Why the “G2” proposal would be a step in the wrong direction
While multi-generational trusts have been used in the United States for many decades, they gained more notoriety when Congress passed the generation-skipping transfer (GST) tax in 1986.1 Wisely, Congress provided an exemption from the GST tax so that grandparents could pass a limited amount, either outright or in trust, to their grandchildren, great-grandchildren or other “skip persons.”2
Multi-generational trusts have been a popular planning vehicle for families because they provide tremendous planning flexibility. These trusts not only permit families to preserve wealth for several generations, but also they provide the family, through the trustees, the freedom to make choices about family governance, education and values that weren't practical when using the more arcane trust forms. Multi-generational trusts not only encourage business continuity, new capital creation and prudent investment, but also they cultivate charitable giving and a stronger sense of family and community responsibility in both participation and governance.3
The Two-generation GST Proposal
In 2005, the Treasury Department proposed a strategy to tax multi-generational trusts by limiting the GST tax exemption to two generations (G2).4 Congress rejected the proposal. Since then, Congress increased the GST tax exemption in 2009 (in the 2001 Tax Act) from $1 million to $3.5 million to track the increase in the estate tax exemption. In December 2010, President Obama signed a bill into law that provided for a $5 million gift, estate and GST tax exemption. This exemption would apply beginning Jan. 1, 2011 for two years.
Recently, several commentators have advocated to the 2005 Joint Tax Committee a proposal for the taxation of multi-generational trusts.5 One commentator opined that two generations of GST tax exemption is enough: Congress couldn't have foreseen 25 years ago (or since) that multi-generational trusts would be permitted to go on for numerous generations, or even forever, in an expanding number of jurisdictions. This commentator's opinion is that the GST tax exemption should be permitted for only “two generations” and that, “left to exist, perpetual trusts will continue to undermine the integrity of the GST tax and federal tax system.” He argues that this would result in a loss of future tax revenue.6
The Multi-generational Movement
With all due respect to the proponents of the G2 proposal, multi-generational trusts aren't the boogeymen they're made out to be. The modern multi-generational trust movement has brought a consumer-type reform to the trust world that was seriously needed to shake up traditional trust institutions. This multi-faceted trend has been good for families and has helped alleviate most of the fears and concerns often cited when criticizing multi-generational trusts.
Modern multi-generational trusts are a good idea for families because they provide more choices and help to develop learning and leadership for extended generations. While much has been made of the possible estate tax savings because of their persistence, the federal government benefits because of increased income tax collections from either tax on the trusts themselves or tax on the distribution of net income to the beneficiaries. Multi-generational trusts and the GST tax exemption “preserve the goose” so that the government can generate far more revenue over time by “taxing the eggs.” Multi-generational trusts, family foundations and other charitable entities are natural partners in that they provide the foundation for value transfers and help to inoculate future generations against “affluenza.”7
Twenty-six states and the District of Columbia have embraced more liberalized rules regarding the duration of trusts. Many jurisdictions have created very family-friendly and flexible trust laws that assist in providing future flexibility in governance and succession.8
While the multi-generational trust movement has increased a sense of competition among jurisdictions for trust business,9 this has caused states to significantly improve their trust laws to accommodate the multi-generational needs of families.10 The beneficiaries are clearly American families, multi-generational small and mid-sized businesses and charities that are now empowered to plan for the future in a more complete and comprehensive way, taking into account the needs, vision, values and goals of the broader family and its long-term personal, business and philanthropic objectives.
Part of the Solution
Multi-generational trusts have evolved to become part of the solution to the problems that have plagued the trust world. The trust technology, planning strategies and governance mechanisms that have been developed to administer multi-generational trusts are nothing short of a remarkable evolution in the way trusts serve people. Trust administrative tools and the bifurcation and trifurcation of the traditional fiduciary roles have actually increased accountability and flexibility of trust management and responsiveness to the objectives of the senior family members for future generations. The refinement of administrative, investment, distribution management and governance roles have changed the way multi-generational trusts work and operate on an on-going basis and create a far more dynamic, responsive and organic operating structure.
There are at least 10 reasons why, in our view, the multi-generational trust movement is part of the solution and should continue — and why the G2 proposal is a bad idea:
The G2 proposal would thwart the legitimate purposes and laws of several states as well as Congress' reasons for the GST tax exemption
In 1986, Congress wisely placed the perpetuities question in the hands of the state legislatures. That's where the decision belongs because it defines the property rights of its citizens. To impose an artificial federal limit now would breach the balance of the federalism consideration that Congress already deemed appropriate.
Congress knew what it was doing when it established the GST tax exemption. The GST tax exemption was established to create a threshold amount to permit assets to pass to heirs in trust without taxation at each generation.
Because most wealth is now intangible, the traditional rule against perpetuities (RAP) is no longer needed to encourage free alienation and transfer of wealth. The existing limit on the GST tax exemption is adequate to prevent great concentrations of wealth.
The GST tax is a relatively recent creation of Congress. The tax isn't deeply rooted in American tradition or values, nor does it have any particular purpose other than as a backstop to the estate tax.
The G2 proposal would make the common law rule look progressive. Harkening back to the late middle ages where kings ruled and the common law RAP was born is a poor argument and in this case being used as a straw man to justify the G2 proposal. While many of our country's founders weren't in favor of inherited wealth, there was no federal estate tax or for that matter, an income tax when Thomas Jefferson was president. In fact, at that time, even a federal income tax was unconstitutional. Today's high tax rates would have been repugnant to the founders, especially for a government that was established by the people and for the people as a result of a war fought over the overreaching British government, King George and his presumptive taxing authority.
Some concentration of wealth has been important to capital creation, the free enterprise system and perpetuation of small and medium sized businesses. In 2001, Congress was attempting to repeal the estate tax and GST tax because they were deemed an anathema to the free enterprise system. Only the very wealthy have the resources to plan to minimize transfer taxes, and as a rule they pay very little when compared to their actual wealth. One million dollars doesn't buy what it used to. Congress should encourage, not discourage, broader wealth creation because it's the engine that drives our economy. Government has shown itself to be a poor steward of wealth, despite its best intentions.
Three perpetual jurisdictions existed before 1986: Idaho, South Dakota and Wisconsin
When the GST tax and exemption were created, three states already had no traditional RAP. They favored a more liberal rule against alienation and suspension of powers.11 The argument that Congress couldn't foresee the perpetual trust movement is weak at best. Some in Congress actually would prefer there were no estate tax at all — which is why we had the 2001 Tax Act. In addition, the RAP wasn't uniform throughout the United States in 1986, since at that time some states preferred the common law rule and others had adopted various forms of the uniform RAP. It was known then that the effect of the GST tax exemption on trusts would be felt differently in each jurisdiction based on its chosen law.
Today, the common law RAP is the minority view
Over the past 25 years, the common law RAP and the statutory RAP have become the minority view within U.S. jurisdictions because they're seen as a barrier to wealth generation and expansion of capital. Not everyone views taxation as the public policy solution to this country's economic problems. Nor is wealth re-distribution always the best policy, especially where small businesses and job growth is concerned. “Give a man a fish, he eats for a day. Teach a man to fish, he eats for a lifetime.”
The multi-generational trust movement has empowered great American families
The most important trend associated with the multi-generational trust movement is that it has shifted the power from the traditional banks and trust companies back to the families and their closest trusted advisors. Proper attention to the drafting of built-in family governance and succession provisions provides administrative flexibility so that the “dead hand” need not rule the trust. Often the governance structures of multi-generational trusts are linked to family foundations, supporting organizations and donor-advised funds. This helps to link wealth with community responsibility and provide what noted philanthropic investment advisor Curt Bassett calls a “family university.”12
Here are a few examples of the more common multi-generational trust provisions or purposes:
- To honor the legacy, vision and values of grandparents, great-grandparents, and so on — and to share that vision in a way that awakens each subsequent generation to their own genius and shared purposes.
- To include incentive provisions to “earn and learn” (such as, $1 trust income for $2 earned income based upon one's W-2; perhaps more for service professions) to ensure future generations are valuable members of society. This generates meaningful income and payroll tax revenue to the federal government as well as trust income tax revenue, which are much greater than the projected federal estate tax savings.
- To provide distribution audits to determine suitability of future distributions (that is, based on net worth). Once a beneficiary attains a certain net worth indexed for inflation, he no longer needs or receives any additional distributions. Funds stay in trust for family members with more economic need and for charities.
- To provide monthly stipends for stay-at-home parents, which encourages families to raise their own children and maximize the effectiveness of the family unit.
- To provide supplemental income if a beneficiary works for a charity, thus promoting social responsibilities.
- To provide for educational costs for family members at each successive generation, thus promoting the enriching value of education in the family.
- To provide monthly payments for academic excellence for family members who excel in their studies or research efforts.
- To provide for medical costs of family members at each generational level when it's beyond their own ability to provide for such costs.
- To provide for the family's charitable donations in perpetuity. History shows that once the trust attains a certain size, a large percentage of distributions are distributed to charity, thus promoting social responsibility and keeping the family name in good stead.
The G2 proposal is overly broad and makes the common law rule look progressive
The G2 proposal, if adopted, would prevent all multi-generational trusts; theoretically, even those that would now meet the common law RAP. Since many seniors are living longer, it's more common to see families with four and five generations of living prodigy. The proposal would have an unfair impact on other living generations of family members and their grandparent's ability to give exempt gifts.
For example, John (age 89) and Mary (90) have two children, Allie (67) and Bill (69) and three grandchildren, Charles (49), Douglas (47) and Emily (45). John and Mary's great-grandchildren are Frank (29), Greg (27), Hanna (25) and Ivan (25). Their children are Kathryn (9), Jim (8), Lisa (7), Mike (7), Nancy (5), and Oscar (4). Under current law in any jurisdiction, a trust may be created for the great-great-grandchildren of John and Mary (Kathryn, Jim, Lisa, Mike, Nancy and Oscar). Under the Joint Committee Task Force Proposal, a trust whose beneficiaries are beyond the grandchild level would be subject to tax. Here, we have two generations who are living and beyond the grandchild level.
One concern is that John and Mary could create aristocratic wealth by using their GST tax exemption to fund a life insurance policy in a multi-generational trust, as Ray M. Madoff's July 12, 2010 New York Times op-ed piece suggests.13 However, we would have to see through to the insurability of John and Mary. In this case, insurance would be costly because of their age. The ability to purchase the $100 million amount that Madoff suggests is unlikely. Even if John and Mary were healthy and 10 years younger, they might have been able to purchase about $60 million in a second-to-die insurance policy, assuming they were to fund a multi-generational trust with the full $7 million (which was the 2009 GST tax exemption for a husband and wife). They now have 15 living decedents that are direct beneficiaries of the trust (not counting spouses). No need to worry that a dynasty is created here or for the members of future generations.
The G2 proposal would increase social and financial costs
The G2 proposal will increase social and financial costs, thwart the good purposes of families that also benefit the community at large and leave a family less well off than they would be otherwise. Its effect would be to reduce net tax revenues and increase the cost of tax planning for families. The proposal, if enacted, wouldn't generate the revenue that the proponents suggested for almost a century. Even then, like the estate and gift tax, the regulatory costs outweigh the benefits to the treasury and therefore would serve only minimal societal purposes. And, it would be at the cost of future income tax revenues. The wealthy, who have the means to plan, would employ other strategies at every other generational level, while those with more modest estates (for example, small business owners), would be hit hardest by the tax. Congress established the GST tax exemption for the very purpose it's serving.
The effect of the G2 proposal is to limit generativity: Human capital as wealth enhances generosity and wise choices
Most multi-generational trusts aren't established with the primary motive of saving taxes. Properly designed multi-generational trusts encourage what author and lawyer James Hughes refers to as “generativity.”14 Hughes defines generativity as the connectivity between each generation, and their gratitude and sense of responsibility based on what is most important to the family. What Hughes speaks so well about is getting families to think of their wealth as not just financial. If families can use their human and intellectual capital to their full potential, then the financial capital empowers them to do good, not just well — and it will bless generations to come. Hughes also advocates that families think in terms of generations when they're doing their planning and decisionmaking. Each successive generation is encouraged to be builders and stewards of family capital (the term “capital” as more broadly defined by Charles Collier in his book, Wealth in Families, to include human capital, intellectual capital and social capital, not just financial capital).15
The GST tax exemption benefits capital creation and growth in the economy
The fear of vast amounts of inter-generational wealth that would be otherwise taxed isn't founded in reality. The exemption remains relatively modest when compared with real wealth. The G2 proposal would hurt mostly the moderately wealthy — that is, those who are responsible for the majority of the capital creation and success for small businesses, light industry, grass roots technical innovation and jobs and those who remain as farmers. Those with greater wealth have the means to legally minimize or avoid the tax through proper planning — a two-generation rule won't prevent them from that goal. Those with modest wealth often lack the same means to pay for ongoing sophisticated planning and accounting. The current GST tax exemption is pegged to the estate tax exemption and is only a modest token for the very wealthy.
The concentration of wealth/trust administration problems are hypothetical
The fears posed by some G2 tax proponents are that: (1) the current exemption causes great concentrations of wealth, and (2) problems develop with trust administration as generations continue. These problems were more common with traditional older trust models, but the technology has changed. These concerns are now hypothetical and no longer relevant given modern trust drafting and improved administrative processes.
For example, most multi-generational trusts are designed to either split or terminate when they become unwieldy or at intergenerational points either per stirpes or per capita. Separate trusts often continue for separate family groups. There's a natural diminution of wealth as the family group grows larger, so the fear of concentrated wealth is more improbable. The fear that fiduciaries won't be able to meet their duty to beneficiaries is also minimized. As a practical matter, most generational trusts will likely last for only a few generations down the line before they terminate on their own. But the good they can do in the meantime is immeasurable for family connectivity and the development of social and financial responsibility.
The G2 proposal isn't supported in the estate-planning mainstream
The majority of estate-planning lawyers and practitioners aren't in favor of eliminating the GST tax exemption for multi-generational trusts. The majority of tax practitioners and state legislative bodies wouldn't support intrusion into their domain by the federal government. Congress rejected the G2 proposal in the past, in part because it imposes a federal RAP that contravenes the legitimate legislative purposes of the states.
Despite the opinion of the proponents of the G2 proposal, multi-generational trusts are in the mainstream of estate planning and the estate-planning practice. They provide a valuable and enduring tool for families to be more effective in their efforts to educate, empower and inspire successive generations. Those who support the G2 proposal are in the minority. Certainly the majority of America's families wouldn't favor such a proposal, and fortunately, the task lies with the majority of our elected officials who are responsible for passing the laws.
No Loophole to Close
Congress intended the GST tax exemption to prevent an additional tax on gifts to all descendants within the exemption amount, including in trust and in dynasty trusts. The Treasury's G2 recommendation creates an artificial federal RAP for trusts. Congress has, in the past, wisely allowed the states to define the property rights of its citizens.
Presently, the exemption is limited in 24 states by either the common law RAP or the uniform statutory RAP. In the remaining 26 states and the District of Columbia, legislatures have lengthened the perpetuities period or eliminated it altogether. While the laws of the various jurisdictions may differ for reasons only known to the legislatures, any person may avail himself of any U.S. jurisdiction for trust law purposes. No one is denied access to his personal choice of trust law.
Multi-generational trusts that have been allocated their permitted GST tax-exempt amount aren't something to be feared, but have provided many positive benefits for families and society.
While there are individuals and professional groups who attempt to inform, influence and encourage the development of laws in all the states, those who have been disappointed with progress of the perpetuities trust movement in the United States16 are in the minority. The trust law innovations that have accompanied this movement have been a promising development. Each state is free to write its own trust legislation and to determine its own perpetuities law, and Congress has wisely continued to support that position since 1986. If adopted, the G2 proposal would end that balance and strike a blow to all the progress that has been made to improve the way trust law helps to meet the developmental needs of families and their charities. Congress knew what it was doing when it enacted the GST tax exemption — there's simply no loophole to close. The authors believe that the G2 proposal is just wrong minded.
— The authors gratefully acknowledge the contributions of Professor Jerome M. Hesch in researching and preparing this article.
- Professor Jerome M. Hesch suggests that the legislative history and commentary regarding the 1976 generation-skipping transfer tax (GST) is relevant to the discussion of the intent of Congress in the development of the 1986 legislation.
- In 1986, Congress adopted the GST tax regime that incorporated some assumptions and safe harbors that were patterned after either the rule against perpetuities (RAP) (under common law, a life in being plus 21 years) or the uniform statutory rule against perpetuities (USRAP) (generally: the longer of 90 years or the common law RAP). But three jurisdictions already had abolished their RAP and instead adopted a more flexible rule against alienation and suspension of powers (RAASP): Idaho (1957), Wisconsin (1969) and South Dakota (1983). These jurisdictions often are referred to as the original “Murphy jurisdictions” after that case validated this approach. See Estate of Murphy v. Commissioner, 71 T.C. 671 (1979), in which the Tax Court held that the Delaware tax trap wasn't violated in Wisconsin. Wisconsin had a perpetuities statute stated in terms of a rule against the suspension of the power of alienation (rather than a rule based upon remoteness in vesting). The Internal Revenue Service acquiesced in Murphy. Originally, the GST tax exemption was $1 million per grandparent. In 2009, Internal Revenue Code Section 2642 provided a GST tax exemption of $3.5 million for each spouse, meaning that a married couple may exempt up to $7 million in assets from the GST tax. The GST tax wasn't in effect in 2010. See IRC Sections 2601-2663. There wasn't a GST tax exemption in 2010 either. See IRC Section 2631.
- One of our clients, an elderly widow, once said, “Well I may not know who my great-great-grandchildren are, but they will know who I am, what I stand for and what is important to me.”
- See Staff Report of Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures 393, available at www.house.gove/jct/s-2-05.pdf. The proposal prohibits the allocation of GST tax exemption to a “perpetual dynasty trust,” except to the trust, provides distributions to beneficiaries in the generations of the transferor's children or grandchildren. Under the proposal, the GST tax exemption is limited to an exemption of a skip of one generation. A “perpetual dynasty trust” is defined as a trust whose situs is a state that either (1) has repealed the RAP, (2) allows the creator of a trust to elect to be exempt from the RAP and the creator so elects, or (3) has modified the RAP to permit creation of an interest for individuals more than three generations younger than the interest's creator. If the situs of a trust is moved from a state that has retained the RAP to a state that has repealed it, its inclusion ratio thereafter will be changed to one.
- See Lawrence W. Waggoner, Commentary, “Message to Congress: Halt the Tax exemption for Perpetual Trusts,” 109 Mich. L. Rev. 23 (2010), www.michiganlawreview.org/assets/fi/109/waggoner.pdf; Lawrence W. Waggoner, “Curtailing the Dead-Hand Control: The American Law Institute Declares the Perpetual-Trust Movement Ill-Advised,” University of Michigan Public Law Working Paper No. 199 (2010), ssrn.com/abstract=1614934. See Letter by Professor Lawrence W. Waggoner, University of Michigan School of Law, to Catherine V. Hughes, Office of Tax Policy, August 4, 2005; Letter by Professor Gregory S. Alexander, Cornell Law School, to Catherine V. Hughes, July 17, 2010; Email to Catherine V. Hughes by Raymond H. Young, attorney with Boston's Young and Bayle, July 20, 2010.
- See Paul L. Comstock, “Financial Parenting Through a Family Foundation,” Trusts & Estates (August 1992) at p. 32. See also Jerry L. McCoy, Family Foundations — A User's Guide (Non-Tax Edition), Twenty-eighth Annual Philip E. Heckerling Institute on Estate Planning, University of Miami Law School, Matthew Bender & Company (1994); Paul L. Comstock, “Uses of Family Foundations,” Presentation at National Conference on Planned Giving, Indianapolis, Ind. (October 1993), quoting a term originally attributed to the Whitman Institute of San Francisco.
- Daniel G. Worthington and Mark Merric, “Which Situs is Best?” Trusts & Estates (January 2010) at p. 54; Jesse Dukemmler and James E. Krier, “The Rise of the Perpetual Trust,” 50 UCLA Law Review 1303, 1316. See Idaho Code Section 55-11 (Michie 2000): Wisconsin Statute Section 70016(5) 0999); South Dakota Codified Laws Section 43.5-8 (1997). See also Delaware Code Ann. Tit. 25 Section 503(a) (Supp. 2000); 765 Illinois Camp Stat. Ann. 305/4 (West 2001); Alaska Stat. Section 34.27.100; New Jersey Stat. Ann. Section 46:2F-9 (West Supp. 2002); Ohio Rev. Code Ann. Section 213108(B) (West Supp. 2003); Maryland Code Ann. Estates & Trusts Section 11-102(0) (2001); Florida Stat. Ann. Section 689.225 (West 2003); Arizona Rev. Stat. Ann. (A) (1) Section M-2901 (West Supp. 2002); Missouri Ann. Stat. Section 456.236 (West Supp. 2003); Nebraska Rev. Stat. Sections 76-2001 (1996 and Supp. 2002); Colorado Rev. Stat. Sections 15-11-1102.5 (2006); Maine Rev. Stat. Ann. Tit. 33, Sections 101 (West 1964); Rhode Island Gen. Laws Sec-tion 34-11-38 (Supp 2003); Virginia Code Ann. Section 55-13-3(C) (Michie Supp. 2002); District of Columbia Code Sections 19-109 (10) (2002); Washington Rev. Code Ann. Section 1l.9B.l30 (West 2002); Wyoming H.B. 77 (2003); New Hampshire Rev. Stat. Ann. Sections 547:3-k and 564:24 (West, Westlaw through 2003 Sess.); Utah Code Ann. Sections 75-2-1201 (Lexis Supp. 2002); Nevada Rev. Stat. Session 111.1031 (see Nev. Rev. Stat. Ann. 2 Sections 1l1.l03-1039 (Michie Supp. 2004)); Tennessee Code Ann. Section 66-1-202(f)(2007); North Carolina Gen. Stat. Section 41-15 (2007); 20 PSA Section 6107.1 (2007); MCLA Section 554.71 (200B); see generally Richard A. Oshins and Steven J. Oshins, “Protecting and Preserving Wealth into the Next Millennium [Part Two],” Trusts & Estates (October 1998) at p. 68; Daniel G. Worthington, “The Problems and Promises of Perpetual Trusts,” Trusts & Estates (December 2004) at p. 15.
- See Robert H. Sitkoff and Max Schanzenbach, “Jurisdictional Competition for Trust Funds: An Empirical Analysis of Perpetual Trusts and Taxes,” 115 Yale L. J. 356 (2005).
- See generally Worthington and Merric, “Which Situs is Best?” supra, note 8.
- Ibid. See also supra, note 1. See July 20, 2010 email from Raymond H. Young, attorney with Boston's Young and Bayle to Catherine V. Hughes, Office of Tax Policy, in support of the two generation proposal, in which Young laments: “As you know, I am consistent with this, having warned the House Ways and Means Committee in 1984 the establishment of a GST exemption was a dangerous inducement to promotes and would lead to a great increase in long-term trusts. Unfortunately, they did not listen to me. And even I hadn't foreseen the multiple effect of eliminating the Rule Against Perpetuities.” Email on file with the authors.
- Curt Bassett is a lawyer and former national Director for Philanthropic Services for Merrill Lynch. Presently he is CE0 of Princeton Social Capital, with offices in Salt Lake City and New York City, and advises affluent families, non-profit organizations and their advisors.
- Ray M. Madoff, “America Builds Aristocracy,” New York Times, July 12, 2010, at p. A17. This would leave less than $4 million per living heir — hardly a dynasty.
- James Hughes, “Families & Wealth: Family Wealth,” Bloomberg Press, Princeton, N.J. (2000); James E. Hughes, Jr., “Family Wealth — Keeping It in the Family: How Family Members and Their Advisers Preserve Human, Intellectual, and Financial Assets for Generations,” Bloomberg Press, Princeton, N.J. (June 2004)
- Charles Collier, Wealth in Families, 2d ed., Harvard Press (2006).
- See supra, note 4.
Daniel G. Worthington, left, is CEO and managing member at Worthington Everidge Group LLC and Family Office USA, LLC in Orlando, Fla. Daniel D. Mielnicki is a shareholder at Berger Singerman in Boca Raton, Fla.
Oh Golly, Gee, Damn!
This 1961 “Breakfast At Tiffany's” (101.5 cm. by 76 cm.) movie poster sold at Christie's Vintage Film Posters auction in London for $10,698 on Dec. 1, 2010. These posters were produced on heavy stock paper to be displayed outside at drive-in cinemas.