Money Flowing into Tax-Free 'Dynasty Trusts'

Wealthy Americans are taking advantage of looser rules in some states that allow so-called dynasty trusts to remain tax-free in perpetuity.

About $100 billion in assets has poured into trusts in states that have started allowing them to last for hundreds of years or even forever, according to new research published in the Wall Street Journal. Since the mid-1990s, certain states have begun eliminating or lengthening the trusts' time limit - usually 90 to 120 years - allowing the trusts to amass vast sums over time.

These moves are taking place as congressional tax experts have suggested limiting the perpetual tax advantages of dynasty trusts. Some estate planners are therefore encouraging clients to fund their dynasty trusts now, in case the tax breaks are eliminated. However, "we are being very careful to be balanced on this and trying not to create fear that's unwarranted," said Robert S. Keebler, a tax partner with accounting firm Virchow, Krause & Co., in Green Bay, Wis.

But even if the trusts' perpetual tax benefits are limited, dynasty trusts may still remain viable. That's because assets in the trusts are generally protected from creditors in case of lawsuits, bankruptcy or divorce.

Dynasty trusts have been attractive because as they can pass from generation to generation without additional estate or generation-skipping taxes, which can soak up about half of a parent's wealth as money moves to the next generation. Even though President Bush has suggested eliminating the federal estate tax, financial planners predict it will remain in place for estates of $5 million or more.

At least 18 states and jurisdictions - Delaware, New Jersey, Virginia and the District of Columbia to name a few - are allowing trusts to last forever, the Journal reported. Wyoming and Utah allow trusts to last 1,000 years. Florida allows them to last 360 years, reversing a centuries-old law called the Rule Against Perpetuities.

A typical dynasty trust arrangement would involve a trustee investing the money for children, grandchildren, great-grandchildren and beyond. If the money stays in the trust and it is structured correctly, it can be passed down from generation to generation without additional taxes. Dynasty trusts do not have to be set up in the state where the grandparents or parents live; only the trustee has to be located there. That's why trust companies have offices in Delaware and the other states that allow perpetual trusts.

The research, conducted by Robert H. Sitkoff and Max Schanzenbach, who are professors at Northwestern University School of Law, noted that merely changing the perpetuity laws was not enough for the money to start flowing. The states also had to have other attractive tax benefits, such as not taxing trust funds created by nonresidents. The research can be found at http://ssrn.com/abstract=666481.

The Journal quoted Neil E. Harl, emeritus professor of economics at Iowa State University in Ames, as a critic of long-term trusts. Tying up "a significant amount of our wealth" could eventually "have a damping effect on economic growth," he said. What is more, it could lead to the concentration of "enormous economic power in the hands of banks and trust companies."


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