GPSolo Magazine - March 2005
Estate and Financial Planning
The Purpose Of Purpose Trusts
Unlike the typical U.S. trust, a purpose trust is a trust established for a purpose rather than for specified beneficiaries. Charitable purpose trusts are permitted, but noncharitable purpose trusts fail for a number of reasons. First, these trusts violate the rule against perpetuities because there is no measuring of human life. Second, no ascertainable beneficiary exists to enforce the trust. An inviolable rule of trust law states that if no one can enforce the trust, then there can be no trust.
Offshore jurisdictions that have recognized purpose trusts have done so through formal legislation. Some states also have adopted purpose trust law, but in a far more limited way than the offshore jurisdictions. The thrust in the United States to adopt purpose trust legislation appears to be largely related to and motivated by the public’s desire to be able to establish valid trusts for their pets, although other “honorary” trusts (such as trusts to maintain gravesites or say masses) are usually allowed on the same basis. The popularity of pet trusts is clearly reflected in the 1993 amendment to Uniform Probate Code § 2-907(b). That section specifically acknowledges and validates honorary trusts and trusts for pets. The Uniform Trust Code also contains a section authorizing trusts for animals.
The few states that have adopted the Uniform Trust Code (UTC) also allow purpose trusts beyond trusts for animals. UTC § 409 provides that “[a] trust may be created for a noncharitable purpose without a definite or definitely ascertainable beneficiary or for a noncharitable but otherwise valid purpose to be selected by the trustee.” The provision limits the term of such a purpose trust to 21 years. Interestingly, the UTC does not invalidate the trust after the 21-year period, but it merely declares the trust unenforceable. Presumably, then, a court, upon petition, could declare the trust invalid, inasmuch as its terms have become unenforceable.
A few states, including, for example, Pennsylvania, allow some form of purpose trust through case law. Whether through case law or by statute, the application and use of purpose trusts in the United States is extremely narrow and the term unnecessarily limited. If a U.S. person wishes to establish a purpose trust for a longer term than permitted in the United States, the grantor can settle the trust in any of the several offshore jurisdictions recognizing such purpose trusts and then can administer the trust in the United States.
Whether the grantor creates the purpose trust offshore or onshore, the trust must meet certain requirements that apply to all trusts, or it will fail, despite the potentially broad scope of such a trust. The first requirement is that the trust be subject to enforcement. Most of the offshore statutes as well as the Uniform Trust Code require the trust to name an enforcer to enforce the terms of the trust and provide for court appointment of one if the trust fails to name the enforcer.
Next, the purpose or object of the trust must be certain, reasonable, and possible. Even if the purpose is possible to carry out, the court will not enforce a purpose that is wasteful, useless, or otherwise against public policy. Those numerous offshore jurisdictions that have adopted purpose trust legislation generally all have the same basic requirements for the trust to be valid, and most of those statutes reflect the elements set forth in the Belize statute, indicating that a noncharitable purpose trust will be valid, provided that: (1) the purpose is specific, reasonable, and capable of fulfillment; (2) the purpose is not immoral, unlawful, or contrary to public policy; (3) the terms of the trust are not so uncertain that its performance is rendered impossible; and (4) the terms of the trust provide for the appointment of a successor to any protector (enforcer).
As to which jurisdiction to select, whether domestic or offshore, there are numerous factors to consider, including the purpose and term of the trust, the most logical place for administration, the laws of the jurisdictions under consideration (which is to say, the flexibility of the applicable statute), and, perhaps, the client’s travel preferences.
What practical uses of purpose trusts have given rise to the increasing recognition of purpose trusts and legislation concerning these trusts? The answer is that modern-day purpose trusts can be used for personal or philanthropic purposes that do not otherwise qualify as charitable. For instance, a purpose trust can hold and provide for perpetual control of a family business; can direct maintenance and preservation of a family or business property without interference by beneficiaries; and can provide complete privacy and creditor protection when, for example, the purpose of the trust is to maintain a noncharitable foundation for the benefit of the settlor and members of the settlor’s family and, quite commonly, to hold ownership interests in companies that lease assets to other companies for off-balance-sheet transactions.
For those attorneys familiar with the establishment of trusts in other jurisdictions, it is a relatively simple matter to form a purpose trust in a selected jurisdiction for a U.S. client and then make the transfer of desired assets to the trust. Typically, the trust is drafted so that the transfer to the trust is tax neutral and the income is taxed to the grantor. Thus, there should be no new taxes to worry about, although IRS information forms must be filed. Because a purpose trust has no beneficiaries, however, if the trust is drafted so that it is not a grantor trust, some tricky, if not odd, tax considerations apply. For instance, Code §§ 641 and 651 provide for a deduction for amounts that a trust distributes to a beneficiary, and corresponding Sections 642 and 652 provide that the beneficiary receiving such distributions shall include the same in his or her gross income. But what happens to these rules in the case of a purpose trust that distributes income for the upkeep of an automobile or the care of a cat? The IRS has considered this odd situation, and in Rev. Rul. 76-486 ruled that, although no deduction is allowed for the trust distributions to a non-individual, the trust should not be taxed at the higher trust rate, because it is not accumulating the income. Instead, the Revenue Ruling provided that the trust in such a case would be taxed at the rate of a married person filing separately.
Even though the trust may be established in an offshore jurisdiction, if the settlor is a U.S. person, U.S. tax laws must still be considered. Because this is the case, perhaps importing the offshore trust and the offshore law to the United States should be considered. If the purpose trust meets the offshore jurisdictional requirements, the trust may be generally administered anywhere in the world, including the United States. Therefore, it should be possible to establish a purpose trust in an offshore jurisdiction and then, after a short time, move administration of the trust to the United States while retaining the governing law of the original jurisdiction. If certain other requirements are met, this could eliminate the need to file the aforementioned reports with the IRS.
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- This article is an abridged and edited version of one that originally appeared on page 34 of Probate & Property, May/June 2004 (18:3).
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