United States: Federal Tax Rules Should Not Be Used To Limit Trust Duration

Professor Lawrence Waggoner's recent article titled ''Effectively Curbing the GST Exemption for Perpetual Trusts'' raises practical and policy problems with the existence of perpetual trusts and indicates that the enactment of the generation skipping transfer tax (GSTT) is responsible for encouraging several states to repeal their limits on perpetual trusts.1 We admire and respect Waggoner and acknowledge that the concerns he raises may be perfectly valid. We also agree that federal tax policy in the form of the GST exemption encouraged perpetual trusts and that the federal government can legitimately end that incentive.

However, we strongly disagree with Waggoner's solution because it is intended to, and would, impose a tax penalty on perpetual trusts rather than merely eliminate the existing tax incentive to create them. In our view, discouraging perpetual trusts is simply not an appropriate use of federal tax law, regardless of the arguments one can legitimately make about their evils. Moreover, as is discussed below, there are simple ways to eliminate the tax incentive to create perpetual trusts.

To date, a limit on the duration of trusts in the United States has been a rule of property law, governed by state statute or case law, and has varied from state to state. In our view, limits on trust duration, like other property law matters, should continue to be left to the states to address.2 State law has long permitted the creation of perpetual trusts for the benefit of charity, and as explained below, some states allowed perpetual trusts for individuals before the current GSTT was enacted. Since the enactment of the GSTT, many other states have decided that individuals should be able to create perpetual trusts for the benefit of individuals as well as charities. Waggoner and others, as well as some of us, think that allowing perpetual trusts for individuals is bad public policy, while others of us disagree with that position. There can be many different opinions about how long trusts should last.

Regardless of how we or our elected representatives to the U.S. Congress may feel about whether the decision of various states to allow perpetual trusts is good public policy, the duration of trusts clearly is not a federal tax issue. Waggoner's proposal does far more than limit the tax benefits given to perpetual trusts, and as such, it would represent an unjustified federal intrusion into an area that is traditionally governed by state law.

Waggoner suggests that the Internal Revenue Code be revised to prohibit the allocation of GST exemption to a trust that does not have a required ending date that is either (1) 21 years after the death of lives in being; (2) 90 years after creation; or (3) the death of the last living beneficiary who is no more than two generations younger than the settlor. It is important to note that the proposal is to prohibit the allocation of GST exemption when the trust is created if there is any possibility that the trust could last longer than these limits, regardless of how long the trust actually lasts. For example, the proposed rule would prohibit the allocation of GST exemption to a trust for a grandchild if the trust could under any circumstances last beyond Waggoner's suggested limits. This would impose a GSTT on the trust for the grandchild when created, even if the trust actually terminates and distributes outright to the grandchild five years after the trust is created. That would be unfair and serve no legitimate federal tax purpose.

Waggoner says that the purpose of the GST exemption was to exempt trusts whose initial value did not exceed the exemption ceiling from the GSTT for the time allowed by state perpetuity law, but no longer. However, no support for this is cited. Elsewhere Waggoner notes that when the GSTT was enacted, three states allowed perpetual trusts. There is nothing in the legislative history of the GSTT that indicates that Congress intended to limit the duration of the benefit of the GST exemption to any particular period, or that Congress was or was not concerned that when the GSTT was enacted, trusts could be perpetual in three different states.

Waggoner's proposal is intended to try to stop individuals from creating perpetual trusts that are valid under applicable state law. Thus the proposal would force taxpayers to conform to the view that trusts should not be allowed to last indefinitely even if applicable state law allows this, because a failure to conform would result in no tax benefit from the GST exemption. In our opinion, that is not appropriate federal tax policy, regardless of one's views about perpetual trusts.

An even more intrusive part of the proposal would require existing irrevocable trusts that do not meet one of the three limits in the proposal to be reformed to comply with the new rule or forfeit any benefit from GST exemption allocated previously. This would apply even though the trust was validly created in a state that allowed perpetual trusts in 1986 when the GSTT was enacted. This would be an unprecedented retroactive federal tax penalty for irrevocable trusts that achieves no legitimate federal tax purpose on conduct that the taxpayer had no reason to believe violated any federal tax principle when the trust was created. This part of the proposal makes it clear that the purpose of the proposal is to end even existing perpetual trusts, not merely to eliminate the GST exemption incentive to create perpetual trusts.

The GST exemption as enacted applies to a trust permanently once allocated. The federal government has known about perpetual trusts for decades. Treasury attempted twice, once in the proposed and then in final GSTT regulations (both withdrawn), to address the allocation of GST exemption to perpetual trusts. The federal government has made no further efforts to address this issue since the final regulations were issued in late 1996, more than 15 years ago. To pass legislation now that requires reformation of irrevocable trusts after all these years to keep the benefit of the GST exemption validly allocated is unwarranted in our view, particularly when the settlor now may be dead or not competent to express an intention about which duration would be preferred.

If Congress now believes that the GST exemption should not be available for a period of time in excess of a traditional perpetuity period (although these rules often vary considerably from state to state), the appropriate federal action in our view would be to reset a trust's inclusion ratio to 1 at some point.3 This is the solution that the Obama administration has previously proposed, and it is all that is needed to address any legitimate federal tax issue. The administration's current proposal adopts a term of 90 years, which was the original Uniform Statutory Rule Against Perpetuities period, after which time the trust's inclusion ratio becomes 1. While one can argue that in light of longer life expectancies today, it may be appropriate to use 100 years, 110 years, or even 120 years as the time limit, selecting the appropriate time limit should be done by those who are charged with the job of determining tax policy. By limiting the time period for the benefit of the allocation of GST exemption, Congress will have removed any federal tax incentive to create perpetual trusts simply and effectively. If the trust terminates before the federal time limit, no GSTT penalty would be paid. In contrast, Waggoner's proposal would adversely affect all trusts that could last longer than his three time limits, even when they do not.

We suggest that if a time limit is adopted for the benefit of the GST exemption, the inclusion ratio also should not change to 1 if the trust is required to terminate and distribute outright4 at the end of 21 years plus lives in being at the creation of the trust that are described and identified in the trust instrument by name or by class. This change would be simple and has the advantage of eliminating any federal tax incentive to create perpetual trusts while allowing individuals to create trusts that last for the traditional 21-year common law rule against perpetuities, which the set time period alone would not. The 21-year rule was very common when the GSTT was enacted and still exists in many states.5 While the federal government chooses how to tax property rights, state law should determine what those property rights are.6 The tax benefit of the GST exemption should not be used to try to force taxpayers to create trusts with a federally mandated termination date or to modify existing trusts to shorten their duration.

Footnotes

1 Tax Notes, June 4, 2012, p. 1267, Doc 2012-9442, 2012 TNT 110-14. The GSTT was enacted as part of the Tax Reform Act of 1986. It allowed each taxpayer to allocate his GST exemption to donative transfers during life or at death. Each taxpayer originally had a GST exemption of $1 million. Currently, that exemption per donor is $5.12 million, although it is scheduled to return to $1 million, indexed for inflation, at the end of 2012.

2 There are several remedies for addressing the possible bad results that may occur by allowing perpetual trusts, such as state legislation or court action in particular cases. The doctrine of cy-pres, which Waggoner cites as addressing issues with perpetual charitable trusts, evolved largely through actual cases when issues arose with charitable trusts that may last indefinitely under state law.

3. A trust that is wholly exempt from the GSTT because of the allocation of the donor's GST exemption has a zero inclusion ratio. The GSTT rate is determined by multiplying the maximum federal transfer tax rate, currently 35 percent, by the inclusion ratio for the trust. Thus a trust with an inclusion ratio of zero is not subject to tax, and a trust with an inclusion ratio of 1 is subject to tax on its taxable transfers at the maximum transfer tax rate in effect at the time of the taxable transfer.

4 'Outright' for this purpose should include a continuing trust after the termination date that is for a single beneficiary and that is includable in all events in the gross estate of that beneficiary to the extent the trust is not distributed to that beneficiary during his life. This protects any revenue loss without forcing taxpayers to make distributions to individuals who may be incapacitated or otherwise unable to manage money.

5 The 21-year rule allows property to remain in trust for a grandchild until age 21 even if the grandchild was not living when the trust became irrevocable and even though the trust could last longer than a set number of years. 6See Morgan v. Commissioner, 309 U.S. 78 (1940).

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Dennis I. Belcher
 
In association with
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
Accounting and Audit
Anti-trust/Competition Law
Consumer Protection
Corporate/Commercial Law
Criminal Law
Employment and HR
Energy and Natural Resources
Environment
Family and Matrimonial
Finance and Banking
Food, Drugs, Healthcare, Life Sciences
Government, Public Sector
Immigration
Insolvency/Bankruptcy, Re-structuring
Insurance
Intellectual Property
International Law
Law Practice Management
Litigation, Mediation & Arbitration
Media, Telecoms, IT, Entertainment
Privacy
Real Estate and Construction
Strategy
Tax
Transport
Wealth Management
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.