As a basic matter, creditors of a trust beneficiary generally do not have access to assets of the trust.[1] The primary exception is that creditors generally can access trust assets distributable to the settlor of the trust, such a trust being considered “self-settled.”[2] Many states have abolished this exception for trusts that satisfy certain statutory formalities, typically referred to “domestic asset protection trusts.”[3] The general rule, therefore, is that assets placed in trust by someone other than the beneficiary are protected from the beneficiary’s creditors. Assets placed in trust by the beneficiary are subject to the beneficiary’s creditors, absent the very specific exception for properly structured domestic asset protection trusts.
These rules sound simple enough. However, in practice, situations are not always so clear. There are several questions that can often be raised within the context of the general rule for which an answer is needed. Some of these questions include:
- If a beneficiary is granted the right to withdraw gifts in trust (usually to qualify for the gift tax annual exclusion[4]) and allows that right to lapse, is the beneficiary deemed to have contributed those assets to the trust? For tax purposes, there is a de minimis exception that makes it clear this will not be the result as long as the lapsed withdrawal amount did not exceed the greater of $5,000 or 5% of the trust assets.[5] That is a tax rule; what about creditors’ rights under state law?[6] Should provisions typically included for valid tax planning reasons affect creditors’ rights?
- Trusts often contain certain tax related provisions such as the right to reimburse the grantor for income taxes attributable to the trust, the right of the settlor to substitute trust assets with assets of equivalent value or to borrow without adequate security.[7] Could these powers be deemed to treat at least some portion of the trust assets available to the settlor’s creditors even if the trust settlor is not a named beneficiary?
- Often a settlor establishes a trust for another beneficiary and grants that beneficiary the power to appoint assets, either during lifetime or at death. What if the beneficiary appoints those assets to a trust for the settlor? What if the settlor becomes a beneficiary of the trust in default of the beneficiary exercising this power?[8] Does it matter if the beneficiary’s power was limited or general (a general power allowing the beneficiary to appoint to themselves, their creditor, their estate, or creditors of their estate)?[9]
- What if a beneficiary is serving as trustee with the power to make distributions to themselves? Does it matter if the power to distribute to one’s self is limited to a specified distribution standard?[10]
- Can a creditor garnish distributions to the beneficiary?[11] Can a creditor enforce a beneficiary’s rights to distributions allowing the creditor to garnish those distributions? What if the trustee directly pays the beneficiary’s expenses? Will that be deemed a distribution subject to garnishment? Is a trustee who makes those payments without paying the creditor personally liable to the creditor for failing to respect the garnishment?
Article 5 of the Uniform Trust Code attempts to answer many of these questions. However, the model Act still leaves many questions unanswered. Some states have adopted non-model provisions as part of their Article 5.[12] As part of the 2020 legislative session, Senate Bill 2851 became law in Mississippi codified at Miss. Code Ann. § 91-8-501 et seq.[13] This new law repeals the previous law in Mississippi addressing some of these issues[14] and adopts an Article 5 to Mississippi’s Uniform Trust Code which became law, without Article 5, in 2014. The new statute addresses many important topics, expanding on previous law. Also, by incorporating these provisions into the Uniform Trust Code, this new law allows for common defined terms with other areas of trust law as well as overall coordination with other provisions of the Uniform Trust Code.
Creditors Rights to Distributions
As a starting point, Miss. Code Ann. § 91-8-501 states that “to the extent not otherwise prohibited by this Article 5, the court may authorize a creditor or assignee of the beneficiary to reach the beneficiary’s distribution in interest by attachment of present or future distributions to or for the beneficiary or other means.” As such, to the extent a beneficiary has a distribution interest in a trust, such interest is subject to creditors’ claims absent an exception. Much of the rest of Article 5 deals with these exceptions.
Discretionary Interests
Miss. Code Ann. § 91-8-503 provides that creditors cannot force or reach a distribution with respect to a discretionary interest[15]. Additionally, this protection from creditors is not affected by the beneficiary serving as a trustee provided that the beneficiary-trustee: (a) does not have discretion to distribute to himself or herself; (b) may distribute to himself or herself limited by an ascertainable standard;[16] or (c) must obtain consent from a third party prior to making distributions to himself or herself.[17]
Self-Settled Trusts
Miss. Code Ann. § 91-8-504(a) provides that property of a revocable trust is subject to creditors’ claims during the life of the settlor. Also, other than for qualified special needs trusts and valid Mississippi asset protection trusts, the creditor of the settlor of an irrevocable trust can access the maximum amount which can be distributed to or for the settlor’s benefit. Therefore, absent the special exceptions, creditors can reach the assets of a self-settled trust to the extent either revocable by or distributable to the settlor. This follows the general rule referenced above.[18]
Support Interests
Miss. Code Ann. § 91-8-505(a) describes creditors’ rights to a beneficiary’s support interest[19] in a trust and makes clear that, notwithstanding that a beneficiary has an enforceable right to distributions under a support interest[20], those rights do not rise to the level of a property interest which may be seized by a creditor. Until distributions are actually made to the beneficiary, a creditor may not reach the support interest. Further, no portion of a distribution may be reached by a creditor to the extent it is necessary for the beneficiary’s health, education, maintenance, and support.[21]
Mandatory Interests
Miss. Code Ann. § 91-8-505(b) describes creditors’ rights to a beneficiary’s mandatory interest[22] in a trust. Only past-due mandatory distributions may be compelled. Further, the statute is clear that no court may compel a trustee to make distributions subject to a mandatory interest directly to a creditor.
Distributions for the Benefit of the Beneficiary (rather than directly to the beneficiary)
Throughout the various statutes, Article 5 is clear that trustees may pay expenses on behalf of the beneficiary, even to the exhaustion of the trust’s income and principal, without subjecting payment of such items to creditors’ claims or subjecting the trustee to personal liability for failing to make payment to the creditor.[23] Additionally, specifically with respect to support interests, use or enjoyment of trust property by the beneficiary will not subject such property to creditors’ claims.[24]
Powers of a Beneficiary to Remove or Replace Trustee
Miss. Code Ann. § 91-8-507 deals with powers of a beneficiary to remove or replace a trustee. The statute states that the power “is personal to the holder and shall not be exercised by the holder’s creditors.” Neither creditors nor courts may compel a beneficiary to exercise such power. Likewise, creditors may not compel a beneficiary-trustee to make distributions.
Revocable Trusts After Death of the Settlor
To provide clarity about the treatment of assets of a revocable trust after the death of the settlor, Miss. Code Ann. § 91-8-504(a)(6) sets forth a set of applicable rules. As a general matter, the statute provides that “property of a trust that was revocable immediately preceding the settlor’s death is subject to claims of the settlor’s creditors” subject to the rights of a decedent to select the source for payment of claims. If there are assets of a probate estate and a revocable trust, the assets of each will be used under the same priority for payment of claims rather than using first the probate estate’s assets, then the revocable trust’s assets.[25]
To cut off creditors’ claims against revocable trust assets, there are two options. First, if a probate estate is opened, then expiration of the period to file claims against the estate will also bar claims against the revocable trust.[26] Second, if a probate estate has not been opened, then the trustee may follow procedures similar to probate to open a 90 day period during which all claims must be filed.[27] In such a case, the trustee provides notice to known creditors and notifies unknown creditors by publication giving them 90 days to notify the trustee of their claim after which the claim will be barred.[28]
Beyond cutting off claims, trustees need assurances they will not be personally liable for distributing assets when creditors’ claims may exist. Miss. Code. Ann. § 91-8-504(a)(6)(C) provides that, a trustee is free to distribute trust assets to the beneficiaries without being subject to liability provided no claim has been presented to the trustee in writing.[29]
What Will Not Be a Self-Settled Trust
As stated in the introduction of this writing, there are a number of situations where someone could be considered to have made a contribution to a trust of which he or she is a beneficiary. Additionally, assets contributed to a trust by an original settlor may be subject to rights of a third party which could be considered as converting the trust’s settlor to the third-party powerholder. Miss. Code Ann. § 91-8-504(b) through (f) deals with determining the identity of the settlor under a number of these situations as follows:
- Presently exercisable or lapsed powers of withdrawal will not cause the beneficiary to be treated as the settlor except to the extent the power exceeds the greater of[30]:
- The greater of $5,000 or 5% of the trust’s assets;[31]
- If the donor of the property subject to the withdrawal right is not married, then the gift tax annual exclusion amount;[32] or
- If the donor of the property subject to the withdrawal right is married, then double the gift tax annual exclusion amount.
The statute clarifies that any cumulative amount subject to withdrawal which may exceed these amounts will not be considered to cause the powerholder to be considered the settlor to the extent the amount granted to the powerholder in any calendar year does not exceed these amounts.
- Certain tax related powers will not cause the trust assets to be deemed to be subject to distribution to the settlor as follows (i.e. the trust will not be self-settled and, therefore, subject trust assets to the claims of the settlor’s creditors)[33]:
- The power of a trustee to reimburse the settlor for income taxes attributable to the trust’s income;
- Powers of the settlor to[34]:
- Deal with the trust for less than adequate and full consideration;
- Borrow without adequate interest or security;
- Vote or direct voting of stock held by the trust and control investments of the trust; and
- Reacquire trust assets by substituting property of equivalent value.
- Any property contributed to any of the following trusts is not considered to have been contributed by the settlor (i.e. the trust will not be self-settled and, therefore, subject trust assets to the claims of the settlor’s creditors)[35]:
- An irrevocable trust established for the settlor’s spouse during the settlor’s lifetime if (a) the settlor is a beneficiary after the death of the settlor’s spouse, and (b) the trust is a QTIP trust[36] or general power of appointment marital trust[37];
- An irrevocable trust of which the settlor’s spouse is a beneficiary if the settlor is a beneficiary after the death of the settlor’s spouse; and
- An irrevocable trust established for any person to the extent trust property was subject to a power of appointment[38] whether the settlor’s interest in trust interest was created by the lapse or exercise of the power of appointment.
- A beneficiary will not be treated as the settlor of the trust merely by holding any of the following powers[39]:
- The power to appoint trust assets to one’s self as beneficiary if exercise of the power either (a) requires consent of a third party, or (b) is limited by an ascertainable standard[40];
- To appoint trust assets to or for the benefit of any person other than the beneficiary, a creditor of the beneficiary, the beneficiary’s estate, or a creditor of the beneficiary’s estate;
- A testamentary power of appointment[41] (note that this power must not be limited as a lifetime power above); or
- A presently exercisable power of withdrawal as described in Miss. Code Ann. 91-8-504(b).
- A person who becomes a beneficiary of a trust due to the exercise of a power of appointment by someone other than himself or herself will not be considered the settlor of the trust.[42] From having worked on this legislate drafting committee, the intention of this provision is to be clear that the exercise of a power of appointment by a trust beneficiary to transfer assets in further trust for the original settlor will not cause assets of the trust to be subject to claims of the original settlor. The beneficiary exercising the power could have appointed assts elsewhere, thereby cutting off the original settlor’s treatment as settlor for purposes of creditor protection.
Limitations on Enforcement
To add certainty to the provisions of Article 5, the law provides for a shortened limitations periods for creditors’ claims in Miss. Code Ann. § 91-8-504(g). The statute serves as an exception to the general statutes of limitations under the Uniform Fraudulent Transfer Act.[43] Under new Article 5, no creditor may bring a claim with respect to a transfer in trust unless it is commenced within the later of (a) two years after the transfer is made, or (b) six months after the person discovers or reasonably should have discovered the transfer. The person is deemed to have discovered the transfer if any public record is made.[44] Further, the creditor must prove, by clear and convincing evidence, that the transfer was made with the intent to defraud that specific creditor. The statute provides favorable ordering rules with respect to contributions and distributions in instances where there are multiple transfers in trust.
Conclusion
This new Article 5 to the Mississippi Uniform Trust Code is a significant clarification of previously uncertain areas of law. The Mississippi statutes, specifically Miss. Code Ann. § 91-8-504, attempts to use the best of statutes from multiple other states including Alabama, Kentucky, Tennessee, and Texas. While there will certainly be situations not covered by this new Article 5, and technical corrections may be found, passage of SB 2851 is a major step forward for Mississippi trust law. It allows planners to advise clients as to the anticipated state law consequences of very standard tax planning provisions in trusts and, generally, aligns the state law consequences to the tax law consequences.
[1] This assumes the trust agreement is created by a third party other than the beneficiary and contains a valid spendthrift provision. See Restatement (Third) of Trusts §58 and § 505 of the model Uniform Trust Code. While self-settled trusts may benefit from creditor protection, those are separate types of trusts established by a settlor for himself or herself complying with specific state laws. See infra Note 3.
[2] Id.
[3] In Mississippi, see the Qualified Disposition in Trust Act at Miss. Code Ann. § 91-9-701 et seq. For a description of the laws of states which allow properly structured self-settled spendthrift trusts to be exempt from creditors’ claims, see Shaftel, David, “Twelfth ACTEC Comparison of the Domestic Asset Protection Trust Statutes,” Updated through August 2019, https://www.actec.org/assets/1/6/Shaftel-Comparison-of-the-Domestic-Asset-Protection-Trust-Statutes.pdf.
[4] See IRC § 2503(c).
[5] IRC § 2514(e).
[6] See Uniform Trust Code § 505(b) which states that (1) presently exercisable powers are essentially deemed to cause a trust to be self-settled to the extent of the power of withdrawal; and (2) lapsed powers cause the lapsed portion to have been contributed by the powerholder to the extent the lapse amount exceeds the greater of $5,000, 5% of the trust assets, or the gift tax annual exclusion amount. But see Irwin Union Bank & Trust Co. v. Long, 312 N.E.2d 908 (Ind. Ct. App. 1974) and University National Bank v. Roadarmer, 827 P.2d 561 (Colo. App. 1991), both of which do not treat a lapsed power of withdrawal as causing the powerholder to become the settlor and also suggesting that even currently exercisable powers are personal and not subject to creditors’ rights.
[7] IRC § 675; relating to the right to reimburse a settlor’s’ income taxes, see Rev. Rul. 2004-64.
[8] Note that Uniform Trust Code § 401 refers to creation of a trust via the “exercise” of a power of appointment but not default provisions that apply in default of exercise. Does this mean that whether a trust is self-settled can depend on whether the new trust is created via the decision to exercise such a power versus accept the trust’s default provisions? See also Restatement (Third) of Trusts § 10.
[9] Regarding the tax treatment of these trusts after the death of the original settlor spouse, see Mitchell M. Gans, Jonathan G. Blattmachr, and Diana S.C. Zeydel, Supercharged Credit Shelter Trust, 21 Prob. & Prop. 52 (July/Aug. 2007).
[10] See UTC § 504(e) which will not deem trust assets as available to the beneifciary’s creditors as long as the right to distribute to one’s self is limited by an “ascertainable standard” (as defined in the UTC) and § 814 which limits a beneficiary-trustee’s discretion to make distributions to himself to an ascertainable standard. For further discussions on this topic, see Morrow, Edwin P., “Asset Protection Dangers When a Beneficiary is Sole Trustee and Piercing the Third Party, Beneficiary-Controlled, Irrevocable Trust,” Steve Leimberg’s Asset Protection Planning Email Newsletter Archive Message #339, March 9, 2017.
[11] See Restatement (Third) of Trusts § 60 granting creditors rights to assets distributed to the beneficiary, potentially subject to exceptions.
[12] See, e.g., Ky. Rev. Stat. Ann. § 386B.5.020; Md. Code Ann., Est. & Trusts § 14.5-507; Tenn. Code Ann. § 35-15-505; Tex. Prop. Code Ann. § 112.035. See also relevant chart attached to Morrow, Edwin P., “IRC § 678 and the Beneficiary Deemed Owner Trust (BDOT),” https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3165592.
[13] http://billstatus.ls.state.ms.us/2020/pdf/history/SB/SB2851.xml
[14] Family Trust Preservation Act, Miss. Code Ann. § 91-5-501.
[15] “Discretionary interest” is defined in Miss. Code Ann. § 91-8-103(9)(B)(iii) as “any interest that is not a mandatory or a support interest and is any distribution interest where a trustee has any discretion to make or withhold a distribution.” The statute goes on to provide examples of language that would create a discretionary interest.
[16] “Ascertainable standard” is defined in Miss. Code Ann. § 91-8-103(2) as “a standard relating to an individual’s health, education, support, or maintenance within the meaning of Section 2041(b)(1)(A) or 2514(c)(1) of the Internal Revenue Code of 1986, as in effect on July 1, 2014, or as later amended.” Absent specific language to the contrary in the trust agreement, Miss. Code Ann. § 91-8-814(d)(1) limits a beneficiary-trustee’s right to make distributions to himself or herself to an ascertainable standard.
[17] Miss. Code Ann. § 91-8-503(b)(5).
[18] Supra note 1.
[19] “Support interest” is defined in Miss. Code Ann. § 91-8-103(9)(B)(ii) as “a distribution interest that is not a mandatory interest but still contains mandatory language such as ‘shall make distributions’ and is coupled with a standard capable of judicial interpretation.” The statute goes on to provide examples of language that would create a support interest.
[20] See Miss. Code Ann. § 91-8-814(c)(1).
[21] Miss. Code Ann. § 91-8-504(a)(3).
[22] “Mandatory interest” is defined in Miss. Code Ann. § 91-8-103(9)(B)(i) as “a distribution interest in which the timing of any distribution must occur within one (1) year from the date the right to the distribution arises and the trustee has no discretion in determining whether a distribution shall be made or the amount of such distribution.” The statute goes on to provide examples of language that would create a mandatory interest.
[23] Miss. Code Ann. §§ 91-8-502(e), -503(b)(3), -505(a)(5) and (6), -505(b)(2) and (3).
[24] Miss. Code Ann. § 91-8-505(a)(4).
[25] Miss. Code Ann. § 91-8-504(a)(6)(F) and (G).
[26] Miss. Code Ann. § 91-8-504(a)(6)(A).
[27] Miss. Code Ann. § 91-8-504(a)(6)(B).
[28] Id.
[29] Note that the trustee could still be subject to liability for claims of the U.S. government pursuant to 31 U.S. § 3713 notwithstanding these provisions.
[30] Miss. Code Ann. § 91-8-504(b).
[31] IRC §§ 2041(b)(2) and 2514(e).
[32] IRC § 2503(b).
[33] Miss. Code Ann. § 91-8-504(c).
[34] IRC § 675.
[35] Miss. Code Ann. § 91-8-504(d).
[36] IRC § 2523(f).
[37] IRC §2523(e).
[38] “Power of appointment” is defined in Miss. Code Ann. § 91-8-103(18) as “an inter vivos or testamentary power to direct the disposition of trust property, other than a distribution decision made by a trustee or other fiduciary to a beneficiary.”
[39] Miss. Code Ann. § 91-8-504(e).
[40] See Note 16.
[41] See Note 36.
[42] Miss. Code Ann. § 91-8-504(f).
[43] See Miss. Code Ann. §§ 91-8-504(g)(1) and 15-13-115.
[44] Miss. Code Ann. § 91-8-504(g)(2)(A).
