Choosing a Domestic Jurisdiction for a Long-Term Trust (Portfolio 867)

Part of Tax

Tax Management Portfolio, Choosing a Domestic Jurisdiction for a Long-Term Trust, No. 867-2nd, explores two important developments in trust law that emerged late in the 20th century. The first was the recognition of the tax and nontax benefits of creating long-term or “dynasty” trusts. The second was the recognition of the benefits that clients may achieve in many situations by creating trusts in states other than the state of residence.

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Description

Tax Management Portfolio, Choosing a Domestic Jurisdiction for a Long-Term Trust, No. 867-2nd, explores two important developments in trust law that emerged late in the 20th century. The first was the recognition of the tax and nontax benefits of creating long-term or “dynasty” trusts. The second was the recognition of the benefits that clients may achieve in many situations by creating trusts in states other than the state of residence.

After covering some preliminary matters, this Portfolio summarizes the federal income and transfer-tax attributes of long-term trusts. It next discusses a client's freedom to choose a jurisdiction for a new trust, the ability of courts to disregard that selection, and factors for clients to consider in making such a choice. The Portfolio then addresses ethical and practical concerns, relocating existing trusts, and the use of dynasty trusts by nonresident aliens. The Worksheets contain illustrations, state law charts, and a sample trust form.

This Portfolio, with commentary, is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.

Wilmington Trust is a registered service mark. Wilmington Trust Corporation is a wholly owned subsidiary of M&T Bank Corporation. Wilmington Trust Company, operating in Delaware only, Wilmington Trust, N.A., M&T Bank, and certain other affiliates, provide various fiduciary and non-fiduciary services, including trustee, custodial, agency, investment management, and other services. International corporate and institutional services are offered through Wilmington Trust Corporation's international affiliates. Loans, credit cards, retail and business deposits, and other business and personal banking services and products are offered by M&T Bank, member FDIC.

Wilmington Trust Company operates offices in Delaware only. Note that a few states, including Delaware, have special trust advantages that may not be available under the laws of your state of residence, including asset-protection trusts and directed trusts.

Authors

Richard W. Nenno, Esq.

Richard W. Nenno, Esq., is a Managing Director and Trust Counsel in Wealth Advisory Services at Wilmington Trust Company, Wilmington, Delaware. Mr. Nenno has over three decades of estate planning experience, is admitted to the practice of law in Delaware and Pennsylvania, and is a Distinguished Accredited Estate Planner. Prior to joining Wilmington Trust in 1982, he was an associate in the Estates Department of the Philadelphia law firm of Ballard, Spahr, Andrews & Ingersoll.
Mr. Nenno is a cum laude graduate of Princeton University with an A.B. degree from the Woodrow Wilson School of Public and International Affairs, and he earned his J.D. degree from Harvard Law School.
Mr. Nenno is recognized as a national speaker and published authority on estate planning issues. He has spoken at the University of Miami Heckerling Institute on Estate Planning, the ALI-ABA Planning Techniques for Large Estates Conference, the IBA/ABA International Wealth Transfer Practice Conference, the Notre Dame Tax and Estate Planning Institute, the AICPA Advanced Estate Planning Conference, the NYU Institute on Federal Taxation, and the Southern California Tax and Estate Planning Forum. He is a member of the Delaware State Bar Association (Past Chair: Estates and Trusts Section); Estate Planning Council of Delaware, Inc. (Past President); American Bar Association, Section of Real Property, Trust & Estate Law (Chair: Non-Tax Estate Planning Considerations Group) and Section of Taxation; Philadelphia Bar Association.
Mr. Nenno is a contributor to Asset Protection: Domestic & Int'l Law & Tactics (2009), and co-author of 868 T.M., Domestic Asset Protection Trusts.

Table of Contents

Portfolio Description
Authors
Description
Detailed Analysis
I. Initial Considerations
A. Background
B. Advisability of Creating Trusts
1. Reasons Not to Create Trusts
2. Reasons to Create Trusts
C. Advisability of Creating Perpetual Trusts
1. Reasons Not to Create Perpetual Trusts
2. Reasons to Create Perpetual Trusts
D. Advisability of Minimizing Federal Income Tax
E. Advisability of Creating Trusts in Other Jurisdictions
1. Reasons Not to Create Trusts in Other Jurisdictions
2. Reasons to Create Trusts in Other Jurisdictions
F. Market Trends and Observations
1. Market Trends
2. Observations
II. Federal Tax Implications of Perpetual Dynasty Trusts
A. Introduction
1. Scope
2. Initial Observations and Planning Considerations
B. The Grandfathered Dynasty Trust
1. Introduction
2. Exercising a Nongeneral Power of Appointment
C. The Exempt Dynasty Trust
1. Introduction
2. Illustrations
D. The Nonexempt Dynasty Trust
1. Introduction
2. Federal Transfer-Tax Advantages of Leaving Nonexempt Assets Outright
a. Make Annual Exclusion Gifts
b. Make Gifts to Enable Spouses to Use Tax Exemptions
c. Take Advantage of Individuals’ Larger Income Tax Brackets
d. Get Increased Income Tax Basis at Death
e. Take Advantage of Marital Deduction
f. Use GST Exemption
g. Use Previously Taxed Property Credit
h. Employ Qualified Disclaimers
3. Federal Transfer-Tax Advantages of Keeping Nonexempt Assets in Trust
a. Tax-Free Gifts Are Possible
b. Tax May Be Saved
c. Utilize Longer Tax Deferral
d. Take Advantage of Lower Tax on Double Skip
e. Total Tax Might Be Lower
4. Choosing Between the Federal Estate Tax and the GST Tax
E. Federal Income-Tax Implications
F. Tax Dangers when Exercising Powers over Trusts
1. Introduction
2. The GST Regulations
a. Grandfathered Dynasty Trusts
(1) Exercise of Nongeneral Power of Appointment by Beneficiary
(2) Other Modifications
b. Exempt Dynasty Trusts
(1) Exercise of Nongeneral Power of Appointment by Beneficiary
(2) Other Modifications
c. Nonexempt Dynasty Trusts
3. Section 2041(a)(3) and §2514(d) — The Delaware Tax Trap (Opportunity)
a. Introduction
b. History
c. Case law
d. How and When to Spring the Delaware Tax Trap
e. Current Delaware Law
f. State of the Delaware Tax Trap in Some Other States
g. Related Issues
III. Client's Ability to Choose a Jurisdiction For a Trust
A. Introduction
B. Restatement Approach
1. Introduction
2. Type of Asset
3. Type of Trust
4. Type of Question — Definitions
a. Validity
b. Administration
c. Construction
d. Restraints on Alienation of a Beneficiary's Interest
5. Type of Question — Effectiveness of Designation
a. Validity
(1) Trust of Movables Created by Will
(2) Trust of Movables Created Inter Vivos
(3) Substantial Relation to the Trust
(4) Strong Public Policy
(5) Most Significant Relationship
(6) Trust of Land Created by Will
(7) Trust of Land Created Inter Vivos
b. Administration
(1) Trust of Movables Created by Will
(2) Trust of Movables Created Inter Vivos
(3) Trust of Land Created by Will
(4) Trust of Land Created Inter Vivos
c. Construction
(1) Trust of Movables Created by Will
(2) Trust of Movables Created Inter Vivos
(3) Trust of Land Created by Will
(4) Trust of Land Created Inter Vivos
d. Restraints on Alienation of a Beneficiary's Interest
(1) Trust of Movables Created by Will
(2) Trust of Movables Created Inter Vivos
(3) Trust of Land Created by Will
(4) Trust of Land Created Inter Vivos
6. Type of Question — Summary
7. Pour Over by Will
8. Application of the Rules — The Peierls Case
a. Introduction
b. Peierls I
c. Peierls III
C. UPC Approach
D. UTC Approach
E. Suggested Language
IV. Beneficiaries’ Ability to Defeat Clients’ Selection of Trust States
A. Introduction
B. Obstacle 1: Home State Court Might Lack Jurisdiction
1. Introduction
2. In Rem Jurisdiction
3. Personal Jurisdiction — General Principles
4. Personal Jurisdiction — Trustee Concerns
5. Rules in Federal District Court
6. Implications
C. Obstacle 2: Home State Court Should/Must Decline Jurisdiction
1. Restatement Approach — Movables
2. Restatement Approach — Land
3. UPC Approach
4. UTC Approach
5. Federal District Court
D. Obstacle 3: Home State Court Should Apply Trust State Law
1. Restatement Approach — Movables
a. Introduction
b. Section 269 and §270 — Validity
(1) Introduction
(2) Questions of Validity
(3) Substantial Relation to the Trust
(4) Strong Public Policy
(5) Most Significant Relationship to the Matter at Issue
c. Section 271 and §272 — Administration
d. Section 268 — Construction
e. Section 273 — Restraints on Alienation of a Beneficiary's Interest
2. Restatement Approach — Land
3. UTC Approach
a. In General
b. Application
(1) Place of Trust's Creation
(2) Location of Trust Property
(3) Trustee's Domicile
(4) Testator's/Trustor's Domicile
(5) Beneficiaries’ Domiciles
(6) Policies of Forum State — Trust State Not the Forum
(7) Policies of Forum State — Trust State as the Forum
(8) Policies of Nonforum State
(9) Justified Expectations, Certainty, Predictability, and Uniformity of Results
c. Comment
d. Rights of Creditors
4. Rules in Federal Court
E. Obstacle 4: Trust State Court Might Not Have to Give Full Faith and Credit to Judgment of Home State Court
1. Respect Due Statutes
2. Implications
3. Respect Due Judgments
V. Factors to Consider in Selecting a Trust State
A. Introduction
B. Favorable Trust Climate
C. Client Objectives
1. Introduction
2. Proper Trust Design Is Key
a. McDevitt v. Wellin (2016)
b. Marvin M. Schwan Charitable Foundation v. Burgdorf (2016)
c. In re Trust Under Will of Flint (2015)
d. Vito v. Grueff (2017)
e. In re Trust Under Agreement of Taylor (2017)
3. Permitted Provisions
4. Modification or Termination of a Trust
a. Introduction
b. Beneficiaries’ Power to Amend or Terminate a Trust
c. Decanting Power
d. Change of Situs
5. Preventing Modification or Termination of a Trust
a. Introduction
b. Lifetime Proceeding
c. No-Contest Clause
6. Striking a Balance
D. Trust Duration
1. Introduction
2. Perpetuities Statutes
3. Creating a Long-Term Trust
a. Introduction
b. Trust of Movables
(1) Trust Under Will
(2) Pour Over to Existing Trust
(3) Revocable Trust Funded During Life
(4) Irrevocable Trust Funded During Life
c. Trust of Land
d. UTC Approach
e. Planning Point
4. Rule Against Accumulations
E. State Income Tax
1. Introduction
a. Background
b. Problem
c. Scope
2. Rules for Taxation of Trusts
a. Introduction
b. Bases of Taxation
3. Determining Whether Imposition of Tax is Constitutional
a. Introduction
b. Early U.S. Supreme Court Decisions
c. State Court Cases
4. Specific State Considerations
a. New York
b. New Jersey
c. Connecticut
d. Delaware
e. Illinois
f. California
5. Planning, Ethical, and Other Issues
F. Investment Return
G. Division of Responsibilities
1. Introduction
2. The State Statutes
a. UTC Approach
b. Protective Approach
c. No Statute
3. Delaware's Experience
4. Case Law
a. Introduction
b. Rollins v. Branch Banking and Trust Company of Virginia (2001)
c. Duemler v. Wilmington Trust Company (2004)
d. Commentary
5. Uniform Directed Trust Act
6. Designing the Directed Trust
7. Related Issues
a. A Caveat
b. Conflict-of-Laws Principles
c. CRT and Advisers
8. The Protector
H. Asset Protection — Third-Party Trusts
1. Introduction
2. Spendthrift Trusts
a. Restatement (Second) of Trusts Approach
b. Restatement (Third) of Trusts Approach
c. UTC Approach
d. State Statutes
3. Discretionary Trusts
a. Restatement (Second) of Trusts Approach
b. Restatement (Third) of Trusts Approach
c. UTC Approach
d. State Statutes
e. Case law
4. Subsequent Protection
5. Applicable Law
6. California
7. Delaware
a. The Spendthrift Trust Statute
b. Statutory Exceptions to Spendthrift-Trust Protection
c. Narrow Court-Created Exception to Spendthrift-Trust Protection — Garretson v. Garretson (1973)
d. Cases Refusing to Create Exception to Spendthrift-Trust Protection
(1) Introduction
(2) Gibson v. Speegle (1984)
(3) Parsons v. Mumford (1989)
(4) Mennen v. Fiduciary Trust International of Delaware (2017)
e. Drafting Suggestion
8. Third-Party Trusts in Divorce
a. Introduction
b. Identifying Marital Property and Nonmarital Property
c. Taking Trust Interests Into Consideration
d. Enforcement of Court Awards
I. Asset Protection — Self-Settled Trusts
1. Introduction
2. State Statutes
3. Applicable Law
4. Protection for Distributions
5. Crummey Powers
6. Income Tax Reimbursement Clause
7. Lifetime QTIP Trust
8. Status as a Self-Settled Trust
J. Power to Adjust and Total-Return Unitrust Statutes
1. Introduction
2. The Problem
3. Statutory Changes
4. Federal Tax Safe Harbors
5. Observations
6. Delaware's Experience
K. Court System
1. Introduction
2. Administrative Costs
3. Recourse to Highest Court
4. Availability of Declaratory Judgment
L. Surviving Spouses’ Right of Election
M. Life Insurance Trusts
1. Introduction
2. Insurable Interest of Trustee
3. Trust Design
4. Premium Tax
N. Noncharitable Purpose Trusts
VI. Ethical and Practical Concerns When Creating a Dynasty Trust in a Trust State
A. Background
B. Ethical Principles
C. Malpractice Concerns
D. Practical Considerations
VII. Moving a Dynasty Trust to a More Favorable State
A. Introduction
1. Background
2. Reasons to Move a Trust
3. Roadblocks to Moving a Trust
4. Comments
B. What Law Applies?
1. Restatement Approach — Introduction
2. Restatement Approach — Trust of Movables — Law Designated
a. Trust Under Will
(1) Validity
(2) Administration
(3) Construction
(4) Restraints on Alienation
b. Trust Created Inter Vivos
(1) Validity
(2) Administration
(3) Construction
(4) Restraints on Alienation
3. Restatement Approach — Trust of Movables — Law Not Designated
a. Trust Under Will
(1) Validity
(2) Administration
(3) Construction
(4) Restraints on Alienation
b. Trust Created Inter Vivos
(1) Validity
(2) Administration
(3) Construction
(4) Restraints on Alienation
4. Restatement Approach — Trust of Movables — Delaware's Experience
5. Restatement Approach — Trust of Movables — Summary
6. Restatement Approach — Trust of Land
7. UTC Approach
C. Effecting the Move
D. Moving to Carry Out Clients’ Objectives or to Facilitate Amendment or Termination of a Trust
E. Moving to Create a Perpetual Trust
F. Moving to Save State Income Tax
1. Introduction
2. Trust Created by Will of Resident
3. Inter Vivos Trust Created by Resident
4. Trust Administered in State
5. Resident Trustee
6. Resident Beneficiary
7. Recommendation
G. Moving to Provide More Investment Flexibility
H. Moving to Provide Greater Protection from Creditor Claims
I. Moving to Use the Power to Adjust or to Convert to a Total-Return Unitrust
J. Moving to Avoid Accounting Requirements and Administrative Costs
K. Federal Transfer Tax Consequences of Moving
VIII. The Nonresident Alien Dynasty Trust
A. Introduction
B. Gift and Estate Tax Rules
C. GST Tax Rules
D. Location of Property
E. United States as Trust Situs

Working Papers

Table of Worksheets
Worksheet 1 Exempt Dynasty Trust Illustrations*
Worksheet 2 Charitable Lead Unitrust Illustrations*
Worksheet 3 State Uniform Trust Code Statutes*
Worksheet 4 State Perpetuities Statutes*
Worksheet 5 Bases of State Income Taxation of Nongrantor Trusts*
Worksheet 6 State Prudent-Investor Rule Statutes*
Worksheet 7 State Directed Trust Statutes*
Worksheet 8 State Third-Party Trust Statutes*
Worksheet 9 State Self-Settled Spendthrift Trust Statutes*
Worksheet 10 State Power to Adjust and Unitrust Statutes*
Worksheet 11 State Liability Systems Ranking*
Worksheet 12 State Noncharitable Purpose Trust Statutes*
Worksheet 13 State Decanting Statutes*
Worksheet 14 State Lifetime Validation of Trust and No-Contest Clause Statutes*
Worksheet 15 State Uniform Trust Code Successor Trustee Statutes*
Worksheet 16 Generation-Skipping Trust Agreement*

 

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