California Asset Protection Laws

California Asset Protection Laws

California Asset Protection Laws

California is not known as a state with strong asset protection laws. The lack of self-settled spendthrift trusts has long ruled out California as a domestic asset protection trust state. However, recent legislative changes have called into question the ability of the other legal vehicles to protect assets in California. The bottom line is this: California asset protection statutes are written for the benefit of the legal profession. Aside from retirement vehicles such as the 401K (not the IRA) the strongest asset protection tool for the California residents is the offshore trust, which we discuss below.

Doesn't Work

California Asset Protection that Doesn’t Work

Discretionary Trusts

Until recently, discretionary trusts were considered to be one of the strongest asset protection structures available to California residents. Discretionary trusts protect assets by giving the trustee discretion over the timing and amount of distributions of assets made to trust beneficiaries. They also give the trustee discretion as to the identity of the beneficiary who receives the assets. Beneficiaries cannot reasonably assume when or if they will ever receive the assets held in the trust. As a result, those assets are protected from the beneficiary’s creditors. Under previous California law, however, it was possible for a discretionary trust to mandate distributions for the health, maintenance, education, or support of a beneficiary. It was understood that creditors could only reach up to 25% of mandatory current distributions as they provided for the basic support of the beneficiary. Future mandatory distributions were completely exempted from the reach of creditors under California law.

Spendthrift Trusts

Prior to 2017, spendthrift trusts provided California residents with a strong option for protecting the assets of beneficiaries. Spendthrift trusts are designed to protect beneficiaries who are incapable of managing their own finances. Spendthrift trusts work by limiting the ability of beneficiaries to transfer or assign the interest that they have in a trust. The limits imposed by a spendthrift trust apply to both the trust’s interest and its principle. The vast majority of modern trusts are drafted to include a spendthrift clause, where applicable.

Since beneficiaries are unable to control their interest in a spendthrift trust, creditors are usually unable to reach the assets held in these types of trusts. The protection provided by spendthrift trusts only works while the assets are held in the trust. Once the assets have been distributed, creditors are able to make claims against those assets. The only assets which creditors cannot attack after distribution are those which are directly used for the financial support of the beneficiary.

Domestic Asset Protection Trusts (DAPT)

A California asset protection trust, in the modern sense, do not exist. Sixteen states in the United States permit self-settled domestic asset protection trusts. Domestic asset protection trusts must be irrevocable and contain a spendthrift clause. They are required to have a trustee who resides in the state where the trust is settled. The trust is required to be administered, at least in part, in the state where the trust has been established. Settlors of domestic asset protection trust are prohibited from acting as the trustee.

Domestic asset protection trusts offer settlors significantly more asset protection than discretionary or spendthrift trusts settled in California. That said, the claims exemption creditors can still reach domestic asset protection trusts. Child support claims, alimony claims, federal tax claims, and state tax claims are all considered to be exemption creditors for this purpose. Domestic asset protection trusts are subject to the judgments of US courts, including judgments regarding fraudulent transfer of assets. To date, domestic asset protection trusts have not been affected by the Ninth Circuit ruling in  United States v. Harris. The precedent could potentially be used to widen the scope of exemption creditors with regards to domestic asset protection trusts in the future.

However, California asset protection planners, such those in our company, have seen courts penetrate domestic trust formed in other states. “Okay great, so you have a Nevada asset protection trust,” quips the results-oriented California  judge. “I don’t care. You are here. Your assets are here in this country. Turn them over.” Case law clearly indicates that the offshore trust is the only structure that consistently protects the wealth of the California resident.

California Law

California Asset Protection Law Changes

Legal precedent set in 2017 dealt death blows to the asset protection afforded by discretionary and spendthrift trusts in California. Two cases adjudicated in the California Supreme Court and the 9th circuit court have effectively limited the statutory protection afforded by discretionary and spendthrift trusts.

United States v. Harris

In the 2017 case of United States v. Harris, the 9th Circuit Court upheld a decision that creditors could garnish the interest that a beneficiary holds in a discretionary trust. The ruling also asserts that  discretionary trusts do not have the power to protect assets from a federal lien.

United States v. Harris concerned the irrevocable, discretionary trusts of a man named Michael Harris. In 1997, Mr. Harris was convicted of eight federal criminal charges resulting from theft in relation to an employee benefit plan. His sentence was 30 months in federal prison and $646,000 in restitution. He paid only a small percentage of the restitution owed. In 2015, the US government learned that Mr. Harris was the beneficiary of two irrevocable, discretionary trusts. These trusts were established by his parents for his support. In 2015, the government attempted to garnish any property which was distributed to him from the trust. The trustee opposed this attempt because Mr. Harris had disclaimed his interest in the trust. In 2017, the Ninth Circuit ruled that the government had the right to garnish the distributions made from the trust. The court ordered that the trustee pay all current and future distributions to the government until Mr. Harris’ restitution is paid in full.

The precedent being set here is that assets held in discretionary trusts can be reached by the government not only for tax claims but also to satisfy criminal penalties. Previously, the government was considered an exemption creditor for tax purposes only. Furthermore, the ruling allowed for the distributions to be claimed in their entirety. This is a substantial difference from the 25% which was previously allowed under California law.

Carmack v. Reynolds

The 2017 case of Carmack v. Reynolds set a dangerous precedent for the use of spendthrift trusts for asset protection in California. In this case, the California Supreme Court decided that creditors can seize 25% of a not only a current distribution but also 25% of all anticipated future distributions. This effectively allows creditors to claim more than 25% of a distribution at one time.

The key change allowed by this ruling is that the courts have now given creditors permission to attack assets before distribution occurs. With a few limited exceptions, creditors may now reach up to the full amount of a distribution that is currently due and payable. The distribution is now within reach even when it is still in the hands of the trustee. Additionally, the creditor may attack 25% of any anticipated future distributions while they are still being held by the trustee up to the full amount owed by the debtor.

In Carmack v. Reynolds, the parents of the defendant established a spendthrift trust for the defendant’s benefit. The trust entitled the defendant to receive over one million dollars. The entirety of this sum was to be paid out of the principle of the trust. Before the first distribution of the trust was made, the defendant  filed for bankruptcy. The court ruled that the bankruptcy trustee, who acted as a hypothetical lien creditor, could attach claims to 25% of the defendant’s current and anticipated future distributions from the trust.

California Strategies

Best California Asset Protection Strategies

Retirement Plans

In light of the above verdicts, retirement plans are one of the few asset protection strategies left for California residents. There are two types of private retirement plans available: qualified retirement plans and non-qualified retirement plans.

Qualified retirement plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA). Under the Act, qualified retirement plans are excluded for a debtor’s bankruptcy estate. Pension plans, defined contribution plans, and 401K plans are all covered by ERISA. ERISA only benefits employees. Employers and sole proprietors are not protected by the Act. In addition, alimony and child support claims are considered to be exemption creditors with regards to qualified retirement plans.

ERISA does not protect non-qualified retirement plans. In California, private retirement plans are protected are protected from creditors. Retirement plans have a significant advantage over discretionary and spendthrift trusts following the recent decisions. Their advantage is that the protection afforded to private retirement plans applies both before and after distribution to the debtor. Private retirement plans are defined as including profit sharing plans, IRAs, and self employment plans. Child support and alimony claims are considered to be exemption creditors for non-qualified retirement plans.

However, IRA’s have the weakest protection in California. (IRAs Could Be Fair Game in Lawsuits [in California] – LA Times.) This is because if a judge feels the debtor has other means of supporting himself or herself in retirement, the judge can order IRA seizure. We have seen IRA seizure time and time again.

Safe: 401Ks

Not safe: IRAs

Strongest Asset Protection: Offshore Trusts

The best asset protection available to California residents lies in the settling of offshore trusts. Many offshore jurisdictions allow for self-settled spendthrift trusts. Unlike the trusts available in California, offshore trusts allow settlors to protect their own assets rather than only the assets of the other beneficiaries.

The majority of offshore trust jurisdictions do not recognize US judgments. As a result, the precedents set in the aforementioned cases will have no effect on the sanctity of an offshore trust. In order for a US judgment to be upheld in an offshore jurisdiction, the case would have to be re-adjudicated in a local court. Furthermore, many offshore jurisdictions do not identify exemption creditors. This means that offshore trusts provide more comprehensive asset protection than that which is afforded to trusts under US law.

Here is how it works. The US judge says, “Give me the money.” The offshore trustee says, “Sorry we don’t cooperate with foreign courts.” You are fully cooperative, so are in the clear. The strongest, most reputable are the Cook Islands trust and the Nevis trust. For more information about California asset protection or setting up an offshore trust, call us at 1-800-830-1055 or +1-661-310-2931 or complete the contact form on this page.