Dynasty Trusts: The Perpetuities Patchwork and Other Considerations

by Genevieve M. Moore - Morrison & Foerster LLP

As the year winds down, many of our clients are taking advantage of the unprecedented opportunity to make gifts of up to $5,120,000, per donor, free of any federal gift tax.  Since the federal generation-skipping transfer tax (GST) exemption is also $5,120,000, many of these gifts are being made to generation-skipping trusts.

Generation-skipping trusts (often called "dynasty trusts"), if properly drafted and efficiently funded and administered, can successfully avoid the payment of estate taxes in the estates of the trust beneficiaries for as long as is allowed under the trust's governing law.1 State laws vary on how long a trust may exist.  Under the common law rule against perpetuities, trust interests generally must vest no later than 21 years after the death of some 'life in being' who was living when the trust became irrevocable.  This would give most trusts - very roughly - an outside limit of about 100 years. 

Under the common law rule, if it is possible that a trust may not vest within the perpetuities period, the trust is invalid from its inception; actual events that occur after the creation of the trust are ignored.  To address this harsh result, the common law rule has been made more flexible in various states by the adoption of a wait-and-see approach.  The wait-and-see approach was initially set forth in a Uniform Statutory Rule Against Perpetuities enacted in 1986, essentially allowing a trust to continue in existence until it became clear that the required interests would (or would not) vest within the applicable perpetuities period.  The Uniform Rule also added an alternate perpetuities period of 90 years, as well as other minor but helpful features.

The Uniform Rule has been adopted to some degree in about half of the 50 states.  For example, some states incorporated the wait-and-see approach; others use the alternate 90-year rule.  Many have added their own gloss in the form of exceptions or specific additional rules. 

Other states have extended their perpetuities period to as much as 500 year or 1000 years for certain types of trusts and trust property.  Even other states have even eliminated the rule against perpetuities.  This may be a blanket elimination as to all trusts, or may apply only as to certain types of trust interests, or certain types of property, or certain powers. 

With this patchwork of state perpetuities provisions, it is important to consider what rules will apply to a client's dynasty-type trusts.  Naturally this will start with a review of the law of the client's home state, if the trust is to be formed under the governing law of that jurisdiction.  Often the effort will start and end there, as most clients form trusts using the law of their own jurisdiction.

However, for clients who may have the appropriate option of forming their trust under the law of another state, it will be even more important to review and understand the specific perpetuities provisions that will apply to the new trust.  This can be a particular issue for dynasty trusts, which your client may wish to form in a jurisdiction with no rule against perpetuities, with the goal of creating a perpetual trust.   In these cases it will be necessary to have the trust drafted or reviewed by an attorney who is admitted to practice in that other state, and who is experienced in trust law, including the perpetuities rules.  That attorney can also advise on any local law requirements for resident trustees; the long-term costs and other implications of having a resident (often corporate) trustee should be fully explored.  Keep in mind that the courts of that state will become the forum for trust legal action, which may or may not be convenient for the trust beneficiaries.  Also, the income tax consequences of using an out-of-state trust should be fully analyzed prior to the formation of the trust.

One final set of questions to explore with any dynasty trust are the real-life implications of a trust that can last for generations.  If the trust is successful, from a tax and investment standpoint, it will be amassing wealth over successive generations, ultimately benefitting descendants the client will never know, instead of known children and grandchildren.  Also, in most cases these beneficiaries will be tied together through the trust - possibly at a generational level so removed from the grantor that the beneficiaries do not know each other or share common interests as to trust management.  In many cases a perpetual trust can end up supporting not only its beneficiaries, but also its corporate trustees, tax advisers, and attorneys for as long as it exists.

Dynasty trusts can be useful tools in many situations.  However, given the fact that they are irrevocable, and may last for nearly a century (if not longer), it is critically important to give thoughtful consideration to perpetuities issues and other issues such as the ones described above before establishing them and transferring significant wealth to them.

1 Barring any imposition of a federal perpetuities period.

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Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients.  If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.

© Copyright 2012 Morrison & Foerster LLP.  This article is published with permission of Morrison & Foerster LLP.  Further duplication without the permission of Morrison & Foerster LLP is prohibited.  All rights reserved.  The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients.  The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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