In the early 1900’s, an elite group of America’s industrialist and entrepreneurs had accumulated a vast amount of wealth. Along with this wealth came power. Oil, steel, and the emerging automobile industry provided John D. Rockefeller, Andrew Carnegie, and Henry Ford with combined fortunes, which in current dollars, would rival if not exceed those of Bill Gates and Warren Buffett.
Along with wealth and power came the desire for control. The big three, Rockefeller, Carnegie and Ford, were under the constant scrutiny of the United States government. The Department of Justice worked very hard to regulate these men and their industries. Through the use of strategic planning (and clever lawyers), many of the industrialists would find ways around regulations and taxes.
Rockefeller, Carnegie, and Ford all lived long enough to see the United States adopt the modern estate tax rules in 1916; each of them took this as a personal attack. When the federal estate tax was initially enacted in 1916, it was only 10%. However, at the tax’s peak between 1941 and 1976, it would reach 77%. Granted the tax was only on the wealthiest Americans, but these three were the wealthiest Americans. At the time of each man’s death, their estates easily put them in the maximum tax bracket:
Andrew Carnegie died in 1919 and the top tax rate was 25%
John D. Rockefeller died in 1937 and the top tax rate was 70%
Henry Ford died in 1947 and the top tax rate was 77%
All three men’s legal teams agreed. The answer to the problem was to transfer large amounts of their wealth into one or more trusts while they were still living. The Dynasty Trust was born.
What is a Dynasty Trust?
A Dynasty Trust is a long-term trust formed to transfer wealth from one generation to another without incurring estate and gift taxes. The Dynasty Trust’s key characteristic is its duration. In the days of Rockefeller, Carnegie, and Ford, the trust could survive for 21 years after the death of the last beneficiary who was alive when the trust was set up. It can theoretically last for more than 100 years. This is known as the Rule Against Perpetuities. Given the size of the fortunes of many of the great industrialists, this was a huge tax savings.
How did it Work?
The grantor would establish one or more trusts. The trust would normally name the grantor’sspouse, children, grandchildren and future generations as the beneficiaries. The grantor would irrevocably place large amounts of his fortune in these trusts. The grantor would appoint a trustee or trustee committee to oversee the administration of the trust. Often institutional trustees were named. In the case of individual trustees, provisions would be established for the appointment of successor trustees upon the death of the named individual.
The trust document would contain the instructions to the trustees with regard to the disbursement and administration of the trust assets. These instructions were individually tailored to meet each family’s current and perceived future needs. The trust would also contain the instructions for the termination of the trust at such time as the Rule Against Perpetuities required final disbursements.
Why did it work so well?
This question can be answered very simply. In 1916 the U.S. enacted the modern day federal inheritance tax. Gift taxes weren’t imposed until 1932. So, in theory any wealthy industrialist could transfer almost his whole fortune into a trust, and it was not subject to tax because it was a gift.
The money could remain in trust for 100 years or more in some circumstances. The benefit of the wealth was passed from generation to generation without the imposition of inheritance taxes at the death of the beneficiaries. By 1932 Congress had caught on to this loophole. They closed it by enacting legislation capping lifetime gifts at $50,000, but allowing for an annual exclusion of $5,000 per donee.
What is the Rule Against Perpetuities and is it Still Relevant?
The Rule Against Perpetuities originated in England in 1682 after a family squabble over titles and succession. In the parts of the United States which were originally British colonies, the laws of England became also our common law. Black’s Law Dictionary, defines this concept by stating “A grant of an estate must vest, if at all, no later than 21 years after the death of some person alive (or in utero) when the interest was created.”
As an example, The father of a family died at age 85. At his death, a trust was created. At that time he had a living great-grandchild who was 1 year old. The trust would have to dissolve 21 years after the child who was 1 died. Assuming the 1 year-old lived to be 90, the trust could last for 111 years.
In many respects the Rule Against Perpetuities still exists just to test the will of many first year law students. Over 21 states have now either repealed the rule or passed other legislation to render it completely irrelevant. If you reside in a state that has not revoked the Rule Against Perpetuities, don’t worry. The majority of the states who have modified or revoked the Rule, also allow non-residents to establish a trust under their laws. Many require your funds to be held in an institution located within that state.
Can a Dynasty Trust Benefit Someone Who is Not on the Forbes Top 500 Wealthiest People List?
Absolutely. The inheritance and gift tax laws today are very favorable for the creation of this type of trust for individuals and couples who are not billionaires. Using lifetime gift-tax and estate-tax exemptions (in 2016, $5,450,000.00 per person) it is possible to create a very nicely funded Dynasty Trust. Assuming you take advantage of the laws of a state that has repealed the Rule Against Perpetuities, the principal will never be subject to estate or inheritances taxes.
Income taxes will have to be paid on the earnings of the trust. However, if earnings are distributed to beneficiaries, the taxes are paid by the beneficiary. This works nicely if earnings are being distributed to students or beneficiaries in marginal tax brackets who need the financial help the trust can provide. Also, you can work with your tax professional to develop an investment structure to reduce taxes.
What are the Other Benefits a Dynasty Trust can Provide?
We live in a financially unstable world. Traditional lending sources are very cautious about making loans. It is not just first time home buyers that feel the squeeze of the credit crunch. Time Magazine ran a feature regarding the fact that former Federal Reserve Chairman Ben Bernanke was recently turned down for a refinance. In essence your Dynasty Trust can also act as your private family bank.
The trust itself is irrevocable, but that does not equal inflexible. As long as the money is not reverting to a grantor, a trust committee can be given broad powers to set criteria for distribution in the future. This can include charitable giving, or incentive based giving to beneficiaries. Incentive based giving can include large gifts upon completion of college, payment for educational expenses, or providing stipends for beneficiaries who choose to work in underpaid professions that provide for the greater social good. The impact of a Dynasty Trust goes far beyond the initial investment.
This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.