South Dakota was the first unlimited duration trust state (1983) with no state income tax. Many advisors and clients struggle with the idea of creating a generation-skipping trust with an unlimited duration (i.e., a dynasty trust) as a result aware of the advantages of creating such a trust and how flexible this trust can actually be. Once the flexibility and advantages are understood, many clients frequently ask the question, "Why wouldn't I want an unlimited duration Dynasty Trust?", however, it is not enough to ask someone whether they want an unlimited duration Dynasty Trust without explaining the advantages, because the typical reaction is that 80 to 120 years is sufficient.
A Trust's Maximum Duration Varies by State:
limit a trust's duration (e.g., the maximum in New York and many other states is “lives in being” plus 21 years).
Trusts can be perpetual in 21 states and Washington D.C.; South Dakota can be distinguished from all of these states, as pointed out in the January 2014
Trusts & Estates magazine article by Mark Merric and Dan Worthington entitled "Which Trust Situs is Best in 2014?".
- The RAP rules are typically based on where the trust is administered.
- Client does not have to live where the trust is administered.
The only reported case involving IRC § 2041(a)(3) is Estate of Murphy v. Commissioner, in which the Tax Court held that the exercise of a limited power of appointment to create another limited power of appointment
did not spring the Delaware tax trap because, under applicable Wisconsin law, the exercise of a limited power of appointment did not commence a new perpetuities period due to the fact that Wisconsin abrogated their common law rule against perpetuity and had a statute expressed in terms of a rule against the suspension of power of alienation. In this case the
IRS acquiesced. The
Murphy case was relied upon by South Dakota in the creation of its RAP laws prior to 1986 and the imposition of the modern Generation Skipping Transfer tax.
Why an Unlimited Trust Duration? Preserving Family Values:
1. Promotion of Fiscal Responsiblity:
Incentive clauses (for instance, $2 of trust income for each $1 of W-2 income) – with exceptions, for example,
Distribution audit to determine suitability of future distributions – cap distributions based upon beneficiaries’ net worth indexed for inflation
Assumption $7.5MM enough to live well, but have to protect it (Financial Counsel)
- Supplemental income for socially responsible ; for instance, artist, musician, teacher, etc
Monthly Stipend for stay-at-home parent, also
adult child to care for elderly relative
- Education costs for family in perpetuity
Lump sum received at college graduation and/or advanced degree(s) (depending upon quality, academic rigor and college reputation)
- If stipulate 3.0 GPA, may choose easier courses
- Monthly payments for academic excellence
- Medical costs for family in perpetuity
- Real estate – “Use Factor”: buy real estate for children, grandchildren within the trust and they “use” it tax free (operates as Family Time Share)
- Clause to encourage descendants to stay in marriage while the children are minors – “vest” extra in trust
- Clause to encourage descendants to get married (wait until certain age, marry right person, etc.)
- Divorce protection
- Floating Spouse Clause (in-laws): define in-law spouses as “spouse I am married to and living with”
- Deny trust payments unless beneficiary has a prenuptial agreement
- Beneficiary conflict clause – if beneficiary sues, they get nothing
Denial of distributions if beneficiary fails a drug test or
- Family Bank: Loan to Beneficiary (term insurance purchased to provide repayment)
- Denial of distributions if beneficiary does not participate in family meetings about charitable giving, family investments, estate planning and trusts
2. Promotion of Social Responsibility:
Prepare written document or transcribed videotape illustrating charitable desires, goals, values and purpose (i.e. mission statement)
- As part of trust or as letter of wishes
- Get buy in from family, advisors and distribution committee
- Education - develop a family learning plan, family/distribution committee meetings, site visits to charities, advice from other philanthropists
- Charitable donations by family in perpetuity once Dynasty Trust attains a certain FMV
- The family distribution committee makes donations from the trust directly to charity, thus actively involving the family with charities and thus promoting the family values and mission statement
- If beneficiary fails to meet trust performance standards, then funds divert to charity
- Child works for charity, family foundation, or volunteers – supplement income
- Conservation easement on family residence and/or vacation home
- Limited powers of separate shares/appointment (charitable giving option)
- Charity gift over
- Governance – distribution committee (possibly hire outside advisor consultants)