In the wake of Alaska's adoption of ground-breaking, self-settled asset protection trust legislation, the state has now enacted additional estate planning legislation. The new statutory provisions are analyzed in the following discussion.

Abolition of Rule Against Perpetuities Refined to Avoid Delaware Tax Trap

At least 17 states have either eliminated the rule against perpetuities or have pending legislation that will do so. A primary impetus for such elimination is to allow trusts to be perpetual so that transfer taxes can be minimized as assets are transferred in trust from generation to generation, particularly in a generation-skipping-tax-exempt trust. In this process of eliminating the rule against perpetuities, practitioners have become concerned about falling into the "Delaware Tax Trap."

Some background is necessary to understand this tax trap. The common law rule against perpetuities provides that every interest in property created through the exercise of a limited power of appointment or testamentary general power of appointment is deemed to have been created at the time of the creation of the power (the "relation back" doctrine). However, this "relation back" does not apply to presently exercisable general powers of appointment, which are the equivalent of ownership for perpetuities purposes. The creation of a limited power of appointment or testamentary general power of appointment is deemed to occur at death in the case of a will or as of the date a trust is created in the case of an inter vivos trust, except for a revocable trust, in which case creation is deemed to occur as of the date the trust ceases to be revocable.

In contrast, Delaware enacted, years ago, a statute which states that every interest in property created through the exercise of a power of appointment is deemed to have been created at the time of the exercise of the power of appointment, rather than at the time of the creation of the power. Thus, in Delaware, the beginning date for measuring the perpetuities period for a property interest created by exercising a power of appointment does not relate back to the date of the creation of the first power of appointment, but rather begins at the date of exercise of the power of appointment. As a result, in Delaware, it is possible to use successive limited powers of appointment to continuously extend the perpetuities period.

Congress, in the Powers of Appointment Act of 1951, responded by enacting the predecessors of I.R.C. Sections 2514(d) and 2041(a)(3) (the "Delaware Tax Trap"). These statutes provide that a gift or estate taxable event will occur if a power of appointment (even if non-general) is exercised so as to create "another power of appointment which under the applicable local law can be validly exercised so as to postpone the vesting of any estate or interest in such property, or suspend the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the date of the creation of the first power."

The Delaware Tax Trap is not "sprung" in a state that has adopted either the common law rule against perpetuities or the Uniform Statutory Rule Against Perpetuities, unless the first power is used to create a second power that is a general presently exercisable power of appointment. The reason the trap is not sprung is that in the case of all other powers, the time period for determining when interests created by the exercise of a limited power of appointment must vest is determined by referring back to the date of the creation of the original power of appointment.

However, in a jurisdiction that has completely abolished the rule against perpetuities, a significant arguement can be made that the Delaware Tax Trap is sprung whenever any power of appointment is exercised so as to create another power of appointment. The theory is that the second power of appointment may be exercised so as to postpone the vesting of an interest in the property "... for a period ascertainable without regard to the date of the creation of the first power."

A serious disadvantage would exist if a state's method of elimination of the rule against perpetuities made trusts susceptible to the Delaware Tax Trap. These trusts could not use successive limited powers of appointment without incurring a tax on the first power. As a result, future generations would be denied the dispositive flexibility that such limited powers provide.

Alaska's new legislation expressly states that the common law rule against perpetuities does not apply in Alaska. Alaska then adopts a two-pronged approach to avoid the Delaware Tax Trap. The purpose of the "first prong" is to re-establish a rule against perpetuities for Alaska in the limited circumstance of property interests subject to a limited power of appointment which is exercised to create a new limited power of appointment. All such property interests are invalid unless within 1,000 years from the time of creation of the original instrument or conveyance creating the original limited power of appointment the property interests vest or terminate.

This provision applies to a trust instrument or conveyance executed on or after 4/2/97, if the instrument or conveyance creates a non-vested property interest subject to the exercise of a power of appointment that creates a new or successive power of appointment. The goal of this provision is to cure the Delaware Tax Trap problem for all trusts created under Alaska law after the initial abolition of the rule against perpetuities in 1997.

The second prong of the new legislation enacts a rule against suspension of the power of alienation of property. The statute provides that a trust is void if the trust terms suspend the power of alienation for a period of at least 30 years after the death of an individual alive at the time of the creation of the trust. However, the statute expressly states that a suspension of the power of alienation can be avoided by giving the trustee the express or implied power to sell the trust property.

This second prong of Alaska's approach to avoid the Delaware Tax Trap is based on the Tax Court's decision in @CASE:Estate of Murphy.¹ In that case, the court held that the Delaware Tax Trap was not violated in Wisconsin, which had a perpetuities statute expressed in terms of a rule against suspension of the power of alienation (rather than a rule based on remoteness of vesting). The IRS has acquiesced in Murphy.²

Charging Order Is Sole Remedy for Creditors of Partners and LLC Members

If a creditor obtains a judgment against a partner or LLC member, most state statutes provide that the creditor can obtain a "charging order" against the debtor's partnership or limited liability company interest. This allows the creditor to receive the distributions to which the partner or member would be entitled.

Generally, these statutes do not expressly permit other creditor remedies. This is consistent with the concept that the other partners of a partnership or members of an LLC should not have their business or investment activity disrupted by being forced to take in a substitute partner or member (e.g., the judgment creditor). This was the generally understood position taken by the Uniform Limited Partnership Act and many limited liability acts.

However, in @CASE:Madison Hills Ltd. v. Madison Hills, Inc.,³ a Connecticut court held that a judgment creditor of a limited partnership could foreclose on the partnership interest. The Connecticut court's holding opened the door for courts to provide a variety of remedies to creditors of partners in limited partnerships and members in LLCs. These additional remedies could result in forced dissolutions of the entities and sale of the assets. The Alaska Legislature concluded that such results could be very harmful to the other partners or members, their families, and their business interests.

The newly enacted Alaska amendments make it clear that a judgment creditor of an Alaska limited partnership or LLC has only the remedy of a charging order. Thus, the creditor will receive all distributions made to the debtor partner or member. But the right to receive such distributions is the judgment creditor's sole remedy. No other remedies are available to the creditor or to a court implementing a creditor's collection request.

The strengthened creditor protection provided to these entities should make them even more popular for estate planning purposes. While many families are attracted to these entities for gift and estate tax reduction, creditor protection may prove to be an equally advantageous reason for their use.⁴

A Qualified State Tuition Program with Special Creditor Protection

Alaska has joined more than 32 other states that have enacted qualified state tuition programs.⁵ Alaska's plan is available to residents and nonresidents alike, and adds special asset protection features.⁶

Pursuant to this new Alaska statute, an account established under the qualified state tuition program is exempt from a claim by the creditors of a participant or of a beneficiary, and is conclusively presumed to be a spendthrift trust. The statute further states that the account is "not an asset or property" of either the participant or the beneficiary, and may not be assigned, pledged, or otherwise used to secure a loan or other advancement. The account is not subject to involuntary transfer or alienation.⁷

Because these accounts are self-settled, and can be withdrawn by the participant at will (but subject to penalty and tax as described below), this creditor protection initially may seem unusual. Nevertheless, the analogy to an IRA is strong. An IRA also is self-settled, and can be withdrawn by the participant (subject to penalty in some circumstances, and tax). Many states have statutes which provide that creditors of an IRA participant cannot reach the assets in the IRA.⁸

The creditor protection characteristic of Alaska's qualified state tuition plan may be very appealing to some families. For example, a parent with asset protection concerns can immediately protect $50,000 per child. If the parent needs the funds in the future, they can be withdrawn (subject to penalty and tax). If not, the funds are available for the child's education.⁹

Trust Notification and Accounting Rules

The general rules in Alaska are that within 30 days of acceptance of a trust, the trustee must inform all the current beneficiaries of the existence of the trust, and upon request, furnish them with an annual accounting. New legislation now allows a settlor to exempt the trustee from these duties. This exemption may not continue beyond the settlor's lifetime or a judicial determination of the settlor's incapacity.¹⁰

Flexible Methods for Modifying and Terminating Irrevocable Trusts

The Alaska legislature has enacted flexible methods for the modification and termination of irrevocable trusts. A trustee, settlor, or beneficiary may initiate proceedings to modify or terminate a trust if, because of circumstances not anticipated by the settlor, modification or termination would substantially further the settlor's purposes in creating the trust. A court may also construe or modify the terms of a trust in order to achieve the settlor's tax objectives.

The legislation further provides that despite the settlor's purposes in creating the trust, the trust can nonetheless be modified by the court upon consent of all beneficiaries if the reasons for modifying or terminating the trust outweigh the interest in accomplishing the material purposes of the trust. The inclusion of a spendthrift clause may constitute a material purpose, but is not presumed to be so. This modification provision allows for the possibility of modification due to the changed circumstances of the beneficiaries, despite what might have been a material intention of the settlor in establishing the trust.

This new statute has particular relevancy for perpetual trusts because it provides a technique for future changes of a dispositive plan. Accordingly, this modification authority helps alleviate concern about control by a "dead hand." A virtual representation principle is included.¹¹

Community Property Agreements and Trusts Strengthened

These amendments clarify ambiguities regarding the right to amend and revoke community property agreements and trusts. The amendments to Alaska Statutes 34.77.090 and .100 specify that if a community property agreement or trust provides for the non-testamentary disposition of property at the death of the second spouse, without probate, then at any time after the death of the first spouse the surviving spouse may amend the community property agreement or trust with respect to the surviving spouse's property to be disposed of at his or her death.

In addition, the amendment eliminates the prior statutory language that a community property agreement or trust may be amended only "on a particular date or on the occurrence of a particular event" set forth in the instrument. Rather, a community property agreement or trust may be amended or revoked at any time if the instrument generally authorizes amendment or revocation by the spouses. The amendments will apply to all community property agreements and trusts executed after the effective date of the Alaska Community Property Act.¹²

"Safety Net" Estate Planning Legislation

All too frequently, estate planning documents fail to contain all the provisions necessary to maximize available federal gift, estate, and generation-skipping tax benefits. The documents may have been drafted long ago, and not appropriately updated. Alternatively, the drafter may have omitted necessary tax provisions.

To partially cure this problem, Alaska has enacted a "Safety Net" bill. This legislation supplements wills and trusts in the following areas: marital deduction trusts, funding, the family-owned business deduction, restriction of powers of a trustee-beneficiary, interest rate for pecuniary devises, conveyances of real property to and from trusts, and applicability to revocable trusts as well as to wills.¹³

¹71 TC 671(1979)@ECASE:.

³644 A.2d 363 (Conn. App., 1994)@ECASE:.

⁴The Alaska Revised Limited Partnership Act is amended by changes to AS 32.11.170 and .340. The Alaska Revised Limited Liability Act is amended by changes to AS 10.50.380. These amendments made by Alaska House Bill 222 apply to remedies pursued after the effective date of 3/8/00. Creditors' remedies with respect to limited partnership and LLC interests in the various states will be explored in a future article in Estate Planning.

⁵Qualified state tuition programs are authorized by I.R.C. Section 529. A participant may contribute cash to the plan for the benefit of a family member. For purposes of the gift tax annual exclusion (presently $10,000), a participant may elect to take the contribution into account ratably over a five-year period. Hence, a participant may make a current $50,000 contribution and, in effect, use in advance the participant's next four years of annual exclusion amounts. Many programs have a maximum contribution limit that appears to be keyed to an approximation of tuition and expenses for an undergraduate education. Unlike funds contributed to a child's or grandchild's trust, funds contributed to the tuition plan grow income tax-free. When distributions are made to the student-beneficiary, they are taxed at the beneficiary's rates (or maybe not at all if proposed federal legislation is passed).

⁶AS 14.40.802.

⁷AS 14.40.802(h). This Alaska asset protection will probably carry over to protect these assets from being reached by a creditor in a federal bankruptcy proceeding; 11 U.S.C. § 541(c)(2) prevents bankruptcy creditors from reaching assets in a spendthrift trust if such assets are protected under applicable non-bankruptcy law.

⁸For example, see AS 09.38.017.

⁹The Board of Regents of the University of Alaska is authorized to administer Alaska's new plan. At a future date, the Board will select and contract with an investment manager. The Board will establish limitations relating to maximum and annual contributions, the penalty for a non-qualified withdrawal, and similar plan matters. Alaska's new provision was enacted by Senate Bill 186, and is effective 3/16/00.

¹⁰The provisions relating to notification and accounting are found in AS 13.36.080. Alaska Senate Bill 163 is effective 8/30/00.

¹¹The new reformation, modification, and termination provisions have been added by AS 13.36.335 through .365, which are contained in Alaska Senate Bill 163.

¹²Alaska Senate Bill 166 is effective as of 3/8/00.

¹³The above-described provisions are contained in Alaska House Bill 275, which enacts amendments to AS 13.12.720, 13.) 16.550, .560, 13.36.153, .169, .335, and 34.25.055. This bill is effective 8/9/00.