“The DAPT Trust”: An Irrevocable Trust Where the Grantor is a Beneficiary

A Domestic Asset Protection Trust, “DAPT”, is an irrevocable trust established under the laws of a state that has sanctioned its use and is managed by an independent trustee. Unlike the typical irrevocable trust, a DAPT is a self-settled trust, which means the grantor (creator) of the trust may also be a discretionary beneficiary. 

Think of the proverbial “have your cake and eat it too.” This feature of retained beneficial interest in trust assets is a game changer for many clients who are leery of sophisticated trust planning and loss of control. So when considering an irrevocable vs. a revocable living trust, the DAPT may persuade you to go irrevocable. 

A common use of the DAPT trust is to protect certain assets from the claims of creditors, with the exception of some domestic relations matters and fraudulent conveyances (the unfair transfer of assets related to a bankruptcy proceeding). But a DAPT can do even more than asset protection. With the rise of personal income tax rates in some states, solutions to eliminate such taxes become appealing. Why pay an 11% tax rate in New York, for example, when New Hampshire’s rate is 0%! Moving certain types of investments into a trust that is created and governed under the laws of a state with no state income tax could, under the right circumstances, provide significant tax savings.

While irrevocable trusts are commonly structured as grantor trusts for income tax purposes, meaning all income is passed through to the grantor of the trust and reported on their individual tax return, in order to save state income tax with a DAPT it must be written as a non-grantor trust. This forces the trust to report the income and can result in paying federal income tax on trust assets at the highest rate and often makes the most sense when the grantor of the trust was already in the highest income tax bracket federally prior to the planning.

As an added benefit, a DAPT may be utilized as a freeze technique for estate and gift tax purposes. The trust could be structured to shelter its assets from estate tax at the grantor’s death by causing transfers into the DAPT to be completed gifts and ensuring that any appreciation in value after the date of funding will occur outside the taxable estate. 

Due to the self settled nature of the DAPT, the grantor of the trust could benefit from this growth during their lifetime. And when a step up in cost basis is more favorable at death than saving estate tax, certain powers can be written into the trust to include the assets within the taxable estate and make them eligible for the favorable capital gains tax treatment instead.