Real Property, Trust and Estate Law Journal

Section 2041(A)(3): A Trap Not Easily Sprung

by Kasey A. Place

Author’s Synopsis: Section 2041(a)(3) of the Internal Revenue Code is referred to as the Delaware Tax Trap. Despite its pejorative name, the Delaware Tax Trap can be a great tool for generating tax savings with respect to trust assets under the right circumstances. However, it is not as readily available as one might think. This Article explores important and often overlooked obstacles that limit its applicability so that practitioners can better identify circumstances in which springing the Trap is an option.

I. Introduction

The Delaware Tax Trap was originally viewed as a highly punitive provision of the Internal Revenue Code (Code) that was to be avoided at all costs. Over time, however, as exemption amounts have increased, it has been re-branded as a clever estate planning tool that can generate significant tax savings under the right circumstances. In light of its newfound popularity and the frequency with which it is now discussed in articles and presentations, one would be forgiven for thinking that the Delaware Tax Trap is a ubiquitous planning device used by trust and estate attorneys on a regular basis. In reality, however, there are two important and often over-looked obstacles that limit its applicability. This Article will describe those obstacles so that practitioners can better identify circumstances in which springing the Delaware Tax Trap is a viable option.

II. Background

The Delaware Tax Trap is the nickname for twin gift and estate tax Code provisions, sections 2514(d) and 2041(a)(3). For simplicity, this Article will refer only to the estate tax provision, section 2041(a)(3).

Before explaining how the Delaware Tax Trap works, it is useful to view it in a broader context. The Delaware Tax Trap is a subsection of section 2041, which is the statute that deals with the estate tax implications of powers of appointment. By way of background, there are two types of powers of appointment for tax purposes. The first type is a general power of appointment. With limited exceptions, a general power of appointment exists when the powerholder has the ability to appoint trust assets to himself, his estate, his creditors, or the creditors of his estate.1 Importantly, with a general power of appointment, the trust assets that are subject to the power will be included in the powerholder’s estate for estate tax purposes, whether or not the power is exercised.2

The second type of power of appointment is a limited power of appointment (also sometimes referred to as a special or non-general power of appointment). A limited power of appointment exists when the powerholder does not have the ability to appoint trust assets to himself, his estate, his creditors, or the creditors of his estate, or when, for some other reason, the power is not a general power.3 Despite its name, a limited power of appointment can be incredibly broad. The powerholder may have the ability to appoint to anyone who is not himself, his estate, his creditors, or the creditors of his estate, and it will still be a limited power of appointment.4

The advantage of a limited power of appointment is that, typically, it will not cause the assets of the trust to be included in the powerholder’s estate for estate tax purposes. The only circumstance in which a limited power of appointment will cause trust assets to be subject to estate tax is when the Delaware Tax Trap applies.5

III. History of the Delaware Tax Trap

According to section 2041(a)(3), the Delaware Tax Trap causes estate tax inclusion with respect to property over which the decedent exercises a limited power of appointment that was created after October 21, 1942, “by creating another power of appointment which under the applicable local law can be validly exercised so as to postpone the vesting of any estate or interest in such property, or suspend the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the date of the creation of the first power.”6

To make sense of the foregoing statutory language, it helps to understand the history behind it. That history began in Delaware in the 1930s. At that time, almost every state, including Delaware, followed the common law rule against perpetuities,7 which says that in order to be valid, trust interests must vest within twenty-one years following the death of someone who was alive at the time the trust was created.8

A lesser-known aspect of the common law rule against perpetuities is something called the relation back doctrine. The relation back doctrine is key to understanding the Delaware Tax Trap. This doctrine provides that if an individual exercises a limited power of appointment or a general testamentary power of appointment over a trust (referred to hereafter as the “Original Trust”) to create one or more additional trusts, the rule against perpetuities period that applies to those additional trusts is measured from the date the Original Trust became irrevocable, not from the date of the exercise of the power of appointment.9

Under the common law rule, the only type of power of appointment that the relation back doctrine does not apply to is presently exercisable general powers of appointment.10 A presently exercisable general power of appointment is equivalent to an immediate withdrawal right.11 It is so much like actual, outright ownership that the rule against perpetuities period is measured from the date the power is exercised.12 In other words, the exercise of a presently exercisable general power of appointment re-starts the rule against perpetuities period.

In 1933, Delaware lawmakers decided that it was time to allow perpetual trusts.13 However, they were not prepared to discard the rule against perpetuities altogether.14 Accordingly, they came up with a clever work-around. They preserved the “lives in being plus twenty-one years” aspect of the Rule but eliminated the common law relation back doctrine.15 This meant that every exercise of a power of appointment (whether limited or general) would re-start the rule against perpetuities period.16 As a result, as long as beneficiaries continued to exercise successive powers of appointment, the trust could last indefinitely.17 Moreover, if those successive powers were limited powers, then because (absent the Delaware Tax Trap) limited powers of appointment do not cause estate tax inclusion and because there was no generation-skipping transfer (GST) tax at that time, not only could the trust last indefinitely, but its assets could also escape transfer tax indefinitely.

Congress may have gotten used to the idea of trust assets escaping transfer tax for the lives in being plus twenty-one years period, but escaping transfer tax forever was something else entirely. Therefore, in 1951, Congress enacted the predecessor to section 2041(a)(3) as an anti-abuse provision to shut down this loophole for Delaware trusts.18

IV. Description of the Delaware Tax Trap

With that background in mind, the following description of the Delaware Tax Trap should make more sense. Put simply, the Delaware Tax Trap will apply if (1) the powerholder exercises a power of appointment (the First Power), (2) that exercise creates another power of appointment (the Second Power), and (3) the Second Power can be exercised in a way that both (a) re-starts the rule against perpetuities and (b) extends the life of the trust.

If all three of these conditions are met, then the assets over which the powerholder exercised the First Power will be includible in her estate for estate tax purposes. In some cases, this will produce a disastrous result.

Example 1: B is the beneficiary of a large GST-exempt trust that her father created for her benefit and over which she has a limited power of appointment. B has significant wealth outside of the trust as well, so much so that she has already made large taxable gifts and used all of her gift and GST tax exemption. If B inadvertently triggers the Delaware Tax Trap, the trust assets, which otherwise would not have been subject to any transfer tax at her death, will now be subject to federal estate tax at a 40% rate. Depending where B is domiciled, the trust assets may be subject to state estate tax as well. If that were not bad enough, because B has already used her own GST exemption, the new trusts created through the exercise of her limited power of appointment will not be GST exempt, and therefore, they will be subject to GST tax when the assets pass to her grandchildren or more remote descendants.

In contrast, there are some situations in which application of the Delaware Tax Trap could result in significant tax savings. As exemption amounts have increased, those situations are becoming more frequent.

Example 2: The facts are the same as those described in Example 1 except that (1) the trust at issue is GST non-exempt, (2) B has no wealth outside of the trust, and (3) B has not used any of her gift or GST tax exemption. Under normal circumstances, the trust assets would be subject to a 40% GST tax when they pass to B’s children at her death. However, if the Delaware Tax Trap were to apply, the trust assets would instead be includible in B’s estate for tax purposes but would be fully covered by her remaining estate tax exemption. Therefore, no federal estate tax would be due. If B is domiciled in one of the thirty-eight states that has no estate tax,19 then no state estate tax should be due either. Even if B is domiciled in a state that has an estate tax, the assets should be fully or partially shielded by her exemption. Finally, B’s personal representative will be able to allocate GST exemption to the continuing trusts created by B’s exercise of her power of appointment because B will now be considered the “transferor” for GST tax purposes.

Example 3: M is domiciled in the District of Columbia. She has a $3 million estate, $10 million of federal estate tax exemption remaining, and is the beneficiary of a $2 million credit shelter trust created at her husband’s death. The trust has $1 million of built-in gain. If M’s children, who are D.C. residents, inherit and immediately liquidate the trust assets at their mother’s death, they will collectively pay as much as $327,500 of combined federal and D.C. income tax.20 However, if the Delaware Tax Trap were to apply, the assets would receive a step-up in basis, so no tax would be due upon liquidation. In addition, because the trust assets would be fully shielded by M’s remaining federal and D.C. exemption amounts, no estate tax would be due.

Unfortunately, the Delaware Tax Trap is not available in every circumstance in which it would be beneficial to cause estate tax inclusion. There are two frequently encountered obstacles that will prevent its application. First, there may be language in the original trust agreement that blocks the Delaware Tax Trap. Second, state law may be an impedi-ment. The remainder of this Article addresses these obstacles in detail.

V. Obstacle 1: The Terms of the Original Trust Agreement May Prevent the Delaware Tax Trap from Applying

If the instrument governing the Original Trust (the trust agreement or, with respect to a testamentary trust, the Will) prohibits exercise of a power of appointment in a way that could extend the life of the trust past the initial rule against perpetuities period, then the powerholder cannot trigger the Trap—neither deliberately nor inadvertently. Any such exercise would necessarily be invalid and, therefore, could not fall within section 2041(a)(3), which requires that the Second Power can be “validly” exercised to re-start the rule against perpetuities period and extend the life of the trust.21

This obstacle to triggering the Delaware Tax Trap, if it exists, is typically found in the perpetuities savings provision of the governing instrument. The perpetuities savings provision is an article or paragraph included in every well-drafted trust that ensures it complies with the applicable rule against perpetuities.22 How this provision is drafted impacts whether or not the Delaware Tax Trap is available as a planning option.

The following is an example of a perpetuities savings provision that would prevent the Delaware Tax Trap from applying: “The trustee shall terminate and forthwith distribute any trust created hereby, or by exercise of a power of appointment hereunder, and still held twenty-one years after the death of the last to die of myself and the beneficiaries in being at my death.”23

In contrast, the following is an example of a perpetuities savings provision that would allow the Trap to apply:

All trusts hereunder shall terminate twenty-one years following the death of the last to die of my parents’ issue who were living on the date of this Agreement. The foregoing sentence shall also apply to trusts created by the exercise of a power of appointment, unless the exercise of the power of appointment commences a new rule against perpetuities.24

The key difference between the foregoing examples is that the first applies to trusts created through the exercise of any and all powers of appointment and the second applies only to trusts created through the exercise of powers of appointment that do not re-start the rule against perpetuities. In other words, the termination date in the second example does not apply in instances where the powerholder exercises the power in a way that re-starts the perpetuities period.

Unfortunately, not all perpetuities savings provisions are straightforward in terms of their application to trusts created through the exercise of powers of appointment and their resulting interaction with section 2041(a)(3). For example, the following provision is ambiguous with respect to whether it precludes the triggering of the Delaware Tax Trap: “All trusts hereunder shall terminate twenty-one years following the death of the last to die of my parents’ issue who were living on the date of this Agreement.”

It is uncertain whether the phrase “all trusts hereunder” includes trusts created through the exercise of powers of appointment that would otherwise re-start the rule against perpetuities period. As a result, whether the Trap can be sprung is unclear. Attorneys confronting such language may recommend a construction proceeding to clarify the phrase’s meaning before advising the client to deliberately trigger the Trap.25

A judicial determination as to the construction of the perpetuities savings provision should be binding on the Internal Revenue Service (Service), provided the determination is obtained (and any right to appeal expires) before the Trap is triggered.26 If the judicial determination is obtained after the Trap is triggered, then its impact is less certain. Under Commissioner v. Estate of Bosch,27 the Service would essentially make its own determination as to the proper construction of the trust instrument under state law.

As with any action to modify or construe a trust, one must be careful of potential tax consequences. If the trust at issue is GST non-exempt, then altering the trust’s GST tax status is not a concern. For trusts that are not subject to the GST tax because they were irrevocable on September 25, 1985, the regulations provide a safe harbor whereby such trusts will not become subject to the GST tax as a result of a construction proceeding, provided “(1) [t]he judicial action involves a bona fide issue; and (2) [t]he construction is consistent with applicable state law that would be applied by the highest court of the state.”28 Because the highest court of the state is unlikely to have ruled on the perpetuities savings language at issue, the safe harbor is of limited utility.

VI. Obstacle 2: State Law May Prevent the Delaware Tax Trap from Applying

The ability to trigger the Delaware Tax Trap is dependent, in part, on state law. No clear consensus exists as to which states allow the Trap to be sprung. This confusion is largely due to uncertainty over how section 2041(a)(3) applies in states that permit perpetual trusts.

Currently, twelve states have no rule against perpetuities.29 Some commentators argue that the Delaware Tax Trap cannot apply to trusts governed by these states’ laws30 because, on its face, section 2041(a)(3) can only apply if the Second Power can be exercised in a way that “postpone[s] the vesting” of any interest in the trust property.31 In other words, under a literal interpretation of the statute, the Delaware Tax Trap can only apply if the Second Power can be exercised in a way that extends the life of the trust. These commentators argue that one cannot extend the life of a trust that is already perpetual and, therefore, the Delaware Tax Trap cannot apply.32 If these commentators are correct, then springing the Trap would also be impossible in situations when the trust instrument opts out of the rule against perpetuities, which is permitted in at least six states and the District of Columbia.33

In direct contrast to the foregoing argument, other commentators suggest that rather than prevent the Trap from applying, the absence of a rule against perpetuities will cause the Trap to apply every time a First Power is exercised to grant a Second Power, unless the state has a so-called “alienation rule” or there is savings language in the trust instrument or in the instrument that exercises the First Power.34 An alienation rule is a rule that “voids property interests in which the power of alienation (sale) is suspended beyond a permissible period.”35 Originally, alienation rules were interpreted to mean that all trusts had to terminate within a certain period of time so that the beneficiaries could convey full ownership of the underlying property.36 Under that interpretation, an alienation rule was similar to a rule against perpetuities in that both prevented perpetual trusts. Now, however, alienation rules are typically considered satisfied if the trustee has a power of sale, even if the trust will last indefinitely.37

If a state has no rule against perpetuities and no alienation rule, according to these commentators, the Trap applies because there is no fixed period during which property interests must vest.38 James P. Spica explained the argument as follows:

In a state with no RAP-like rule] the Second Power can be exercised to postpone the vesting of interests in personal property held in trust forever, and the period that runs forever from the date of the Second Power’s exercise is certainly ascertainable, if at all, without regard to the date of creation of the First Power—and, therefore, the Trap is sprung!39

While other commentators have strongly refuted the foregoing argument, including, most prominently, Richard W. Nenno,40 numerous states have taken the finite period requirement seriously enough that, rather than repeal their rule against perpetuities, they have enacted very long perpetuities periods—360 years in Florida, 500 years in Arizona, and 1,000 years in Colorado, for example.41 It is unclear, however, whether such artificially long periods are any different in a practical sense than full repeal of the rule against perpetuities. Therefore, there is some doubt as to whether they successfully avoid the Trap.42

Other states have dealt with the risk of inadvertently triggering the Trap by enacting or codifying an alienation rule.43 For example, nearly every state that permits drafters to elect out of the rule against perpetuities in the trust instrument requires that the trustee have a power of sale or alienation for the election out to be effective.44 This requirement implicitly recognizes the existence of an alienation rule.45

Opining on the merits of the foregoing contradictory arguments is beyond the scope of this Article. The point is that there is significant ambiguity with respect to the Delaware Tax Trap in states that have eliminated their rule against perpetuities and with trusts that opt out of the rule against perpetuities. This ambiguity is not surprising given that the predecessor to section 2041(a)(3) was enacted well before the trend toward extending and repealing the rule against perpetuities. Accordingly, its drafters never anticipated these fact patterns, and its language does not make clear sense in this context.

The application of section 2041(a)(3) is more certain in states that have not repealed their rule against perpetuities. In those states, the general rule is that one can only trigger the Delaware Tax Trap by exercising the First Power to confer a presently exercisable general power of appointment.46 Said differently, there are very few states where the Delaware Tax Trap can apply if the Second Power is a limited power of appointment.47 This is because most states still follow the common law relation back doctrine mentioned earlier that says, in relevant part, that the exercise of a limited power of appointment does not restart the rule against perpetuities.48 Instead, the rule against perpetuities period continues to be measured from the date the Original Trust became irrevocable, which prevents the Delaware Tax Trap from applying.

Because of the foregoing, in many states, the only option for triggering the Trap is to exercise the First Power to confer an immediate withdrawal right.49 This may be a nonstarter for many clients, as it eliminates all of the benefits of using a trust, including creditor protection, spending restraints, and estate tax exclusion. The powerholder can take the money and run.

As discussed below, there is a potential loophole under the Uniform Statutory Rule Against Perpetuities (USRAP) that would allow the Trap to apply to successive limited powers. However, the loophole is not without added complexity.

VII. Possible USRAP Solution: Appoint to an Existing Irrevocable Trust

In his article USRAP Surprise Trigger of Delaware Tax Trap, attorney Les Raatz sets forth a creative solution for triggering the Delaware Tax Trap without conferring a presently exercisable general power of appointment.50 This solution would seem to be available in all of the twenty-six jurisdictions that have adopted the USRAP.51 It involves exercising the First Power to appoint assets to an irrevocable trust that is already in existence, which irrevocable trust confers a limited power of appointment.

Section 2(c) of the USRAP provides, “For purposes of this [act], a nonvested property interest or a power of appointment arising from a transfer of property to a previously funded trust or other existing property arrangement is created when the nonvested property interest or power of appointment in the original contribution was created.”52 This section is relevant to trusts funded in tranches. Under section 2(c), subsequent contributions to an irrevocable trust do not change the date that measures its rule against perpetuities period. Instead, only one rule against perpetuities period applies to the entire trust, beginning with the date of the initial contribution (assuming the trust was irrevocable at that time). This provision is intended to simplify administration of the trust by avoiding the need to track a different perpetuities period for each separate contribution.53

As a result of section 2(c), if a powerholder exercises his limited power of appointment over the Original Trust to appoint assets to an existing trust that contains a limited power of appointment (the Second Power), the rule against perpetuities period will be measured from the existing trust’s creation date. If the existing trust postdates the Original Trust, the Second Power can be exercised in a way that restarts and extends the rule against perpetuities. Consequently, the Delaware Tax Trap should apply.

Example 4: A is the beneficiary of a large GST non-exempt trust that her father created for her benefit (Trust One) and over which she has a limited power of appointment. A has no wealth outside of the trust and has not used any of her gift or GST exemption. As a result, it would make sense to subject the trust assets to estate tax, rather than GST tax, via the Delaware Tax Trap.

Trust One is governed by D.C. law, a jurisdiction that has adopted the USRAP.54 Under section 2(a) of the USRAP, the common law relation back doctrine continues to apply, meaning the exercise of a limited power of appointment does not restart the rule against perpetuities. As a result, in general, one can only trigger the Delaware Tax Trap with respect to a D.C. trust by conferring a presently exercisable general power of appointment. This is a problem for A, whose only child is not responsible with money.

Luckily, A’s attorney is aware of an exception to the general rule, which is set forth in section 2(c) of the USRAP. On advice of counsel, A creates an irrevocable trust for the benefit of her son (Trust Two) and funds it with $10,000. The son has a limited power of appointment over Trust Two. A can now trigger the Delaware Tax Trap by exercising her power of appointment over Trust One to appoint the assets to Trust Two.

The foregoing is a relatively new technique that, to the author’s knowledge, is untested. However, no obvious reason exists for the technique not to work.

VIII. Conclusion

The Delaware Tax Trap can be a great tool for generating tax savings under the right circumstances. However, the Delaware Tax Trap is not as readily available as one might think. Practitioners must keep the above-described obstacles in mind in determining whether springing the Delaware Tax Trap is an option for their clients.

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Endnotes

1. See I.R.C. § 2041(b)(1). If the power is limited by an ascertainable standard or is not exercisable except in conjunction with the creator of the power or an adverse party, then it is not a general power of appointment. See id. § (b)(1)(A), (C). All state statutory citations in this Article refer to the current statute unless otherwise indicated. The same applies to state regulations and ordinances.

2. See I.R.C. § 2041(a)(2).

3. See I.R.C. § 2041(b)(1).

4. See id.

5. I.R.C. § 2041(a)(3).

6. Id.

7. See Grayson M.P. McCouch, Who Killed the Rule Against Perpetuities?, 40 Pepp. L. Rev. 1291, 1294 (2013); Howard M. Zaritsky, The Rule Against Perpetuities: A Survey of State (and D.C.) Law, 2 (ACTEC 2012), https://www.actec.org/assets/1/6/Zaritsky_RAP_survey.pdf.

8. See John C. Gray, The Rule Against Perpetuities § 201 (4th ed. 1942) (“No [nonvested] 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.”).

9. See Stephen E. Greer, The Delaware Tax Trap and the Abolition of the Rule Against Perpetuities, 28 Est. Plan. 68, 68 (Feb. 2001) (“The common law Perpetuities Rule . . . provide[s] that the validity of an interest in trust created by the exercise of a nongeneral power of appointment is measured from the date the original trust was created. Thus, the measuring period for determining the validity of non-vested interests created by the exercise of a nongeneral or a general testamentary power of appointment ‘relates back’ to the date the original trust was created.”) (internal citations omitted).

10. See id. at n.7.

11. See id. at 70.

12. See Unif. Statutory Rule Against Perpetuities § 2 cmt. (Unif. Law Comm’n 1990).

13. See Greer, supra note 9.

14. Delaware lawmakers had no such reservations in 1995 when they repealed the rule against perpetuities for personal property held in trust. See H.B. 245, 138th Gen. Assemb., Reg. Sess. (Del. 1995).

15. See 38 Del. Laws 198, § 1 (1933) (predecessor to present-day Del. Code Ann. tit. 25, § 501).

16. See id.

17. See id.

18. See Powers of Appointment Act of 1951, Pub. L. No. 58-165, § 2, 56 Stat. 942 (1951).

19. See ACTEC State Death Tax Chart, https://www.actec.org/resources/state-death-tax-chart/ (revised January 27, 2020). In addition to state estate taxes, one must consider potential inheritance tax consequences as well. Five states (Iowa, Kentucky, Maryland, New Jersey, and Pennsylvania) have a state-level inheritance tax, while Nebraska has a county-level inheritance tax. See id. At least with respect to Pennsylvania, the inheritance tax does not apply to property over which the decedent had a power of appointment. See 72 P.S. § 9111(k) (“Property subject to a power of appointment, whether or not the power is exercised, and notwithstanding any blending of such property with the property of the donee, is exempt from inheritance tax in the estate of the donee of the power of appointment.”). Therefore, the Delaware Tax Trap should not cause the Pennsylvania inheritance tax to apply. See Michael Breslow, Deliberately Violating the Delaware Tax Trap to Achieve a Step-Up in Income Tax Basis, Phila. Est. Plan. Council, Spring 2016, at 1, 4.

20. This assumes that the highest marginal federal capital gains rate (20%) and the highest marginal D.C. rate (8.95%) apply together with the 3.8% Medicare surtax.

21. The regulations confirm the relevance of the trust instrument to the Delaware Tax Trap. See Treas. Reg. § 20.2041-3(e)(1)(ii) (explaining that the Delaware Tax Trap applies “[i]f the power is exercised by creating another power of appointment which, under the terms of the instruments creating and exercising the first power and under applicable local law, can be validly exercised so as to (a) postpone the vesting of any estate or interest in the property for a period ascertainable without regard to the date of the creation of the first power, or (b) (if the applicable rule against perpetuities is stated in terms of suspension of ownership or of the power of alienation, rather than of vesting) suspend the absolute ownership or the power of alienation of the property for a period ascertainable without regard to the date of the creation of the first power”) (emphasis added).

22. See Unif. Statutory Rule Against Perpetuities § 1(a)(1) cmt. (Unif. Law Comm’n 1990) (“Knowledgeable lawyers almost routinely insert perpetuity saving clauses into instruments they draft. Saving clauses contain two components, the first of which is the perpetuity-period component. This component typically requires the trust or other arrangement to terminate no later than 21 years after the death of the last survivor of a group of individuals designated therein by name or class. The second component of saving clauses is the gift-over component. This component expressly creates a gift over that is guaranteed to vest at the termination of the period set forth in the perpetuity-period component, but only if the trust or other arrangement has not terminated earlier in accordance with its other terms.”).

23. Jonathan G. Blattmachr & Jeffrey N. Pennell, Adventures in Generation-Skipping, or How We Learned to Love the Delaware Tax Trap, 24 Real Prop. Prob. & Tr. J. 75, 93 (1989).

24. This language is based, in part, on language from Wealth Transfer PlanningTM software. See generally InterActive Legal, https://interactivelegal.com/Wealth-Transfer-Planning.php.

25. See, e.g., Rev. Rul. 73-142, 1973-1 C.B. 405.

26. See id.

27. 387 U.S. 456 (1967).

28. Treas. Reg. § 26.2601-1(b)(4)(i)(B).

29. This number can be debated, as different states have eliminated or modified the rule in varying degrees. Nevertheless, Alaska, Delaware, Idaho, Kentucky, Michigan, New Jersey, North Carolina, Oklahoma, Pennsylvania, Rhode Island, South Dakota, and Wisconsin are the twelve states referenced. See Alaska Stat. § 34.27.075 (Alaska retains a rule against perpetuities, however, with respect to the exercise of certain powers of appointment, Alaska Stat. § 34.27.051, and it has an alienation rule at Alaska Stat. § 34.27.100); Del. Code Ann. tit. 25, § 503 (rule against perpetuities repealed for personal property held in trust); Idaho Code § 55-111 (Idaho still has an alienation rule at Idaho Code § 55-111A.); Ky. Rev. Stat. Ann. § 381.224 (Kentucky retains an alienation rule at Ky. Rev. Stat. Ann. § 381.225); Mich. Comp. Laws § 554.93 (rule against perpetuities has been repealed for personal property held in trust except with respect to the exercise of certain powers of appointment); N.J. Rev. Stat. § 46:2F-9 (New Jersey still has an alienation rule at N.J. Rev. Stat. § 46:2F-10); N.C. Gen. Stat. § 41-23(h) (North Carolina still has an alienation rule at N.C. Gen. Stat. § 41-23(a), and there are questions about the validity of its rule against perpetuities repeal due to a constitutional prohibition of perpetuities); Okla. Stat. Ann. tit. 60, § 175.47(C) (Oklahoma retains an alienation rule at Okla. Stat. Ann. tit. 60, § 175.47(A), and there are questions about the validity of its rule against perpetuities repeal due to a constitutional prohibition of perpetuities); 20 Pa. Cons. Stat. § 6107.1(b)(1) (Pennsylvania retains a rule against perpetuities with respect to the exercise of certain powers of appointment); R.I. Gen. Laws § 34-11-38; S.D. Codified Laws Ann. § 43-5-8 (South Dakota has an alienation rule at S.D. Codified Laws Ann. § 43-5-1); Wis. Stat. § 700.16(5) (Wisconsin has an alienation rule at Wis. Stat. § 700.16(1)). In addition to the foregoing, there are states in which the rule against perpetuities does not apply to certain trusts. See, e.g., Ark. Code Ann. § 18-3-104(8); Haw. Rev. Stat. § 525-4(6); Mo. Rev. Stat. § 456.025(1).

30. See, e.g., Memorandum from Jerold I. Horn, on Limitation of Duration, Savings Clauses, Exercises of Powers of Appointment, and the Delaware Tax Trap (May 21, 2011) expanded from Jerold I. Horn, Flexible Trusts and Estate for Uncertain Times, ch. 13 (4th ed. 2010); Charles E. Rounds, Jr. & Charles E. Rounds, III, Loring & Rounds: A Trustee’s Handbook, § 8.15.18 The Delaware Tax Trap 1196 (ed. 2017) (“If the Rule were abolished altogether, a trust could last forever, which arguably is not a finite period beyond which there could be a vesting. In other words, the trap may well have a finite-period requirement. No finite period, no trap; no trap, no springing of the trap.”); Robert J. Kolasa, Problems in Springing the Delaware Tax Trap, Tr. & Est., April 2018, at 12, 15; James M. Kane, Income Tax Planning Using the Delaware Tax Trap, (Steve Leimberg’s Estate Planning Newsletter) Mar. 30, 2015 (noting that deliberately springing the Delaware Tax Trap “likely will not work . . . for the states that have abolished the rule of perpetuities applicable to trusts, without otherwise purposely defining a stated vesting period within the trust document”).

31. Kolasa, supra note 30, at 13 (emphasis omitted).

32. See, e.g., id. at 15 (“For states that have neither a RAP nor an alienation rule, the analysis is that there can be no postponement of the vesting date of perpetual trusts because there’s no initial limitation on vesting. That is, all competent future interests should vest in the perpetual perpetuity period set by the first power, as such period of infinity isn’t changed or postponed by the second power. The Trap can’t be sprung in such jurisdictions as the postpone requirement won’t be satisfied.”).

33. See id. (“By opting out, one may be forfeiting the ability to spring the Trap.”). States in which the rule against perpetuities does not apply if the trust drafter so states in the governing instrument (provided, in some cases, that certain other requirements are met) are the District of Columbia, Illinois, Maine, Maryland, Nebraska, New Hampshire, Ohio and Virginia. See D.C. Code Ann. § 19-904(a)(10); 760 ILCS 3/1404(a)(8); Me. Rev. Stat. Ann. tit. 33, § 114(7); Md. Code Ann., Est. & Trusts § 11-102(b)(5); Neb. Rev. Stat. § 76-2005(9); N.H. Rev. Stat. Ann. §§ 547:3-k, 564-B:4-402A, 564:24; Ohio Rev. Code Ann. § 2131.09(B); Va. Code Ann. § 55.1-127(A)(8).

34. See, e.g., Greer, supra note 9; James P. Spica, A Trap for the Wary: Delaware’s Anti-Delaware-Tax-Trap Statute Is Too Clever by Half (of Infinity), 43 Real Prop. Tr. & Est. L.J. 673, 678–82 (2009). This author is only aware of two states that have neither a rule against perpetuities applicable to the exercise of powers of appointments nor an alienation rule: Delaware (with respect to personal property held in trust) and Rhode Island. However, trusts that have validly opted out of the rule against perpetuities in a state that has no alienation rule would be equally vulnerable to this argument.

35. Kolasa, supra note 30, at 12.

36. See Greer, supra note 9 (citing Ira Mark Bloom, Transfer Tax Avoidance: The Impact of Perpetuities Restrictions Before and After Generation-Skipping Taxation, 45 Alb. L. Rev. 261 (1981)).

37. See generally In re Walker’s Will, 45 N.W.2d 94, 97 (Wis. 1950).

38. See, e.g., Greer, supra note 9; Spica, supra note 34, at 682.

39. Spica, supra note 34, at 682; see also Greer, supra note 9 (“In a jurisdiction that abolished the rule against perpetuities and has no rule against the suspension of the power of alienation, there is no stated period of time within which a property interest must vest. When a power of appointment is exercised to create a successive nongeneral power of appointment, the property subject to this power will have its vesting postponed for a period of time that cannot be ascertained by referring back to the date of the instrument creating the first power of appointment. As stated in the legislative history accompanying Florida’s HB 599, ‘there is no ‘period’ ascertainable by reference to the date [a] . . . power was created, because there is no rule against perpetuities and thus there simply is no ‘period.’ Thus, if trust property is subject to the exercise of a nongeneral power of appointment, the exercise of that power to create a trust giving the beneficiaries nongeneral powers of appointment renders that property subject to estate or gift tax.”).

40. See Richard W. Nenno, Terrors of the Deep: Tax Dangers When Exercising Powers Over Trusts–the GST Regulations and the Delaware Tax Trap, 34 Est., Gifts & Trs. J. 76 (2009); see also Kolasa, supra note 30, at 15 (“Supporting the rebuttal is the empirical observation that the IRS has never adopted this theory.”).

41. See Ariz. Rev. Stat. Ann. § 14-2901A.2; Colo. Rev. Stat. § 15-11-1102.5(1)(b)(I); Fla. Stat. § 689.225(2)(4). For a description of Florida’s rationale in adopting a 360 year period, see Charles E. Rounds, Jr., Loring: A Trustee’s Handbook (2007) (“When we worked on our statute in Florida, we chose not to guess on the outcome of the Delaware tax trap issue—that is, is it a problem or not? Is infinity really a number for purposes of section 2041(a)(3)? We concluded that it would be more than sufficient to allow trusts to last for a very long period of time set by a fixed number of years. Our draft of the statute provided for a 1,000 year maximum duration. Why would anyone care for a longer term? What client cares about infinity? A fixed term of years avoided the problem[.] . . . One Senator wanted a term that was divisible by 90 years (the basic USRAP period), and another Senator did not want to go beyond 350 years. The compromise was 360 years.”) (internal citations omitted).

42. See Kolasa, supra note 30, at 15; see also Nenno, supra note 40, at 92–97 (“For purposes of analyzing the second power, a near perpetual period is the functional equivalent of a perpetual period, and it seems wrong to treat it as anything else within the context of the Trap.”).

43. See, e.g., Alaska Stat. § 34.27.100; N.J. Rev. Stat. § 46:2F-10; N.C. Gen. Stat. § 41-23(a). To address the Delaware Tax Trap risk, Alaska enacted both an alienation rule (Alaska Stat. § 34.27.100) and a 1,000-year perpetuities period that applies when a limited power of appointment is exercised to create another limited power of appointment or a general testamentary power of appointment (Alaska Stat. § 34.27.051). See generally David G. Shaftel, Alaska Refines Its Abolishment of the Rule Against Perpetuities to Avoid the ‘Delaware Tax Trap, State Tax Notes, May 29, 2000 at 1, available at http://shaftellaw.com/article11.html (stating seventeen states eliminated or are eliminating the rule against perpetuities).

44. See, e.g., Idaho Code § 55-111A; K.Y. Rev. Stat. Ann. § 381.225; N.J. Rev. Stat. § 46:2F–10.

45. See, e.g., D.C. Code § 19-904(a)(10) (providing that the rule against perpetuities does not apply to “[a] trust in which the governing instrument states that the provisions of this chapter do not apply to the trust and under which the trustee, or other person to whom the power is properly granted or delegated, has the power under the governing instrument, applicable statute, or common law to hold, sell, lease, or mortgage property for any period of time beyond the period that is required for an interest created under the governing instrument to vest”). Cf Va. Code Ann. § 55.1-12(A)(8) (imposing no sales requirement as part of the election out option).

46. See Les Raatz, USRAP Surprise Trigger of Delaware Tax Trap, Est. Plan. Mag. (May 2016) at 22, 24.

47. Under Arizona law, one can re-start the rule against perpetuities period upon exercise of a limited power of appointment by so providing in the Deed of Exercise. See Ariz. Rev. Stat. § 14-2905.C (“For the purposes of this Article, if the person who exercises a power of appointment so provides in the exercise, a nonvested property interest or a power of appointment . . . is created when the power is irrevocably exercised or when a revocable exercise becomes irrevocable.”). Under Delaware law, the exercise of any power of appointment (limited or general) restarts the rule against perpetuities period, although there is a special rule that applies to GST exempt and GST grandfathered trusts. See Del. Code Ann. tit. 25, §§ 501, 504. Theoretically, this should trigger the Delaware Tax Trap even if the Second Power is a limited power of appointment, although reconciling the provision with Delaware’s repeal of the rule against perpetuities for personal property held in trust is difficult. Moreover, as discussed above, some commentators argue that one can never trigger the Trap in a perpetual trust jurisdiction.

48. See Greer, supra note 9 and accompanying text.

49. See, e.g., N.Y. Est. Powers & Trusts Law § 9-1.1 (stating New York continues to follow the common law rule against perpetuities).

50. See Raatz, supra note 46, at 28–29.

51. See Zaritsky, supra note 7, at 2.

52. Unif. Statutory Rule Against Perpetuities § 2(c) (Unif. Law Comm’n 1990).

53. See id.

54. See D.C. Code § 19-902.

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Kasey A. Place

Kasey A. Place is a partner in the estate planning group at Ivins, Phillips & Barker, Chtd. in Washington, D.C.