Article: Dynasty Trusts - Keep Your Family Business in the Family


	Jim Schmidt

Dynasty trusts: preserving wealth for future generations

No longer the sole domain of the very rich, "dynasty trusts" offer you an excellent way to avoid taxes and preserve your estate

During the early part of this century, America’s wealthiest families commonly established a "dynasty trust" to avoid estate taxation and to preserve their wealth for future generations of family members.

For families like the Rockefellers and Kennedys, the idea was to hold assets in trust for as long as possible without distributing them outright to any beneficiary. The trust assets continued to grow in value, providing a rising stream of income.

For decades, the Internal Revenue Service argued that transfer taxes should be levied on wealth as each generation benefited from it. Finally, in 1976, Congress created the "generation skipping transfer" (GST) tax. The tax applies to transfers in excess of $1 million from a grandparent to grandchildren or later generations, whether or not the assets are put into a trust. (The exemption for married couples is $2 million.) The tax is imposed at a flat 55%, the highest marginal estate and gift tax rate. And it is levied on top of any estate and gift taxes that are due.

Still an attractive option. The GST tax legislation may have dealt a blow to the very rich, but, for less wealthy millionaires it preserved the passage of significant wealth through multiple generations, without estate or transfer taxes, and the beneficiaries are able to use the property as though they had outright ownership. A trustee should acquire assets for the "use" of the beneficiaries rather than to make distributions to them. The exempted assets may include such assets as closely held stock, limited partnership interests, financial assets, artwork, life insurance, real estate, family heirlooms, cash, etc.

The advantages of a dynasty trust go beyond tax avoidance; it can also protect beneficiaries against claims of creditors or divorcing spouses. Because the beneficiaries don’t actually own the assets of the trust, they are immune to such claims. This is an important factor if you worry that your assets will wind up in the hands of people outside the family.

Due to the long-term nature of a dynasty trust, its terms – e.g., how trust income and principal will be distributed – should be flexible. You could, for example, provide incentives for your heirs to accomplish certain goals, such as graduating from college, obtaining employment (i.e., $1 of trust income for every $2 of earned income), starting a business, etc. If the trust is properly established, the assets placed in the trust – as well as all future appreciation on those assets – remain free from federal and state transfer taxes on future generations so long as the assets remain in the trust.

The million-dollar exemption can be worth much more than its face value if it’s used in conjunction with a dynasty trust. Here’s how: If you put an asset worth $1 million into a trust for your grandchildren, that asset is valued at the amount it was worth at the time it became trust property. As long as the asset remains in the trust, it can appreciate in value without being subject to estate taxes.

Preferred trust assets. Dynasty trusts are particularly useful for assets that you don’t intend to sell for a long period of time and that are likely to appreciate in value.

Real estate. For example, you convey to the trust your vacation home. The trustee can allow one or more of your grandchildren to use the home. As long as the trust retains ownership, the value of the home won’t be taxable in your grandchildren’s estates when they die, as it would be if it had been given outright, and subsequent generations can go on using it.

Life insurance. Another asset that lends itself to such trusts is life insurance. If you establish an irrevocable trust to purchase a policy that pays a substantial benefit on your death, with several successive generations of family members named as beneficiaries, your estate can avoid tax on the benefits when you die and when future generations follow you. Only the premiums are put into the trust; thus, the insurance death benefit – which is likely to be many times the premiums paid and can be more than the amount of the exemption – would be exempt from the GST tax.

For example, your trust buys a $5 million policy and pays $800,000 in premiums during your lifetime. You will have transferred $5 million in benefits but used up only $800,000 of the $2 million exemption available to you and your spouse. That would leave you another $1.2 million to give to future generations, free of GST tax.

Questions

Is a dynasty trust applicable in all situations? No. If the next generation (i.e., your children) is the only generation you care about, a dynasty trust is unnecessary. Getting back to the life insurance example, you could simply make your children the owners of the policy, and the death benefits wouldn’t be subject to estate tax at your death.
How long can a dynasty trust last? Trusts established under Arizona law can last until 21 years after the death of the last to die among beneficiaries who were alive at the time the trust was created. After that time, trust assets must be distributed to the remaining beneficiaries.
Who should serve as trustee? Although a family member could serve as trustee, it’s a good idea to name an institutional co-trustee or successor trustee, such as a bank trust department. Since a dynasty trust is designed to continue beyond a single generation, you don’t want to place with a single individual the sole responsibility for overseeing the trust. A bank may also be preferable to a family member if you want professional management of the assets and an objective view of the needs of the beneficiaries.
What are the trustee’s powers? The trustee’s powers and duties are essentially the same as those in a conventional trust, with this addition: The trustee should be given the ability – and the obligation – to terminate the trust if maintaining it no longer makes sense.
Will a dynasty trust alone meet all of my objectives? It probably won’t, but it will give subsequent generations a good start toward a secure financial future.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.