Breaking Bad Introduces Irrevocable Trusts to the World

There are three audiences for this blog post.  I’ll have some Breaking Bad fans that pick apart every minute detail and want to learn more about the irrevocable trusts mentioned in the show’s series finale.  There’s the potential client investigating irrevocable trusts and finding some interesting, if obscure, pop culture reference.  And then there’s going to be a few asset protections dorks like me, thrilled at the mention of one of our bedrock tools being featured on the highest profile primetime television episode in years. 

Until now, there weren’t many of group one who mingled with group two.  However, tonight’s series finale gave us yet another twist that utilized irrevocable trusts to resolve at least two loose ends. 

To catch non-viewers up to speed, the most relevant details here are that Walter White is the dying father of two children, both minors.  He’s sitting on a mountain of cash (literally) and very forcefully requires that two former colleagues place the funds into an irrevocable trust to be made available to the eldest child on his 18th birthday, less than a year hence.  If you’re a non-viewer and still interested in learning more about irrevocable trusts, I suggest reading my other blog entries on the topic since further discussion will be riddled with unfamiliar names and subjects, only further blurring already hazy subject matter.

So what is an irrevocable trust?  Very simply, it’s an entity respected by state and federal law, that exists separately from the person who places assets into it.  Think of a business entity like an LLC or corporation.  What makes it more unique is that the person for whose benefit it is created cannot lose the trust property to a creditor.  Any creditor, if the circumstances are right.  That is critical in this case because Walt is afraid that this money could be taken by the federal government after seeing what happened to Mike and his granddaughter. 

Walt is justified in placing his faith in an irrevocable trust because every state in the country has what are known as spendthrift trust laws on the books.  Spendthrift trust statutes prevent a creditor from having any right to remove a trust asset from a beneficiary, and likewise, withhold from a beneficiary the freedom to give it to them.  That means that no matter what Flynn (forget ever hearing him referred to as Walter Jr. again!) does or more importantly, what the Feds try to do, he can’t lose the money to an outside party.  It will remain in the bank unless an independent trustee distributes trust funds to Flynn, the beneficiary, or purchases something for his benefit, like tuition or a place to live.  Moreover, Flynn will likely have the option to control those trust funds directly, potentially even on his 18th birthday, and the trust will still provide that very same protection.

We saw Walt desperate to deliver some cash to his kids, but his wife and son continually rejected him.  At least with this method, Walt has some hope that the money will be preserved so that if Flynn ever changes his mind, its available.  In the mean time, Walt expects that the government (if they ever even become aware of its existence) won’t be able to touch it.  The end result is that Walt’s goal of taking care of his family financially is met, and his desire to make things miserable for his former Grey Matter co-founders is satisfied.

The plan is not perfect.  While the Schwartz’s had no choice but to agree to cooperate, I don’t know how enthusiastic they will be with their chosen attorney to provide all the flexibility the trust should include.  I also don’t see how they can possibly fund the trust via a bank account without raising red flags, even if they go offshore with it.  But assuming they get good counsel to help them navigate those issues, we, as fans, can take solace in Flynn having some nice financial options for Skyler, Holly and himself in the future.

Now, if you really want to dig deeper (as any Breaking Bad fan does), there are a lot more issues beneath the surface that only trust geeks would care to analyze.  Who is the grantor here:  Walter, or Gretchen and Elliot Schwartz?  What of the State’s existing creditors, whether federal or local?   Surely they were existing creditors at the time of the transfer.  Upon discovery of the transfer, will their lookback period claim succeed in unwinding the transfer?   Even if the funds make it in an account, to what lengths will the State go to freeze the assets and how successful might they be, regardless of the principles protecting the assets?  Holly isn’t mentioned as a beneficiary, but Walt expects Flynn will provide for the family, so is she named as a beneficiary or will Flynn provide for her via a personal gift post-distribution?  Can he possibly remain inside of a HEMS standard distribution and still take care of his sister and mother? Is New Mexico the best situs to govern the trust?  Not a question, but that's going to be a steep annual income tax bill unless the remaining White's are spending down hard.  Which trust company, if any, just fell into some massive trustee fees and do they sacrifice disclosure amid the sticky and vague origin and existence of the funds? 

This post attempts to serve as no more than an introduction to the topic than the brief mention in tonight’s episode did to introduce the subject at all.  No doubt there will be many posts to come from trust commentators and analysts who will answer the questions above and many more.  It falls right in line with one of the brilliant elements of the story: the deeper you dig, the more you find.  Hopefully this provides just a bit of contextual insight to yet another of Walt’s brilliant decisions.  For me, this one stood out as one of the most brilliant of all (self-serving or not)!

SPA Trust vs. NAPT

When it comes to asset protection trusts, the discussion with my clients almost always comes down to whether or the Nevada Asset Protection Trust (NAPT) or the Special Power of Appointment Trust (SPA Trust) is a better fit. Of course, it's always determined on a case by case basis and I will emphatically direct you to my disclaimer at the bottom of the blog before reading further, but there are certainly a couple common factors to consider when deciding.

Both trusts are spendthrift trusts designed to prevent creditors from reaching trust assets and endow the trustee with absolute discretion over distribution decisions. Where they differ is the self-settled aspect. The "Nevada" of the NAPT refers to the provision in NRS 166 that allows a grantor (aka settlor or trustor) to also be a beneficiary. Nevada and a few other states offer this nuance which was inspired by offshore trusts that do the same. By using a domestic trust, the grantor avoids the stigma of placing assets outside the U.S. and does not have to file notice forms with the IRS.

The SPA Trust is not self-settled, instead relying on the power of appointment to appoint assets back to the grantor, should the need arise.

GRANTOR ACCESS
The NAPT offers greater access for the grantor because he is treated the same as any beneficiary. The trustee may make distributions at any time to the grantor, giving the grantor the ability to protect trust assets, but still be able to enjoy the income or principal at any time. The power of appointment used by the SPA Trust is not used the same way. Instead it's generally a single use tool to receive some or all of the trust assets without being a beneficiary of the trust.

NON-RESIDENT GRANTOR
A grantor can appoint a professional, Nevada resident trustee to the trust to qualify the trust to be governed by Nevada law. That has its own inherent benefits, but is mandatory for the NAPT if the grantor is not a Nevada resident. Even when all of the trust assets are located in Nevada, I still recommend a resident trustee for a non-resident grantor. The risk for non-resident grantors, though, is the possibility that a non self-settled trust jurisdiction could apply their own trust law in a suit against the trust, extinguishing the asset protection provided to the grantor-beneficiary. Though I haven't seen it happen, in theory it could. Nevada residents are protected from this event, but non-residents with self-settled trusts can't be sure.

As already discussed, since the grantor is not a beneficiary of a SPA Trust, such a concern is moot.

CONCLUSION
Also important to the decision is how business entities will be used to support the strategy, the availability of a trustworthy distribution trustee to the grantor, and more. There is no right answer for every circumstance so it is important to discuss these matter with an experienced asset protection attorney who will intelligently guide you through the process. Most important to the entire process is timing. As always, transfers to an irrevocable trust should be done when the waters are calm to ensure the most effective arrangement.

Establish asset protection when you don't need it

The down economy has significantly reduced the average American's discretionary income.  The effect is the consumer re-prioritizing where they spend their money.  Unfortunately, that has resulted in consumers sacrificing wiser, long-term beneficial expenditures in favor of short-term relief.  There are countless examples of this principle at work.  Choosing to forgo routine car maintenance will result in expensive repairs down the road.  Letting your expensive health insurance policy lapse to save money in the short term may result in incurring significant medical bills later.  Avoiding regular dental checkups can necessitate the suffering and cost of a root canal.

Another example of this is failing to draft and implement an asset protection plan before a claim against your assets arises.  When drafted and used correctly, the only real threat to assets inside of an asset protection trust are fraudulent transfer claims.  These are claims made by a creditor that assets were transferred to the trust to "hinder, delay, or defraud creditors."  Such claims will fail if the grantor can show that the transfers were made before a claim existed or the grantor had reason to know of a claim yet to arise.  That means that transfers to an asset protection trust need to be made while the waters are calm if the plan is to be completely effective.  this concept is sometimes referred to as 'seasoning' the trust.  The longer the time period between transfers to a trust and a claim against you, the more secure the trust assets will be.

If you think that one day such a claim might arise, then establish an asset protection plan now.  Funding an asset protection trust after events leading to litigation have already occurred will still provide you leverage in negotiations with  creditors.  However, you can't effectively transfer assets to a spendthrift trust unless the timing of those transfers is proper.  While avoiding the legal fees of creating an asset protection plan may boost your bank account a bit in the short term, if a judgment is found against you down the road, you'll be kicking yourself for not engaging in planning sooner.

Special Power of Appointment Trusts

Unlike basic estate planning, asset protection is constantly evolving. Nevada spendthrift trust law remains the best in the country with the State Legislature frequently making tweaks and adjustments to keep it that way.

However, a new type of asset protection trust has become popular recently and one of its advantages is that it functions just as well in any jurisdiction. It's known as the Special Power of Appointment Trust (aka "SPA Trust"). It uses the power of appointment, a well-established estate planning tool, to allow the trustee of an irrevocable trust, in his full discretion, to appoint assets back to the grantor without sacrificing creditor protection.

This irrevocable spendthrift trust functions as most any other with an independent trustee endowed with discretionary powers of distribution to named beneficiaries. However, it does not require a "self-settled trust" situs like Nevada, Alaska, Delaware, etc., where local trust law allows the grantor to also be a beneficiary. Instead the grantor bestows a special power of appointment upon the trustee, who in turn, may choose to use that power of appointment to appoint assets back to the grantor. The technique does not jeopardize the asset protection of the trust thanks to the inherent prevention within this type of power of appointment that prohibits the "donee" of the power, in this case the trustee, from appointing assets to himself or his creditors. The "permissible appointee," here, the grantor, may receive assets without being a beneficiary, which in a majority of states, would eliminate any protection from creditors that trust is written to provide.

Noted asset protection attorney Lee McCullough, III has brought this tool to the attention of asset protection attorneys, including myself. You can read more about it at his website, or in the article published in the January issue of Estate Planning Magazine.

If you're interested in asset protection and/or what a SPA trust can do for you, call my office.

Protecting your money from yourself

A person is a spendthrift when they spend money recklessly or wastefully. A spendthrift trust is an irrevocable trust established on behalf of a beneficiary that gives full control to an independent trustee who will, in his sole discretion, determine when the beneficiary will receive distributions. It's done this way to protect a spendthrift beneficiary from recklessly or wastefully using the trust assets.

Two reasons why it's so desirable are 1) it provides protection of the trust assets from creditors of the trust creator (the grantor) because the assets are no longer in the grantor's possession. A creditor of a person can't reach what that person doesn't own. And 2) the beneficiary is prevented from spending the trust assets set aside for the beneficiary's benefit without the approval of the trustee. Unless the trustee actually makes a distribution, the beneficiary doesn't have a claim on the trust property.

This type of trust is most commonly used all over the country by parents who want asset protection and want to ensure their children use the trust assets wisely, taking advantage of the two benefits listed above. A unique use in Nevada, and another handful of states that allow self-settled spendthrift trusts, is for the grantor to place assets in the trust to protect them from himself or herself.

Nevada allows the grantor of the trust, the person who contributed the trust assets, to also be a beneficiary and trustee. I've had a couple cases recently where my client knew that if he had the cash, he would spend it unwisely. In both cases these clients had a lot to lose. They each wanted the safeguard of asset protection and the limitation of access to the cash in the trust. In both cases, I named the client as grantor and beneficiary. In one case we appointed a committee of family members as co-trustees and in the other, a bank as trustee. In both, we designed the trust with specific guidelines regarding the payment of living expenses, medical expenses, education and other related needs. We also set up an allowance, again on a discretionary basis, to be distributed to the grantor-beneficiary. The result was a limitation on the availability of funds to the literal spendthrift.

It's difficult to find an institution whether it be a bank or a life insurer or otherwise, who will create a product that doesn't provide access to deposited funds. Most likely they will discourage withdrawals from accounts like CDs or permanent life insurance policies with cash penalties, but access is still available. This is the best solution I'm aware of that will provide full asset protection and limitation of distributions to the original owner of the funds. Of course, it can't happen without the cooperation of the grantor, but when it works, the benefit is immense.

The value of an independent trustee on your asset protection trust

When establishing an asset protection trust, I advise my clients to retain an independent professional trustee in Nevada with limited duties in addition to the trustee they have chosen who will carry the bulk of the responsibility. Here are a few reasons why:

1) If the Nevada resident settlor ever leaves the state, establishing a domicile elsewhere, then the settlor risks losing Nevada as the trust situs. NRS 166.015(1)(c) requires the settlor to be domiciled in Nevada for NRS 166 to govern the trust. Alternatively, the trust property may be located in Nevada, but as the years go by, Nevada property may be sold and accounts may be moved out of state, so I don't feel comfortable relying on those provisions alone. Moreover, if the trust is self-settled then the Nevada property provisions don't apply. The safer option is to take advantage of paragraph (d) in that statute that provides for a "qualified person" trustee (aka Nevada trustee) who has limited powers such as maintaining trust records and handling some trust administration. No matter what becomes of the trust property or where the settlor is domiciled, the trust will remain a "Nevada Trust."

2) A Nevada trustee will add another layer of legitimacy as a result of the trustee's independent relationship with the settlor. Unlike the appointed investment trustee, the Nevada trustee has no prior relationship with the settlor. In exchange for a fee agreed upon between the settlor and the trustee, the Nevada trustee will fill his or her role from a distance without any personal ties to the settlor.

3) The Nevada trustee's job description includes duties that might otherwise be overlooked. If a note is owed by the trust, the trustee will maintain an amortization schedule to keep track of payments. The trustee will arrange for tax returns to be filed and maintain all trust records. In my opinion the value of the trustee's administrative supervision far exceeds the monetary cost to retain the trustee.

Ultimately it's the client's decision whether to appoint a Nevada trustee since it's not mandatory, provided the other requirements in NRS 166.015 are met. But when the purpose of the trust is to protect significant and valuable assets against all claims, any additional layers of available, nonsuperfluous protection should be investigated and considered.

Another way Nevada makes it difficult to attack a Nevada asset protection trust

One of the most common strategies used by creditors to reach trust assets is applying the technique of veil piercing. Usually this involves proving the trust is merely the alter ego of the settlor. The creditor will argue that the settlor of the trust did not respect the trust as a distinct and separate entity, showing that the settlor, instead, used the trust as his or her personal piggy bank. Creditors use the same strategy to reach the business assets of a defendant sued individually by showing the defendant commingled personal and business funds or used the business to unjustifiably purchase personal use property.

While a business owner guilty of this type of irresponsibility may not have a leg to stand on, Nevada protects trust settlors who make similar mistakes. NRS 163.418 has effectively removed from consideration much of the evidence a creditor might use to attempt to establish a case of alter ego liability to attempt to pierce the trust veil. Under this statute, a creditor attempting to build an alter ego case cannot rely solely on the fact that a settlor has himself made distributions from the trust. Neither can they rely on proof that the settlor directed the trustee to hold, sell or transfer property from the trust. In other words, evidence that a settlor who foolishly writes a check from the trust account to pay his own credit card bill, will not on its own be available as evidence against him. Of course, such a practice should never be routine and the wall of separation between a settlor and his trust should always be respected, but it is comforting that it is unlikely Nevada would expose trust assets for occasional mistakes made by the settlor.

What Makes Nevada Self-Settled Spendthrift Trusts So Special?

If you're reading this, you're probably already aware of the concept of a self-settled spendthrift trust. If not, it's simply an asset protection trust that enables the settlor to also be a beneficiary of the trust. Often the self-settled feature is not written into the trust at the outset due to its as yet unconfirmed acceptance by the courts.

Though the ability for the settlor to also be a beneficiary is unique to Nevada and a handful of other states, what makes Nevada a superior forum for spendthrift trusts is the statutory discretion given to the trustee.

In an asset protection trust, the settlor gives the trustee discretion to make distributions to the beneficiaries. While the settlor will provide a list of recommendations or suggestions, the trustee is not required to make these distributions. The benefit of this arrangement is that no beneficiary is unconditionally entitled to a distribution from the trust. That means if one of your beneficiaries is sued for money damages and loses, the resulting creditor cannot order payment from that beneficiaries’ interest in the trust. That beneficiary does not have any mandatory payouts due, so there's nothing for the creditor to acquire.

All states recognize some sort of spendthrift trust that limits the transferability of beneficiary interest, effectively keeping most creditors out. However, most states carve out certain exceptions in the form of “protected classes.” While a state will provide statutory support for their spendthrift trust, the state will also define certain groups that are not shielded from the assets of the trust. South Dakota protects personal injury claimants. Delaware leaves assets available for division in a divorce. Utah leaves trust assets open to a whole host of creditors.

By now, you can probably guess the answer to the title of this entry. What makes Nevada so special is that Nevada law does not leave trust assets open to any class of creditors. According to NRS 166.110 (1), discretionary power of the trustee is absolute. Nevada asset protection trust law is the best in the country and many commentators point to the lack of protected classes as the key reason.

While this is just one beneficial aspect of Nevada asset protection trust law, to many it is the most significant. While transfers still have to be timely and can’t be made with the purpose of defrauding creditors, Nevada residents (and out of state residents with a qualified Nevada trustee) who create a carefully-drafted Nevada asset protection trust enjoy a remarkable asset protection advantage thanks to absolute discretion granted to their trustees.