We wrote previously on special powers of appointment and how they can be used in domestic trusts for asset protection purposes. Powers of appoint have been around for a long time, dating back to times of old English common law. It’s true that a special power of appointment can be quite useful, but it is not optimal when the goal is protection of assets.
Beneficial Uses of a Special Power of Appointment Trust
The most widespread reason for including a special power of appointment in a domestic trust is to create what is known as an intentionally defective grantor trust (an “IDGT”). But why, you might ask, would anyone want to create a defective trust on purpose? Good question. The reason is simply that the IRS and state laws have different rules for determining what is and what is not a trust. An IDGT is a trust that is not recognized by the IRS but is recognized by state law.
Including a special power of appointment in a trust is one way create a trust that is defective in the eyes of the IRS. The result is a trust that is not a taxable as a separate entity. In other words, the income on assets put in the trust is taxed to the creator of the trust. An additional benefit of a trust being defective is that there is no gift tax associated with contributing assets to the trust. The grantor–the trust creator–is essentially giving assets to him or herself, so the IRS does not recognize a taxable gift.
Tax-related benefits are the primary purposes served by a trust containing a special power of appointment.
Offshore Trumps the Special Power of Appointment for Asset Protection Purposes
It is true that a special power of appointment may create a certain degree of privacy. If, for example, a trust creator is asked “Are the you beneficiary of a trust?” the answer is “no.” But what about a question like “Have you ever signed a document that created a trust?” If asked that question under oath, all the “privacy benefits” of a special power of appointment just went out the window. You would have to answer “yes,” and that will lead to discovery of the trust, if you are ever involved in lawsuit.
The main purpose of an asset protection trust is that it actually shields assets in the trust from being used to satisfy a judgment against you. Once a trust is discovered (and it likely will be if you’re involved in litigation), the first question a plaintiff’s attorney will ask him or herself is “How easily can we get to the trust assets?”
Continue reading Offshore Trusts versus Special Power of Appointment . . . .
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