Crossing to Delaware: Factors in Determining a Trust Jurisdiction
Delaware punches well above its weight in helping advisors protect client family assets.
For more than one hundred years, the state has actively supported trusts and it continues to lead the country in estate planning innovations. Delaware is now home to nine state non-deposit trust companies and 24 state limited purpose trust companies.
Tax considerations, asset protection and confidentiality are three prominent considerations for high net worth families in selecting a trust jurisdiction. Delaware does not impose income or capital gains taxes on trusts administered in the state1. At the same time, asset protection is arguably stronger in Delaware than in any other trust jurisdiction. Legislation that emphasizes the importance of a trust’s intent is balanced with measures to protect the privacy of family members involved2.
Also important is the jurisdiction’s breadth and depth of fiduciary expertise. Created in 1792, the Delaware Chancery Court is a court of equity rather than a court of law, meaning that it fashions a remedy in those circumstances where a monetary ruling is not sufficient.
These advantages are generally known to many families, and certainly to their attorneys and other advisors. Less understood but also of significant interest to families establishing trusts today is the jurisdiction’s encouragement of flexibility in trust administration. Here, Delaware has advantages that significantly distinguish the state from other U.S. locations. These include:
- A full range of investment options. The state’s Prudent Investor Rule, adopted in 1986, allows trustees to acquire just about every kind of investment. The trust’s investment performance is judged based upon the performance of the entire portfolio, rather than on an asset-by-asset basis. Delaware trusts can be used to hold hedge funds and more speculative investments, enhancing potential growth for future generations.
- Self-settled asset protections. In 1997, Delaware enacted a self-settled asset protection trust law. The Qualified Dispositions in Trust Act provides asset protection for certain self-settled trusts that meet specific requirements, permitting a settlor to transfer his or her own assets through a qualified disposition to an irrevocable trust, while retaining certain beneficial interests in the trust, but protecting those assets from claims of the settlor’s future creditors.
- Perpetual trusts. Delaware has allowed certain types of trusts to exist in perpetuity since 1995.
- Delaware Incomplete Non-Grantor Trusts. These allow a non-grantor asset protection trust to grow free of state income tax and be subject to federal gift tax only when distributions are made to individuals other than the grantor. Unfortunately for New York residents, this technique is no longer tax-efficient. A New York state throwback rule has made untaxed income distributed to New York resident beneficiaries taxable over several years.
Perhaps the most important of Delaware’s trust benefits is the ability to bifurcate a trustee’s traditional duties to two or more persons. Delaware law allows a trust’s investments to be directed by an investment advisor, and the distribution decisions to be directed by a distribution advisor, provided that both are acting in a fiduciary manner.
As Jeff Maurer discusses on page 16, families who have entrusted their trust investments to a particular investment professional may retain that advisor with a Delaware-directed trust. Individual investment advisors can also provide more flexibility, enabling a trust to more easily hold a low-basis stock or an illiquid asset (e.g., closely held business, family farm, or private equity investment held in an LLC). Similarly, a distribution advisor, who knows the beneficiaries personally and can assess their needs and evaluate their behaviors in that context, may also direct decisions regarding distributions to beneficiaries.
In situations involving an investment advisor and/or a distribution advisor, the traditional trustee function is modified to that of an administrative trustee, typically with a corresponding fee adjustment, if appropriate. Delaware law also allows a trust protector to be named to make changes to an irrevocable trust instrument including changing a power of appointment, exercising a removal or appointment provision, or amending a trust to achieve a favorable tax result or to improve administration.
For example, a family can appoint their longtime financial advisor to serve as the investment advisor to their trust. In addition to managing its marketable securities, the advisor could direct the trustee to hold a 100% interest in the family’s limited liability company, or LLC, which in turn holds their interest in a private equity firm, in this case. With this type of plan in place, the administrative trustee has no responsibility for the investments and, absent willful misconduct, would not be liable for any actions taken with regard to the investments. The trust could hold the LLC interest without any pressure to diversify or otherwise dispose of this asset.
Should the LLC generate income to the trust, the distribution advisor determines the amount of any disbursements to be made to the beneficiaries. Should a beneficiary require, say, a tuition payment or similar discretionary distribution of trust principal, the distribution advisor would direct the administrative trustee to facilitate that distribution, free of layers of bureaucracy inherent in many large institutions. In short, the beneficiaries won’t need to wait – and wait – for trust committees to meet and decide on their distribution request.
Directed trusts can also provide long-term benefits for a range of structures, including dynasty trusts that protect closely held businesses or family farms. Dynasty trusts can be drafted to provide a discretionary income interest to each generation, with principal being expended (at the distribution advisor’s discretion) for health, education, maintenance and support. These trusts can also last into perpetuity, and the family can maintain control over the closely held business or farm, free of pressure to diversify or sell the assets.
Additional tools available to Delaware-sitused trusts include the use of decanting, merger and non-judicial settlements to fix so-called broken trusts. We will be addressing these in future editions of Independent Thinking.
Darlene Marchesani is the Chief Trust Officer and Trust Counsel of Evercore Trust Company of Delaware. She can be contacted at firstname.lastname@example.org.
2Delaware does not require the trustee to file trust agreements with a court or public agency, nor does it mandate annual trust accountings.