Last year (2016), there was a U.S. District Court case in Arizona that imposed a federal tax lien on a beneficiary’s interest in an asset protection trust. The case was Duckett v. Enomoto (decided on April 18, 2016). The trust at issue was set up by the beneficiary, partly for purposes of asset protection. The beneficiary had unpaid federal taxes. The trust provided that the independent trustee “shall pay” to the beneficiary distributions from the trust as needed for health, education and support. The trust also gave the trustee sole discretion in determining the monetary amount of such distributions.
The issue came down to whether the “sole discretion” language in the trust was sufficient to cause the trust assets to be a “mere expectancy” of any distribution being made. If the trust was purely discretionary, then the beneficiary would have no rights or power to compel a distribution and therefore would not have any “property” interest (from a federal law standpoint) to the trust assets that the IRS could garnish.
The Court concluded that under Arizona’s Uniform Trust Code (ATC), the term “discretionary trust” is broadly defined to include “support” trusts such as the one under consideration. Therefore, the court reasoned, the beneficiary has an enforceable right to compel distributions notwithstanding the discretionary nature of the trust provisions. As such, that right under Arizona law is sufficient under the broad federal definition of property to be an attachable asset for IRS lien purposes.
The moral of the story is that if you really want to have an effect asset protection trust, you should:
- Opt out of the ATC to the extent allowed by law. A.R.S. 14-10105 (A) provides that the ATC governs the rights and interests of a beneficiary “except as otherwise provided in the terms of the trust.”
- Have the trust say “may pay” rather than “shall pay.” Also, omit language that suggests a purpose of the trust that would give the beneficiaries any entitlement to, or power to access, trust assets now or in the future.
- Avoid language that seems to impose a duty on the trustee to make a distribution.
- Avoid language that would grant the beneficiary any power to control the ability to receive trust assets.
- Avoid a history of regular distributions having been made to the beneficiary over the previous years.
- Avoid having the beneficiary being the sole current beneficiary.
This area of law continues to change. Do not rely on this blog post for making legal decisions. If you have an irrevocable trust or an asset protection trust, talk to a competent attorney about whether it should be changed. Feel free to call us at 602-443-4888.