Perpetuities Law: Trusts And Their Exemptions

The Rule Against Perpetuities (RAP) is a legal doctrine that prevents people from keeping their wealth locked up in trusts indefinitely. The rule, which originated in England over 300 years ago, states that no interest in land 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 means that any interest in a trust must vest within 21 years of the death of the last beneficiary who was alive when the trust was created. If the interest doesn't vest within this time frame, the trust is considered void. While the RAP is still enforced in most states, some states have modified or abolished the law to make it less cumbersome for estate attorneys and to allow for extended trust planning.

The Rule Against Perpetuities (RAP)

The RAP has been enforced for centuries and is still enforced in most states in the United States. However, its effectiveness as a legal doctrine is waning as states move to repeal it or adopt statutes that reduce its legal effect. For example, Alaska has abolished the RAP altogether, while Colorado and Utah have extended the vesting period from 21 years to 1,000 years.

The RAP is known for its complexity and has been a source of controversy due to its harsh consequences for non-compliance. If a trust violates the RAP, it can be invalidated, which can have significant implications for the distribution of assets held in the trust. This has made it critical for trust documents to be carefully drafted to avoid violating the RAP.

Modern interpretations and statutory reforms have been implemented to address the challenges posed by the RAP. The Uniform Statutory Rule Against Perpetuities (USRAP) was proposed by the Uniform Law Commission, adopting a 90-year vesting period instead of referring to 'measuring lives' or 'lives in being'. This reform provides that an interest that is not certain to vest within the common law rule's timeframe is still valid if it vests within 90 years of its creation.

The evolution of the RAP

The Rule Against Perpetuities (RAP) is a legal doctrine that has evolved significantly over the past 400 years. The RAP was created in 1681 as a response to the English practice of holding title to real property in 'fee tail', which made the property inalienable by locking it into the family's bloodline. This led to landowners devising new future interests and conditions to title transfers, tying up land in 'perpetuity'.

The most famous definition of the RAP is that of John Chipman Gray: "No interest is good unless it must vest, if at all, not later than 21 years after some life in being at the creation of the interest." This definition, while succinct, left many questions unanswered and led to mistakes when vesting could be delayed. The common law RAP was harsh; it voided any contingent future interest that might vest beyond the perpetuities period. This created a trap—a long-duration trust holding real property for longer than the RAP period was void from its inception.

The 20th century saw the beginning of the RAP reform movement, led by prominent law professors Barton Leach and Lewis Simes. Leach proposed a 'wait-and-see' approach, which would allow for a prescribed period of time to pass before determining if the interest had vested. Simes opposed this approach, arguing that it would only allow perpetuities to persist.

In 1979, the American Law Institute's Restatement (Second) of Property (Donative Transfers) formally adopted the 'wait-and-see' approach, resulting in the Uniform Law Commission's proposed Uniform Statutory Rule Against Perpetuities (USRAP). The USRAP made a significant technical change by adopting a simple 90-year period instead of referring to 'measuring lives' or 'lives in being'. As of 2020, 34 states have repealed the RAP, and none have reinstated it. This repeal movement has been led by banks seeking to attract trust business and wealthy families looking to take advantage of tax exemptions.

USRAP and its technical change

The Rule Against Perpetuities (RAP) is a legal doctrine created in 1681 to deal with the confusion caused by the old English practice of holding title to real property in 'fee tail'. The common law RAP was harsh and voided any contingent future interest that might vest beyond the perpetuities period. This led to the invalidation of long-duration trusts.

The 20th century saw a RAP reform movement, which resulted in the adoption of the 'wait-and-see' RAP approach by the American Law Institute's Restatement (Second) of Property (Donative Transfers) in 1979. This, in turn, led to the Uniform Law Commission's proposal of the Uniform Statutory Rule Against Perpetuities (USRAP). A significant technical change was made to USRAP: instead of referring to 'measuring lives' or 'lives in being', it adopted a simple 90-year period. The key language of the USRAP states:

> "An interest that is it not certain to vest within the period of the common law rule is still valid if it actually vests within 90 years following the date it was created."

USRAP was adopted by 25 states, with Michigan being one of them in 1988. However, the trend across the nation is to either eliminate or drastically curtail the RAP to permit dynasty trusts to flourish. As of 2020, 34 states have repealed the RAP, and none have reinstated it.

GST Reform

In 1979, the American Law Institute's Restatement (Second) of Property (Donative Transfers) formally adopted the 'wait-and-see' approach to the Rule Against Perpetuities (RAP). This resulted in the Uniform Law Commission's proposal of the Uniform Statutory Rule Against Perpetuities (USRAP). However, a slight but significant technical change was made. Instead of referring to 'measuring lives' or 'lives in being', the USRAP adopted a simple 90-year period.

In the same year, Congress introduced a revised generation-skipping transfer tax (GSTT), signalling to the wealthy that long-duration trusts could avoid both estate tax and GSTT on at least $1 million. This encouraged the adoption of dynasty-type trusts. As the GST exemption increased over the years, so did the pressure on state legislatures to repeal the RAP and USRAP to take advantage of the trust-business opportunity and the associated tax savings.

In 2010, the American Law Institute continued its work on reforming the RAP, proposing a new version of the rule that replaces the 90-year 'wait-and-see' period with a requirement that the trust terminate at the death of all beneficiaries who are more than two generations younger than the settlor. This version of the RAP is viewed as a compromise, attempting to honour the original purpose of the ancient RAP against remote vesting. However, as of 2020, no state has moved to adopt this reform.

The generation-skipping transfer tax (GSTT) is a simplified version of a tax originally instituted in 1976. Congress explained that the tax was designed to prevent wealthy families from using trusts to benefit several generations while avoiding federal estate tax. In response, Congress created the GSTT, which imposes a flat tax on gifts and bequests above the estate/lifetime gift exclusion that skip one or more generations, such as to grandchildren.

The GSTT is payable when a taxable distribution or taxable termination occurs. Taxable distributions are reported to skip persons by a trustee, who notifies the recipient of the value of the distribution and the trust's inclusion ratio. The skip persons are then responsible for filing the Generation-Skipping Transfer Tax Return for Distributions, on which the GSTT is calculated. Taxable terminations have a less complicated reporting system, with the trustee reporting the termination, the value of the property subject to the termination, the trust's inclusion ratio, and the tax due.

The GSTT comes into play whenever a donor gifts assets to a 'skip person'. A skip person is someone who is more than 37.5 years younger than the transferor, and grandchildren and great-grandchildren are the most common skip persons. A trust is a skip person if all the beneficial interests of the trust are held by skip persons, or if no current beneficial interests are held by skip persons but no distributions can be made to 'non-skip persons'.

The GSTT exemption is best leveraged to prevent subsequent additional estate taxes. Allocating the exemption to a trust that will bypass the estate tax when a client's children die can produce significant tax benefits. Taxpayers can opt out of automatic allocation to direct skips, preserving their exemption for taxable distributions or taxable terminations, known as indirect skips. Late allocations may also be made but can adversely affect the amount of the exemption allocated to trust assets.

Reforming the RAP

The Rule Against Perpetuities (RAP) is a legal doctrine that has been in existence for almost 400 years. It was created in 1681 as a response to the old English practice of holding title to real property in 'fee tail', which allowed the real property to be inalienable by locking the title into the family's bloodline. The RAP is all about preventing 'dead-hand control' that ties up real property in perpetuity.

The 20th century triggered a RAP reform movement, with law professors debating how the reform should be implemented. Professor Barton Leach promoted the 'wait-and-see' RAP approach, which would allow for a prescribed period of time to pass before determining if the interest had vested. On the other hand, Professor Lewis Simes opposed this approach, expressing concern that it would only allow perpetuities to persist. Despite this opposition, the 'wait-and-see' approach was formally adopted by the American Law Institute's Restatement (Second) of Property (Donative Transfers) in 1979, resulting in the Uniform Law Commission's proposed Uniform Statutory Rule Against Perpetuities (USRAP).

The USRAP made a significant technical change by adopting a simple 90-year period instead of referring to 'measuring lives' or 'lives in being'. This change is reflected in the key language of the USRAP: "An interest that is not certain to vest within the period of the common law rule is still valid if it actually vests within 90 years following the date it was created." However, as of 2020, 34 states have repealed the RAP, and none have reinstated it. This repeal movement has been led by banks seeking to attract trust business and wealthy families looking to take advantage of tax exemptions.

The American Law Institute has continued its work on reforming the RAP, proposing a new version of the rule that replaces the 90-year 'wait-and-see' period. This new version requires that the trust terminate at the death of all beneficiaries who are more than two generations younger than the settlor. While this proposal is seen as a compromise to honour the original purpose of the ancient RAP, no state has moved to adopt this reform.

The RAP has been criticised for its complexity and the potential for catastrophic consequences if documents are deemed void due to non-compliance. Modern interpretations and statutory work have altered the rule, and it continues to evolve to balance the interests of preventing property interests from being tied up for generations while also providing flexibility for long-term trust planning.

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