Alabama Qualified Dispositions in Trust (QDIT) Act
By: Dalton Bradshaw, CPA
When considering asset protection from creditors, most individuals and advisors immediately think of assets being hidden away in foreign accounts by the world’s ultra-wealthy. However, legislatures in multiple states across the country have begun to enact statutes that provide domestic asset protection without the hassle of creating foreign accounts. On April 24, 2021, Alabama became the twentieth state to enact such legislation when Kay Ivey signed into law the Alabama Qualified Dispositions in Trust Act (the “Act”). The motivations for the Alabama legislature passing this bill included giving Alabama residents the ability to set up a domestic asset protection trust without utilizing the trust laws of some other jurisdiction, and allowing the banking industry in Alabama to compete for this trust business.
In 1997, Alaska became the first state to enact such legislation, with a multitude of states passing similar statutes in the years that followed. While this sort of trust structure is not a novel concept, it has recently been brought into mainstream focus by media reports on what has become known as the “Pandora Papers.” This multi-national media release outlines strategies that the world’s ultra-wealthy have utilized at all levels to protect their assets, including domestic asset protection trusts (DAPTs) in the United States. Within the documents, South Dakota, Florida and Delaware accounted for most of the United States’ domestic asset protection trusts created to shield assets.
While the reports within the Pandora Papers may be troubling, they have mostly drawn scrutiny due to the involvement of foreign dignitaries using such statutes to shield their assets and evade taxes in their respective countries. Asset protection as a legitimate risk management strategy can be achieved without the utilization of foreign accounts and/or entities, which are often misunderstood as conferring tax benefits that actually do not exist. The Act in Alabama seeks to provide this sort of attractive trust structure to its residents, while also combatting abuse through a number of safeguards and deterrents.
What is a Domestic Asset Protection Trust?
A domestic asset protection trust (DAPT) is a form of a self-settled, irrevocable trust that allows the settlor to be the named beneficiary while avoiding attachment of trust assets by creditors. By creating a DAPT, individuals can retain ownership of their assets without fear of creditor rights against those assets, as long as all requirements under the law are satisfied.
What did the Act change for Alabama?
Section 19-3B-505(a)(2) of the Code of Alabama 1975 provides that, “With respect to an irrevocable trust, a creditor or assignee of the settlor may reach the maximum amount that can be distributed to or for the settlor’s benefit.” This provision within the Code essentially grants Creditors and Assignees the power to invade trust assets, to the extent the beneficiary is due distributions, to satisfy an individual’s personal obligations. This power is also referred to as a “process of attachment.”
With the enactment of the Act, an exception to this rule was introduced. Section 19-3E-9 of the Code of Alabama provides the following:
“Except as otherwise provided in this act, the interest of a beneficiary in a trust or portion of a trust that is a qualified disposition is not subject to a process of attachment issued against the beneficiary and may not be taken in execution under any form of legal process directed against the beneficiary, trustee, trust estate, or any part of the income of the trust estate. The whole of the trust estate and the income of the trust estate shall go to and be applied by the trustee solely for the benefit of the beneficiary, free, clear, and discharged of all obligations of the beneficiary.”
In other words, this exception allows individuals to avoid the limitations of 505(a)(2), so long as certain requirements are met. Given this key provision, the Act provides another powerful tool for individuals and advisors in financial and estate planning. The key takeaway is that the Act now includes provisions that will foster the creation of DAPTs under Alabama Law. For those of you who do not enjoy reading additional technical requirements regarding the Act and Alabama DAPTs, please feel free to contact your BMSS professional to learn more and discuss possible application to your situation.
For those of you who do enjoy digging into the details, we present a summary of some of the requirements for establishing a DAPT under the Act, the pros and cons of DAPTs under the Act, and other observations regarding the Act below.
What are the requirements to set up a DAPT in Alabama?
To create an eligible DAPT in Alabama, the trust formation must satisfy all of the following:
- Transferor to the trust must first sign a qualified affidavit,
- Transferor funds the trust through a qualified disposition, and
- One or more trustees must be considered a qualified trustee.
By requiring a signed qualified affidavit, Alabama seeks to deter illicit activity within the state by residents and foreign individuals. The requirement for a qualified affidavit is not present in most states with DAPT provisions. Under Section 19-3E-6 of the Code of Alabama, the qualified affidavit must be signed before funding the trust and must confirm that at the date of transfer, the transferor:
- Has full right, title, and authority to transfer the property to the trust,
- Will not be rendered insolvent by the transfer of the property to the trust,
- Has no intent to defraud a creditor by transferring the property to the trust,
- Has no knowledge of pending or threatened court action against the transferor,
- Is not involved in any administrative proceedings,
- Is not currently in arrears on child support obligations by more than 30 days,
- Has not considered filing for relief through Chapter 11 bankruptcy, and
- Did not derive the property being transferred from unlawful activities.
Once the qualified affidavit requirement has been satisfied, the transferor may proceed with funding the DAPT through a qualified disposition. A qualified disposition is defined in Section 19-3E-2(18) of the Code of Alabama as “a disposition of property to one or more trustees, at least one of whom is a qualified trustee, which is governed by a trust document…”
The final hurdle in creating a DAPT under the Code of Alabama is establishing a qualified trustee. A qualified trustee is defined in Section 19-3E-2(19) as a person, other than the transferor, who meets all of the following conditions:
- Is an individual who is an Alabama resident, or is an organization that is authorized by the law of Alabama to act as a trustee and whose activities are subject to supervision by the Alabama State Banking Department, the FDIC, the Comptroller of the Currency, or the Office of Thrift Supervision,
- Maintains or arranges for custody in Alabama of some or all of the property that is the subject of the qualified disposition and administers all or part of the trust in Alabama, and
- Whose usual place of business is located in Alabama or, if the person does not have such a place of business, who is a resident of Alabama.
In summary, an individual can establish a DAPT in Alabama once they have signed a qualified affidavit, appointed a qualified (independent) trustee, and made a qualified disposition of property to the trust.
Pros of DAPTs in Alabama
While there are a multitude of hurdles to clear before establishing a DAPT in Alabama, there are a number of alluring benefits that come as a result of its creation. Generally, a transferor does not have any power or right with respect to property that is the subject of a qualified disposition. However, Section 19-3E-4(b) of the Code of Alabama provides specific rights and powers to the transferor of a qualified disposition as follows:
- Power to direct investment decisions,
- Power to veto a distribution,
- Special power of appointment through the transferor’s will or other written instrument effective at their death,
- Right to income of the trust,
- Right to discretionary principal distributions, and
- Right to remove and replace a trustee or advisor.
Additionally, due to the involvement of an independent trustee, DAPTs provide an enticing estate planning tool for Alabama residents. When the qualified disposition is made, it will be considered a completed gift, and removes the assets from the transferor’s gross estate. A gift tax return will be required for the completed gift, but the transferor will still have access, although limited to the trustee’s discretion, to the income and principal as beneficiary of the trust. The property will then be able to grow within the trust, and the appreciation will be free of estate tax upon the transferor’s death.
While this is not an all-encompassing list of the rights and powers granted to the transferor, it does outline a few of the benefits of this trust structure. In addition to these rights and powers, the most attractive benefit of a DAPT structure is the asset protection from creditors. Individuals can rest easy knowing that their treasured assets, especially those that they plan to pass down to future generations, will not be invaded to satisfy personal obligations.
Cons of DAPTs in Alabama
As with any sort of financial planning, there are no shortage of drawbacks to setting up a DAPT in Alabama. The most notable drawback outlined within the Act is the requirement to establish a qualified, or independent, trustee. Due to this requirement, the trust will incur additional expenses in administration through its responsibility to pay fees to the independent trustee for his/her fiduciary responsibilities. Additionally, the involvement of an independent trustee serves as a deterrent for placing closely held or illiquid assets, such as a residence or interest in a family partnership, in a DAPT. Therefore, DAPTs would be most useful for holding liquid assets, such as cash or securities, so that an independent party is not directing the management of closely held assets or liquidating those assets to satisfy their fees.
Although the intent of establishing a DAPT in Alabama is to protect assets, creditors still retain certain rights of attachment to DAPT assets in specific situations. The rights and remedies of creditors with respect to DAPTs are found in Sections 19-3E-5 and 19-3E-7 of the Code of Alabama. Creditors seeking to bring an action for attachment or other remedy for property that is subject to a qualified disposition, must bring the action forth under the Alabama Voidable Transactions Act. For claims that arise after a qualified disposition has been made, creditors must prove that the disposition was “…made with actual intent to hinder, delay, or defraud the creditor,” and must prove this through a preponderance of evidence.
If the creditor’s claim arose concurrently with or after the qualified disposition, the claim must be brought forward within two years after the qualified disposition’s date. If the claim arose prior to the qualified disposition, it must be brought forward within the later of (i) two years after the qualified disposition date, or (ii) if the claim is fraudulently concealed, the earlier of one year after the qualified disposition was or could reasonably have been discovered by the claimant and the time allowed under the applicable statute of limitations under Section 8-9B-10 of the Code of Alabama. If a creditor is able to avoid a qualified disposition, it will be limited to the extent of the present value of the debt.
In conclusion, the Alabama Qualified Dispositions in Trust Act provides another powerful tool for individuals and advisors in financial and estate planning. While there are a number of specific requirements that must be met, this sort of trust structure could prove to be incredibly beneficial. Additionally, although the requirements are somewhat stringent, they serve as safeguards towards abuse of state legislation like we have seen in states like South Dakota. If you believe that establishing an Alabama DAPT trust could be beneficial for your financial situation, or if you have additional questions on the specific provisions of the Act, please contact your BMSS professional.
A special thank you to Vincent J. Schilleci, III of Dominick, Feld, Hyde, P.C. for his efforts in co-drafting this bill and providing an informative summary of its provisions.