Probate & Property Magazine


P R O B A T E   &   P R O P E R T Y
July/August 2008
Vol. 22 No.4

Fifty-one Flowers

Current Perpetuities Law in the States

 

By Lynn Foster

Lynn Foster is the Arkansas Bar Foundation Professor of Law at the William H. Bowen School of Law of the University of Arkansas at Little Rock.
A significantly longer version of this article is published at 29 U. Ark. Little Rock L. Rev. 411 (2007). Readers are urged to consult it for more detail.

 

More than a century ago, Harvard law professor John Chipman Gray formulated the most common expression of the common law rule against perpetuities: “No interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.” The rule, which voids future interests that remain nonvested past a certain period of time after their creation, exists pristine and unreformed in only one state today: Alabama. The rule fell prey to several factors: its own shortcomings, changes in the nature of the property affected by the rule, changes in tax law, state competition for trust investments, and significant changes in the law of trusts, which have legitimized perpetual trusts (trusts that can legally last forever) and dynasty trusts (here used to mean trusts that can legally last longer than the rule period but not forever).

Many sweeping generalizations have been made about the decline, death, and doom of the rule. Is the rule really completely dead? After decades of “perpetuities wars,” the unmodified Uniform Statutory Rule Against Perpetuities (USRAP) is currently the law in roughly one-third of the states, with Arkansas being the most recent to adopt it (see pages 34–37 for a state-by-state list of the status of the rule). About half of the states have legalized dynasty or perpetual trusts. A few have completely abolished the rule in any form. Thus, the answer is “no” in the 18 USRAP states, and essentially “no with respect to nontrust property” in almost all of the rest. Of course, most commentators would agree that more property continues to be held in trust as the popularity of trusts increases.

This article will provide the current status of the rule in the states. Although it hardly seems possible, the law of perpetuities is much more complicated today than it was 20 years ago. The rule is not dead, but there is more variation in perpetuities law among the states than at any time previously in U.S. history, and this unprecedented variation presents risks and challenges for estate planners.

The Reform of the Rule

The first salvo in the decades-long “perpetuities wars,” as they have been labeled by Prof. Susan French, took place in the 1950s, and was fired by Harvard professor W. Barton Leach. In two companion articles, Leach criticized the rule on a number of grounds, coining vivid names still used today (the “Magic Gravel Pit” and the “Unborn Widow,” for example) to label what he argued were its shortcomings. See generally W. Barton Leach, Perpetuities: Staying the Slaughter of the Innocents, 68 L.Q. Rev. 35 (1952); W. Barton Leach, Perpetuities in Perspective: Ending the Rule’s Reign of Terror, 65 Harv. L. Rev. 721 (1951–1952). He criticized the rule for its hypothetical nature, its failure to reform instruments, thus destroying the testator’s intent, and its illogical exemption of reversionary future interests. He suggested reforms to correct these defects and recommended the American Law Institute, the National Conference of Commissioners of Uniform State Laws, or the American Bar Association as proper entities to draft an appropriate statute.

Two prongs of reform resulted from Leach’s criticisms: the wait-and-see approach, which would wait out the period of the rule (lives in being at the creation of the interest plus 21 years) to see whether the questionable interests actually vested or failed during that time; and cy pres, or the ability of courts to reform instruments to conform to the rule. A number of states adopted one or both of these reforms, and in 1983 the Restatement (Second) of Property: Donative Transfers adopted the wait-and-see approach. Reform of the rule culminated in the Uniform Statutory Rule Against Perpetuities (USRAP), adopted in 1986 by the National Conference of Commissioners on Uniform State Laws, and its subsequent enactment by more than half of the states. USRAP imposed a 90-year wait-and-see period and cy pres on petition of an interested party. It should be noted that despite impassioned debate over each of these reforms, no one urged the abolition of the rule. The bar and the academy presumably bought into the policy considerations behind the rule: the desirability of keeping real property out of the marketplace indefinitely and the undesirability of private trusts that would last indefinitely.

Limiting and Abolishing the Rule

USRAP proved to be the apogee of reform of the rule, however, because ironically, during the same year it was adopted, Congress passed legislation that contained within it the seeds of the rule’s demise. In 1986, Congress enacted a major revision to the estate-tax provisions of the Internal Revenue Code. Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085 (1986). Before 1986, decedents were able to escape the transfer tax by transferring successive life estates across multiple generations. For example, if O devised in trust for the benefit of A for life, then to B, A’s estate would pay no transfer taxes. To close this loophole, Congress enacted the generation-skipping transfer (GST) tax. Code
§§ 2601–2063. Thus, in the above hypothetical, a GST tax would be payable on all trust assets at A’s death. The GST tax rate is significant—it equals the highest rate of the estate tax, which as of 2008 is 45%. 26 U.S.C.A. §§ 2641, 2001(c)(2) (West 2007). Although Congress imposed the new GST tax with one hand, with the other hand it granted an exemption from the tax. Originally the exemption amount was $1 million. In 2007, it became $2 million, and as the legislation stands, it will increase to $3.5 million by 2009. Staff of J. Comm. on Tax., 109th Cong., Options to Improve Tax Compliance and Reform Tax Expenditures 394 (Comm. Print 2005), available at www.house.gov/jct/s-2-05.pdf.

Congress intended uniformity across the states with the GST tax and its exemption; the limit on the GST exemption was to be the rule, which at that point in time was the law in all but three states. Id. at 394. Without the rule, a grantor could establish a trust that lasted for generations, paying no transfer taxes. Of course, such a trust would be subject to state and federal income taxes, but these are much less onerous than the GST tax. Together, federal and state income tax on a trust may amount to approximately half of the income; on the other hand, the GST tax is almost half of the principal. Indeed, some states charge no income tax on trusts. Further, if the trust assets appreciate in value, the appreciation is exempt from the GST tax also. Estate planners realized that with a longer rule period or no rule at all, this would constitute a new, advantageous, highly marketable investment opportunity.

In 1995, Delaware became the first state to respond by abolishing the rule as applied to interests in a trust. This development was followed by what seemed to be a race among the states, as a flurry of articles urged the abolition of the rule or chronicled its demise. As of this writing, half of the states have abolished the rule or USRAP to a greater or lesser extent; most of them only for trusts (see table on pages 34–37). The race to lengthen the permissible period of trusts was also accompanied by the adoption of asset protection trusts and/or the repeal of income tax in a significant number of states. Commentators have listed reasons for abolition of the rule, such as its complexity; the fact that in a trust regime, restriction of alienability is no longer a concern if the trustee has a power of sale; and the current advantages of trusts, especially with the advent of the Uniform Trust Code, adopted in 2004 by NCCUSL and currently the law in 19 states and the District of Columbia. It is hard to escape the conclusion, however, that the two most important reasons for the rule’s decline are the wagging tail of the GST tax exemption and competition among states to offer the most favorable legal climate for trust investments. Nine states have legalized asset protection trusts ( Alaska, Delaware, Missouri, Nevada, Oklahoma, Rhode Island, South Dakota, Tennessee, and Utah). All but two of them have either lengthened the rule period or effectively abolished the rule in the case of trusts. See the state-by-state list on pages 34–37.

The Status of Perpetuities Law in the States Today

Before the GST tax exemption, three states had in effect abolished the common law rule for trusts: Idaho, Wisconsin, and South Dakota. It does not appear that either Idaho or Wisconsin abolished the rule to entice investors; in fact, today they retain an income tax on trusts. In 1983, however, South Dakota abolished the rule as part of a campaign to attract trust and banking positions to the state.

In 1995, Delaware was the first state after the enactment of the GST tax exemption to allow perpetual trusts, citing the need, whether real or perceived, to entice investors away from South Dakota and Wisconsin. Jesse Dukeminier, The Uniform Statutory Rule Against Perpetuities and the GST Tax: New Perils for Practitioners and New Opportunities, 30 Real Prop. Prob. & Tr. J. 185, 208 n.54 (1995). Since then, 19 states plus the District of Columbia have enacted legislation that either (1) extends the allowable perpetuities wait-and-see period beyond USRAP’s 90 years, (2) allows perpetual trusts, or (3) goes the full distance and simply repeals the rule. This legislation is by no means uniform, although it can be grouped into several broad categories. Put most succinctly, the following is the status of the common law rule as of this writing: one lone state, Alabama, still follows the common law rule unmodified by any reform doctrines. One state, Kentucky, follows the common law rule modified by the wait-and-see doctrine. New York, Oklahoma, and Texas follow the common law rule modified by varying degrees of cy pres, while Iowa, Mississippi, and Vermont follow the common law rule modified by both cy pres and wait-and-see.

A total of seven states have modified the common law rule to permit perpetual trusts. Of them, for other interests in property, Delaware and New Hampshire follow the unreformed common law rule; Maine and Maryland have adopted wait-and-see; Missouri has adopted cy pres; and Ohio follows the common law rule modified by both cy pres and wait-and-see. Illinois has reformed the common law rule to prevent such excesses as the “Unborn Widow” and the “Slothful Executor.” Delaware limits the perpetuities period for real property owned by a trust to 110 years. All of these states except for Missouri and Delaware require the trust to “opt out” of the rule.

Wyoming, with a constitutional provision forbidding perpetuities and a “model” statutory rule that essentially codified the common law rule, has extended the rule’s period to 1,000 years for trusts. But any real property owned by a trust is still subject to the common law rule’s life in being plus 21 years.

Arkansas , California, Connecticut, Georgia, Hawaii, Indiana, Kansas, Massachusetts, Michigan, Minnesota, Montana, New Mexico, North Carolina, North Dakota, Oregon, South Carolina, Tennessee, and West Virginia have enacted USRAP with minor or no amendments.

Eight states and the District of Columbia have enacted USRAP but have later repealed or amended it to allow for dynasty or perpetual trusts, either automatically or by opt-out provisions. Of these preceding states, Arizona, the District of Columbia, Nebraska, and Virginia allow perpetual trusts; Alaska, Colorado, and Utah allow 1,000-year trusts; Nevada allows 365-year trusts; and Florida allows 360-year trusts.

The remaining states basically do not have a rule against perpetuities. Idaho abolished the rule in the 1950s and allows perpetual trusts. New Jersey has repealed USRAP and abolished the common law rule to allow perpetual trusts. Pennsylvania, Rhode Island, South Dakota, and Wisconsin have abolished most or all of the common law rule and allow perpetual trusts. These states have reached the far end of the spectrum. Louisiana is not on the spectrum at all because it does not recognize common law future interests.

Some generalizations may be made about current law. In most states, the rule still exists for nontrust property, and most states still limit restraints on alienation, even if they have liberalized the rule. As of this writing, the uniform alternative followed by the largest number of the states (18) is USRAP, either unamended or slightly amended. Some states, such as Georgia and Iowa, have considered abolition of the rule but have declined. But, if one asks how many states allow dynasty or perpetual trusts, by whatever means, the answer is 23 states and the District of Columbia.

In virtually every state that has adopted USRAP or freed the way for perpetual trusts, a “before” and “after” date will be in force for decades because little of the legislation is retroactive. Indeed, some states that adopted USRAP and later switched to perpetual trusts have two before-and-after dates—one to mark the application of USRAP to trusts executed after the date and the second to mark the date after which perpetual trusts can be established. Some statutes are partially retroactive.

Some aspects of the legislation raise questions. Many state statutes exempt trusts from coverage by the rule if the trustee has the power to sell trust property beyond the period of the rule. It is not uncommon, however, for grantors to prohibit the trustee from selling real property in the corpus of the trust if it has been in the family for generations, no matter how unproductive it has become. Is such a trust still exempt from the rule? Are only part of the assets, those that can be sold, exempt? The statutes are not clear on this point.

Have all of the states that have extended or abolished the rule achieved their goals? Probably not. Simply abolishing the rule does not guarantee respite from federal GST taxes. States may still fall prey to the Delaware Tax Trap. The Delaware Tax Trap, now no longer a problem in Delaware, originated when Delaware amended the rule to provide that whenever a nongeneral power of appointment was exercised, the rule period did not “relate back” to the creation of the power (as is the case under common law), but instead the rule period began to run when the power was exercised. Thus, if a nongeneral power of appointment was exercised before the period of the rule had run, the clock would start over. Delaware thus made it possible to create a perpetual trust, as long as successive powers were exercised again and again during each new period of the rule. Jesse Dukeminier & James E. Krier, The Rise of the Perpetual Trust, 50 UCLA L. Rev. 1303, 1332 (2002–2003).

Delaware ’s law, however, did not escape the eye of Congress, which responded by enacting Code
§ 2041(a)(3). This statute provided that if the donee of a power creates a new power of appointment that can be exercised to postpone the vesting of any interest or to suspend the absolute ownership or power of alienation of property for a period ascertainable without regard to the date of the creation of the first power, then the trust assets subject to the power are taxable. This Code section applies to all states, but it is not a problem
in states that follow USRAP or the common law rule. If a jurisdiction abolishes the rule or extends its period, however, and it does not have a statute prohibiting the suspension of the power of alienation or does not require that a nongeneral power be exercised within a certain period of time, then, if a nongeneral power is exercised after the perpetual trust is created and outside the period of the common law rule, it will incur the imposition of the GST tax on the property subject to it. Id. at 1333–34.

Thus, after examining perpetual trust statutes enacted before 2002, Dukeminier and Krier concluded that only in Alaska, Florida, Idaho, New Jersey, South Dakota, Washington, Wisconsin, and Wyoming could trusts be established that would allow nongeneral powers to be exercised beyond the rule’s period without falling into the Delaware Tax Trap and incurring the GST tax. Id. at 1333 n.127. On the other hand, trusts in Arizona, Delaware, Illinois, Maine, Maryland, Missouri, Nebraska, Ohio, Rhode Island, and Virginia were still subject to the Delaware Tax Trap. Id. at 1333 n.128. But experts disagree. The same year, attorney Julia B. Fisher stated that trusts in Alaska, Illinois, Maine, Maryland, New Jersey, Ohio, South Dakota, and Wisconsin would not fall into the Delaware Tax Trap, but those in Arizona, Colorado, Delaware, Idaho, Rhode Island, and Virginia would. Julia B. Fisher, Dynasty Trusts: Problems and Drafting Considerations, ALI-ABA Course of Study, Advanced Estate Planning Techniques 67–68 (Feb. 21–23, 2002). Yet another commentator, reviewing statutes in 2006, placed Delaware, Idaho, Missouri, New Hampshire, New Jersey, South Dakota, and Wisconsin in the first group. His second group consisted of Alaska, Arizona, Colorado, District of Columbia, Florida, Illinois, Maine, Maryland, Nebraska, Nevada, Ohio, Rhode Island, Utah, Virginia, Washington, and Wyoming. Daniel G. Worthington, Perpetual Trust States—The Latest Rankings, Tr. & Est., Jan. 2007, at 59, 60. Clearly, there is little agreement or certainty in this area of the law. Richard Nenno contends that if the IRS interprets Code § 2041(a)(3) to require an ending “period” to avoid the application of the Delaware Tax Trap, then the period will be no longer than the USRAP period of 90 years, and the GST tax will apply, even to dynasty and perpetual trusts. Richard W. Nenno, Choosing and Rechoosing
the Jurisdiction for a Trust,
40 Ann. Heckerling Inst. on Est. Plan.
§ 404.4(D)(6) (2006) (recounting informal discussions with the IRS).

Furthermore, an empirical study conducted by two professors demonstrated that only states that both allowed dynastic or perpetual trusts and abolished fiduciary income taxes on trusts benefiting nonresidents have attracted significant increases in out-of-state business, but states that only abolished the rule or lengthened its period and kept a tax experienced no similar increases. Robert H. Sitkoff & Max M. Schanzenbach, Jurisdictional Competition for Trust Funds: An Empirical Analysis of Perpetuities and Taxes, 115 Yale L.J. 356, 420 (2005).

Will the Pendulum Swing Back?

The estate and gift tax and GST tax are slated for abolition in 2010, but beginning in 2011, unless Congress adopts additional legislation, the pre-2001 Tax Act law will once again be in effect, and the three transfer taxes will be restored. Congress never intended to exempt the GST tax forever; when it enacted the exemption, all but three states enforced some version of the rule. What if Congress removes the GST tax exemption or amends the estate tax to tax trust assets as they pass through each generation? Even if grantors stopped creating perpetual trusts, it is doubtful that states would reenact the rule. One commentator has proposed a federal rule. John G. Shively, Note, The Death of the Life in Being—The Required Federal Response to State Abolition of the Rule Against Perpetuities, 78 Wash. U. L. Q. 371 (2000). Although unlikely in today’s political climate, this might be possible in a future in which the federal deficit worsens. Prof. Dobris has offered a panoply of “termination tools” such as “oppressive taxation,” a “bureau of trust enforcement,” and “a Sarbanes-Oxley for perpetual trusts.” Joel C. Dobris, Undoing Repeal of the Rule Against Perpetuities: Federal and State Tools for Breaking Dynasty Trusts, 27 Cardozo L. Rev. 2537, 2541–43 (2006). Meanwhile, estate planners should be sure to carefully check each state’s statutes and not hesitate to consult or retain counsel in those states when planning across state lines.

 


P R O B A T E   &   P R O P E R T Y
July/August 2008
Vol. 22 No.4