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Incentive Trusts and Planning Across Generations (With Sample Provisions)

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Incentive Trusts and Planning Across Generations (With Sample Provisions) INCENTIVE TRUSTS AND PLANNING ACROSS GENERATIONS (WITH SAMPLE PROVISIONS) LAUREN J. WOLVEN is a Partner with Levenfeld Pearlstein, LLC, in Chicago. The information contained in this outline is for educational and instructional use only. No war- ranty, express or implied, is made as to their use. Any tax advice contained in this outline was not intended or written by the author to be used and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Before using any tax advice contained in this outline, a taxpayer should seek advice based on the taxpayer’s particular circum- stances from an independent tax advisor. I. INTRODUCTION — BECAUSE MONEY knowing wealth and typically not having witnessed DOESN’T COME WITH INSTRUCTIONS the obstacles overcome to create it, knows no bet- ter and dissipates the family wealth. The fourth In 1758, prior to the birth of our nation, Benjamin generation is then left to start from scratch—from Franklin printed a short treatise entitled The Way shirtsleeves to shirtsleeves. This dilemma is not just to Wealth. One of the first, if not the first Ameri- an American problem, however, as many cultures can book on personal finance, The Way to Wealth around the world have parallel metaphors. is the source of such famous aphorisms as “early to bed, and early to rise, makes a man healthy, wealthy The concept reflected by the shirtsleeves meta- and wise.” Franklin translated his work into a book phor is not purely financial, however. John Adams of picture riddles for children entitled The Art of is attributed widely with having said “I must study Making Money Plenty, believing that it was never politics and war that my sons may have liberty to too early to begin learning the concepts of financial study mathematics and philosophy. My sons ought management. to study mathematics and philosophy, geography, natural history, naval architecture, navigation, com- The fact that our founding fathers struggled with merce and agriculture in order to give their children the challenges associated with transitioning wealth a right to study painting, poetry, music, architecture, to the next generation, with which difficulties we statuary, tapestry, and porcelain.” With the change still find ourselves wrangling today, is not necessar- in financial fortune over the generations often ily a comforting realization. Unfortunately, there is comes a shifting of values, and Adams eloquently no one answer or simple way to educate the next captured that sentiment. generation or one magic transfer technique that fits all occasions. There are numerous studies regarding family wealth transition that all reach the same conclusion: the We still live in a world where the failure of wealth senior generations, particularly the Baby Boomers, transfer gives rise to clichés such as “shirtsleeves do not put enough thought and effort into planning to shirtsleeves in three generations.” The first gen- for transition of wealth to succeeding generations. eration creates the wealth. The second generation, The reasons that individuals with wealth to pass on often having experienced the struggles of their to their descendants fail to plan is unclear. Perhaps parents to earn and save, and generally under the it is a discomfort with facing their own mortality, or watchful eye of the first generation, preserves the perhaps they are frozen by paralysis of analysis when wealth. The third generation, having grown up faced with difficult family dynamics? Regardless of 8 | ESTATE PLANNING COURSE MATERIALS JOURNAL AUGUST 2019 the reasons behind the inaction, the result generally second part to his wife, and the third part dis- is not positive, either emotionally or financially. posed of at the decedent’s pleasure.2 3. The Supreme Court in 1896 stated that it knew In order to successfully tackle stumbling blocks that prevent successful wealth transfer, it is useful to of “no legal principle to prevent the legislature understand the societal forces affecting and legal from taking away or limiting the right of testa- issues restricting transition of family assets and val- mentary disposition, or imposing such condi- ues. Most of the drafting techniques considered tions upon its exercise as it may deem conducive and issues discussed are relevant to estate plan- to public good.”3 ning in the 21st century, regardless of the testator’s a. One hundred years later, however, the net worth. Furthermore, the educational methods Supreme Court, in Hodel v. Irving, seemed to noted to help transmit values along with wealth are find that a constitutional right to bequeath adaptable to varying net worth situations. property did exist.4 i. Hodel involved seizure of tribal lands II. HISTORICAL DEVELOPMENT OF from estates of individual owners by Con- THE RIGHT TO BEQUEATH gressional Act. A. Constitutional History ii. In the early 1980s, members of the Oglala 1. As a general rule, the laws dictating the rules for Sioux tribe brought suit seeking a declar- intergenerational wealth transfer are controlled atory judgment to hold the section of by the states. the Indian Land Consolidation Act (Act) unconstitutional on the grounds that a. Federal law does interact with state law in it authorized seizure without the just this arena, though, most often with respect compensation required by the Fifth to taxation of estates and trusts and distribu- Amendment.5 tion of trust income. (1) The Act stated, “No undivided frac- b. There is significant variation from state to tional interest in any tract or trust or state, it is important to understand the appli- restricted land within a tribe’s reserva- cable law of the governing jurisdiction, some tion or otherwise subjected to a tribe’s of which is set forth by statute, but much of jurisdiction shall descedent [sic] by which stems from common law. intestacy or devise but shall escheat c. In certain significant instances, however, the to that tribe if such interest represents federal courts have set forth some important 2 per centum or less of the total acre- rules that provide a framework for testamen- age in such tract and has earned to its tary disposition. owner less than $100 in the preceding 2. Historically, the laws of all civilized states recog- year before it is due to escheat.”6 nized the absolute right of citizens to earnings, (2) The issue before the court was whether the enjoyment of property, and the disposition it was constitutional to prohibit pass- 1 of property by will. ing de minimus amounts of Oglala a. This right to pass property, both real and per- Sioux Tribe land by intestate succession sonal, has been part of the Anglo-American or devise and to instead force escheat system since feudal times. to the tribe.7 b. Under King Henry II’s reign, a man’s goods b. The Supreme Court noted that the right to were to be divided into three equal parts: “pass on property” has been a part of the one part to his heirs or lineal descendants, a legal system since feudal times and that the INCENTIVE TRUSTS AND PLANNING ACROSS GENERATIONS (WITH SAMPLE PROVISIONS) | 9 attempted regulation amounted to the abro- preserve the privilege of the white gation of the right to pass property.8 women of South Africa. (1) “Moreover, [the] statute effectively ii. Natal University College petitioned the abolishe[d] both devise and descent of court to have the trust modified to delete these property interests…”9 the terms “European,” “British,” and “Dutch South African” deleted. (2) In affirming the Eighth Circuit’s deci- sion in Irving v. Clark the Supreme Court (1) The college relied on a provision of confirmed a constitutional right to pass law that allows trust modification if, in property by devise and descent that is the opinion of the court, the provision integral to today’s successful transfer of creates consequences the settlor could intergenerational wealth. not anticipate and hinders the purpose of the trust, prejudices the interests of B. The Influence of Society the beneficiaries, or runs contrary to 1. The rules governing a testator’s ability to place public interest. conditions on a gift at death are continually (2) The court determined that to allow evolving. funds to be allocated to a specific pop- ulation in a discriminatory manner was a. The law reacts to societal adjustments. against public interest and granted the b. Laws of different nations (and States) react at petition of the college. a different pace according to what the occu- pants of the political subdivision consider III. A SURVEY OF CASE LAW REGARDING acceptable values. RESTRICTIVE BEQUESTS AND TRUST PROVISIONS c. For example, consider the 2009 case involv- A. Posthumous Meddling or Valid Conditions? ing Natal University College.10 1. Testators have tried to control from the grave i. In the mid-1930s the testator, Sir Charles since the beginning of time under the very basic George Smith, drafted a will that left one- rationale that it is their money and they should third of his estate in trust to fund the uni- be able to dispose of it as they choose. For the versity education of European girls born most part, the U.S. courts have agreed with this of British South African or Dutch South principle. African parents. 2. In 1917, the Iowa Supreme Court was asked to (1) At the time his will was drafted, his determine whether a testator’s provision vested intent was to assist poor white women his son with a fee simple absolute or with a who were financially disadvantaged defeasible fee.11 and unlikely to attend college or a. The testator bequeathed one-half of his university. estate to his son on the condition that at the (2) Sir Charles would not have focused on time of the son’s death he was survived by African women because at that time living issue.12 Upon the son’s death, the son’s very few Africans, in general, attended wife challenged the condition and argued college, let alone African women.
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