If a beneficiary files for bankruptcy and has created a trust for his own benefit such as a revocable living trust, the bankruptcy court will simply ignore the revocable living trust much like the IRS ignores it for tax purposes. The assets will be considered to be held directly by the bankruptcy debtor. Depending on the type of bankruptcy, the assets will then either pass to ownership by a bankruptcy trustee or will be subject to administration in a chapter 13 bankruptcy.
If it is an irrevocable trust that someone else created for the debtor’s benefit and it contains spendthrift language, those assets are generally not going to be subject to the bankruptcy. Thus, a person can help insulate assets that pass to his children from the threat that they are going to be taken by their children’s creditors or liquidated in a bankruptcy, by putting spendthrift language into the trust.
What Happens if a Trustee Files Bankruptcy or Gets a Judgment Against Him?
If a trustee files for bankruptcy, since he does not own the trust assets outright, the trust assets will not be subject to his bankruptcy. The trustee holds the assets in a fiduciary capacity only which the bankruptcy court is required to respect. If that happens the trustee will typically resign before he files for bankruptcy and a new trustee will be appointed to manage the trust. But if it should happen that the trustee files for bankruptcy at a time when he is acting as trustee, the assets will not be subject to that trustee’s bankruptcy because he does not have a personal interest in those assets.
Who Uses Offshore Trusts and When Are They Appropriate?
Typically, offshore trusts are appropriate when a high net worth individual has or expects to have significant claims made against him, and who wants to put those assets outside the reach of his creditors. They tend to be expensive to set up and maintain and that is why they are mostly used by high net worth individuals who have significant legal problems and are unable to insulate their assets in states like Nevada that recognizes special asset protection trusts. They can also be used for international tax planning.
Their creation and funding are usually handled by international trust attorneys who have experience in setting up offshore trusts. There is a certain amount of risk involved in them because a person is required to put his assets into the management of a foreign person who is not subject to United States laws or the jurisdiction of state or federal counts and who typically are unable to have those trust assets invested in Unites States based investments.
Offshore trusts can also be used where the owner is trying to put money outside the reach of the IRS because of unfavorable tax rates or other kinds of tax considerations, which is why these kinds of trusts are set up by attorneys who have international law and tax experience and training.
Would You Recommend that a Trust Be Set Up in Another State or Does it Have to Be in California?
California trusts are appropriate for the typical situation where a person is trying to avoid probate and set up protective plans for the kids once a person passes away, and there are no special claims of creditors. If a person is trying to protect assets from his own creditor claims, he has to go to another state that recognizes that kind of trust, such as Nevada. There are also certain states such as Idaho and Utah that recognize what are called dynasty trusts which extend over several generations.
California does not permit such trusts because we consider it against public policy to allow a person to manage and control assets over multiple generations extending beyond his own death. High income, high net worth individuals that have the desire to extend control of assets over several generations, need set up such a trust in one of those states. However, California is the appropriate jurisdiction for most types of trusts that we set up in the standard estate plan. Specialized trusts such as asset protection trusts and dynasty trusts have to be set up in other states because California does not have the authorizing legislation to allow those types of trusts to be created.
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