Article About Family Trusts

This Article is about family trust companies and the way they are used by very wealthy families to preserve great fortunes. The province of the megarich (who remain very much upon the American landscape, the recent economic crisis notwithstanding), the family trust company is generally thought to be a vehicle for families with a net worth of at least $200 million. While the family trust company has long been important in securing the fortunes of some of the nation’s wealthiest families, the academic bar has paid it scant attention. This Article aims to redress this longstanding oversight, especially in light of recent changes in the law that make these entities far more accessible to the very wealthy.

The purpose of this Article is not, however, merely to attend to the particulars of these new laws that so effectively facilitate establishment of these entities. The tendency of all lawyers (including legal scholars) is to examine laws seriatim, one by one, rather than pursuing the combined effects of rules drawn from diverse areas of the law–thus discerning neither the extraordinary burdens of such combined effects nor the opportunities created by layering the benefits of laws not intended to be used in concert. Accordingly, the real significance of new laws affording the very wealthy ready access to the family trust company cannot be apprehended if these rules are treated in isolation. The intent of this Article is to examine–indeed to expose–the role of the family trust company as the masterstroke in a series of aggressive planning techniques (tax-driven and otherwise) that are used by the very wealthy to secure and grow a fortune for untold generations to come. The family trust company positions a wealthy family to exploit the elimination of the Rule Against Perpetuities in certain states to create perpetual trusts, to “leverage” exemptions from or credits against federal transfer tax applicable to the transfers into such trusts, and, most importantly, to make the most of new laws under which the determination of investment risk for such trusts has become as much art as science.

But further, what must also be appreciated is that these new laws facilitating the establishment of family trust companies (with the attendant opportunities to exploit other laws) are by some lights enormously consequential for the health of a democratic polity. It has long been a commonplace of democratic theory that, while democracy is largely immune to some degree of material difference within a polity, intransigent and radical differences in means are problematic. For this reason, the dissipation of great fortunes–whether from the pressure of taxation or due to other causes–has been viewed as salubrious in a democratic polity. “Shirtsleeves to shirtsleeves in three (or so) generations” is more than a proverb; it is arguably an operating condition of a healthy democracy, ensuring relative equality over time, a similar vulnerability to the vicissitudes of fortune. If the family trust company succeeds where advisers claim it can, however, great fortunes will cease to dissipate, and what many believe to be a background condition of a thriving democracy will be (at least for the United States) a thing of the past.

Furthermore, as part and parcel of its implications for democracy, the family trust company understood as a crucial element in an architecture of complex planning techniques provides rich social commentary. In some of the literature surrounding the family trust company, this entity is offered up not only as the keystone in an edifice of diverse legal rules, an apparatus to hold and manage various types of wealth, but also as a central locus of family activity. In particular, some advisors to the very wealthy recognize the family trust company as a venue for what is termed “financial reproduction.” The family trust company can create a place (the suggestion is made) where the older generation can tutor the younger in wealth preservation consistent with the family’s particular ethos about money and investing. As each generation (operating within the trust company) embraces this ethos to preserve the family fortune, each generation becomes quite self-consciously identified with its wealth, cognizant of its privilege, and able– even eager–to manage its unique circumstances into the future. Thus the family trust company serves not merely to frame the family’s financial life but to frame the lives of the wealthy broadly understood. As the family trust company is explored along with those complex planning techniques for which it can be crucial, the impression is inescapable: the lives of the rich are as much informed by their extraordinary wealth as the lives of the poor are by their poverty.

Part II of this Article examines recent changes in the laws in some states that allow for ease of set up and operation of a trust company serving a related group of people. This Part examines both the “lightly regulated” and the unregulated versions of the family trust company, highlighting their advantages and disadvantages.

Part III presents tax-minimization strategies that are commonly utilized in conjunction with the establishment of the family trust company to virtually eliminate the transfer tax liability when families move assets from the initial wealth-creating generation to later generations. In particular, we consider the “Note-Sale,” a strategy used to “leverage” exemptions from or credits against federal transfer tax, allowing a family to move tens of millions of dollars into trust with little to no transfer tax liability. Further, if this trust is established in a “non-perpetuities” jurisdiction (something readily accomplished given that those states that allow the creation of a family trust company have also eliminated the Rule Against Perpetuities), the wealth denied to the federal fisc (along with the rest of the family fortune) can remain safely stowed in trust to serve successive generations of the family forever.

But these families are not merely interested in transferring great wealth into perpetual trust in ways that ensure that their wealth will escape transfer tax both at the time of transfer and later. These families are also concerned about what becomes of their fortunes after they are placed in trust. Part IV presents what is probably the most significant advantage afforded to the very wealthy by the family trust company: the opportunity to serve as trustee, and in that capacity, to continue to determine its own investment risk. Until the advent of the family trust company, provisions of the tax regime made it problematic for the family to employ strategies such as the “Note-Sale” and then name a family member to serve as trustee of the trusts necessitated by these strategies. These families have typically had to resort to banks and other institutional trustees–most of which are inclined to invest conservatively, missing opportunities for returns rather than put the portfolio in jeopardy. This has not made these families happy. But further, about fifteen years ago, the law governing the investment of trust assets became more liberal as a result of the Prudent Investor statute, which made the determination of the risk profile appropriate to any portfolio in trust as much an art as a science. While institutional trustees may still be inclined to invest more conservatively, a case can now be made that, if the account is large enough and the horizon long enough, even highly speculative investments (with potential for enormous returns) can be appropriate for property in trust. Once the family establishes a family trust company, the family, serving as its own trustee, is poised to accept Prudent Investor’s invitation to invest aggressively. These trusts, which are filled with wealth that has never been and will never be subjected to transfer tax, potentially become investment juggernauts.

Whatever control of investing a family may acquire by establishing a family trust company, this control will be useless if the family cannot muster from generation to generation the financial acumen and the discipline to make state-of-the-art investment decisions. Part V examines the family trust company as a venue for what has been termed “financial parenting.” In this process, members of a wealthy family discern and embrace the magnitude of their privilege as well as its financial underpinnings–and acquire an “identity apart” from the rest of society. If the operation of a family trust company requires certain skills and attitudes, the trust company itself can serve as a forum in which education in these skills and attitudes can take place. But more importantly, the sustained process of gathering together for the purpose of preserving and growing wealth encourages families to discern and embrace the privileges of great wealth in such a way that the family trust company can only be privilege-sustaining, indeed privilege-enhancing.

Finally, in the wake of the recent economic turmoil, we might think that anyone with an entrepreneurial mindset would feel chastened, particularly given that many speculators have suffered enormous losses, and speculative excess is what–so many say–brought the U.S. economy to its knees. Many of the wealthy have seen a decline in the value of their holdings like everyone else. Be that as it may, with pundits disagreeing about the effectiveness of various antidotes to the crisis and no one confidently foreseeing the light at the end of the tunnel, the time could not be riper for the wealthy to want to manage their own risk, to protect against further downside, and to position portfolios to take advantage of early opportunities that will appear when the U.S. economy starts to recover. And this is no less the case where the property is held in trust.