In a time when business owners across the board are losing much of the value they have worked so hard to attain, it’s nice to hear there is something you can do to protect what’s left.
On January 2, 2009, New Hampshire’s “Qualified Dispositions in Trust Act” will go into effect. This law was designed not only to create a favorable trust environment for New Hampshire residents, but to attract out-of-state grantors to establish New Hampshire-based trusts as well. Massachusetts residents, particularly business owners, would do well to consider this potential asset protection strategy.
The law overrides the long-standing legal principle which is still the law in Massachusetts that a person cannot transfer assets into a trust of which that person (“grantor”) is a beneficiary and have the trust assets avoid that person’s creditors. There are may unforeseen liabilities which could arise and jeopardize a business owner’s assets. An owner could be sued personally through a doctrine known as “piercing the corporate veil.” Under some environmental, tax and pension laws, corporate liabilities are deemed to be the personal liabilities of the business owners.
Under this law, Massachusetts residents can establish a trust and so long as a number of the requirements outlined below are met, assets timely transferred into that trust are insulated from creditor attack. The first step is to create a trust instrument which meets the following requirements.
- The trust states that New Hampshire law will govern its validity, construction and administration;
- The trust is irrevocable;
- The trust provides that neither the grantor nor any other beneficiary may transfer, assign, pledge or mortgage the trust property (a “spendthrift” provision);
- The trustee cannot be the grantor; and
- The trustee must be either a New Hampshire resident or a federally chartered bank or trust company having a place of business in New Hampshire and maintains or arranges for custody in New Hampshire of the trust property, maintains records in New Hampshire or arranges for the preparation of income tax returns in New Hampshire or otherwise materially participates in the administration of the trust.
The second step is to make a timely transfer of property to the trust. Four types of creditors can reach trust assets:
- a creditor whose claim arose prior to the creation of the trust;
- a creditor’s claim which arose after the transfer and lawsuit is brought within four years after that date;
- a person’s claim for support or alimony for the grantor’s spouse, former spouse or children or for the distribution of property to the grantor’s spouse or former spouse; and
- a person who suffers death, personal injury or property damage on or before the date the trust was created for which the grantor is liable.
It is important to note that the grantor can receive back discretionary distributions of income and principal. Other members of the grantor’s family can also be beneficiaries. The New Hampshire trustee can be the sole trustee and make these distribution decisions. While the grantor cannot require distributions to himself, the grantor can veto distributions to others. The grantor can also retain the right to remove and replace the trustee so long as that trustee is not related or subordinate to the grantor. It is also possible to create a board of “trust advisors” who have the authority to direct trust distributions. These trust advisors need not be New Hampshire residents. Finally, the grantor can also add a “limited power of appointment” to indicate how assets are to be distributed upon the grantor’s death. Therefore, assuming that the business owner has an adequate team of professional advisors, or has a harmonious family situation, then the creation of a New Hampshire asset protection trust should provide the business owner with significant asset protection while still retaining the ability for the grantor or the grantor’s family members to receive back assets when the need arises.
The grantor can draft the trust so that the income earned by the trust can be taxed back to the grantor (an “intentionally defective grantor trust”). By having the grantor pay the income taxes on the trust, the trust continues to grow income tax free, while the grantor’s assets are diminished by the amount of the tax liability. Asset protection trusts can be structured so that the grantor only makes a gift for federal gift tax purposes when assets are distributed out to beneficiaries other than the grantor.
One significant state income tax advantage also presents itself. New Hampshire only imposes a tax on interest and dividends, not capital gains. Interest and dividends which are accumulated in the trust for the ultimate distribution to out-of-state beneficiaries are not subject to New Hampshire tax. In this way, a Massachusetts grantor may avoid State of Massachusetts income taxes. It may also be possible for an owner of a business to transfer his business ownership interest into an asset protection trust and have that trust sell the business ownership interest and avoid a Massachusetts income tax.
New Hampshire’s asset protection law creates an extremely favorable trust environment in which Massachusetts business owners can hold their assets. Given the proximity of our two states and a number of common financial institutions, New Hampshire should become an attractive alternative for Massachusetts business owners seeking asset protection.