What Would Settlor Do? Immortal Trust Settlors, Federal Transfer Taxes, and the Protean Irrevocable Trust

Abstract

The increasingly protean irrevocable trust puts substantive trust law and the federal transfer taxes at cross-purposes. State trust law’s overriding objective is simply to carry out the intent of the trust settlor. Settlors intend to manage or control the benefits from gifts over some period of time—that is, after all, the purpose of the donative trust. In contrast, the federal transfer taxes seek, by major policy purpose, to decrease the incidence of dynastic wealth—wealth locked into single-family possession and passed on from generation to generation. Yet state legislative changes to trust laws—abandoning or extending the terms of rules against perpetuities, for example—pave the way for dynastic wealth by allowing trusts to entrench that wealth in families for generations, or even indefinitely. Evolving trust laws also increasingly permit trust settlors, often by postmortem proxy, to repeatedly modify, refresh or even completely restructure irrevocable trusts in response to post-transfer events.

This essay looks critically at a change to the common law equitable deviation doctrine that ensures that irrevocable trusts can always be optimized in the face of circumstantial uncertainty. This modified equitable deviation doctrine invites trustees and courts to first imagine how the settlor would respond to unanticipated circumstances affecting an irrevocable trust, then further directs modification of the trust terms accordingly. Although this development expands settlor control over irrevocable trusts qualitatively and chronically, thereby increasing both the durability and duration of dynastic wealth, current federal transfer tax provisions are likely insufficient to discourage its proliferation. Trust settlors privileged to take advantage of the post-disposition control offered by trust laws already own a vastly disproportionate share of the nation’s wealth. Perpetual post-transfer control of wealth by a trust settlor or his proxy further entrenches this inequality of ownership and contributes to the problems it causes, including the erosion of democratic institutions. Unmitigated allegiance to the expansive value of freedom of disposition and its corollary, “the intent of the donor,” should be tempered, in post-transfer analyses, with a view to its consequences. Failing that, especially but not exclusively where costs to third parties are implicated, certain post-disposition trust modifications should be deemed new dispositions that bring about transfer tax penalties to the trust corpus.

Keywords: trusts, estates, wills, tax, estate tax, gift tax, transfer tax, wealth, inequality, property, property rights, equitable deviation