Preservation and growth through multiple generations is one of the biggest challenges that California’s wealthy families must confront regarding their wealth. One solution for many wealthy families is a tradeoff involving ownership versus control. That is, structuring wealth in a way in which family members can have the desired degree of control over that wealth without having ownership for transfer tax purposes. Sometimes the private trust company might be the best way to thread that needle.
Wealthy families place a high premium on giving each generation the opportunity to participate in decisions regarding the preservation and growth of their wealth. However, preservation and growth are threatened by the federal transfer tax system, divorce and litigation.
One response to these threats by wealthy families is to use irrevocable trusts which often involve transferring family wealth to them. When an individual or a financial institution is serving as trustee of irrevocable trusts, the ability of family members to have a voice in the management of their wealth inside of those trusts is difficult if not impossible.
To retain some voice in the management of their wealth, wealthy families look for structures that permit and encourage the participation of each generation in the investment management of family wealth held in irrevocable trusts. One such structure that is the private trust company.
A private trust company is also referred to as an exempt trust company or a family trust company. Except in a few states, it is a entity chartered by a state that is formed for the express purpose of providing trust and fiduciary services to a single family; it is not allowed to transact business with the general public. More importantly for wealthy families desiring involvement in the management of family wealth in irrevocable trusts, it creates a forum for current and future generations to discuss and influence the preservation and growth of that wealth.
In addition to the ability to be involved in the management of family wealth in irrevocable trusts, the following are some of the key reasons wealthy families form private trust companies:
Limited personal liability. As a general rule, the members of the board of directors of a private trust company have limited liability, and they are operating within a business standard as opposed to the higher fiduciary standard for trustees. Family members and trusted advisors who serve as individual trustees have unlimited personal liability.
Greater willingness to consider retention of heavily concentrated family assets. Private trust companies are less risk adverse and better attuned to family assets and the special place they hold within the context of the family compared to corporate trustees.
Elimination of trustee succession issues. Trustee succession issues which often occur when individuals or financial institutions are named as trustee are resolved.
Ability to select a favorable forum. Nevada, Texas, Wyoming, South Dakota and Texas are some of the more popular states where wealthy families are chartering private trust companies because they promote such trusts by enacting favorable tax laws.
Potential Disadvantages of a Private Trust Company
Required information disclosure. As part of the charter application process, certain information will have to be disclosed to regulatory authorities about family members and non-family members who will be board members, principal shareholders or executive officers of the proposed trust company.
Capital requirements. A private trust company must meet minimum capital requirements to exercise the fiduciary powers granted to it by the chartering state. These capital requirements vary from state to state.
Threat of additional regulation. Since a private trust company must apply for and obtain a charter from the state where it is to be located, the private trust company is subject to the laws and regulations of that state which can change from time to time by that state’s legislature. The lone exception is an unregulated trust company which can be formed in Massachusetts, Nevada, Pennsylvania, Virginia, and Wyoming.
The IRS issued Notice 2008-63 which contained a proposed revenue ruling addressing the transfer tax and income tax consequences of a private trust company serving as trustee of family trusts. The stated goal of the IRS was to show that the tax consequences of using a private trust company as trustee were no more restrictive than if the taxpayer acted directly in that role.
For more information about this, call your tax attorney. Mitchell A. Port is a tax lawyer in Los Angeles.