The Advisor: Helping You Manage Your Life and Legacy in Today's Complex World
This quarterly newsletter provides articles of interest, insights, and recent developments involving interdisciplinary legal topics affecting high-net worth individuals as well as family offices, trust companies, financial advisors, and similar private client service providers. We hope you find this publication informative, and we welcome your feedback on topics you'd like to read about in future publications.
Connecticut: Newly Attractive State for Trusts
By Edward A. Vergara, Sarah Constantine, Ashley C. Slisz
On July 12, 2019, Connecticut Governor Ned Lamont signed into law sweeping changes to the state's trust laws, which will take effect January 1, 2020. As stated in the preamble, the law was enacted to "modernize Connecticut trust law in order to allow the state to remain economically competitive, create jobs and retain businesses in the state."1 The new law dramatically alters the landscape of trust administration in Connecticut and positions the state among the leading trust jurisdictions.
With Connecticut's central location in the northeast and robust finance industry, high net worth families who previously considered forming dynasty trusts, directed trusts or asset protection trusts in Delaware or similar jurisdictions but were uncomfortable with a corporate trustee, may (beginning January 1, 2020) create such trusts in Connecticut by appointing a Connecticut resident individual (e.g., family member, close friend, advisor, attorney) as trustee.2 Similarly, families who have existing dynasty trusts, directed trusts, and/or asset protection trusts, may avail themselves of the new law by appointing a Connecticut resident trustee and migrating the trust to Connecticut.
The new law comprises three acts, Connecticut's versions of each of the Uniform Trust Code (UTC), Uniform Directed Trust Act (UDTA), and Qualified Dispositions in Trust Act (QDTA) (collectively, the Act). The adopted provisions of the UTC provides Connecticut fiduciaries and trust beneficiaries long overdue guidance with respect to the administration of Connecticut trusts, greatly expands the statutory period that a new trust may be in existence (from approximately 110 years to 800 years), and permits nonjudicial settlement agreements and judicial modifications/terminations. The Uniform Directed Trust Act permits the bifurcation of trustee powers, which maximizes flexibility and control by the settlor and beneficiaries. Finally, the Qualified Dispositions in Trust Act permits individuals to establish self-settled domestic asset protection trusts (DAPTs), which can provide spendthrift creditor protection to the settlors of such trusts. Below is a high-level summary of the key benefits of the Act.
Greater Ability to Engage in Multigenerational Planning
Many flexible, generation-skipping trusts have been created to permit distributions of income and/or principal for the benefit of children, grandchildren and possibly further descendants, with the understanding that these trusts will not be subject to the imposition of gift, estate or generation-skipping transfer (GST) taxes as they pass from one generation to the next. Trust beneficiaries are often advised to use assets outside of these GST exempt trusts (which would otherwise be subject to estate or GST taxes) before consuming the GST exempt trust assets. However, prior to the enactment of the Act, if such trusts were formed in Connecticut they would be required to terminate this highly-favorable, multi-generational tax planning at the expiration of the applicable perpetuities period—approximately 110 years. The Act has now changed the landscape of this dynasty planning by permitting trusts formed in Connecticut after January 1, 2020, to exist for a maximum of 800 years.
Prior to the passage of the Act, Connecticut resident settlors desiring to preserve their wealth for multiple generations were often forced to settle trusts in jurisdictions without a perpetuities period, such as Delaware, Nevada, New Hampshire, South Dakota, or Wyoming, and appoint a corporate trustee to administer the trusts. This structure frequently resulted in significant fees and administrative burdens. The Act allows settlors resident in Connecticut (or any jurisdiction) to appoint a friend, family member, or trusted advisor residing in Connecticut as trustee (Connecticut Resident Trustee) and thereby avail themselves of Connecticut's extended perpetuity period without appointing a corporate trustee. Settlors resident in neighboring jurisdictions with a shorter perpetuities period—e.g., New York (approximately 110 years) and Massachusetts (approximately 90 years)—desiring to preserve their wealth nearly indefinitely for future generations might consider forming a trust governed by Connecticut law.
Directed Trusts Enable Maximum Flexibility and Control
With the enactment of the UDTA, Connecticut joins the trend of states shifting control of trusts away from traditional trustees—primarily banks and other large institutions—back into the hands of independent trust companies, advisors, and most importantly, settlors and beneficiaries. The UDTA statutorily bifurcates trustee duties and responsibilities between fiduciaries: (i) a "directed trustee," generally resident in Connecticut; and (ii) "director(s)"3 (e.g., a distribution director(s), trust protector(s), or investment advisor(s)). While the directed trustee acts in a fiduciary capacity, the directed trustee has no discretionary authority except as otherwise provided in the trust instrument.
For example, a directed trust could provide for the appointment of a distribution director, investment director and directed trustee, among others, to serve as "directors" each with the following responsibilities:
- the distribution director could have full discretion to determine when and how distributions should be made and the exclusive authority to instruct the directed trustee to make the distributions. The settlor of the trust or any other designated person (e.g., a Protector) could retain the power to remove and replace the distribution director.4
- the investment director could have sole authority to instruct the directed trustee which investments it should make on behalf of the trust. The settlor of the trust or any other designated person (e.g., a Protector) could retain the power to remove and replace the investment director;5 and
- the directed trustee could be required to act at the direction of the distribution director and investment director and have limited liability for actions taken pursuant to such directions. As such, a directed trustee could ultimately have only limited powers to handle administrative matters without direction (e.g., filing of tax returns, preparation of annual statements and accountings, etc.). Nevertheless, regardless of the terms of the trust, the Act provides that a trustee cannot be relieved of liability for breaches committed in bad faith or with reckless indifference to the purposes of the trust or the interests of the beneficiaries.
Prior to the adoption of the UDTA, Connecticut law lacked clear statutory or common law authority on the bifurcation of trustee duties. Similar to dynasty trusts, before the enactment of the Act, settlors desiring to establish directed trusts were advised to establish trusts in jurisdiction that had codified directed trusts—which often required the appointment of a corporate trustee. Beginning January 1, 2020, Connecticut resident settlors and non-resident settlors, particularly residents in neighboring states that do not have a directed trust statute (e.g., New York, Massachusetts and Rhode Island), may find Connecticut an appealing alternative to Delaware because they can avail themselves of the jurisdiction by appointing a close friend or advisor resident in Connecticut. Additionally, clients who have existing directed trusts may consider migrating their trusts to Connecticut if the circumstances permit.
Asset Protection Trusts Provide New Opportunities for Connecticut Residents
With the passage of the Act, Connecticut becomes the 19th state to have DAPT-enabling legislation. The other 18 states are Alaska, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. The Connecticut DAPT law is similar to the statutes enacted by the other states.
By way of overview, a DAPT is an irrevocable self-settled trust in which the settlor is designated a permissible beneficiary. If properly structured, creditors of the settlor shouldn't be able to reach the DAPT's assets. The ability of a DAPT to successfully defeat the claims of creditors depends on a variety of factors. Most fundamentally, a DAPT can never serve to frustrate the claims of current or imminent creditors. In addition, certain types of creditors will have an enhanced ability to reach the assets of a DAPT (e.g., claims for child support). Subject to these generally limitations, however, Connecticut law will allow for the establishment of a DAPT as long as the following basic requirements are satisfied:
- providing that Connecticut law governs the validity, construction, and administration of the trust;
- requiring the trust to be irrevocable;
- including a spendthrift clause (i.e., a provision that prevents any beneficiary from assigning his or her interest in the trust);
- subject to certain limitations, requiring that the DAPT be funded by means of a disposition by or from the transferor, with or without consideration; and
- that the DAPT be administered by a "qualified trustee", namely someone other than the transferor, who (i) is an individual resident of Connecticut or (ii) a state or federally chartered bank or trust company having a place of business in Connecticut, authorized to engage in trust business in Connecticut and maintaining or arranging for custody in Connecticut of some or all of the property that is the subject of the qualified disposition.
The Act makes clear that a Connecticut DAPT may provide for trust directors (as discussed above) and that the transferor may serve as a trust director provided the transferor's power is limited to a "veto right" over distributions.
Connecticut residents seeking to protect their assets from future unanticipated claims may wish to consider a Connecticut DAPT. Non-Connecticut residents considering a Connecticut DAPT will need to assess the risks and benefits of creating a Connecticut DAPT, which determination will depend on a variety of factors, including the public policy of the settlor's state of residence.
Non-Judicial and Judicial Modifications Offer Flexibility to Change Terms of Irrevocable Trusts
Subject to certain restrictions, the Act codifies the authority of "interested persons" to enter into binding, nonjudicial settlement agreements (NJSAs) with respect to any matter involving an inter vivos trust. The statute enumerates the following non-exclusive list of trust matters that a NJSA may resolve: (i) interpretation or construction of the trust terms; (ii) approval of a trustee's report or accounting; (iii) direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power; (iv) the resignation or appointment of a trustee and the determination of a trustee's compensation; (v) transfer of a trust's principal place of administration; and (vi) liability of a trustee for an action relating to the trust. An NJSA may not modify or terminate an irrevocable trust and is valid only to the extent it includes terms and conditions that could be properly approved by the court under the Act and does not violate a material purpose of the trust.
The Act also codifies the authority of the courts to modify or terminate a noncharitable irrevocable trust formed after January 1, 2020, upon the consent of the settlor, trustees and all beneficiaries, even where the modification or termination is inconsistent with the material purpose of the trust. Courts also have the authority to modify or terminate noncharitable irrevocable trusts with the consent of all of the beneficiaries, provided the court concludes that the modification is not inconsistent with the material purpose of the trust or the continuance of the trust is not necessary to achieving any material purpose of the trust. Distribution of a trust terminated pursuant to the foregoing must be made as agreed to by the beneficiaries.
Where a beneficiary's consent to a modification or termination is withheld or unavailable, the Act permits the court to proceed with a proposed modification or termination if it is satisfied that (i) had all of the beneficiaries consented, the trust could have been modified or terminated; and (ii) the interests of a non-consenting beneficiary will be adequately protected.
Taken together, the Act's changes to the rules for judicial and nonjudicial modification of trusts should greatly simplify the process of administering, interpreting and modifying both revocable and irrevocable trusts, and further enhance Connecticut's status as a favorable jurisdiction for the establishment of trusts.
As noted above, the Act takes effect on January 1, 2020, and will forever change the landscape of trust law in Connecticut. Clients considering establishing a trust or migrating an existing trust to a jurisdiction that has more flexible and modern trust law may wish to consider Connecticut as a possible jurisdiction.
Seriously Delinquent Tax Debt May Affect a Taxpayer's Passport Status
By Joel Deuth
Under current law, the Internal Revenue Service (IRS) has the discretionary authority to certify that a taxpayer owes "seriously delinquent tax debt," which, if certified, forces the Treasury Secretary to transmit such certification to the Department of State (State) for denial, revocation or limitation of the taxpayer's passport. The IRS announced this summer that it will issue a letter (Letter 6152, "Notice of Intent to Request US Department of State Revoke Your Passport") to affected taxpayers, giving them advance warning that they are in danger of becoming certified as owing seriously delinquent tax debt, and providing these taxpayers with an opportunity to avoid denial, revocation or limitation of their passport.
A "seriously delinquent tax debt" means an unpaid, legally enforceable federal tax liability of an individual (1) which has been assessed, (2) which is greater than $50,000 (indexed for inflation; $52,000 in 2019), and (3) with respect to which (a) a notice of lien has been filed pursuant to Section 6323 of the Internal Revenue Code of 1986, as amended (the Code) and the administrative rights under Section 6320 of the Code with respect to such filing have been exhausted or have lapsed, or (b) a levy is made pursuant to Section 6331 of the Code.
A seriously delinquent tax debt does not include non-tax debts, including Affordable Care Act assessments, criminal restitution assessments, child support obligations or Report of Foreign Bank and Financial Accounts (FBAR) assessments. It also does not include (1) a debt that is being timely paid pursuant to an installment agreement or an offer-in-compromise, or (2) a debt with respect to which collection is suspended because a due process hearing is requested or pending, or because innocent spouse relief has been requested or is pending.
In July 2019, the IRS indicated that it would begin issuing letters called "IRS Letter 6152" to taxpayers who have seriously delinquent tax debt warning them that the IRS may transmit certifications relating to such debt to State, who in turn may revoke the taxpayers' passports. This letter is intended to serve as a notice for taxpayers to contact the IRS upon receipt of such letter so that they might make a good faith effort to resolve their tax debts before the IRS contacts State. Taxpayers must contact the IRS within 30 days of receiving the letter (or 90 days for taxpayers who live outside the United States). (The IRS sends a notice called a "Notice CP 508C" to taxpayers who the IRS has certified to State as owing a seriously delinquent tax debt.)
To avoid having the IRS notify State about a seriously delinquent tax debt status, a taxpayer can, of course, pay the tax debt in full, or pay under an installment agreement, offer-in-compromise, or settlement agreement with the Department of Justice.
Under certain circumstances, taxpayers may not be subject to an IRS certification, and potential revocation of their passport. Those circumstances include:
- victims of tax-related identity theft;
- accounts that are currently not collectible due to hardship;
- taxpayers who are located within a federally declared disaster area;
- taxpayers who have a request pending with the IRS for an installment agreement;
- taxpayers who have a pending offer-in-compromise with the IRS; or
- taxpayers who have a pending adjustment that will pay the full tax period.
However, the IRS announced that it will not provide a broad exception for taxpayers who have open cases with the IRS Office of the Taxpayer Advocate, an independent organization within the IRS that assists taxpayers with navigating the IRS.
The IRS must reverse its certification to State when the tax debt has been fully satisfied, or when the tax debt ceases to be treated as seriously delinquent tax debt. Taxpayers will receive a separate notice from the IRS of its reversal of certification.
Taxpayers may file suit in district court or Tax Court to challenge the validity of a certification. There is no administrative appeals process to challenge a certification.
In summary, taxpayers who know or anticipate a seriously delinquent tax debt must consider the consequences beyond just interest and penalties, such as an impact on the taxpayers' ability to travel internationally. Pay attention to any correspondence from the IRS and respond to the IRS by the deadlines set out in such correspondence.
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© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This newsletter is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
Unlike other jurisdictions, Connecticut does not tax a trust on the basis of residency of a fiduciary. As such, appointing a Connecticut resident trustee would not, in and of itself, result in the trust being subject to tax in Connecticut. CGS § 12-701(4).
Careful consideration should be taken when appointing “directors”, as the tax residence of the directors/advisors may result in adverse state tax implications (e.g., California taxes trusts on the basis of residency of a fiduciary, which is broadly construed and generally includes, but is not limited to, trustees, investment advisors, and protectors).