Legislature(1999 - 2000)
03/22/2000 01:14 PM House JUD
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* first hearing in first committee of referral
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+ teleconferenced
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SB 162 - RULE AGAINST PERPETUITIES [HB 219 was the companion bill heard previously in the House Judiciary Standing Committee.] REPRESENTATIVE GREEN announced that the first order of business would be CS FOR SENATE BILL NO. 162(JUD), "An Act relating to the rule against perpetuities, nonvested property interests, and powers of appointment; and providing for an effective date." [SB 162 was sponsored by the Senate Judiciary Committee by request. The companion bill, HB 219, had been heard and moved out of the House Judiciary Standing Committee on 5/12/99. In committee packets was proposed House CS for CSSB 162, Version M (1-LS0485\M, Chenoweth, 3/6/00).] Representative Green asked Lesil McGuire, Committee Aide, to make opening remarks. Number 0070 LESIL McGUIRE, Legislative Assistant to Representative Pete Kott, Alaska State Legislature, speaking as the Committee Aide to the House Judiciary Standing Committee, explained that the companion bill [HB 219] had already passed through this committee. There was a little bit of confusion in the process, however, and the bill version [that passed out of the Senate] had a glitch. MS. McGUIRE advised members that in April 1997, the legislature amended AS 34.27.050(a) of Alaska's trust law to include a [paragraph] (3), which made the rule against perpetuities inapplicable to those trusts where a trustee has the ability to make a distribution to a person living when the trust is created. In adding this language, the legislature in effect abolished the rule against perpetuities, making it possible to create a trust that can continue forever. The abolition was significant for Alaska's trust business, booming since 1997. With careful drafting, perpetual trusts can avoid all federal estate tax and continue to grow for the use of successive generations; that is the goal in creating those trusts. The tax advantage has caused at least ten states to abolish the rule against perpetuities, and five others have pending legislature that would do so. MS. McGUIRE told members that the legislation before the committee seeks to fix a problem discovered by a group of Anchorage trust and estate attorneys. Affectionately called the "Delaware tax trap" - because when Delaware enacted something similar to this legislation, the Internal Revenue Service (IRS) found a way to collect tax on that - this problem is fatal to numerous trusts created in Alaska since passage of the 1997 Act. MS. McGUIRE explained the problem: Any person who creates a perpetual trust usually wants to give the trust beneficiaries the power to direct the disposition of their assets at death, as a means of making the trust more flexible; that is the power of appointment. Under present law, however, if a beneficiary exercises a special power of appointment by directing that the trust assets continue in trust for the benefit of an individual who is the beneficiary, and if that beneficiary also is given a special power of appointment in the trust, then the trust assets eventually will be subjected to either an estate or a gift tax liability. MS. McGUIRE told members the problem is fixed in this bill by stating that the trust will vest in 1,000 years. Practically speaking, that makes it perpetual but provides an end-point; for tax purposes, that seems to cure the "Delaware tax trap" problem. Ms. McGuire deferred to Steve Greer, who she said had provided effective explanations to herself and Chairman Kott in Anchorage a month before. Number 0420 STEPHEN GREER, Attorney at Law, came forward, noting that he is a sole practitioner in Anchorage who focuses on estate and gift tax planning. He told the committee this is a technical bill, remedial in nature. He agreed that the rule against perpetuities was rendered ineffective in April 1997 so that trusts could go on forever, and that there is a tax reason for wanting to do this; however, it created the little-known problem known as the "Delaware tax trap." He said he wouldn't be surprised if all 50 states have similar legislation within five years. Number 0482 REPRESENTATIVE CROFT asked what tax consequences there are to abolishing the rule against perpetuities. MR. GREER posed an example where he wants to create a trust, using his own money, for Ms. McGuire. He can give Ms. McGuire rights to this trust that are really almost tantamount to outright ownership, and as long as he falls short of that threshold, the properties in the trust won't be subject to estate tax at her death; they can pass on to her children, and to their children. The rule against perpetuities says that cannot be. It says all interest must vest "within the lives in being" at the time the trust is created - Ms. McGuire's life, in this instance - plus 21 years, at which point the trust must terminate and the assets must be distributed to those beneficiaries. MR. GREER continued. If it were possible to have a trust continue forever - because the rule against perpetuities has been done away with - he could give Ms. McGuire the following: the right to be trustee of her own trust; the right to all of the income that the trust generates; and the right to as much of the principal as she determines, in her position as trustee, is necessary for maintenance and support. Furthermore, he could give her a special testamentary power to appoint those assets to other beneficiaries at her death, either outright or in trust for the benefit of those beneficiaries. MR. GREER emphasized that giving Ms. McGuire that testamentary special power of appointment is incredibly important for these kinds of trusts, because if they can run on in perpetuity, one wants the beneficiaries - whose properties these really are - to be able to change the disposition of that trust to meet changing conditions. In this instance, his own trust would probably say that if Ms. McGuire doesn't exercise this testamentary special power of appointment at her death, [the trust assets] will go to her children in equal shares, per stirpes. MR. GREER continued. If one of Ms. McGuire's children has a disability, for example, Ms. McGuire could exercise her testamentary special power of appointment and leave that property in trust for the benefit of that child. Or if she had two children, a doctor and a drug addict, she could diminish the amount that the drug addict would receive, or at least leave it in trust for that child, and give the other share to the child who has done well in life and has worked hard. MR. GREER again emphasized the importance of including the special power of appointment. He said this is why all of these states are getting in line to abolish the rule against perpetuities. When he creates this trust, he has to allocate an amount of generation- skipping tax exemption equal to the value of the trust when he funds it, but from that point forward, this trust can grow to whatever value. As long as he doesn't give those beneficiaries rights that exceed the threshold which he had just described, these properties can pass on and on and on, in further trust. This legislation allows people to essentially create a fund that can go on forever without being subject to a federal estate tax. Number 0766 REPRESENTATIVE CROFT said the object, then, is to give Ms. McGuire the money; if it were given straight out, then at the end of her life she would have to pay estate tax. This gives it to her, in effect, with almost all of the rights of it but in a way that avoids estate tax forever. MR. GREER affirmed that, saying that is the law now. He reiterated that within ten to fifteen years all fifty states will have similar legislation; he pointed out that most of the ten states onboard now came onboard within the last three years, and five others have pending legislation. "We all wonder at what point the federal government's going to get tired of this," he commented, saying the federal government is in a state of flux with the whole estate and gift tax regime. "But all we can do is form trusts on the basis of the law as it now stands, and that's the way it is right now," he concluded. Number 0835 REPRESENTATIVE GREEN asked: If Ms. McGuire has the authority to modify the trust and pass that right on to her doctor child [in the hypothetical situation], how does that differ from having full authority? MR. GREER responded that this is a tax definition; that is all it is. If he said that [Ms. McGuire] has the power to appoint these assets at her death to her estate or to creditors of her estate, then she has a general power of appointment, and all that property would be subject to estate tax at her death. "As long as you exclude those two individuals, you can include everybody else," Mr. Greer said, "and yet, under ... the federal estate and gift taxation of what defines a general power of appointment and a special power of appointment, ... it will not be included in her estate because it's considered to be a special power of appointment." Number 0905 REPRESENTATIVE GREEN said without the rule against perpetuities, then, his own [trust] could go on for another 1,000 years. However, he thought that was the whole purpose of the rule against perpetuities. MR. GREER agreed the trust could go on and on. He said this is a "technical thing" and isn't meant to get into the argument of whether to abolish the rule against perpetuities, which has already been done. This tries to fix a problem, to give beneficiaries of a perpetual trust a special power of appointment so that the trust can retain flexibility. There is even a public policy reason for that, he suggested. However, a provision in the Internal Revenue Code passed in 1951, found under Sections 2041(a)(3) and 2512(d), says that if Ms. McGuire, in this case, takes her special power of appointment and creates a trust for the benefit of her child, in turn giving that child a special power of appointment regarding those assets in trust at his or her death, that sets off the "Delaware tax trap." She would be considered to have created a general power of appointment, and all that trust property would be thrown into her estate. MR. GREER acknowledged how technical this area is. Offering some history, he said at first the desire was to abolish the rule against perpetuities and make that clear, instead of doing this sleight of hand that essentially rendered it ineffective. Therefore, they had proposed SB 162. However, Mr. Greer had started wondering whether that created a "Delaware tax trap" problem; he knows national experts and had posed this question to others. He had wanted to actually initiate the "Delaware tax trap" to get out of the generation-skipping tax problem. He had talked to a University of Tennessee law professor, Amy Hess (ph) and then to Jonathan Blattmachr, who was instrumental in the legislation and who at first dismissed the idea. MR. GREER provided further history, noting that he had continued his correspondence. He mentioned the University of Miami estate planning program, from which he had graduated, then said Bruce Stone (ph), who heads the legislative drafting committee in Florida, had put out legislation for that state; that legislative history included a concern that many states which had abolished the rule against perpetuities had stumbled into the "Delaware tax trap." With Mr. Stone's corroborative report, Mr. Greer had returned to Mr. Blattmachr and his own attorney group, who saw the need to fix this problem. His solution, then, was to abolish the rule against perpetuities, but with respect to this limited circumstance where one takes a special power of appointment and exercises it to create a further special power of appointment, the property subject to that special power of appointment must vest within 1,000 years. Number 1151 REPRESENTATIVE CROFT asked whether there wasn't some logic, however, to the decision interpreting the [1951] tax code. If one exercises a special power to grant that special power again, isn't that coming so close to a general power that it is general? And shouldn't taxes be paid at that point? "Or no one should ever pay estate tax," he added. MR. GREER said that is a philosophical question. REPRESENTATIVE CROFT suggested that it is a public policy discussion which legislators should be concerned with. MR. GREER responded that the legislature took the position in 1997 that abolishing the rule was a good thing, and other states apparently feel the same way. This is probably the most important piece of legislation that exists as far as trying to create a trust industry here in Alaska, he said. Many states have recently enacted these statutes and fallen into the "Delaware tax trap"; he cited Rhode Island as an example. Mr. Greer said he has even declined to write an article in the country's most prestigious estate planning magazine on this unless [Alaska] fixes its legislation to cure this; he doesn't want to highlight any other states' problems, which would, in turn, highlight Alaska's problems. If this isn't fixed, he believes millions or possibly hundreds of millions of dollars are at stake. As far as the estate and gift tax question, he asked whether that isn't a congressional debate, in the federal government's hands. Number 1353 REPRESENTATIVE GREEN said this sounds like a really fine line. He asked whether it is certain that the IRS would agree that this change [to 1,000 years] still would not be quite full ownership. MR. GREER said it would fix the problem, for a number of reasons. He had submitted the draft [legislation] to Jonathan [Blattmachr]'s law firm, which he believes is composed entirely of Harvard Law School graduates and which has represented Jackie Onassis and the Rockefellers, for example; he had received revisions back as recently as last month. Mr. Greer stated: Yes, we think it will work ... To be honest with you, we know it'll work with respect to all future trusts because this legislation [hinges itself] on a Wisconsin statute; in fact, we just mimicked the Wisconsin statute. And the [United States] Tax Court, in the Estate of Murphy [Murphy, Mary Margaret, Estate of v. Comm.], says, "Yes, indeed, it does work if the statute reads this way." But we had to go further. We had to fix all those existing trusts that were created since April of '97. And so this legislation does two things. We've actually got two lines of defense here. We've got the Estate of Murphy, and we go further and we set up a perpetuity period of a thousand years in that limited circumstance where a special power is exercised to create a further special power. REPRESENTATIVE GREEN surmised that when the thousandth year is reached, some taxes would have to be paid if the trust still exists. MR. GREER clarified, "Well, someone's got to get the money." Number 1371 REPRESENTATIVE MURKOWSKI referred to the retroactivity to April 1, 1997. She asked how many trusts are in this "Delaware tax trap." She further asked whether this remedies the situation not only for trusts created after the date of passage of SB 162 but also for other trusts caught in the trap, without having to go into those individually to fix them somehow. MR. GREER said the answer is yes to all. He cannot imagine a competent attorney setting up a perpetual trust without giving beneficiaries special powers of appointment, which provide flexibility to meet changing conditions over time. He noted that [Internal Revenue Code] Section 2041(a)(3) is complicated but essentially states that to determine whether the "Delaware tax trap" will be set off, one must look at local law. If, by looking at local law, the time in which a property subject to that special power of appointment vests cannot be ascertained without looking back to the date of the creation of the instrument creating the first special power of appointment, then the "Delaware tax trap" exists. He likened it to rocket science. MR. GREER explained that by changing the law to read that this property has to vest within 1,000 years of that date of creation of the original trust instrument, it now falls outside of the literal reading of 2041(a)(3), and "we're home free." He referred to retroactivity. Noting that the ability to create a perpetual trust has only existed since April of 1997, he said they are looking at perpetual trusts created between then and the date of enactment for this current bill. The solution is already found in our law, adopted from the uniform statutory rule against perpetuities passed by the national commissioners. In that law, [AS] 34.27.07(a), the second sentence says that if one exercises a special power of appointment, the law in effect at the time that occurs will be the law that controls. If Alaska were to pass a law that is different from what the law was back then, someone who exercises a special power of appointment with respect to one of these old trusts would look to the laws that now exist. Mr. Greer explained: And the reason they did that was ... because previous to enacting this law, we only had the common law rule against perpetuities, which says all property interests must vest within the lives in being plus 21 years. And the uniform statutory rule said, "You know, this is a pretty difficult thing to understand." I think in law school, if you can remember, ... that was the one area of law we [were] told you could never malpractice in; it's just too complicated for anyone to understand. ... What they did with the uniform statutory rule against perpetuities, they put in a wait-and-see provision of 90 years: ... "We'll wait and see whether or not ... these property interests vest within this 90-year period, okay? And this will affect all those old trusts that you may have created, where you haven't exercised the special power of appointment .... We'll wait and see if it vests within the 90-year period from the date that you exercise that special power of appointment." So, ... the body of law is already there to make it retroactive back to April of '97. MR. GREER remarked that the complexity of the rule against perpetuities is one reason why a lot of states have decided to abolish it. He asked what good a law is that no one understands. Number 1706 REPRESENTATIVE MURKOWSKI referred to Mr. Greer's mention of comments from Florida. She asked whether Alaska is the first state to figure out how to get around this "Delaware tax trap" with legislation like that before the committee. MR. GREER answered yes, except that if Alaska essentially had abolished the rule against perpetuities back in April of 1997 and had put in its place another statute, a rule against the suspension of the power of alienation, "we would have been home free." He added, "We wouldn't even have to address this problem because under the Estate of Murphy, we ... wouldn't have to reckon with this 'Delaware tax trap.' But we did not." Mr. Greer told members, "What's novel about our statute is this: ... it provides ... a vesting regime with respect to property interests that are subject to the exercise of this special power of appointment; and we're saying that it has to vest within the 1,000-year period." He indicated the 1,000-year period was an idea offered by a Florida professor. Number 1780 REPRESENTATIVE GREEN asked what happens if ten years from now the legislature modifies this law. Could that negate this? Would [Ms. McGuire's] hoped-for estate be "tax due" at the end of her lifetime? Once established, could her estate falter? MR. GREER said no, it is fixed; this is just a fixing statute. However, there is no guarantee that what they do will be good ten years from now. "And we're all wondering what the federal government is going to do," he added. In response to a further question about what happens if the federal government passes superseding legislation, Mr. Greer suggested the need to keep current no matter what the area of law or life. Number 1906 REPRESENTATIVE ROKEBERG referred to Section 7 of the bill and said he was trying to understand the thrust of that. Mentioning the hypothetical situation discussed earlier by Mr. Greer, he asked how one manages the corpus of the trust regarding selling [assets], for example, if one is "restricted from your power of alienation." MR. GREER suggested that the public policy reason behind the rule against perpetuities is to ensure free marketability of the property in trust. He added, "Well, in a sense we're doing that now." He said previously [Alaska] never had a rule against the suspension of power of alienation; that rule says one must always be able to give someone the ability to sell property, which makes it transferable. The gist of Section 7 is that one cannot suspend that power for more than 30 years; in other words, even though this trust can continue on forever, one has to be able to give the trustee the ability to sell the property while it is in trust. That is one good reason for including Section 7. MR. GREER pointed out that the principal reason for including Section 7, however, is this is what the Estate of Murphy hinged on. He commented that the [United States] Tax Court and the IRS - the [Department of the] Treasury - have both misinterpreted the rule against perpetuities, and he really wonders what they were reading. He noted that the seminal article on this, "Perpetuities in a Nutshell," was written by Profession Leach (ph) in 1934 in the Harvard Law Journal. MR. GREER told members that, in short, the tax court says that some states have characterized their rule against perpetuities as a rule against the remote vesting of property, whereas other states have characterized theirs as a rule against the suspension of the power of alienation. In the latter instance, as long as the special power of appointment relates back to the date of the original trust instrument, the "Delaware tax trap" will not be violated. The irony is that one can give a trustee the power to sell property - which every trust would do - and never violate the rule against the suspension of the power of alienation; nonetheless, the property can still stay in trust forever and still be excluded from estate taxes that pass from one generation to the next. He said that really makes one wonder if the [Department of the] Treasury knew what they were doing. MR. GREER noted that the tax court, in fact, pointed that out, saying, "But you wrote the regulations, and now you're stuck with it." Furthermore, the IRS acquiesced and now agrees they will be stuck with this decision. However, the big point is what will happen down the road and whether Congress will put forth a rule that says these trusts cannot go on forever without being subject to some sort of estate and generation-skipping tax. "But that isn't the case now," Mr. Greer added. Number 2106 REPRESENTATIVE ROKEBERG requested confirmation that the State of Alaska has no inheritance taxes. MR. GREER responded that it does, but it works like this: "If you pay the federal government a dollar, ... the state may get 20 cents out of that dollar - it's not even really that high - ... but the federal government will get the remaining 80 cents. ... You don't end up paying $1.20; ... it's a type of revenue sharing." REPRESENTATIVE ROKEBERG posed a scenario where one uses a special power [of appointment] to change the nature of the asset mix. He asked whether one must keep a trail of the corpus of the principal at all times. He stated his understanding that Mr. Greer had said one even could use up a substantial portion of the principal of the trust. He said presumably there would be some remainder to be passed on to the next generation. MR. GREER agreed but said that with the special power of appointment one could actually say that the trust is coming to an end and distribute the assets. It only continues if that is desired. One wants the special power of appointment so that one can terminate the trust down the line. Number 2204 REPRESENTATIVE MURKOWSKI recalled that when [HB 219] was heard in committee previously, it was addressing that the charitable lead trust aspect had been overlooked. She said she assumes that with the newly revised and updated SB 162, they are rolling all the good things from the former versions into this one. MR. GREER affirmed that and said he feels comfortable with it. Number 2304 DAVID SHAFTEL, Attorney at Law, testified via teleconference from Anchorage. He agreed that a number of states have abolished the rule against perpetuities for tax and non-tax reasons. A number have avoided the glitch by prohibiting suspension of the power of alienation; when they combine that with the use of the power of sale, they don't have the problem that Alaska and a few other states have stumbled into, the "Delaware tax trap," which is obsolete but nonetheless exists in the law. All this bill does is provide a way to avoid that glitch. The unfortunate alternative would be to not use special powers of appointment in these perpetual trusts, which are very popular right now, because those special powers of appointment provide flexibility so that generation after generation can make adjustments. This amendment places Alaska on the same footing as other states that have already done this in a little different way. Mr. Shaftel concluded: I think it's a very good bill. There are a number of us up here who have discussed this and looked at it. And, as I've mentioned to you before, we're an informal group of estate planning attorneys who have a lot of experience in this area. There have been a lot of these trusts created by Alaskans. They have created them with the expectations that they will get the same ... advantageous treatment that the residents of other states are getting in their estate planning. ... And so, it really is very important, in my view and the view of our informal group, that this glitch be remedied. So I'd urge your support of ... this bill. Number 2430 REPRESENTATIVE GREEN asked Mr. Shaftel whether he concurs with Mr. Greer that until the law is changed, either at the federal or state level, people who set up these trusts would be protected with the passage of this legislation. MR. SHAFTEL affirmed that. Number 2449 DOUGLAS BLATTMACHR, President and Chief Executive Officer, Alaska Trust Company, testified via teleconference from Anchorage, agreeing that the bill [Version M] corrects a glitch. He concluded, "Probably 99 percent of the trusts that we have, have that provision in there, so we would strongly recommend that the committee approve this legislation." Number 2465 RICHARD THWAITES, JR., Attorney at Law, testified briefly via teleconference from Anchorage that he supports the legislation [Version M], a worthwhile change to the statute that would assist in "the planning that we do" and would keep Alaska in the forefront. TAPE 00-35, SIDE B Number 0001 MR. SHAFTEL, in response to a question by Representative Rokeberg, emphasized the importance of retroactivity and the immense popularity of perpetual trusts, which have been set up by Alaskans and nonresidents of Alaska who desire that perpetual characteristic for their trusts. The bill is designed to provide that type of benefit. "I don't see any downsides, nor have I heard any downsides discussed of the retroactivity," he concluded. "It's a pure positive." REPRESENTATIVE ROKEBERG stated: Just for the record, Mr. Chairman, I would assume that the public policy that this legislature decided on in '97 when we introduced the first legislation to establish the trust, this is merely a ratification thereof, making sure that those particular instruments that were created by that policy are retained in place and not changed. And this is a vote of confidence, if you will, for that. Number 0060 REPRESENTATIVE GREEN asked whether most attorneys are aware of this in Alaska or it is only shared by a few. MR. GREER reiterated that estate tax planning is very complicated; typically, it requires him to spend two months every year, at no pay, on continuing legal education, and Mr. Shaftel does the same. The people who engage in this must dedicate their lives to it. He said he had attempted to share this problem with the entire estate planning section of the bar association on countless occasions; however, perhaps only five or six people really understand it. REPRESENTATIVE GREEN thanked Mr. Greer, saying he believes it is an extremely important issue. Noting that there were no further testifiers signed up, he closed public testimony. He asked whether there was any discussion; none was offered. Number 0132 REPRESENTATIVE ROKEBERG made a motion to adopt the proposed HCS for CSSB 162, Version M [1-LS0485\M, Chenoweth, 3/6/00], as a work draft. There being no objection, it was so ordered. REPRESENTATIVE ROKEBERG made a motion to move HCS CSSB 162, Version M, from committee with individual recommendations and the attached zero fiscal note. There being no objection, it was so ordered and HCS CSSB 162(JUD) was moved from the House Judiciary Standing Committee.
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