Michigan Asset Protection Trusts – Think “Outside the Box”

Take-Away: Other uses for a Michigan Qualified Dispositions in Trust exist, more than just protecting assets from future creditor claims. One such use is to hold family legacy assets, like a cottage, in the trust.

Background: A Michigan Qualified Dispositions in Trust is Michigan’s version of a domestic asset protection trust, or DAPT. [MCL 700.1045.] Such a trust has been available in Michigan since 2017. At its most basic level, the Michigan Qualified Dispositions Trust (or MQDT, for short) is a type of irrevocable trust where the settlor transfers assets to the trust but still benefits from and can use the transferred assets. Normally the settlor is the lifetime beneficiary of the MQDT, who retains some, but not all, decision-making in connection with the trust’s administration. In some situations, the transfer into the MQDT is an incomplete gift with respect the powers that the transferor/settlor retains in the trust, e.g. a veto power over distributions.

MQDT Benefits: The transferor/settlor who transfers assets to a MQDT will enjoy protection from creditor claims, in the form of a short statute of limitations and a heightened burden of proof that is not available for other transfers. [MCL 700.1042(2)(a) and (3).] Thus, a MQDT enables a transferor/settlor to create a trust that will govern the use of the trust’s assets for the settlor and his/her family from claims by creditors. Additionally, due to recent concerns about the effectiveness of a prenuptial agreement in protecting assets in the event of a subsequent, a MQDT that is funded more than 30 days before a marriage can act as a backstop to a prenuptial agreement; if assets are transferred to a MQDT more than 30 days before the marriage, the property held in the MQDT is not considered marital property, is not considered, directly or indirectly, part of the transferor/settlor’s real or personal estate, and is not to be awarded to the trust beneficiary’s spouse in a judgment for annulment of a marriage, divorce, or separate maintenance. [MCL 700.1045(4)(b).]

MQDT: There are some ‘hoops to be jumped through’ to create a MQDT. Technical requirements for a trust to comply with the MQDT statute include the following requirements:

• Michigan Law Governs: The trust instrument must expressly incorporate Michigan law to govern the trust’s validity, construction, and administration [MCL 700.1042(aa)(i)];
• Irrevocable: The trust instrument must be irrevocable [MCL 700.1042(aa)(ii).];
• Voluntary and Involuntary Transfers Prohibited: The trust instrument must provide that the interests of the transferor/settlor or other trust beneficiary in trust property may not be transferred, assigned, pledges, or mortgaged, whether voluntarily or involuntarily, before the qualified trustee actually distributes trust property to the trust beneficiary, and that provision of the trust instrument is considered a restriction on the transfer of the transferor/settlor’s beneficial interest in the trust that is enforceable under applicable non-bankruptcy law within the meaning of Section 541(c)(2) of the Bankruptcy Code. This is the self-settled spendthrift trust language that is legal under the MQDT statute [MCL 700.1042(aa)(iii);
• Settlor Cannot be Trustee: The transferor/settlor may not serve as the sole trustee of the MQDT;
• Qualified Trustee Required: There must be a qualified trustee. [MCL 700.1042(p)(i).] A qualified trustee must be a Michigan resident if the qualified trustee is an individual. If the qualified trustee is not an individual, then it must be authorized under other Michigan statutes to ‘act as a trustee’ and that trustee’s activities must be ‘subject to supervision by the department of insurance and financial services, the FDIC, or the Office of Thrift Supervision.’ [MCL 700.1042 (r)(i).] Therefore, the qualified trustee must conduct some trust activity in Michigan, such as maintaining or arranging custody in Michigan of some or all of the trust property that is the subject of the qualified disposition, as well as administered, some or all of the assets of the trust within the State of Michigan. If the qualified trustee is a corporate trustee, then its primary trust officer must be located in Michigan. If the qualified trustee is not a corporate entity, then the trustee’s records that pertain to the trust must be kept in Michigan;
• At Least One Qualified Trustee: The Act’s only requirement is that there must be at least one qualified trustee of the MQDT; a family member is not expressly prohibited from serving as a trustee or the qualified trustee, but if a family member serves in that fiduciary capacity, that could create some vulnerability should the trust later be challenged by a creditor. There is no limitation on the number of trustees who may serve, nor does the Act prescribe the duties and responsibilities of multiple trustees of a MQDT, just so long as the qualified trustee retains enough authority under the trust to conduct sufficient trust activity in Michigan to meet the requirements to be considered a qualified trustee.
• Limitations: There are certain limitations that the transferor/settlor and persons who are related or subordinate to the transferor/settlor, aka related persons, may hold under the MQDT. The Act incorporates the definition under IRC 672(c). Practically speaking this means that a family member or employee of a business where the transferor/settlor is an executive or significant owner faces some limitations. One is that that the settlor/related person may not hold the power to consent, approve, or veto investment decisions, but may direct investment decisions. [MCL 700.1042(a) and (p)(iv).] Another is that the transferor/settlor and related person may not hold the power to direct, consent, or approve of distribution decisions, but may veto distribution decisions. Accordingly, while it is possible to view that the power to consent, approve, or veto investment decisions is simply a form of direction, and they there is no difference between a power to veto distribution decisions, it is important to use the term ‘direct’ when referring investment decisions and use the word ‘veto’ when reference is made to a distribution decision to remain consistent with the Act’s language.
• Qualified Affidavit: Besides the actual MQDT instrument, the transferor/settlor is required to execute a qualified affidavit in conjunction with most transfers to the MQDT in order to gain the creditor protection benefits of the MQDT. [MCL 700.1046(2) and (4).]

Expanded Uses of a MQDT: While MQDT’s are normally considered when there is a desire, or need, to protect the transferor/settlor’s assets from future creditor claims, e.g. a surgeon is worried about future medical malpractice claims, there are other reasons when a MQDT can be effectively used to meet an individual’s estate planning goal. Artwork, collectibles, heirloom real properties quickly come to mind as assets that are expected to be held for multiple generations to be used and benefit the entire family.

• Cottage Example: By way of example, consider the ‘family cottage’ which many families struggle to retain for the benefit of future family generations. Title to such a cottage could be transferred by the owners to a MQDT. The former owner can continue to use and enjoy the cottage for their lifetime as one of the MQDT’s beneficiaries. If the family cottage is held in a MQDT, the trust can protect against creditor claims that might be filed against any family member. The same goes for a future divorce of a family member. As long as the MQDT is established in accordance with the Michigan statute, the assets titled in the name of the MQDT are protected.
  But more than just creditor protection, like any other estate planning trust that might hold a family cottage, the MQDT can detail the trustee’s responsibilities for the use and maintenance of the cottage, and include some clear policies and guidelines which are directed to the use and maintenance of the cottage by multiple trust beneficiaries over an extended period of time, such as:

1. identify which family members are intended to be the beneficiaries of the trust, including the transferor/settlor;
2. created rules that determine the use of the cottage a specific times or holidays by the individual beneficiaries;
3.  address the ability to lease of the cottage to non-family members, along with potential rent to be charged for that that use;
4. allocate of the responsibility for paying expenses associated with the use and maintenance of the cottage if there is no separate ‘side fund’ used to pay the regular and recurring expenses, e.g. dock installation and removal;
5. allocate the responsibility among the beneficiaries to ‘open’ the cottage in the spring and ‘close’ the cottage in the fall;
6. identify the choice of service personnel who will be hired to make necessary repairs to the cottage;
7. establish rules that apply to bringing pets into the cottage, or smoking inside the cottage, along with penalties or the forfeiture of right of usage provisions should these ‘rules’ be ignored, or violated; and
8. identify rights of first refusal should the decision be subsequently made to sell the cottage and terminate the trust

Caution: To protect the cottage from creditor claims, the MQDT must be created and funded a certain amount of time before a creditor claim arises or a divorce action is filed against the transferor/settlor. This requires advance planning by the transferor. In addition, the transfer of the cottage’s title by deed to the MQDT will be subject to the Michigan Fraudulent Transactions Act, hence the need to comply with the qualified affidavit requirement. Finally, like with any other trust, there will be federal estate and gift tax considerations that will have to be addressed when the cottage is transferred to the MQDT.

Conclusion: As the saying goes, an asset protection trust is not for everyone. That said, there are occasions beyond the immediate concern of future creditor claims where a MQDT can still be effectively used as a self-settled trust.