Volume XV, Number 2 – November 2006
© Donlevy-Rosen & Rosen, P.A.
Special Planning Technique Examined
BACKGROUND. An entity trust is a trust settled (created) by an entity, such as a corporation, limited liability company, trust, or partnership. An entity trust might also be settled by an appropriate group of entities, such as a related or commonly owned group of corporations, limited liability companies, trusts, or partnerships (for ease of reading, however, in this issue we’ll refer to an entity trust settled by a single entity unless otherwise noted).
ENTITY TRUST USES. Although one might not ordinarily think of an entity as creating a trust, entities settle trusts all the time. For example: pension trusts, profit-sharing trusts, and unprotected non-qualified deferred compensation trusts are commonly settled by entities. So why not asset protection trusts as well?
An entity trust would be appropriate, for example, to protect assets of an entity in a high risk business. Such a trust could be used to safeguard the entity’s excess cash and/or to hold the proceeds of an equity stripping loan transaction (a strategy used to protect the entity’s real estate, accounts receivable, equipment, etc.). See: APN, Vol. XI, No. 3, Nov. 2002.
The entity trust provides two-pronged protection: first, it provides protection for the entity itself from potential future creditors of the entity, and second, it provides protection for the owner(s) of the entity from his/her creditors with respect to the ownership interest in the entity. It accomplishes the latter by removing the internal value of the entity. With the internal value of the entity removed, the entity ownership interest itself becomes a far less attractive asset to the creditors of the owner(s) because the availability of entity assets (equity) for litigation settlement has been removed. An entity trust could also be used to establish a protected non-qualified deferred compensation arrangement which would avoid the constructive receipt rules of IRC §409A. For example, a CPA partnership with 20 partners has liquid assets far beyond its operating requirements. The partners recognize the high risk of litigation inherent in the accounting profession. For a variety of reasons, the partners have decided not to make current distributions of the liquid assets, but, rather, have decided that the partnership will form an offshore asset protection (entity) trust. The trust will then be funded with partnership liquid assets not required for current operations. Upon a partner’s retirement, a retirement distribution might be made to the partner from the entity trust. See the example in the next section illustrating how that distribution can be safely made for the benefit of the retiring partner even if he has a judgment against him or is involved in litigation when a distribution is to be made to him.
ENTITY TRUST STRUCTURE. As stated above, the entity trust will be settled by a single entity or by an appropriate group of entities. The discretionary beneficiaries (possible distributees) of the trust will include the settlor entity (or entities), and, typically, the entity owner(s), officers, directors, and managers. The beneficiary class could also be structured to include, as possible distributees, any trust settled by any of the foregoing persons, and any trust under which any of the foregoing is or may be a beneficiary to any extent. Such a broad-based beneficiary class provides significant flexibility for current and future asset protection needs. For example, an entity owner, having long ago settled his personal asset protection trust, has run into hard times and has had a judgment entered against him. Utilizing the flexibility of the above discretionary beneficiary classes, the trustee of the entity trust would be authorized to make a distribution directly from the (offshore) entity trust to the owner’s personal (offshore) asset protection trust thereby completely eliminating any possible exposure of that distribution to the owner’s judgment creditor.
ENTITY TRUST TAXATION. The entity trust will be treated as a grantor trust under U.S. income tax law. As such, the trust itself will pay no income tax, but, rather, it will file an “information” tax return and the entity settlor will report and pay tax on the trust’s income (regardless of where in the world earned). Depending upon other factors, additional information returns may be required to be filed, including reporting foreign bank and financial accounts.
CONCLUSION. The entity trust is a valuable planning strategy with a variety of applications.