Estate Planning Exemption Capture Planning Generation-Skipping Transfer (“GST”) Tax

Proposed Resurrection of the Common Law Rule against Perpetuities—At Least for GST Tax Purposes

Kyle G. Durante 

There is one common law rule that haunts most law students, and many legal practitioners: “no interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.” This rule, known as the rule against perpetuities, has many applications, but, most importantly, it limits the duration that an irrevocable trust may remain in existence. This rule was initially adopted in an effort to limit dead-hand control over property by requiring property to vest in a beneficiary within a certain period of time.

Generally, at common law, an irrevocable trust could remain in existence for a period of time not exceeding 21 years after the death of all members of a particular class of persons who were alive at the time the perpetuities period began. For an irrevocable trust, generally, the perpetuities period will begin on the date the trust was created. While some states, such as New York,[1] continue to follow the common law rule, a number of states, such as New Jersey, Pennsylvania, Delaware, and South Dakota,[2] have completely abrogated the rule, while others have extended the period of time that an irrevocable trust may remain in existence, such as Connecticut (which applies an 800 year period in gross) and Florida (which applies a 1,000 year period in gross).

The length of time an irrevocable trust may remain in existence becomes particularly important when taking into consideration the federal generation-skipping transfer (“GST”) tax. The federal GST tax is in addition to the federal gift and estate tax, and it generally applies to transfers to beneficiaries (either outright or in trust) who are more than one generation removed from the donor or settlor (i.e., an individual establishing a trust) or more than 37½ years younger than the donor or settlor. Similar to the federal gift/estate tax, every individual has an exemption from the federal GST tax, and, effective January 1, 2023, the federal GST tax exemption amount increased to $12,920,000.[3]

Under current law, if a settlor establishes a properly structured irrevocable trust and allocates GST tax exemption equal to the fair market value of the assets the settlor transfers to the trust, the trust property, including all appreciation and growth on the initial transfer, can continue to be held in trust up to the maximum permissible perpetuities period, without being subject to federal wealth transfer taxation. In states that have abrogated the rule against perpetuities, these trusts may remain in existence for an indefinite period of time, permitting the settlor to preserve generational wealth and avoid transfer taxation for an unlimited class of future generations. However, when the law establishing the GST tax was enacted in 1986,[4] Congress did not anticipate that trusts may remain in existence, shielded from federal wealth transfer taxation, for an indefinite period of time, since, at that time, almost all states followed the common law rule against perpetuities.

As such, for the second year in a row, the Department of the Treasury’s Green Book[5]has included a proposal to limit the duration of time that an irrevocable trust may maintain its exemption from the federal GST tax.

Under the proposal, “the benefit of the GST exemption, which shields property from the GST tax, would not last for a trust’s duration. Instead, the GST exemption would only shield the trust assets from GST tax for as long as the life of any trust beneficiary who is either no younger than the transferor’s grandchild or is a member of a younger generation who was alive at the creation of the trust.” Essentially, under this proposal, upon the expiration of a specific period of time, which is basically the time period imposed by the common law rule against perpetuities, a trust that was fully exempt from the federal GST tax will lose that exemption, causing the remaining assets of the trust to be subject to the federal GST tax.[6]

As detailed by the Department of the Treasury, the need for the change is that “[a]t the time of the enactment of the GST provisions, the laws of most States included a common[] law Rule Against Perpetuities (RAP) or some statutory version of it requiring that every trust terminate no later than 21 years after the death of a person who was alive at the time the trust was created. Today, many States either have limited the application of their RAP statutes . . ., or entirely repealed their RAP statutes. In those States, trusts are permitted to continue in perpetuity and the property in those trusts has been permanently removed from the estate and gift tax base.”

This proposal will not have a significant impact in states, such as New York, that continue to follow the common law rule against perpetuities given that, under state law, the trust would be required to terminate around the same time that the trust would lose its GST tax exempt status. However, this proposal will have a substantial impact in states that have completely eliminated or expanded the common law rule. Presently, high-net-worth individuals who would like to establish dynastic estate planning vehicles to protect and preserve wealth will establish trusts in states that have eliminated or expanded the common law rule. However, under the proposal, regardless of the state in which the trust was established, the trust will lose a significant tax benefit likely within two generations.

Although this proposal is still in its infancy, given that we have seen this proposal twice now, coupled with the current administration’s interest in raising revenue through, among other things, the federal gift/estate and GST tax, we may see this proposal gain traction. As such, this proposal and the possible future limitations on the GST tax exemption must be considered in establishing dynastic estate planning vehicles and planning for their ultimate distribution.

[1] Although New York continues to follow the common law rule, New York has made a number of changes to the rule’s application. See Kyle G. Durante, A Modern Guide to the Modifications of the Rule Against Perpetuities in New York, 32 Touro L. Rev. 941 (2016).

[2] States differ on whether the rule has been completely eliminated or eliminated just with respect to certain types of property. For instance, some states have eliminated the rule for all purposes, except as it applies to real estate.

[3] The federal GST tax exemption amount (and the federal gift/estate tax exemption amount) will continue to increase for inflation each year until January 1, 2026, when, under current law, the exemption amounts are scheduled to be automatically reduced by approximately one-half.

[4] The GST tax was first adopted in 1976. However, the 1976 GST tax was subsequently repealed, and a new GST tax was adopted in 1986.

[5] Each year, the Department of the Treasury releases its explanation of the revenue proposals included in the current administration’s fiscal year budget, which includes proposed changes to the Internal Revenue Code and Treasury Regulations and is known as the Green Book.

[6] Under current law, the federal GST tax imposes tax at a rate of 40 percent.