Rule against Perpetuities

Rule against Perpetuities

The common law rule against perpetuities forbids some future interests (traditionally contingent remainders and executory interests) that may not vest within the time permitted; the rule "limit[s] the testator's power to earmark gifts for remote descendants".  In essence, the rule prevents a person from putting qualifications and criteria in his will that will continue to control or affect the distribution of assets long after he or she has died, a concept often referred to as control by the "dead hand" or "mortmain".

The rule is often stated as follows: “No interest is good unless it must vest, if at all, not later than twenty-one years after the death of some life in being at the creation of the interest.” For the purposes of the rule, a life is "in being" at conception. Although most discussions and analysis relating to the rule revolve around wills and trusts, the rule applies to any future dispositions of property, including options. When a part of a grant or will violates the rule, only that portion of the grant or devise is removed. All other parts that do not violate the rule are still valid. The perpetuities period under the common law rule is not a fixed term of years. By its terms, the rule limits the period to at the latest 21 years after the death of the last identifiable individual living at the time the interest was created ("life in being"). This "measuring" or "validating" life need not have been a purchaser or taker in the conveyance or devise. The measuring life could be the grantor, a life tenant, a tenant for a term of years, or in the case of a contingent remainder or executory devise to a class of unascertained individuals, the person capable of producing members of that class.

The rule against perpetuities at common law has been amended by statutes. In England, the Statute of Uses (1536) and the Statute of Wills (1540) and the consequent rise of flexible future interests made the rule a significant judicial tool in defeating the intent of landowners in grants and devises. Major alterations to the common law rule in the United Kingdom came into effect under the Perpetuities and Accumulations Act 1964, including the application of traditional 21-year limitation on options.

The rule is notoriously difficult to properly apply, as pointed out by a 1961 decision of the Supreme Court of California which held that it was not legal malpractice for an attorney to draft a will that inadvertently violated the rule against perpetuities. Therefore, in the United States it has been abolished by statute in Alaska, Idaho, New Jersey, Pennsylvania  and South Dakota. The Uniform Statutory Rule Against Perpetuities validates non-vested interests that would otherwise be void under the common law rule if that interest actually vests within 90 years of its creation; it has been enacted in 26 states (Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Florida, Georgia, Hawaii, Indiana, Kansas, Massachusetts, Minnesota, Montana, Nebraska, Nevada (365 years), New Jersey, New Mexico, North Carolina, North Dakota, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia, Washington, West Virginia), the District of Columbia and the U.S. Virgin Islands, and is currently under consideration in New York. Other jurisdictions apply the "wait and see" or "cy-près doctrine" that validate contingent remainders and executory interests void under the traditional rule in certain circumstances. These doctrines have also been codified in the United Kingdom by the 1964 statute.

The states of the United States have differing approaches. Some states follow the "wait-and-see approach," or "second look doctrine," and/or apply the "cy pres doctrine". Under the wait and see approach, the validity of a suspect future interest is determined on the basis of facts as they now exist at the end of the measuring life, and not at the time the interest was created. Under the cy pres doctrine, if the interest does violate the rule against perpetuities, the court may reform the grant in a way that does not violate the rule, and will reduce any offensive age contingency to 21 years.

 Other states have adopted the Uniform Statutory Rule Against Perpetuities (or some variant of it) which extends the waiting period typically to 90 years after creation of the interest.

 Many states have repealed the rule in its entirety, or extended the vesting period of the wait and see approach for an extremely long period of time (in Florida, for example, up to 360 years for trusts). The motive behind these reforms seems at least in part the desire to take advantage of a loophole in the 1986 Tax Act which has led to the formation of dynasty trusts. The 1986 Act allows the inheritance transfer tax to be avoided if a trust is set up that is valued over a floor minimum (US$2.5 million in 2005) for each transfer which would be allowed by the Rule Against Perpetuities. The result is that states with no Rule Against Perpetuities, or an extremely long perpetuities period, will attract more large trusts as there would never be a transfer tax on the trust.

Abusive Trust Tax Evasion Schemes - Special Types of Trusts

Abusive Trust Tax Evasion Schemes - Special Types of Trusts

http://www.irs.gov/businesses/small/article/0,,id=106553,00.html

Common Law Trust                                   

Contrary to the claims of promoters, "common law trusts" no longer exist since all states now have statutes relating to the creation and operation of trusts.

Foreign Trust

Through 1996, a trust was foreign if the trustee, corpus, and administration were foreign. Since 1996, a trust is foreign unless a U.S. court supervises the trust and a U.S. fiduciary controls all substantial decisions. U.S. taxpayers are subject to filing Form 3520, Creation of or Transfer to Certain Foreign Trusts, Form 3520-A, Annual Return of Foreign Trust With U.S. Beneficiaries, and Form 926, Return by a Transferor of Property to a Foreign Estate or Trust, when contributing property to a foreign trust. These trusts are usually U.S. tax neutral and are treated as grantor trusts with income taxed to the grantor.

Foreign trusts that have income attributable to U.S. sources and are not grantor trusts are required to file Form 1040NR, U.S. Nonresident Alien Income Tax Return. Foreign trusts that have income attributable to U.S. sources and are grantor trusts would have that income directly attributable to the grantor (if U.S. grantor income, it must be included on Form 1040; if nonresident alien grantor income, it must be included on Form 1040NR).

Personal Residence Trust

A personal residence trust involves the transfer of a personal residence to a trust with the grantor retaining the right to live in the residence for a fixed term of years. Upon the shorter of the grantor's death or the expiration of the term of years, title to the residence passes to beneficiaries of the trust. This is an irrevocable trust with gift tax implications.

Qualified Personal Residence Trust

A qualified personal residence trust (QPRT) involves the transfer of a personal residence to a trust with the grantor retaining a qualified term interest. If the grantor dies before the end of the qualified term interest, the value of the residence is included in the grantor's estate. If the grantor survives to the end of the qualified term interest, the residence passes to beneficiaries of the trust. A QPRT is a grantor trust, with special valuation rules for estate and gift tax purposes, governed under IRC 2702.

Grantor Retained Income Trust

In a grantor retained income trust, the grantor creates an irrevocable trust and retains the right to all trust income for: (a) the earlier of a specified term or the death of the grantor; or (b) a specified term. If the grantor survives the specified term, the trust principal passes to others according to the terms and provisions of the trust instrument. For federal tax purposes, this trust is treated as a grantor trust.

Grantor Retained Annuity Trust

In a grantor retained annuity trust, the grantor creates an irrevocable trust and retains the right to receive, for a specified term, an annuity based on specified sum or fixed percentage of the value of the assets transferred to the trust. A grantor retained annuity trust is specifically authorized by Internal Revenue Code Section 2702(a)(2)(B) and 2702(b). For federal tax purposes, this trust is treated as a grantor trust.

Grantor Retained Unitrust

A grantor retained unitrust is similar to a grantor retained annuity trust. However, in a grantor retained unitrust, the grantor creates an irrevocable trust and retains, for a specified term, an annual right to receive a fixed percentage of the annually determined net fair market value of the trust assets (Treasury Regulation Section 25.2702-(c)(1)). For federal tax purposes, this trust is treated as a grantor trust.

Charitable Trusts

Charitable Lead Trust

A charitable lead trust pays an annuity or unitrust interest to a designated charity for a specified term of years (the "charitable term") with the remainder ultimately distributed to non-charitable beneficiaries. There is no specified limit for the charitable term. The donor receives a charitable deduction for the value of the interest received by the charity. The value of the non-charitable beneficiary's remainder interest is a taxable gift by the grantor.

Charitable Lead Annuity Trust

A charitable lead annuity trust is a charitable lead trust paying a fixed percentage of the initial value of the trust assets to the charity for the charitable term.

Charitable Lead Unitrust

A charitable lead unitrust is a charitable lead trust paying a percentage of the value of its assets, determined annually, to a charity for the charitable term.

Charitable Remainder Trust

In a charitable remainder trust, the donor transfers assets to an annuity trust or unitrust. The trust pays the donor or another beneficiary a certain amount each year for a specified period. In an annuity trust, the payment is a specified dollar amount. In a unitrust, the payment is a percentage of the value of the trust, as valued each year. The term of the trust is limited to 20 years or the life of the designated recipients. At the end of the term of the trust, the remaining trust assets must be distributed to a charitable organization. Contributions to the charitable remainder trust can qualify for a charitable deduction. This charitable contribution deduction is limited to the present value of the charitable organization's remainder interest.  Revenue Procedures 89-20, 89-21, 90-30, and 90-31 provide sample trust forms that the Service will recognize as meeting charitable remainder trust requirements.

Pooled Income Fund Trust

A pooled income fund is an unincorporated fund set up by a public charity to which a person transfers property, reserving an income interest in, and giving the charity the remainder interest in that property. The Code and Regulations under Section 642 establish trust requirements. These funds file Form 1041.

Life Insurance Trust

An insurance trust is generally an irrevocable trust that owns insurance on the life of the grantor or grantor and spouse. The trust is designed to avoid federal estate taxation of the insurance proceeds on the deaths of the grantor or spouse. When premium payments or other gifts to the trust are made, the trust instrument grants specified beneficiaries Crummey withdrawal rights over the gifts so that they will qualify for the federal gift tax annual exclusion. These trusts would generally file a Form 1041 as a complex trust, if the $600 income requirement were met.

Qualified Subchapter S Trust (QSST)

A QSST is a statutory creature established by IRC Section 1361(d)(3). By meeting the requirements of a QSST, a trust may own S Corporation shares. An election must be made to be treated as a QSST and once made is irrevocable.

Electing Small Business Trust (ESBT)

An ESBT is a statutory creature established by IRC Section 641(d). By meeting the requirements of an ESBT, a trust may own S Corporation shares. ESBT's must file Form 1041 and the S Corporation income is taxed at the trust's highest marginal rate. No income distribution deduction is allowed to beneficiaries. To be treated as an ESBT, an election must be made.

Funeral Trust

This is an arrangement between the grantor and funeral home/cemetery to allow for the prepayment of funeral expenses. The funeral trust is a "pooled income fund" set up by a funeral home/cemetery to which a person transfers property to cover future funeral and burial costs. These are grantor trusts with the grantor responsible for reporting income. The trustee may make an election on qualified pre-need funeral trusts to not be treated as a grantor trust, with the tax being paid by the trustee.

Rabbi Trust

An irrevocable trust that functions as a type of retirement plan or deferred compensation arrangement that offers a limited amount of security to the deferring employee.

Business Trust

The term "business trust" is not used in the Internal Revenue Code. The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. If the grantor maintains control of the trust, then grantor trust rules will apply. Otherwise, the trust would be treated as a simple or complex trust, depending on the trust instrument.

Pure Trust

The term "pure trust" is not used in the Internal Revenue Code. Whatever the name of the arrangement, however, the taxation of the entity must comply with the requirements of the Internal Revenue Code. The requirements are based on the economic reality of the arrangement, not its nomenclature. If the pure trust meets the definition of a trust, then it would be taxed under simple, complex, or grantor trust rules, depending on the trust instrument.

Illinois Land Trust

In Illinois, and in five other states, legislation has been enacted that creates a special type of trust, commonly referred to as an "Illinois Land Trust". These trusts are designed to house real estate within a grantor trust and provide limited access to grantor or beneficiary information contained in the trust instrument or known to the trustee. Once a land trust is established, the ability to trace property transactions becomes limited as state law establishes the right of the trustee not to disclose the true owner of the property or those with a beneficial interest. The "land trust" has no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of the trust instrument. Filing requirements would depend on the type of trust.

Delaware Business Trust or Alaska Business Trust

A trust established to hold and invest assets with greater flexibility than allowed by most trusts. Permits limited liability, creditor protection, and valuation discounts. These trusts are a creation of the Delaware and Alaska legislatures and have no impact on taxation of trusts for federal purposes. These "business trusts" have no special distinction in the Internal Revenue Code and would be a simple, complex, or grantor trust depending on the terms of trust instrument. The regulations require that trusts operating a trade or business be treated as a corporation, partnership, or sole proprietorship, if the grantor, beneficiary or fiduciary materially participates in the operations or daily management of the business. Filing requirements would depend on this classification.

Unincorporated Business Organization (UBO)

A term used by trust promoters to identify trusts they sell and to disguise the fact that it is a trust. This term and the term "Massachusetts Business Trust" are often used interchangeably. These are not terms used by the Internal Revenue Code.

Nevada Dynasty Trusts

Nevada Dynasty Trusts

A type of trust used by the wealthy to shelter assets from estate taxes for hundreds of years and is set to change by the fed at the end of 2012.

On October 1, 2005, certain provisions of Senate Bill 64 (“SB64”) from the 2005 Nevada legislative session became effective. Those provisions amended Chapter 111 of the Nevada Revised Statutes (“NRS”) to change Nevada’s rule against perpetuities to 365 years. This new law creates an opportunity for Nevada residents, as well as residents of other states, to pass assets in a Nevada dynasty trust that is not subject to estate taxes, creditors and divorcing spouses of the trust beneficiaries for 365 years.

Prior to the passage of the new law, Nevada’s rule against perpetuities under NRS Chapter 111 limited the duration of a trust under Nevada law to the greater of 90 years or “lives in being plus 21 years,” which generally allowed a trust to continue for approximately 90 to 120 years before the trustee would have to distribute the trust assets to the beneficiaries, thus moving the assets from an estate tax, creditor and divorce-protected environment to one which exposes the assets to estate taxes, creditors and divorcing spouses.

Because 17 states and Washington, D.C currently have laws allowing trusts to continue perpetually with no estate taxes, prior to passage of the new law, Nevada had been at a huge disadvantage to the other states and was losing significant revenue and jobs to the other more favorable jurisdictions. Now that trusts can be created under Nevada law for up to 365 years, very few Nevada residents will choose to create trusts under the laws of the other states, and any non-residents who otherwise would have created trusts under the laws of other states will now choose to domicile their trusts in Nevada. Nevada is now one of only a few states with a long perpetuities law as well as no state income tax.

President Obama’s proposal  of estate provisions in his 2012 budget, would limit tax-free "dynasty trusts" to 90 years.

The chances of passage are practically zero this year, say experts. But taxpayers should know that the idea is in play—and act accordingly. As proposed, the change would apply to new trusts or additions of money to existing ones, but not to those already funded.

Bottom line: If you are considering setting up a dynasty trust, move swiftly. Among them: the current generous terms of the estate and gift tax—a $5 million individual exemption and a top 35% rate, both of which are set to expire at the end of 2012.

I am encouraging people who want these trusts to set them up now.

 Dynasty trusts have gathered steam since the 1986 tax overhaul installed the current version of the "generation-skipping tax." This levy imposes taxes that would be avoided if taxpayers left assets to heirs who are more than one generation below.

Example: Robert, a widower, has a net worth of $15 million and his heirs include children, grandchildren and great-grandchildren. If he leaves everything to his children and they in turn leave everything to theirs and so on, there could be an estate tax toll with each generation.

Robert would like to put his entire estate into a trust and skip layers of tax. But if he does, the generation-skipping tax kicks in and replaces the lost taxes—except for an exempted amount, which is currently $5 million per individual or $10 million per married couple. That $5 million can be pumped up using discounts, life insurance and other leveraging techniques.

Dynasty trusts push that generation-skipping tax exemption to the max, putting the exempted amount beyond the reach of estate taxes for the life of the trust. That, in turn, means the heirs don't have to "spend" their own exemptions on those assets. These trusts are now allowed in 23 states and the District of Columbia , to the delight of companies that charge fees to manage them. Taxpayers don't have to live in a state to put a trust there.

To enable these trusts, most of the states allowing them had to get rid of an old common-law principle called the "rule against perpetuities," which allowed trusts to exist only for about 90 years. The Obama administration proposal would reinstate this old principle in a way by removing the federal tax exemption after 90 years. So the trust can go on indefinitely, but the exemption can't. (The pass applies to taxes on wealth transfers, of course; annual income taxes are always due.)

This type of trust creates a new tax-free, creditor-proof wealth.

The main benefit of long-lived trusts is that they protect family assets from being dispersed by creditor claims and divorce. For most trusts 90 years will be long enough.

For those opting into dynasty trusts, all the experts urge care in drafting because the distant future is full of unknowns. In particular, it should allow for the removal of the institution handling the trust so heirs won't be captive to high fees or poor performance.

What is a Dynasty Trust?

A dynasty trust is an irrevocable trust that leverages the estate, gift and generation-skipping transfer tax exemptions for as many generations as applicable state law permits.  Whereas most attorneys draft trusts to provide for mandatory distributions to the grantor’s children at staggered ages (e.g., one-third at age 25, one-half of the balance at age 30, and the balance at age 35), a dynasty trust is drafted to encourage the trustees of the trust to keep the assets in trust for the benefit of the beneficiaries and to allow the beneficiaries to "use" the trust property rather than receive it outright where it will be subject to estate taxes, creditors and divorcing spouses.

For estate tax purposes, it is not sufficient to plan for only one generation at a time. The potential estate taxes that the clients' children's estates may face as a result of such inferior planning are often not given enough consideration by the attorney in drafting the trust. As of 2006, the tax code allows each person to transfer up to $2 million without any federal generation-skipping transfer (“GST”) tax. Meanwhile, the exemptions in 2006 for federal estate and gift taxes are $2 million and $1 million, respectively.

Interestingly, the estate and gift tax exemptions are utilized in nearly every estate plan, yet all too often attorneys do not draft their trust agreements to utilize the GST tax exemption. Failure to use an individual's GST tax exemption is a horrific economic waste over the course of time. Most likely, this failure is a result of the attorney using a canned “form” agreement that is more suited for a very small estate but is not appropriate for a medium or large sized estate.

Designing the Dynasty Trust

Most dynasty trusts are designed as Beneficiary Controlled Trusts. The beneficiaries usually become trustees of their own trust upon reaching the age at which most attorneys’ trusts would distribute the trust assets outright to the beneficiaries. There are two general classifications of Beneficiary Controlled Trusts – discretionary trusts and support trusts.

Discretionary Trusts - For maximum creditor and divorce protection, an independent trustee is used to make discretionary distributions and other tax sensitive decisions. The primary beneficiary can be given the power to remove and replace the independent trustee with or without cause. Additionally, the primary beneficiary can be the investment trustee thereby being able to make all investment decisions over his trust assets.  Thus, the primary beneficiary has the control over and use of the trust property as though he owned it free of trust. However, by having the dynasty trust as the owner, if drafted correctly, the assets are protected from estate taxes and from the beneficiary's creditors, including divorcing spouses. This co-trusteeship, although slightly more complex than having just one trustee, provides the ultimate combination of control, estate tax savings and creditor protection.

 Support Trusts - Alternatively, the primary beneficiary can be the sole trustee. With this option, the beneficiary can only distribute assets to himself for his health, education, maintenance and support. This is often called a “support trust,” as opposed to a “discretionary trust” which uses an independent trustee for discretionary distributions. Although a support trust is simpler to administer than a discretionary trust, certain creditors of the beneficiaries of a support trust may access the trust assets, so it is less protective than a discretionary trust.

 The types of creditors that may access the assets in a support trust depend upon which classes of creditors the court allows as exceptions to the general rule that a spendthrift trust is protected from creditors. Some examples of these “exception creditors,” as defined in the Restatement Second of Trusts, include (1) alimony or child support, (2) necessary services or supplies rendered to the beneficiary (such as medical services), (3) a claim by the U.S. or a state to satisfy a claim against a beneficiary (such as a tax lien), and (4) services rendered and materials furnished that preserve or benefit the beneficial interest in the trust (such as attorneys’ fees to protect a trust).

Conclusion

The passage of SB64 has made Nevada one of the most favorable jurisdictions in the country in which to create a dynasty trust. Nevada residents, as well as non-residents, can use this new law to protect assets from estate taxes, creditors and divorcing spouses for up to 365 years. The combination of the new perpetuities law with Nevada’s lack of a state income tax makes Nevada an ideal jurisdiction. These attributes make this one of the most historically significant changes to Nevada trust law.

CORPORATE VEIL DIFFERENCE BETWEEN NEVADA AND WYOMING

CORPORATE VEIL DIFFERENCE BETWEEN NEVADA AND WYOMING

The corporate veil separates the assets and liabilities of the company from the assets and liabilities of its owners; thus protecting owners from business risk.  In order to pierce the corporate veil, and attach assets of individual owners to satisfy the debts and obligations of the business, a court must apply a legal doctrine known as "alter ego” theory, which establishes that the business and the individual cannot be separated.  Each state has a different standard for defining alter ego doctrine.  In most cases, it is defined in the precedent of case law, such as in California where presently 28 separate factors can be used to pierce the corporate veil.  In a few cases, it is defined in statute.  Nevada defines the alter ego doctrine by statute; Wyoming uses a combination of statutory reference and case law.

Under Nevada statute (NRS 78.747) alter ego can only be applied when all three of the following factors are present:  a) The corporation is influenced and governed by the individual; b) There is such a unity of interest and ownership that the corporation and the individual are inseparable from one another, and; c)  To keep the corporation separate from the individual would be to promote fraud or manifest injustice.  This is the “best” corporate veil protection available, because it relies on the standard of “fraud or manifest injustice”, which requires evidence of ill intent to proceed with veil piercing.

Wyoming code (17-16-622) states that “unless otherwise provided in the articles of incorporation, a shareholder of a corporation is not personally liable for the acts or debts of the corporation EXCEPT THAT HE MAY BECOME PERSONALLY LIABLE BY REASON OF HIS OWN ACTS OR CONDUCT.”  This definition leaves open to the interpretation of the court as to what constitutes the type of acts or conduct that may create personal liability.  Traditionally, the doctrine of legal separation of the entity from the individual revolves around the basic tenant that “if the individual doesn’t treat the corporation like a separate entity, neither will the court.”  This general principle can be applied broadly by the court, to include numerous “acts” by the individual that fall far short of Nevada’s “fraud or manifest injustice” standard, including such things as commingling funds, failure to maintain corporate formalities, undercapitalization, failure to maintain arm’s length transactions, etc.  Thus, Nevada has a clear and distinct advantage over Wyoming regarding the strength of the corporate veil.  This advantage applies to LLCs as well, for this and other reasons.

Most Common Reason for Asset Protection

The number 1 most common reason to have asset protection!

Many states have poor homestead exemptions for your home in a chapter 7 or even a 13 bankruptcy (BK) situation. One of those states is Missouri with a $22,000 exemption. One would think what would $22,000 do for me if the BK Trustee decided to take my home? Well in my opinion, not much, with exception to renting a home. In today's economy it is hard to finance a new home after a BK has been started or even adjudicated and 22,000 may not be enough for a down payment since there are no more 100% loans available. On a $150,000 home you would need $30,000 plus costs for the down payment.

If you put your home into a trust prior to any foreseeable creditor problems, even if you have a mortgage, so long as you do this without what is considered fraudulent conveyance, the trust will prevent the BK Trustee from taking the home under 11 USC sec. 541(b)(1).

11 USC sec. 541“(b) Property of the estate does not include—

(1) any power that the debtor may exercise solely for the benefit of an entity other than the debtor;”

Fraudulent conveyance are considered as moving assets from you to someone else or to another entity after a creditor has made you aware they intend to sue you for the money owed or in some cases after the amount owed became due.

To get full BK protection under 11 USC sec. 541(b)(1) you must fully disclose the trusts.