I. TRUST PURPOSES

A. Asset management and preservation

B. Income tax savings

C. Estate and gift tax savings

D. Asset protection from creditors

E. Splitting beneficial economic interests

F. Avoidance of probate


II. TYPES OF TRUSTS

A. Trust created by will

A trust is testamentary when it is created by donation mortis causa. (R.S. 9:1733). A mortis causa donation is one made by will.

B. Trust created during lifetime

All trusts not testamentary are considered inter vivos, regardless of the time of creation. (R.S. 9:1734). An inter vivos donation is one made during lifetime.

C. Irrevocable trust

An irrevocable trust is one in which no one has the power to revoke the trust. However, an irrevocable trust could include a power to modify the trust in designated ways.

D. Revocable trust

A settlor may reserve the right to modify or revoke a trust to the extent that the settlor expressly reserves the right to do so. (R.S. 9:2021)

E. Class trust

A Class Trust is a trust in favor of a class consisting of some or all of a settlor's descendants or descendants of a collateral relative of the settlor, although some of the members are not yet in being at the time of the creation of the trust provided at least one member of the class is in being. (R.S. 9:1891). This trust may be either created by will, during lifetime, irrevocable or revocable. This special type of trust was created by the Louisiana legislature to make exceptions to the general requirements that all beneficiaries must be in being on the date of the creation of the trust.


III. PARTIES TO A TRUST

A. What is a trust?

A trust is the relationship resulting from the transfer of title to property to a person to be administered by him as a fiduciary for the benefit of another. (R.S. 9:1731). Most people consider a trust to be an entity even though statutorily it is only a relationship.

B. Who creates the trust?

A settlor is a person who creates the trust. A person who subsequently transfers property to the trustee of an existing trust is not a settlor. (R.S. 9:1761). Other terms used interchangeably with settlor are grantor or trust creator.

C. Number of settlors

There may be one or more settlors of an inter vivos trust. (R.S. 9:1762).

D. Who may be settlor of inter vivos trust?

A person having capacity to contract by onerous or gratuitous title may be a settlor of an inter vivos trust. (R.S. 9:1763).

E. Who may be settlor of testamentary trust?

A natural person having capacity to make a donation mortis causa may be the settlor of a testamentary trust. (R.S. 9:1764).


IV. WHAT MAY BE TRANSFERRED TO A TRUST OR ACQUIRED BY A TRUST?

A. General rule

Property susceptible of private ownership, and any interest in such property may be transferred in trust. (R.S. 9:1771).


V. HOW IS A TRUST MANAGED?

A. Trustee defined

A trustee is a person to whom title to the trust property is transferred to be administered as a fiduciary. (R.S. 9:1781).

B. Number of trustees

There may be one or more trustees. (R.S. 9:1782).

C. Who may be trustee?

Only the following persons or entities may serve as a trustee of a trust established pursuant to the Louisiana Trust Code:

1. A natural person enjoying full capacity to contract who is a citizen or resident alien of the United States.

2. A federally insured depository institution organized under the laws of Louisiana, another state, or of the United States, subject only to the restrictions applicable to national banks or a trust company organized under the laws of Louisiana.

3. A nonprofit corporation or trust for educational, charitable, or religious purposes that is designated as income or principal beneficiary may serve as trustee of a trust for mixed private or charitable purposes. (R.S. 9:1783).

D. Manner in which trustee chosen

An original trustee, an alternate trustee, or a successor trustee may be designated in the trust instrument or chosen by the use of a method provided in the trust instrument, but neither failure of the trust instrument to so provide nor disqualification or removal of the trustee for any reason, incompetence or unwillingness to at of the person so designated or chosen shall invalidate the trust. In such a case, the proper court shall appoint one or more trustees. (R.S. 9:1785).

E. Removal of trustee

A trustee may be removed in accordance with the provisions of the trust instrument or by the proper court for sufficient cause shown. (R.S. 9:1789).


VI. WHO BENEFITS FROM A TRUST?

A. Beneficiary defined

A beneficiary is a person for whose benefit the trust is created and may be a natural person, corporation, partnership, or other legal entity having the capacity to receive property. A trustee of a trust, in his capacity of trustee, can be the beneficiary of another trust. (R.S. 9:1801).

B. Requirement that beneficiary be in being and ascertainable

A beneficiary must be in being and ascertainable on the date of the creation of the trust, except as otherwise provided in this Code. An unborn child is deemed a person in being and ascertainable, if he is born alive. (R.S. 9:1803).

C. Settlor as beneficiary

A settlor may be the sole beneficiary. (R.S. 9:1804).

D. One or several beneficiaries; separate beneficiaries

There may be one beneficiary or two or more beneficiaries as to income or principal or both. There may be separate beneficiaries of income and principal, or the same person may be a beneficiary of both income and principal, in whole or in part. (R.S. 9:1805).

E. Successive income beneficiaries

Several beneficiaries may be designated to enjoy income successively. (R.S. 9:1807).

F. Term of the Trust

If the trust instrument stipulates a term and unless an earlier termination is required by the trust instrument, or by the proper court, a trust shall terminate at:

1. The death of the last surviving income beneficiary or the expiration of twenty years from the death of the settlor last to die, whichever last occurs, if at least one settlor and one income beneficiary are natural persons;

2. The death of the last surviving income beneficiary or the expiration of twenty years from the creation of the trust, whichever last occurs, if none of the settlors is a natural person but at least one income beneficiary is a natural person;

3. The expiration of twenty years from the death of the settlor last to die, if at least one settlor is a natural person but none of the income beneficiaries is a natural person;

4. The expiration of fifty years from the creation of the trust, if none of the settlors and none of the income beneficiaries is a natural person.

(R.S. 9:1831) However, the term of a trust established as a Class Trust may, as a practical matter, be established in perpetuity in the event that the income beneficiary consists of some or all of the settlor's descendants and the principal beneficiary is a charity. Since the income interests continue in perpetuity, the principal beneficiary may never receive any assets from the trust.

G. Nature of interest

An interest in income may be given absolutely or conditionally. It may be given for the life of a beneficiary or for a term, certain or uncertain, not exceeding the life of a beneficiary.

A settlor may allocate to a beneficiary of income a portion of income. Any income not allocated to an income beneficiary shall be allocated to principal.
Except as otherwise provided with respect to the legitime in trust, a settlor may give a trustee who is not a beneficiary of the trust discretion without objective standards except that of the average reasonable man to allocate income in different amounts among the income beneficiaries or to allocate some or all of the income to principal. The settlor may allow income that is not allocated by the end of the year in which it is received to remain unallocated by the trustee until a future year. Any income unallocated when the trust terminates shall be allocated to principal. (R.S. 9:1961).

H. Distribution of income

In the absence of a contrary stipulation, income shall be distributed to the designated beneficiary at least every six months. (R.S. 9:1962).

I. Permissible stipulations regulating distribution of income

Except as otherwise provided with respect to Class Trusts and the legitime in trust, a settlor may stipulate when the income allocable to a designated beneficiary shall be distributed to him, or he may stipulate that the trustee has discretion to determine the time or frequency of distribution or to accumulate some or all of the income. (R.S. 9:1963).

J. Termination of income interest; undistributed income

An interest in income terminates upon the death of the designated beneficiary, or at the expiration of the period of his enjoyment if the interest is for a period less than life. At the termination of an income interest, accumulated or undistributed income that has been or is required to be allocated to the beneficiary shall be paid to the beneficiary or his heirs, legatees, assignees, or legal representatives, except as otherwise provided in this Code. (R.S. 9:1964).

K. Effect of termination of interest

Termination of the interest of the sole income beneficiary prior to the termination of the trust causes each principal beneficiary to become a beneficiary of income in an amount proportionate to his interest in the principal, unless the trust instrument provides otherwise. Termination of an interest in income of one of several income beneficiaries causes the other income beneficiaries or their successors to become beneficiaries of that interest in income in proportion to their interests in the balance of trust income, unless the trust instrument provides otherwise. (R.S. 9:1965).

L. Treatment of income upon death of principal beneficiary

Upon a principal beneficiary's death, his interest vests in his heirs or legatees, subject to the trust; provided, however, that the trust instrument may stipulate otherwise to the extent permitted under prescribed circumstances when a beneficiary dies intestate and/or without descendants. (R.S. 9:1972).

M. Shifting interest in principal

The trust instrument may provide that the interest of either an original or a substitute principal beneficiary who dies intestate and without descendants during the term of the trust or at its termination vests in some other person or persons, each of whom shall be a substitute beneficiary.

Except as to the legitime in trust, the trust instrument may provide that the interest of either an original or a substitute principal beneficiary who dies without descendants during the term of the trust or at its termination vests in some other person or persons, each of whom shall be a substitute beneficiary. (R.S. 9:1973).

N. Substitute beneficiary's interest may be conditional

The interest of a substitute beneficiary may be conditioned upon his surviving the principal beneficiary. The trust instrument may provide for one or more alterative substitute beneficiaries if a substitute beneficiary does not survive the principal beneficiary. (R.S. 9:1974).

O. Requirement that substitute beneficiary be in being and ascertainable

Except as otherwise provided by statute, a substitute beneficiary must be in being and ascertainable on the date of the creation of the trust. Two exceptions to this include the income beneficiaries of a Class Trust and when provision is made for a substitute principal beneficiary. (R.S. 9:1975).

P. Treatment upon death of substitute beneficiary whose interest in not conditioned on survival

Upon a substitute beneficiary's death, his interest, if not conditioned on survival, vests in his heirs or legatees subject to the trust. (R.S. 9:1976).


VII. IRREVOCABLE LIFE INSURANCE TRUST

A. Use

An irrevocable life insurance trust is an excellent and extremely popular wealth preservation planning tool. It is probably the most used of all trusts. This trust can be used to fulfill all of the Trust Purposes set forth in Section I. It can be tailored to the specific goals, needs and problems of a particular client. This trust is usually not funded. The settlor is usually the insured. The trustee is frequently the insured's spouse. The settlor's spouse is usually the trust income beneficiary and the settlor's children are usually the trust principal beneficiaries. If the trust designates grandchildren as principal beneficiaries, then a generation skipping transfer tax analysis is required.

B. Primary Purpose

The primary purpose of many, if not most, irrevocable life insurance trusts is to provide the settlor's spouse with a life income interest and the settlor's descendants with the invested insurance proceeds subsequent to the death of the settlor's wife without the policy proceeds being taxable in either the settlor's estate or the estate of the settlor's spouse. A settlor can achieve this objective with proper planning.

C. Trustee

The settlor's spouse may be the trustee if limitations are placed upon the trustee against invading and distributing principal.

One principal invasion term that is satisfactory authorizes the trustee to make distributions of principal at such times and in such amounts as the trustee determines, in his or her sole discretion, to provide for the income beneficiary's support, maintenance and medical needs in accordance with the income beneficiary's accustomed standard of living. In the event that the trustee's powers of invasion are too broad, then the trust principal may be taxable in the trustee's estate.

D. Pitfalls

1. Crummey powers

Only gifts of present interests in property are eligible for the federal annual gift tax exclusion of $10,000. Outright gifts of life insurance policies are gifts of a present interest but the interest of an income beneficiary may be considered a future interest since life insurance is not income producing. Therefore, each principal beneficiary must be given the right of withdrawal of an amount equaling the annual contributions made to the trust for such beneficiary's benefit. This withdrawal right must be real and not illusory and the beneficiary must be properly notified. In the event that a settlor creates an irrevocable life insurance trust which does not include a crummey power, then the settlor will not be eligible for the federal annual gift tax exclusion.

2. Premiums

The trust should prohibit utilizing trust income to pay insurance premiums. The insurance premiums are best paid by annual donations from the settlor.

3. Three year rule

If an insured transfers a policy to a life insurance trust or relinquishes retained incidents of ownership within three years of death, the policy proceeds will be includable in the insured's gross estate. However, if a new policy is acquired directly by the life insurance trust from the insurer, the policy proceeds will not be includable in the insured's gross estate, even if it is acquired within three years of the insured's death.

4. Generation skipping transfers

Be careful! It may be necessary to file a gift tax return and make an appropriate election annually in order to prevent the policy proceeds and the accumulated earnings thereon from becoming a taxable generation skipping transfer.

E. Step by step process

The irrevocable life insurance trust is one of the most efficient means of achieving a variety of estate planning goals, provided that the trust is carefully drafted and properly implemented.

The execution of the life insurance trust and the acquisition of the insurance should follow a series of steps which must take place in the proper sequence so that the tax driven estate planning goal can be achieved.

1. Determine if the client is insurable.

2. Obtain medical examination of insured.

3. If the insurance company will not permit a medical exam without a policy application, have someone other than the insured sign the application, preferably the party ultimately to be selected as trustee.

4. Determine the appropriate amount of coverage and the applicable annual premium level.

5. Design the trust to conform with the client's needs. Select:

a. Appropriate crummey clause for the annual premium amount;

b. Trustee; and

c. Beneficiaries.

6. Execute the trust and obtain tax identification number.

7. The trustee executes the policy application or amended application.

8. The insured writes a check to the trustee in an amount equal to the required premium.

9. The trustee opens a bank account in name of the trust using the trust's federal identification number and deposits the donated check.

10. The trustee issues the crummey notice(s) and awaits the required notice delay period set forth in the trust and in the notice.

11. Only after the crummey delay has elapsed should the trustee pay the premium to the insurance company.


VIII. WEALTH REPLACEMENT FOR A CHARITABLE REMAINDER TRUST

A. Structure

1. Donor transfers cash or appreciated property to an irrevocable inter vivos or testamentary trust.

2. The income beneficiary is a non-charitable beneficiary, usually the donor, donor's spouse or children, etc.

3. The principal beneficiary is a qualifying charity.

4. The term of the trust is either for the life or joint lives of the income beneficiary(ies) or a term of years, not to exceed 20.

B. Types of charitable remainder trusts

1. Annuity Trust. Pays a specified dollar amount each year to the non-charitable income beneficiary; but not less than 5% of the initial FMV of property placed in trust. Income shortfalls must be made up from corpus. Subsequent contributions are prohibited. Shifts in future values of trust assets affect the charity only.

2. Unitrust. Pays a specified percentage of the value of the trust principal each year to the non-charitable income beneficiary. Income shortfalls may be made up from corpus in future years. Subsequent contributions are permitted. Shifts in future value affect both the charitable and non-charitable income beneficiary.

C. Transaction tax effect

The donor will receive an income and gift tax deduction for inter vivos gifts and an estate tax deduction for testamentary gifts equal to the present value of the charity's remainder interest, which will depend upon a number of factors including:

1. The value of the property transferred to the trust;

2. The age of the non-charitable income beneficiary or beneficiaries (if for life) or the term of the trust;

3. The amount of the annuity or the percentage of the unitrust interest;

4. The frequency of payments;

5. The required applicable federal interest rate.

D. Purpose

The donor may receive substantial benefits from creating a charitable remainder trust such as:

1. Avoidance of capital gains taxes

2. Ability to convert non-income producing appreciated assets into income producing assets without incurring capital gains taxes.

3. Increased income.

4. Income tax savings

E. Taxation of trust

The income beneficiary's annuity or unitrust payment is treated as having the same characteristics as the trust's income, in the following order:

1. ordinary income, then

2. capital gain, then

3. other (tax-exempt) income, then

4. corpus.

A charitable remainder trust is a tax exempt trust and, consequently, pays no income tax of its own, nor will the charitable principal beneficiary.

F. Life insurance use

1. A life insurance policy on the donor is a good investment vehicle for a spousal charitable remainder unitrust, particularly when the unitrust provides that income deficiencies may be distributed in later years; i.e., after the death of the insured. Prior to the death of the settlor, the trust may have no income. However, after the receipt of life insurance proceeds, it should then generate income for the surviving spouse.

2. The donor utilizes the income tax saving created by funding a charitable remainder trust to purchase life insurance naming the insurance beneficiaries as the policy owner. This wealth replacement method can result in the donor's beneficiaries receiving a larger after-tax inheritance than if the donor did not create a charitable remainder trust. The donor can acquire additional insurance by funding it with the increased annual income earned by the donor from his or her charitable remainder trust.


IX. DYNASTY TRUSTS

A. Definition

A "dynasty" trust (a/k/a "legacy" or "perpetual" trust) is a long-term trust designed to last for specific or unlimited future generations. Up until recently, most American states and offshore trust domiciles limited the duration of a trust. This limited duration period was based upon a doctrine enacted in 1536 and known as the "Rule Against Perpetuities." At least twelve states have now either abolished the Rule Against Perpetuities or specifically permit the term of a trust to expire at a later date than previously allowed.

B. Permissible Louisiana dynasty trusts

Except for a Class Trust, Louisiana prohibits a trust from extending after the later of the death of the last income beneficiary or twenty years after the settlor's death and requires that the beneficiary be in being and ascertainable on the date of the creation of the trust. Therefore, except for a Class Trust, a Louisiana trust may not last for more than the lifetime of a designated beneficiary, in being at the time of the creation of the trust or twenty years after the settlor's death (R.S. 9:1803, 9:1831 and 9:1834).

C. Term of Louisiana Class Trust

1. La. R.S. 9:1831 provides that a trust terminates upon the death of the last surviving income beneficiary or twenty years after the settlor's death, whichever last occurs. The term "surviving income beneficiary" would include a principal beneficiary who is designated as a beneficiary of income in the future or who becomes entitled to enjoy income because of the termination of the rights of an income beneficiary. La. R.S. 9:1835. However, subpart H of part I of the Trust Code dealing with the maximum permissible term of a trust does not apply to Class Trusts or to mixed private and charitable trusts. La. R.S. 9:1834.

2. A Class Trust does not terminate before the class closes. La. R.S. 9:1897. The trust may state a date or method for defining a date when the class closes. Unless the trust provides otherwise, the class closes when no members can be added. La. R.S. 9:1896. Once the class closes, the general rules applicable to the permissible term of a trust apply. La. R.S. 9:1897.

3. La. R.S. 9:1901 provides that after the class closes, the trust does not terminate until the death of the last surviving member of the class, unless the trust stipulates an earlier termination date.

D. 1997 Class Trust for descendants

In 1997, La. R.S. 9:1891 was amended to afford the opportunity to create dynasty trusts in Louisiana by permitting the class to consist of some or all of the settlor's "descendants in the direct line, regardless of degrees, or any descendants in any collateral line, regardless of degrees, or any combination thereof, although some members of the class are not yet in being at the time of the creation of the trust, provided at least one member of the class is then in being." Thus, a class could be created for "all of my future descendants," even though the settlor has one child in being and no other descendants in being beyond the first generation.

E. Distributions to class income beneficiaries

1. The trust can provide when income is distributed to the class of income beneficiaries, or it can provide the trustee with the discretion to determine the time or frequency of income distributions or to accumulate some or all of the income. La. R.S. 9:1899. However, income attributable to the legitime in trust must be payable not less than once each year. La. R.S. 9:1841.

2. Generally, if the class consists of persons in more than one generation, then their interests are equal by heads, unless the trust provides otherwise. La. R.S. 1891B.

3. A non-beneficiary trustee may, without objective standards except that of the average reasonable person, allocate income in different amounts ("spray" provisions) among the income beneficiaries and to allocate some or all of the income to principal. La. R.S. 9:1961C.

4. A trustee may invade and distribute accumulated income and principal for the income beneficiary's support, maintenance, educational, or medical expenses, or, pursuant to an objective standard, for any other purpose. La. R.S. 9:2068.

5. The trust may provide that if a class beneficiary dies without descendants, his or her interest vests in the other members of the class. La. R.S. 9:1895A. However, this provision would not give a member of the class of income beneficiaries a right of testamentary transfer to others just because he/she has descendants, since, by definition, his/her income interest terminates upon death.

F. Distributions to class principal beneficiaries

1. Generally, the interest of a principal beneficiary is immediately vested upon the creation of the trust. La. R.S. 9:1971 and 9:1891A. This doctrine was initially eroded with the introduction of the Class Trust concept. The class could be defined as the principal beneficiaries of the trust, which means that after born members of the class dilute the interests of the existing principal beneficiaries. Furthermore, the Trust Code provided a limited substitution whereby the interest of a member of the class of principal beneficiaries could shift to the other class members where the beneficiary died intestate and without descendants. La. R.S. 9:1973A. This provision was further amended in 1997 to permit a shift (except as to legitime) to other class members if the beneficiary merely died without descendants, regardless of whether the beneficiary had a will. La. R.S. 9:1973B.

2. In creating a Louisiana dynasty trust, the class should be the designated income beneficiaries and one or more charitable organizations as the principal beneficiary.

a. If the class is the principal beneficiary, a member of the class could prevent a shift of his/her interest at death through a will where he/she has descendants. La. R.S. 9:1895A.

b. If a charitable organization is designated as the principal beneficiary of a perpetual dynasty trust, the trustee may be given the power to change the charitable beneficiary, particularly if the charity goes out of existence. La. R.S. 9:1951, 9:2271, 9:2292, 9:2295 and 9:2331.

G. Dynasty trust purposes

1. Estate and gift tax savings

The tax savings associated with a Dynasty trust do not occur when it is first funded. It occurs through the avoidance of taxes upon the death of income beneficiaries. (This is based upon the assumption that when the trust is created, it will be eligible for exemption from the generation skipping transfer taxes).

2. Asset management and preservation

This trust provides the same type of asset management alternatives as does any other trust.

3. Asset protection from creditors ("spendthrift trust")

a. Potential creditors

(1) Contract creditors (consumer debt, bank debt, guaranties, partnership liabilities, etc.).

(2) Tort creditors (personal injury, malpractice, officer and director liability, etc.).

(3) Regulatory liability (e.g., environmental, ADA).

b. Divorce (child support, alimony, property settlement).

c. Disabled beneficiaries (preservation of need-based governmental assistance, such as SSI and Medicaid).

4. Restrictions on asset protection

a. The degree of asset protection will depend upon applicable state law and exceptions to spendthrift provisions.

(1) La. R.S. 9:2004 provides that a beneficiary's interest in income and principal is subject to seizure by the beneficiary's creditors to the extent the beneficiary has donated property to the trust, directly or indirectly.

(2) Notwithstanding a spendthrift provision, La. R.S. 9:2005 permits a proper court to seize a beneficiary's interest in trust income and principal in its discretion and as may be just under the circumstances if the claim is based upon a judgment for:

(a) Alimony or maintenance of a person whom the beneficiary is obligated to support;

(b) Necessary services rendered or necessary supplies furnished to the beneficiary or to a person whom he beneficiary is obligated to support; or

(c) Tort creditors of the beneficiary or of a person for whose acts the beneficiary is responsible.

(3) What is a beneficiary's interest subject to seizure if the beneficiary is merely an income beneficiary and a non-beneficiary trustee has discretion to spray income under La. R.S. 9:1961C? Generally, a court cannot direct the trustee to act or refrain from acting in a particular way, unless there has been an abuse of discretion by the trustee. La. R.S. 9:2115. See, Read v. U.S., 169 F.3d 243 (5th Cir. 1999).

5. Provide for educational and medical costs for family in perpetuity.

6. Encourage beneficiaries to act in desired ways (e.g., by providing funds only if the beneficiary attends college, earns a certain amount of income, marries, or has children).

7. Discourage beneficiaries from acting in undesirable ways (e.g., by providing funds only if the beneficiary is not addicted to drugs or alcohol).

8. Protect the beneficiaries from imprudent or designing persons.

9. Perpetuate family name.

10. Provide for charitable donations form the trust in family name once trust principal attains certain levels.

H. Life insurance dynasty trust

An irrevocable life insurance trust may be a dynasty trust but the donations of the annual premium will not be subject to the annual gift tax exclusion of $10,000.00 per donee and, therefore, a crummey clause may not be utilized. However, it is recommended that a restricted crummey clause be inserted in this trust in the event that the generation skipping transfer tax law is amended. In addition, the trustee could also authorize the purchase of life insurance on some or all of the income beneficiaries, i.e., the descendants of the settlor. This would have the effect of replenishing the trust for distributions previously made to particular descendants.


X. BRASS RING - INTENTIONALLY DEFECTIVE IRREVOCABLE GRANTOR DYNASTY CLASS TRUST

A. Definition

An intentionally defective grantor trust is a trust which is defective for income tax purposes; i.e., the grantor, during his lifetime, pays all trust income taxes even though the grantor does not receive the trust income. However, for gift and estate tax purposes, the trust is not defective and is considered as an ordinary irrevocable trust which, therefore, it being a completed gift for gift tax purposes or a bequest for estate tax purposes in the event that the trust is created in a testament.

B. Purpose

The purpose of this trust is to increase the tax benefits obtained through the utilization of a dynasty trust, while, at the same time, benefitting from valuation discounts.

Example: The settlor creates a limited liability company to which he transfers stocks and real estate valued at Three Million Dollars and designates himself as the manager of the limited liability company. At the same time, the settlor creates an irrevocable dynasty trust and donates his available equivalent exemption amount, currently $650,000.00. This irrevocable dynasty trust will be an intentionally defective irrevocable trust, resulting in the income of the trust being taxed to the settlor during his lifetime. This is accomplished by the grantor retaining an administrative power, such as a power to reacquire trust corpus by substituting other property of an equivalent value. The settlor then sells fifty percent of his limited liability company to the defective dynasty trust for One Million Dollars, which is based upon an appraisal utilizing a thirty percent discount from the market value of the assets owned by the limited liability company. This is a credit sale and effectively freezes the settlor's estate tax value on his previously owned fifty-one percent interest in the limited liability company.

C. Benefits

1. Income tax consequences

a. Since the trust is a grantor trust, the installment sale of the LLC units to the trust will be ignored for income tax purposes. The settlor will not recognize any gain or loss on the installment sale.

b. The settlor is not taxed separately on the interest payments made on the trust's promissory note.

c. The settlor is taxable on all of the income of the trust.

(1) The settlor would have been taxable on income had the settlor done nothing.

(2) The settlor's payment of the income tax allows the trust to grow at a faster rate unreduced by income taxes.

(3) The settlor's payment of income taxes reduces the settlor's estate for federal estate tax purposes.

(4) The settlor's payment of income taxes should not be treated as a gift for gift tax purposes, thus preserving settlor's annual gift tax exclusion and available unified credit for other gifts, such as additional units of the LLC to the trust.

2. Gift tax consequences

a. The donation to the trust is considered as a completed gift for gift tax purposes.

b. IRS may allege that the settlor's payment of income taxes on trust income not received by the settlor is a taxable gift.

3. Estate tax consequences

a. Although the trust is treated as "owned" by the settlor for income tax purposes under the grantor trust rules, the trust assets are not included in the settlor's estate for federal estate tax purposes.

b. If settlor dies before the trust's note has been paid in full, the balance due on the note will be included in settlor's estate. The promissory note is a "leaky" freeze technique in the sense that the growth in value of the LLC units owned by the trust is removed from settlor's estate but is offset by the interest payments on the note (reduced by the settlor's income tax payments under the grantor trust rules).

4. Non-tax benefits

a. The settlor controls the assets as Manager of the LLC.

b. The settlor continues to have access to cash flow by virtue of the trust's payments on the note.

c. The settlor has the security of the LLC units sold to the trust if the trust defaults on its payments.

D. Selecting the situs of the trust

1. Consider state tax laws

2. Consider whether the trustee must be a state domiciliary

3. Consider the maximum term of the trust

4. Consider asset protection laws

5. Consider investment latitude

6. Consider authorizing trustee to change the situs of the trust

E. Selection of trustee

1. Corporate fiduciary

a. Professional management

b. Lessens family friction (neutrality)

c. Impersonal

d. May be required to invoke laws of another state

2. Committee elected by branches who serve as trustees or select trustee.

3. Combination of corporate and individual trustees with bifurcation of responsibilities (corporate trustee holds and manages assets; family trustee(s) make income and principal distribution decisions).

4. Power to remove and replace trustee (at will or for appropriate reasons).

a. Could permit removal by decision of all or a specified percentage of the competent adult beneficiaries either at will or for stated cause (e.g., poor investment performance).

b. Alternatively, the family trustee(s) could be given the power to remove and replace corporate trustee.

c. Default provision if no successor is chosen or willing to serve. In Louisiana, a trust will not fail for lack of a trustee. A proper court can appoint a successor. La. R.S. 9:1785.

5. Committees and/or multiple trustees frequently used for distributions and investment decisions. Could provide that at least one of the trustees making distribution decisions is from outside of the family. In many states, the committee members need not be trustees, but in Louisiana, it is doubtful whether a non-trustee can be granted the equivalent of trustee powers. However, the trustee probably could be required to take investment instructions from a named investment advisor.

6. To avoid the IRS determining that the trustee has a general power of appointment (which could lead to estate and/or gift tax liability and to the constructive receipt of income and capital gains), perhaps distribution decisions should be left to an independent trustee who nevertheless can be required to consult with an advisory committee of one or more family members for non-binding advice. The trust should provide that funds cannot be used to meet the support obligations of a trustee if the trustee is to avoid having income taxed to him.

7. Avoid trustee deadlocks by providing odd numbers of trustees.

F. Life insurance

The intentionally defective irrevocable grantor dynasty Class Trust is an excellent wealth preservation planning tool that can be partially funded with life insurance. Life insurance may be acquired on the life of the settlor and also on some or all of the income beneficiaries in order to replenish the trust distributions previously made to descendants.

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