Federal Income Tax Treatment. If the grantor of an asset protection trust (APT) retains the right to receive discretionary income and principal distributions, then the trust will be a grantor trust. Grantor trusts are disregarded entities and all trust income, when it is received by the grantor, is taxed to the grantor. However, if distributions to the grantor must be approved by an adverse party, it could be a non-grantor trust, thereby insulating the grantor from tax liability.

Gift Tax. A transfer to an irrevocable trust is not automatically a completed gift. If the grantor retains certain limited powers of appointment, the completed gift status along with the resulting potential gift tax consequences can be avoided. Also, transfer to an APT is a completed gift should the grantor surrender his control over assets. But, the inability of the grantor's creditors to reach assets negates retained control.

Escaping Income Tax and Gift Tax. Two rulings allow the grantor to escape both income tax and gift tax. In these rulings, the grantor was not found to be the owner of the trust due to the existence of adverse parties who exercised discretion in making distributions, thereby protecting him from income taxation. These same rulings further held that the grantor did not make completed gifts to an irrevocable trust, due to the retention of a limited testamentary power of appointment.

Estate Tax. Inclusion of the trust assets in the gross estate is dependent on the degree of control that the grantor retains in the trust. A discretionary receipt of income or principal is not a retained interest in the trust and absents an understanding with the trustee, whereas other retained interests would compel inclusion in the gross estate. Furthermore, the inability of creditors to reach trust assets negates the implied ability to revoke or terminate the trust.

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