By Scott Dondershine, CPA, Esq.
Virginia and Maryland recently adopted different but important tools to help their residents protect assets from the claims of creditors. This Client Alert explains the tools in generic terms providing general guidance only (primarily for residents of Virginia and Maryland) and should not be relied upon for legal advice.
I. Virginia’s New Self-Settled Trust Statute. The 2012 General Assembly of Virginia adopted a “self-settled” trust statute pursuant to which it is now possible to establish an irrevocable trust for the purpose of protecting assets against the claims of creditors of the grantor. In doing so Virginia became just the 13th state to provide for said protection.
Pursuant to the statute, the grantor (also known as the “settlor”) can contribute assets to a “qualified self-settled spendthrift trust” (“QSST”), and the general rule that would otherwise permit creditors of a grantor to make claims against the trust assets will no longer apply. The requirements for qualifying are listed below, and a creditor has five years to bring an action to avoid a transfer that would otherwise be effective to shelter assets in a QSST.
The main requirements of a QSST are:
(a) The trust must be irrevocable and must have been created during the grantor’s lifetime;
(b) A transfer must not have been made with the intent to delay, hinder or defraud creditors based upon some reason other than establishing the trust, e.g., the transfer is made by an insolvent grantor or causes the grantor to be insolvent;
(c) The grantor must be entitled only to discretionary distributions of income and/or principal and there must be at least one other beneficiary entitled to the same type of distributions;
(d) At least one trustee must be a resident of Virginia or legally authorized to act in Virginia (for corporate trustees) and the trust must meet certain other “nexus requirements” specified in the statute; and
(e) The trustee authorizing distributions to the grantor must reside in Virginia and be independent of the grantor, e.g., someone other than the grantor or the grantor’s spouse, parent, descendant, sibling, employee or business entity controlled by the grantor.
Given the statute, a grantor can now effectively use the protection of a Virginia statute to shelter assets from the claims of his or her own creditors. Prior to adoption of the statute, Virginia grantors generally had to use the laws of another state or country to establish a trust (called a domestic asset protection trust or offshore trust) or employ other techniques (such as using a limited liability companies or tenants by the entirety titling) to gain protection. Although there are differences between a Virginia QSST and the techniques offered by other jurisdictions (in some respects the Virginia statute is not as favorable as the statute in some of the other states), it is now less expensive with more certain results than prior to adoption of the QSST where Virginia residents had to “shop around” for the less certain benefit of other state or country statutes. Creditor protection plan remains tricky, however, as there are usually a number of different alternatives to explore, each with its own set of advantages and disadvantages.
II. Adoption by Maryland of Virginia’s Tenants by the Entirety Statute. The publication/client alert section of our website (www.dbd-law.com) contains a Client Alert (Recent Developments in Estate Planning) describing Virginia’s unique statute concerning the ability of spouses to protect assets owned as “tenants by the entireties” even though the assets are transferred to revocable trusts for each spouse. Maryland recently followed Virginia’s lead in adopting its own statute (codified at Section 14-113 of the Maryland Estates and Trusts Volume of the Code of Maryland).
Tenants by the entireties titling is usually the best way of holding property owned by a husband and wife since the creditors of one spouse generally cannot reach property that is owned with the other spouse. The same is not true of property titled joint tenancy by right of survivorship or as tenants in common.
Only married persons can own property as tenants by the entireties. While real estate deeds for property owned by a married couple usually include the requisite language, investment accounts do not and are more typically titled as joint tenants by right of survivorship and not as tenants by the entireties — unless, you specifically request titling as tenants by the entireties.
Unfortunately, owning property jointly usually conflicts with the goal of reducing estate taxes by making sure that each spouse has enough separately owned assets with which to absorb the first spouse to die’s estate tax exemption. The Virginia statute (Section 55-20.2) provides that real or personal property owned as tenants by the entireties can be conveyed to one or more revocable living trusts established by the spouses (thus being “separate” property for estate tax exemption purposes) while still retaining the characteristic of tenants by the entireties property for creditor protection purposes. In other words, the statute allows the best of both words, i.e., utilization of both spouses’ applicable exclusion amounts and creditor protection. The Maryland statute essentially works the same way, although there are some differences that are beyond the scope of this Client Alert.
Based upon the statutory protection, my firm generally recommends that all clients review the titling of assets to make sure that any real or personal property transferred to the revocable living trusts of a husband and wife is first owned as tenants by the entireties and then is transferred to the revocable living trusts. Future additions of property to your trusts should also be handled in the manner, i.e., first established as tenants by the entirety property before transfer to both spouses’ trusts. We recommend that a joint checking account be owned by you outside of your trusts as tenants by the entirety so that you can create tenants by the entirety protection on future funds deposited to your checking account and then transfer such funds to the trust accounts.
If property, such as an investment account, is owned jointly but not as tenants by the entireties, we are recommending that the property first be titled as tenants by the entireties and then transferred to the trust(s). If property is already owned by the trust(s), it may also be worth the exercise of taking the property out of the trust(s), owning it as tenants by the entities and then re-transferring it to the trust(s). Although multiple transfers are needed as establishing a paper trail is important, taking advantage of the favorable statutes in Virginia and Maryland law could become important if one spouse develops a problem with creditors after the transfers. Each spouse should understand that one potential drawback of the strategy is that if a spouse transfers property solely owned by that spouse in the manner discussed above then the transferring spouse may be granting to the non-transferring spouse “marital rights” to said property in the event of a subsequent divorce.
III. Summary. The current legislative trend at least in the estate and trust planning world is for progressive states to enact laws favorable to individuals allowing them to “protect” their property rights in and to certain assets. Although creditors may not appreciate the new rights, the rights are undeniable and it appears as if Maryland and Virginia are “competing” in the race to cater to their residents. This phenomenon is known as either the “race to the top” or “race to the bottom”, depending upon your perspective, e.g., the individual who benefits versus the creditor who loses. As an individual, you should make sure that you fully take advantage of the opportunity provided by the statutory protections. Let us know if you need further guidance on any of these issues.
Reston Law Group, LLP is a law firm that concentrates in providing full-range business legal services to businesses and business owners, including business, tax and estate planning. This Client Alert is intended to provide general information about significant legal developments and should not be construed as legal advice on any specific facts and circumstances.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this Client Alert is not intended or written to be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this Client Alert.