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Dynasty Trust – Estate Planning

Dynasty Trusts and the Rule Against Perpetuities How Long Can the Dynasty Last?

Understanding the Rule Against Perpetuities.

  1. An understanding of the generation skipping transfer tax and how a Dynasty Trust is funded to fit within the GST tax exemption is an essential element in understanding the operation and advantages of a Dynasty Trust.
  2. Similarly, an understanding of the workings of the rule against perpetuities is another essential element in the Dynasty Trust universe.

How Long May the Dynasty Last?

  1. The issue is easy to state, or how long may a trust be allowed to exist? Obviously, the longer that a trust may last without requiring the trust property to vest in a beneficiary, the longer transfer tax may be avoided. Central to the concept of a Dynasty is the expectation that vesting may be postponed for a significant length of time, if not indefinitely.
  2. The answer to this question, however, is not so simple. In the first instance, the answer depends on state law. Each state has dealt with the question of how long a trust may be allowed to exist by reference to the manner in which it treats the rule against perpetuities.

Beware

  1. Another purpose of the rule was to limit the influence of the dead. This referred to the ability of the creator of a conveyance to influence or control the disposition of the property beyond his or her lifetime regardless of the wishes of living beneficiaries.
  2. The purpose of the rule was to limit the influence of the dead hand so that it could not reach beyond the perpetuities period.

Statement and Explanation of the Rule.

  1. The common law rule against perpetuities states that no interest in real or personal property is valid unless it must vest, if at all, not later than 21 years after lives in being at the creation of the interest.
  2.  The rule does not require that the trust terminate within the period of perpetuities, but does require that interests in a trust must vest within that period. Accordingly, once all of the life estates have vested, the trust will terminate. Under current federal tax law, vesting of the life estates will generate potential liability for the estate tax upon the death of the vested life tenant.
  3. It is certainly possible to keep a trust in effect for a period of 100 years even within the restrictions of the rule. The grantor typically selects his or her living descendants as measuring lives, but there is no requirement to use family members or other relatives.  Some draftsmen name members of a prominent large family (Kennedy, Rockefeller, etc.) as the measuring lives. If there are several newborns in the year the trust is created, the lifetime of the oldest survivor of that group, plus 21 years, becomes the applicable perpetuities period. An 80 year life expectancy (if a large enough pool of lives in being is chosen) plus the 21 years allowed by rule gets the trust to the 100 year mark.
  4. To increase the chances for a longer trust duration, and to avoid an unexpectedly short measuring life situation, it is advisable to use established.

Significant Differences in State Laws.

  1. The duration of trusts in the United States may be divided into three categories to determine how long a trust may continue within the perpetuities period.

What distinguishes these categories is the version of the rule against perpetuities that has been enacted by each state.

Note: This is a dynamic area of debate and contentiousness within various states. The categorization of the states below represents the author Is best efforts to discern the laws of each state as of the time these materials are written. However, changes are certainly possible, and everyone should verify the rules of a particular state before proceeding with any serious decisions regarding forming a Dynasty Trust within a particular state.

  • Category 1. These are states that have adopted the Uniform Statutory Rule Against Perpetuities. (USRAP).
    • The states that follow USRAP include: California, Connecticut, Georgia, Hawaii, Indiana, Kansas, Massachusetts, Michigan, Minnesota, Montana, New Mexico, North Carolina, North Dakota, Oregon, South Carolina, Tennessee and West Virginia.
    • What distinguishes an USRAP jurisdiction from a common law jurisdiction is that under USRAP, there are two alternative perpetuities periods. An interest in trust will be valid if it either:
      • Will vest or fail within lives in being plus 21 years (i.e. it follows the common law rule against perpetuities); or
      • Actually vests within 90 years of the creation of the trust.
      • Accordingly, the grantor, upon creation of the trust, can select which perpetuities period is desired the 90 years certain, or the common law period which could either be shorter or longer than 90 years, depending on the longevity of the measuring lives in being at the inception of the trust.
      • Ideally, the grantor may wish to create a trust in an USRAP state designed to last for the longer of the common law perpetuities period or the 90 year period. However, the creation of such an alternative duration is specifically prohibited by Section 1 (e) of the USRAP statute. Yet, this same section does allow the donee of a special power of appointment to elect to change to the common law perpetuities period at the end of 90 years.
      • Treasury Regulations also address this point. A donee holding a special power of appointment may appoint in further trust for the duration of the common law perpetuities period (using, of course, measuring lives that were in being at the creation of the trust) or for a period of 90 years from the date the trust was created. The donee holder of such a power may also change the duration of a trust from the common law perpetuities period to a period of 90 years without jeopardizing GST tax exemption. Reg. 26.2652 1(a)(4) and 26.26521 (a)(6), Example 10.
      • However, the donee holder may not exercise the special power to extend the trust for the longer of 90 years or the common law perpetuities period without seriously negative tax implications. Such an exercise is treated as a new transfer by the donee, resulting in the loss of the exemption from GST tax, as well as making the transfer by the donee subject to gift or estate tax. Reg. 26.2652 1(a)(6), Example 9.
  • Category 2. These are states that follow the common law perpetuities period as described in Section 111, D, above. These states include Alabama, Arkansas, Iowa, Kentucky, Louisiana, Mississippi, New York, Oklahoma, Pennsylvania, Texas, and Vermont.
  • Category 3. These are states that have abolished the rule against perpetuities.
    • The states that have abolished the rule against perpetuities include: Alaska, Arizona, Colorado, Delaware, Florida (up to 360 years) Idaho, Illinois, Maine, Maryland, Missouri, Nebraska, New Hampshire, New Jersey, Nevada (up to 365 years), Ohio, Rhode Island, South Dakota, Utah (up to 1000 years), Virginia, Washington (15 0 years), Wisconsin, Wyoming (up to 1000 years), and the District of Columbia.
    • Note: Other states have considered abolishing or modifying the rule, so that placing a state in one of the above Categories is subject to ongoing modification.
    • While there may be differences among the actual statutory provisions from one state to another, in states where the rule has been abolished, the trust will typically provide that either:
    • The trustee has the power to sell an absolute ownership interest in the trust assets, generally within 21 years after the death of a person who was a life in being at the time the trust was created (thus continuing to require free alienation of the property albeit by the trustee that gave rise to the rule originally) or,
    • A person then living (typically the holder of a special power of appointment) has the unrestricted power to terminate the trust (thus continuing the purpose of the rule to limit the influence of the dead not allowing the wishes of the trust grantor to defeat for all time the wishes of the beneficiaries).

No Federal Exceptions to the Rule.

  • Neither the Code nor the Regulations imposes a limitation on how long a trust may remain exempt from the generation skipping rules. Accordingly, a Dynasty Trust created in a state which has abolished the rule against perpetuities may, in theory, at least, last forever without ever becoming subject to the GST tax (assuming it was funded with assets falling within the GST tax exemption).

Note: In 2004, the Joint Committee on Taxation staff issued a money, the absence of transfer taxation, and the possible absence of state income taxation, the advantages of the Dynasty Trust become apparent.

Watch Out for State Income Taxes.

  • Consider state income tax issues in selecting the jurisdiction in which the Dynasty Trust will reside. Many states tax the income of trusts having a situs within those states. Some states do not have any personal income tax. (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming) Other states have an income tax, but some do not impose it on the income of trusts with non resident beneficiaries (Delaware, for example). Florida does not have a state income tax, and recently repealed its tax on intangible personal property.
  • Keep in mind of course, that states may change these rules at any time, and make then more or less favorable. Courts may also get into the act here, deciding that a state does or does not have sufficient nexus to extend its taxing arm to a trust, regardless of what the grantor or the trustee may have intended or expected. Quill Corp. v. North Dakota, 504 U.S. 298 (S.Ct. 1992); Swift v. Director of Revenue, 727 S.W. 2d 880 (Mo. 1987); District of Columbia v. The Chase Manhattan Bank, 689 A. 2d 539 (D.C. Ct. App. 1997).