The U.S. Supreme Court recently indirectly validated the provisions of Wyoming law allowing the formation of a domestic asset protection trust ("DAPT") by residents of another state or states for the purpose of protecting those assets from creditors and, directly, from the pernicious taxation of those assets by the state in which the beneficiaries reside.
Facts: An individual ("Grantor") formed a trust in NY for the benefit of his children in his home state and appointed a resident of that state as trustee. The trustee was given "absolute discretion" to distribute the trust's assets to beneficiaries. In 1997, one of the Grantor's children moved to North Carolina. The trustee then divided the initial trust into three separate sub-trusts, one of which had as its beneficiary the daughter residing in NC, which sought to tax her trust under a law authorizing the state to tax any trust income that "is for the benefit of" a state resident."
The state trial, appellate and supreme courts sided with the trust reasoning that the trust and its beneficiaries "have legally separate, taxable existences" and, thus, the contacts of the NC daughter were inadequate to allow NC taxation.
Domicile: The following facts were enumerated by the Supreme Court:
- Trust subject to NY law;
- No trustee lived in NC;
- Trust documents and records kept in NY;
- Trust asset custodians were not in NC;
- Trust maintained no physical presence in NC;
- Trust made no direct investments in NC; and
- Trust held no real property in NC
Held: The 14th Amendment's Due Process Clause applies to the imposition of taxes in this instance and the presence of in-state beneficiaries alone does not empower a state to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain to receive it. The Due Process Clause requires, first, "some definite link, some minimum connection (so as to not offend the notion of "fair play"), between a state and the person, property or transaction it seeks to tax" and, secondly, "the income attributed to the State for tax purposes must be rationally related to 'values connected with the taxing state.'"
- First, the Due Process Clause limits states to imposing only taxes that "bear fiscal relation to protection, opportunities and benefits given by the state."
- Second, the Due Process Clause focuses on the extent of the in-state beneficiary's right to control, possess, enjoy, or receive trust assets.
- Third, the residence of trust beneficiaries alone does not supply the minimum connection necessary to sustain a state's tax.
The Court refuted the repetitively regurgitated state counter-part arguments:
- First argument: Trust and its constituents are inextricably intertwined. Responding: Although a beneficiary is central to the trust and has an equitable relationship, there are wide variations in these interests which does not support a categorical rule.
- Second argument: Ruling against the state would undermine numerous taxation regimes.
- Third argument: Court's result would lead to opportunistic gaming of state tax systems.
- Responding: There is no certainty such behavior will regularly occur.
A DAPT in Wyoming is established under Wyoming law and a Wyoming private trust company ("PTC") is organized and domiciled in Wyoming for the purpose of administering the trust. In Wyoming the PTC fulfills the requirement of an independent trustee. The PTC provides for a DAPT distribution committee under an applicable IRS notice. The PTC maintains an office in Wyoming on behalf of itself and the trust and keeps DAPT documents and records there. The PTC on behalf of the DAPT opens accounts with Wyoming custodians. The DAPT maintains no contacts outside Wyoming other than its beneficiaries. The DAPT does not invest directly into any beneficiary’s resident state, nor does it directly hold no real property there.
Conclusion: A properly structured Wyoming DAPT and PTC will fulfill all requirements of the Kaestner case and allow tax structure and timing and asset protection no other state can efficaciously provide.