THE ALASKA TRUST ACT

By Jacqueline Aiken and Ted D. Englebrecht

The old adage, "north to Alaska," is as appropriate today as anytime in the past. Specifically, the new Alaska Trust Act allows Alaskans and residents of other states to establish perpetual trusts in Alaska for the benefit of themselves and their families. An Alaska trust can save estate taxes and the assets of the trust can be immunized from the claims of unknown future creditors.

Advantages of the New Alaska Trust Act

The act became effective on April 2, 1997. It makes two changes to trusts created under Alaska law. Both changes may be of significant interest to individuals throughout the U.S. First, the act effectively eliminates the rule against perpetuities, which, until the passage of the act, limited the time a trust can last to approximately 90 years in Alaska. Now, any U.S. citizen can create a trust in Alaska and provide for it to last forever. This means the benefits the trust provides to the beneficiaries can last as long as the family wants. Second, trust benefits can include protecting trust assets from claims of the beneficiaries' creditors, including claims that may arise in a divorce of any beneficiary. This provision may also reduce estate taxes.

Because Alaska has no income tax, an Alaska trust can be used to avoid state income taxes on trust income that is not distributed currently to trust beneficiaries. However, an Alaska trust cannot be used to avoid state income taxes if the creator lives in a state that imposes an income tax and the trust is a "grantor trust" (one that attributes the trust's income to the grantor).

State vs. Foreign Trust

Alaska retains judicial jurisdiction over custodial trusts created in Alaska. Prior to the act, foreign situs trusts were the only vehicles available to obtain the same benefits now available through an Alaska trust. With a foreign trust, the grantor or settlor has the power to appoint or discharge a trustee. With a trust created under the new laws of Alaska, this same privilege is available. A major advantage, however, to an Alaska trust is that it is situated in the U.S. Naturally, grantors are more comfortable transferring their assets to a trustee in a politically stable jurisdiction. Any distribution to a U.S. beneficiary from a foreign trust of previously accumulated trust income is subject to a very high nondeductible compounded interest charge under the "throwback rules" of IRC section 665. Because of the throwback rules, as amended by the Small Business Job Protection act of 1996, distributions to U.S. beneficiaries from foreign trusts are so onerous that the beneficiaries would have been better off if the trust had been domestic rather than foreign. Foreign trusts have to make extensive reports to the IRS, which is reviewing trust arrangements as part of a national compliance strategy to identify abusive trusts.

Requirements

As of April 2, 1997, anyone in the U.S. can create an Alaska trust by stating that the laws of Alaska will govern the trust. Part or all of the assets transferred to the trust must be deposited in Alaska. The trustee must either be a bank or trust company with its principal place of business in Alaska or an individual who is a resident of Alaska. The Alaska trustee must have the power to maintain trust records in Alaska and file tax returns for the trust. Additionally, part or all of the administration must occur in Alaska, such as holding some trustee meetings or affecting some trades.

The act allows an individual to create a trust in Alaska and be eligible to receive distributions at the discretion of the trustee. An Alaska trust can continue forever for the benefit of decedents and can be constructed so that the trust assets are not included in any of their estates.

If drafted properly, assets transferred to an Alaska trust will be protected from claims of creditors. To protect assets from claims of creditors, the grantor must not intend to defraud creditors. The trustee must have discretion over income and principal, although the grantor may receive distributions. As a result, an individual can transfer assets to an irrevocable Alaska trust and be a beneficiary to whom the trustee can distribute trust property. This protection applies even if the settlor is the only person to whom the trustee may distribute assets and income. When there are beneficiaries in addition to the grantor, the protection from the claims of creditors also applies even if the settlor retains the right to veto distributions to other beneficiaries of the trust. This protection applies even if the grantor retains the right to direct where the trust property is to pass upon his or her death.

Transfers to a trust will not be protected from the claims of creditors if the grantor may revoke or terminate all or part of the trust. Also, if the trust says that all or part of the income or corpus, or both, must be distributed to the grantor, it will be subject to creditor claims. Therefore, if the trust is irrevocable and the trustee may distribute income or principal to the grantor, but is not required to, assets transferred to the trust will not be subject to the claims of creditors, provided the transfer was not intended to defraud known creditors. If there are other beneficiaries in addition to the settlor, they would be afforded the same protection.

Gift and Estate Taxes

A major impediment to individuals making lifetime gifts for asset protection planning has been concern over losing all interest in the property given away. A transfer is complete for Federal gift and estate tax purposes only if or when it is no longer subject to claims of creditors of the transferor. A transfer of property to a trust is void against the grantor's creditors to the extent the grantor is entitled or eligible in the discretion of the trustee to receive distributions from the trust. To this extent, transfers to the trust will not constitute completed gifts and will be includable in the gross estate of the transferor.

Transferring assets to a trust in a state where the grantor's creditors cannot attach the assets makes that transfer a completed gift for Federal estate and gift tax purposes. The IRS held in Letter Ruling 9332006 that a transfer to an offshore trust was a completed gift and would not be included in the grantor's estate. This was because creditors under the trust's local law could not attach the trust assets even though the grantor was eligible, at the discretion of another as trustee, to receive distributions. This is precisely the situation under current Alaska law unless the grantor retains a power to veto distributions to other beneficiaries or a testamentary power of appointment.

A sizable amount of assets and their potential appreciation can be transferred by gift to an Alaska trust and removed from an estate. For example, assume a taxpayer, age 60, parts with $600,000 of assets that will appreciate at eight percent over the next 25 years, then dies at age 85. The assets will have grown to $4.2 million. If gifted to an Alaska trust, the taxpayer's estate has saved $1,950,800 in estate taxes. A taxpayer and his or her spouse can each use an Alaska trust for his or her $1 million exemption and avoid the punitive generation-skipping taxes at 55%.

Where the transfer to the trust is a completed gift, the grantor presumably will want to minimize distributions back to him- or herself because such distributions would erode the estate tax deduction benefits of having a completed gift to the trust. *

Jacqueline Aiken, MBA, CPA, is a professor of accounting at the College of the Albemarle, Elizabeth City, N.C. Ted D. Englebrecht, PhD, is Eminent Scholar, professor of accounting, and director of the masters of taxation program at Old Dominion University, Norfolk, Va.

Editors:
Eric M. Kramer, JD, CPA
Farrell, Fritz, Caemmerer, Cleary, Barnosky & Armentano, P.C.

Alan D. Kahn, CPA
The AJK Financial Group

Contributing Editors:
Richard H. Sonet, JD, CPA
Marks Shron & Company LLP

Frank G. Colella, LLM, CPA
Own Account

Jerome Landau, JD, CPA

James B. McEvoy, CPA
The Chase Manhattan Bank

Nathan H. Szerlip, CPA
Edward Isaacs & Company LLP