As this blog discussed in the recent past, dynasty trusts are trusts that allow for a benefactor to pass wealth on to future generations via various legal mechanisms that allow a trust to carry on for literally hundreds of years, overcoming the traditional rule against perpetuities that limited trusts to a life in being plus 20 years, thereby ending the legal life of a trust essentially at about 90 to 100 years.  In March, 2016 President Obama submitted a proposed budget that includes a provision that would effectively eliminate these state trusts at about 90 years.

Every year, the Department of Treasury prints what is called a green book which outlines proposals, which, among other things, contains suggestions that the presidential administration believes are needed and appropriate changes to the law, policy or other regulatory and legal matters.  It also contains information regarding exceptions and issues that are unique to dealing with the federal government.  Under President Obama’s proposal, as found in after page 190 in the green book, this would be done by eliminating the generations skipping tax exemption at 90 years from the date of its creation.  

At the time that the Generation Skipping Transfer Tax was created, all but three states still followed the common law Rule Against Perpetuities, so that there would be a foreseeable tail end to the trust, even if it was indeed a long time out.  Following this, Congress unwittingly granted a tax exemption for perpetual trusts, thus creating the market.  

Over time, banks and financial institutions lobbied states to create trusts that could last a very long time.  With various states changing their laws, there are some jurisdictions that allow for a trust that is essentially perpetual and without foreseeable end.  This did not prevent the wealthy from other states from utilizing these legal mechanisms, they simply just created a flood of out of state money into the the local banks and trust companies in these jurisdictions.  One study suggested a figure of approximately $100 billion in assets flowed to states that had such favorable laws.

The Obama Administration proposes that this occur by way of increasing the inclusion ratio for the trust, as defined under 26 U.S.C. § 2642 (which is the primary statutory basis for the generation skipping transfer tax), to one.  This means that no part of the trust is exempt from the federal generation skipping transfer tax.  

The good news is that even under the current legal structure, the government treats monies received from different benefactors/trustors even into one trust, as separate trusts.  Therefore, the different streams of income into the trust, flowing to the beneficiaries can keep the life of the trust alive, thereby stretching and mitigating any large tax bills that may become due.  The law, fortunately, contains exceptions for passing money onto special needs type trusts, for disabled persons, provided that any money they receive and that in turn pours into the special needs trust is part of their gross estate for federal estate tax purposes.  

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