From Here to Eternity: The Folly of Perpetual Trusts

Abstract:     
Trusts that can operate for as many as a thousand years or even forever, typically for the benefit of the settlor’s descendants living from time to time, now and in the future, are all the rage in banking and estate-planning circles. Before 1986, when Congress passed the federal generation-skipping transfer tax (GST tax), settlors had little incentive and probably little desire to establish perpetual trusts, even though they were permitted to do so under the law of Wisconsin, South Dakota, or Idaho. The GST tax created an artificial incentive for the wealthy to establish such trusts.

The origin of the perpetual-trust movement is the GST exemption, which is part of the GST tax. When Congress granted the GST exemption, it did not impose a durational limit on trusts that qualify for the exemption, but instead relied on state perpetuity laws to supply that limit. The reliance on state perpetuity laws was badly misplaced. At the instigation of state banking groups and estate-planning attorneys, states began to pass legislation allowing trust settlors to create perpetual trusts — trusts that can last for several centuries or even forever. With state perpetuity laws out of the way, the wealthy began creating perpetual trusts in significant numbers.

This essay questions whether the state legislators who vote to authorize perpetual trusts and the wealthy who create them are thinking through what they are allowing or putting in place. The essay shows the folly of such trusts, primarily by producing a table projecting how, with each step down the generational ladder, the number of beneficiaries will proliferate and the settlor’s genetic connection with the beneficiaries will decline.

The essay then points out that the primary responsibility for the perpetual-trust movement rests not with the state legislators or the wealthy, but with Congress. The primary responsibility for curtailing it also rests with Congress, but so far Congress has not acted. The American Taxpayer Relief Act of 2012 made the problem worse, by making the $5 million ceiling ($5.25 million as adjusted for inflation) on the GST exemption permanent.

Comprehensive tax reform is now on the agenda of the House Ways and Means Committee, but no public Committee document indicates an interest in curtailing the GST exemption for perpetual trusts or even an awareness of the problem.

The only agency of the federal government that has publicly taken an interest in curtailing the GST exemption for perpetual trusts is the Treasury Department. The Treasury Department’s position is that the absence of a durational limit on the GST exemption is inconsistent with the purpose of the exemption and undermines the policy of the GST tax. Treasury’s proposed solution, however, is disappointing because it is not as effective as it could be: Treasury would allow perpetual trusts created before enactment of its proposal to continue to be unburdened by a durational limit and would allow perpetual trusts created after enactment to qualify for the GST exemption, but would have the exemption expire 90 years after the trust was created.

The Treasury Department’s proposals are better than nothing. If enacted as part of comprehensive tax reform (or as part of a smaller measure), they would gradually dampen the perpetual-trust movement and its associated perpetual GST exemption. But they would leave many trusts and much wealth exempt from GST tax for much longer than Congress originally intended. Once enactment would appear possible, the stampede would be on to get in before the deadline. Super-rich clients who were on the fence would be encouraged to establish GST-exempt perpetual trusts before the door closed on the opportunity.

The essay concludes by offering Congress a solution that is consistent with the original intent of the GST exemption and would be truly effective to end the perpetual-trust movement.

Number of Pages in PDF File: 19

Keywords: perpetual trusts, generation skipping transfer (GST) tax

JEL Classification: K10, K34

working papers series