Legislature(2001 - 2002)
02/23/2001 01:09 PM House JUD
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* first hearing in first committee of referral
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HB 34 - RULE AGAINST PERPETUITIES Number 0040 CHAIR ROKEBERG announced that the first order of business would be SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 34, "An Act relating to the statutory rule against perpetuities, to nonvested property interests and trusts, and to the suspension of the power of alienation of property; and providing for an effective date." Number 0063 REPRESENTATIVE LESIL McGUIRE, Alaska State Legislature, sponsor, said that as complicated as the rule of perpetuities is, SSHB 34 is very simple. In 1997 Alaska passed the Trust Act, which was an attempt to bring Alaska up to the standards of other states such as Delaware - a state considered to be forward-thinking with regard to trust laws. She noted that Alaska has a unique tax structure, in that it is virtually nonexistent. To take advantage of this fact and create a new industry in Alaska, the Trust Act was passed. Through passage and revisions of the Trust Act, a group of attorneys discovered problems with the original legislation. Alaska's attempt to abolish the rule against perpetuities was not entirely successful. Current law still rendered trusts subject to estate and gift tax on the federal level. Last year, SB 162 was an attempt to clarify that the rule against perpetuities was abolished for all practical reasons in Alaska, in other words, to allow for the creation of dynasty trusts, or perpetual trusts, as they are sometimes called. These trusts enable transfer of property to successive generations without federal or state income tax. REPRESENTATIVE McGUIRE explained that SSHB 34 was a minor modification to Alaska's trust law, which would allow a legislatively approved policy to be carried out. She added that the committee may face similar technical bills in the near future and asked the committee to remember that the legislature had made a decision for Alaska to become a forward-thinking state with regard to trust laws. In an attempt to diversify the state economically, the area of trusts was chosen, and she warned that this required that Alaska stay ahead of other states in order to attract the same dollars. She added that this was why SSHB 34 was retroactive. On another note, she said that while this was a complex issue, it was not controversial, primarily due to the tax structure in Alaska. Number 0595 CHAIR ROKEBERG added that revisions to Alaska's trust law had created an entire new industry. One of the changes was the ability to elect community property status within a marriage, which would avoid a "step up in basis" should a spouse pass away. He also noted that the establishment of trusts would generate jobs and bring money to the state. This would also allow for a capital base increase for investment purposes. He pointed out that Alaska Trust Company, National Bank of Alaska, Alaska USA [Federal Credit Union], and Key Bank have all availed themselves of this law to generate business. The State of Delaware has attempted to replicate Alaska's trust laws. He added that Alaska has minimized, to a very small percentage, the premium tax on life insurance policies that are involved in the establishment of trusts. This was called the jumbo policy premium tax, and with its abolishment, the amount of revenue generated to the state has increased. Other states now come to Alaska and use the state's trust law and combine it with insurance products; thus they can buy several multimillion- dollar policies and pay very little tax. He said he hoped that SSHB 34 would be one of the few cleanup bills [the legislature] would see this year. REPRESENTATIVE McGUIRE also noted that one of the requirements of the original legislation adopted was that trusts had to be administered by an Alaskan trust company. It is this requirement that generates jobs in Alaska. Number 0977 STEPHEN E. GREER, Attorney at Law, testified via teleconference and assisted with the presentation of SSHB 34. He explained that SSHB 34 was needed to clarify legislation that was passed last year [SB 162]. The dynasty trust, which is just one small aspect of the entire umbrella of trust legislation, allows an individual to create a trust that can go on from generation to generation, whereby individuals within a family can make use of the trust assets. It can also be structured in such a way so that, as assets pass from generation, federal and state tax can be avoided. However, when the rule [against] perpetuities was abolished, Alaska inadvertently fell into what is called the Delaware tax trap. He said that although last year's legislation fixed that problem, current law still lacks a distinction between a presently exercisable general power of appointment and a testamentary general power of appointment. He opined that SSHB 34 was a technical amendment that provided for this distinction in Alaska's rule against perpetuities. Number 1275 MR. GREER explained that the rule against perpetuities says that at some point in time, all trusts must end and the trust assets must be distributed to the beneficiaries. That length of time is measured by "life and being," at the time of the creation of the trust, plus 21 years. Essentially, a trust can go on for the benefit of an individual's children, but it has to end at some point when it gets distributed to the grandchildren, thereby subjecting the assets to gift taxation, and to estate taxation when the grandchildren die. He offered that it would be wonderful to create a trust whereby the assets are made available for use to succeeding generations, a trust in which the assets are not subject to estate tax as they pass to succeeding generations. In order to accomplish the creation of this type of trust, the rule against perpetuities was amended in 1997 so that the period of time a trust may continue extended for as long as beneficiaries existed. This allowed people of wealth to establish trusts that ensured dramatic growth of assets by not subjecting them to estate taxation. MR. GREER gave an example of a $1 million trust with a return of 5 percent after taxes. If that trust was permitted to grow for 120 years, but subjected to an estate taxation of 50 percent at each generation, it would grow to $21 million. However, if that same trust were exempt from estate taxation, it would grow to $348 million. He went on to say that Alaska had abolished the rule against perpetuities so that individuals could create these types of trusts. All that is needed is an Alaskan resident willing to take on the duties of trustee. Out-of-state residents wishing to create such a trust must move their money to Alaska because the trusts must be administered in Alaska. He said he understood that South Dakota, another state that had abolished the rule against perpetuities, managed over $80 billion in trusts. He believed one of the primary reasons South Dakota had been able to garner so much money was because Citicorp moved in and had huge marketing potential. Currently Alaska has not had any similar large institution enter the state in order to market Alaska's [trust] law. Number 1693 MR. GREER also explained that a dynasty trust could be structured in such a way that the assets would be made available for the use of an individual's children without being included in the children's estate tax base, and the assets would not be subject to the claims of the children's creditors. In order to accomplish these goals and stay within state tax law, certain powers can be given to the children: a child can be made the beneficiary of his or her own dynasty trust and use both income and principal as he or she sees fit; also, the child can be given a nongeneral power of appointment so that he or she could decide who receives the assets and how they are distributed at his or her death. MR. GREER brought up the fact that the Internal Revenue Code contained a provision whereby if a beneficiary of a trust who possesses a nongeneral testamentary power of appointment exercises that power in such a way that the trust assets are passed on to another trust, which also has a beneficiary with a nongeneral power of appointment, then the assets will be subject to estate tax at the death of the original beneficiary. This is sometimes known as the Delaware tax trap. Currently, any state that has abolished the rule against perpetuities will fall into this tax trap if a beneficiary exercises his or her nongeneral power of appointment to create a further nongeneral power of appointment. He believed that SSHB 34 would allow Alaska to fix its trust law retroactive to April 22, 1997, in order to avoid this tax trap. MR. GREER outlined that a beneficiary of a trust who has a nongeneral testamentary power of appointment can exercise that power without estate taxation resulting. A beneficiary could also choose to vest the trust to himself or herself. The rule against perpetuities demands that the time a trust might last must be computed. With the passage of SB 162, trusts could no longer go on forever, and would thus avoid the tax trap. There had to be a period of time within which trusts must end. Current law dictates that a trust must vest within a thousand years of the creation of the trust if a beneficiary exercises a nongeneral testamentary power of appointment. If, on the other hand, a beneficiary is given a presently exercisable general power of appointment, it is as if the beneficiary were just given the trust property, and thus the thousand-year computation begins from the time the beneficiary received the power. He listed an example of a beneficiary of a trust in excess of $1 million who has a testamentary nongeneral power of appointment and gives another beneficiary a presently exercisable general power of appointment in order to avoid a 55 percent generation- skipping tax. This action actually trips the tax trap, but by doing this, it subjects the property to the lesser estate tax rate versus the higher generation-skipping tax rate. MR. GREER concluded by expressing his belief that SSHB 34 would perfect Alaska's trust law and conform it to common law understanding of the rule against perpetuities. TAPE 01-23, SIDE B Number 2390 MR. GREER, in response to questions from Representative Coghill, said that it was unlikely SSHB 34 would see any court challenges. He also said that if Alaska were to change its estate tax structure, it might necessitate altering the trust laws to accommodate dynasty trusts. However, because often states choose to have their estate and income taxes resemble the federal taxing scheme, dynasty trusts would probably be allowed to continue. He said he saw that the biggest threat to Alaskan trusts would be the imposition of an income tax on the trust's assets. MR. GREER elaborated on points brought up by Chair Rokeberg by saying that if a state income tax were to be established, a provision could be made to exempt nonresident trusts maintained in Alaska, but he did not see any way to avoid taxation of trusts formed by Alaska residents. Mr. Greer went on to say that he believed, should Congress repeal the estate tax, Alaska would have an ability to take the billions of dollars outside of dynasty trusts and move them to Alaska because current Alaska law exempts trust assets from state income taxation and protects them from creditor claims. MR. GREER explained that the reason for the changes in Section 1 was to make a distinction in the law between presently exercisable general power of appointment and testamentary general power of appointment. The latter power relates back to the date of the original trust instrument. The former power relates to the date that power was granted to a beneficiary. He also clarified that the addition of the words "of alienation" in Section 3 was to conform with the first part of each sentence in which those words were added. Mr. Greer confirmed that the term "settlor", inserted in Section 3, was someone who had formed a revocable trust and subsequently died, causing the trust to become irrevocable. He also agreed that he was in favor of raising estate taxes higher than they are currently but capping them to protect small businesses. Number 1457 REPRESENTATIVE OGAN moved to report SSHB 34 out of committee with individual recommendations and the accompanying zero fiscal notes and asked for unanimous consent. There being no objection, SSHB 34 was reported out of the House Judiciary Standing Committee
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