to pass inherited property to a more protected
individual, such as a young child.
B. In 1999, the Supreme Court issued a ruling in Drye v. United States,193
finding that a disclaimed inheritance qualified as “property and rights to
property” under IRC § 6321.
C. Irma Drye died in 1994, leaving her estate to pass by intestacy. Her sole
heir under Arkansas law was her son, Rohn F. Drye, Jr., an insolvent man
who at the date of his mother’s death owed the government more than
$300,000 in tax deficiencies. After petitioning to become the administrator
of his mother’s estate, Drye, Jr. served for six months and then filed a
written disclaimer of all interests he held in his mother’s estate. Once he
disclaimed his interest, under Arkansas law, Drye, Jr.’s daughter, Theresa
Drye, became the sole beneficiary of Irma Drye’s estate. When the estate
was fully administered and Theresa Drye received the final distribution,
she thereupon took the proceeds she received from her grandmother’s
estate and used it to create a spendthrift trust under which she and her
parents were HEMS beneficiaries.
D. While negotiating his tax liabilities with the IRS, Drye, Jr. divulged that
he had a beneficial interest in the trust his daughter established. Shortly
thereafter, the IRS attached a federal tax lien against the trust. The trust
filed a wrongful levy action against the government in the District Court.
The District Court found for the government, and the Court of Appeals
affirmed. The case was then appealed to the Supreme Court.
E. In analyzing whether the government properly attached a federal tax lien
against the disclaimed property, the Supreme Court looked to IRC § 6321.
It noted that the language of that statute is very broad, and is “meant to
reach every interest in property that a taxpayer might have.”194 The Court
stated that it must look first to whether the taxpayer has a state-law right to
the property, and then to whether the state-law right qualifies as
“property” or “rights to property” within the meaning of IRC § 6321.
F. Drye argued that once he disclaimed his inheritance, he no longer had a
right to the property. The Court noted that Drye indeed had a right to
disclaim his inheritance under Arkansas law. However, the Court found
that the right to disclaim, in itself, was “a right of considerable value,”
because Drye could choose to inherit or to pass his inheritance off to a
family member. The Court cited Morgan v. Comm’r195 for the proposition
that “[t]he important consideration [in determining whether state-law
rights are ‘property’ or ‘rights to property’ under IRC §6321] is the
breadth of control the [taxpayer] could exercise over the property.”
Because a person controls the very disposition of inherited property when
they choose to disclaim it, disclaimed property is “property” or a “right to
property” and therefore subject to federal tax liens.
G. As a result of the Drye case, a disclaimer is no longer an effective tool to
protect an inheritance from a federal creditor. However, like the tenancy
by the entirety, it may still provide protection from creditors bringing suit
under state law.
Id. (citing United States v. National Bank of Commerce, 472 U.S. 713, 719-720 (1985)).
309 U.S. 78, 83 (1940).
H. The application of the Drye case extends beyond disclaimed property. The
Court extended the definition of “property” or “rights to property” to any
property a taxpayer has control over pursuant state law. The impact of this
extension was seen in the Craft case, where the court attached a federal tax
lien against property held as tenancy by the entirety. The likely result of
the Court’s broad ruling is weakened creditor protection, at least on the
federal level, of other asset protection tools which allow the taxpayer to
retain some control over his property.