New Tennessee Law Permits Asset Protection Trusts
by J. Nelson Irvine, Gregory D. Willett and Amy J. L. Mason

A new law takes effect in Tennessee on July 1, 2007.  The Tennessee Investment Services Act of 2007 ("Tennessee Act") provides that a person (referred to as a "transferor") may transfer assets to an irrevocable trust which, if the trust complies with the provisions of the Tennessee Act, will protect the trust assets from the claims of the transferor's creditors as well as the creditors of the trust beneficiaries.  This protection may be available even though the transferor may retain certain powers or rights to receive or control the disposition of the income of the trust.  This special type of trust is sometimes referred to as an "asset protection trust" or a "self-settled trust".  The Tennessee Act refers to the asset protection trust as an "investment services trust" ("IST"). 

What is an IST?
An IST is an irrevocable domestic trust (meaning subject to Tennessee law) that is established and operated in accordance with the Tennessee Act and other applicable Tennessee laws, including the Uniform Trust Code.  To establish the IST, the transferor must transfer assets to a "qualified trustee".   A qualified trustee may be either an individual who is a resident of Tennessee, or an institution whose activities are subject to supervision by the Tennessee Department of Financial Institutions, or certain federal supervisory authorities.  The qualified trustee must maintain or arrange for custody in Tennessee of some or all of the trust assets and must materially participate in the administration of the IST.  The statutory provisions of the Tennessee Act are similar in form to statutory provisions in Delaware and Rhode Island. 

What are the elements of an IST?
To establish a valid IST, several requirements must be met.  First, the transferor must sign a sworn statement that states the following:

• The transferor has full title to the assets which will be transferred and the authority to transfer the assets to the trust
• The transfer of the assets to the trust will not cause the transferor to be insolvent
• The transferor does not intend to defraud a creditor by the transfer
• The transferor does not have any pending or threatened court actions or administrative proceedings except those which the transferor specifically lists in the affidavit
• The transferor does not contemplate filing bankruptcy
• The assets transferred were not derived from unlawful activities.

Second, the transferor must irrevocably transfer assets to the qualified trustee who will administer those assets as an IST.  The transferor cannot serve as the qualified trustee of the IST.  The trust document for the IST must be irrevocable, expressly incorporate Tennessee law, and include certain statutory creditor protection language, commonly referred to as "spendthrift trust" language.

Third, at least part of the trust assets must be administered by a qualified trustee in Tennessee.   

How well protected are the assets held by an IST?
Generally, if the transferor meets all of the requirements to establish an IST, the assets transferred to and held in an IST are protected from the claims of creditors to the extent provided by the Tennessee Act.  There are several statutory exceptions to the protection provided by the statute.  First, if a claim arose against a transferor before the transfer of assets to an IST or if the transfer is subject to the Tennessee Uniform Fraudulent Transfer Act, a creditor can bring an action against the IST assets if the action is brought within the applicable statute of limitations - generally 4 years.  For claims arising concurrent with or subsequent to the transfer of assets to an IST, a creditor's action must be brought within 4 years of the transfer to the IST.    Second, after the transfer to the IST occurs, the Tennessee Act does not protect discretionary trust distributions made to a beneficiary (including the transferor) from the claims of a beneficiary's creditors after the trust funds have been distributed to a beneficiary.  Third, the Tennessee Act does not protect trust assets to the extent mandatory distributions are required.

What control and benefit may the transferor have over the assets transferred to an IST?
Though the IST is required to be an irrevocable trust, the transferor may retain certain rights and powers in the trust property.  The transferor may not serve as a qualified trustee, but the transferor may serve as an investment advisor to the IST.  The transferor is also permitted to retain the following rights and powers: 

• The power to veto a distribution from the trust
• A limited power of appointment exercisable on the transferor's death designating the beneficiaries of the trust, provided that the beneficiaries are not the transferor's creditors, his estate, or the creditors of his estate
• The right to receive income generated by the trust assets
• If the IST is a charitable remainder trust, the right to receive income or principal from the trust
• The right to receive up to five percent (5%) annually of the initial value of the trust (or its value determined from time to time as specified in the trust)
• The right to receive distributions of trust principal in the trustee's sole discretion under certain circumstances, such as for the transferor's health, maintenance, support and education
• The right to remove and replace the trustee, so long as the trustee is not related to or subordinate to the transferor
• If the IST is a personal residence trust, the right to use real property held under the trust.

How long can assets be held in an IST?
The Tennessee Act extends the maximum amount of time assets may be held in trust.  Under the Tennessee Act, assets may continue in trust for 360 years, provided that the trust grants a power of appointment at death to at least one member of each generation of beneficiaries who are beneficiaries more than 90 years after the creation of the trust interest. 

What are the estate and gift tax implications when creating an IST?
There are various ways to use and establish an IST depending on the transferor's individual estate planning needs and objectives.  For example, an IST may be used to delay any estate and gift tax consequences until the transferor's death.  Alternatively, the transferor may opt to treat a transfer to an IST as a completed gift for gift tax purposes and utilize the transferor's gift and/or generation-skipping transfer tax exemption to offset the gift or generation-skipping transfer tax on the transfer.

Planning Opportunity
The passage of the Tennessee Investment Services Act opens the door for Tennesseans to use a more secure method of setting aside and protecting their assets from the claims of unknown and unforeseeable creditors.  If you have any questions about this article or would like more information about establishing an Investment Services Trust, please do not hesitate to contact any member of our Taxation & Estate Preservation Group or your primary contact at Chambliss, Bahner & Stophel, P.C.