A purpose trust can preserve your legacy for a business, charitable or other goal but there are issues with this technique and an alterative approach may be better.
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Patagonia’s Purpose Trust
Purpose trusts are a fascinating estate planning tool and they have received considerable attention since the founder of Patagonia, Yvon Chouinard (1973) used a purpose trust as a keystone of his estate plan focused on environmental efforts. The entire structure was certainly a noble goal to accomplish good in the world. In very simplistic terms Chouinard transferred the Patagonia voting stock to a purpose trust. Most of the non-voting stock was transferred to a special type of charitable trust that would not trigger gift tax and which would permit payments to influence legislation to support environmental goals. A downside of this type of charitable trust is that there is no income tax deduction as might be realized with a donation to a charity. This type of trust is named after the section of the Internal Revenue Code that permits it: 501(c)(4), sometimes abbreviated as just “C4.” Business profits will fund the C4’s operations. You can create a purpose trust for a variety of reasons and regardless to whether it is paired with a C4. Chouinard’s structure, from what can be ascertained from public documents, was a clever way to accomplish his unique wishes. Your plan, whether or not you use a C4, should be structured to accomplish your goals using whatever components makes sense for your situation.
Certainly, if such a high profile shareholder and company could create a purpose trust it is feasible, but costly and complicated. Although there has been growing talk about purpose trusts, there are potential issues. Hopefully, those issues will be resolved over time because purpose trusts, for the right situation, could become a great tool and can accomplish much good.
What is a purpose trust?
While Chouinard’s purpose trust above illustrates what a purpose trust is, describing the concept more generally will help you understand the concept, issues and then an alternative approach that might help your planning. First, at the risk of stating what might be obvious, what is a regular trust? The typical trusts are designed to benefit specific people (e.g. a spouse and children, or a class or group of people, e.g., descendants), and perhaps charities. A purpose trust is, as its name implies, is not intended to benefit people, although in some variations it might, but rather to fulfil a stated purpose. That purpose may support certain causes that don’t fit neatly into the charitable envelope (like Chouinard’s plan above). It might be to preserve a business for the future of the town where it is based, or the employees who work there. But fulfilling a purpose is quite different then benefiting people and the laws of trusts that have evolved over time have focused on people trusts not purpose trusts. That is changing but until the law fully catches up caution is in order.
A purpose trust, in any of the many variations it can be designed to include, may be useful when there are no heirs the benefactor wishes to benefit. Often there are both causes or purposes as well as people that the benefactor wishes to benefit. In those instances the alternative approach described below might be preferable. Purpose trust arrangements might be useful where the benefactor has a strong ideology. That seems to be at the heart of Chouinard’s plan. In many cases the benefactor may desire to maintain continuity of the business or activity.
Issues and Risks of a Purpose Trust
This article will provide an overview of some of those issues and suggest an alternative approach that uses traditional trust and entity building blocks that may accomplish many or all of the same goals as a purpose trust, with less risk. This alternative approach may in fact be sufficiently useful that even as the laws affecting purpose trusts evolve the alternative approach may remain a viable option to better accomplish your goals.
Purpose trusts might face issues with their status as to whether or not they will be respected as trusts for income tax purposes (they might instead be recharacterized as corporations). The transfers to shift assets, like a business, into the purpose trust might trigger gift tax if further planning is not done. Given how limited the use of purpose trusts the documentation to use in the creation and structure of the trust and overall arrangement might have to be custom created. That makes the purpose trust and related planning more unique, less routine. That means less knowledge and law as to what works and what might not. Also, creating customized unique documents is more costly. Using new-fangled documents that are custom created from scratch, rather than modifying a form can be useful, but there is a downside that may be more significant then just the cost that creates. What provisions should be used? What happens if something important is forgotten in the newly created document? What law is there on how to interpret such a unique document? These concerns are a possible advantage of the alternative approach discussed below. Finally, there might also be complications or uncertainties as to how to administer the trust and related structures.
Some of the questions to ponder if you are creating a purpose trust might include:
- What does state law say, if anything, about purpose trusts?
- What is the current IRS view as to the classification of a purpose trust for income and transfer (gift, estate and GST) tax purposes?
- What state law would permit the trust to last in perpetuity if that is the intent?
- Who enforces the trust when there are no beneficiaries? If there are people who can benefit from a trust the concept or theory is that they will make noise and take action if the trustee is abrogating their trustee fiduciary responsibilities. If there is no human beneficiary who will watch the trust cookie jar?
- What happens to the mission or goals of the trust, business and other components of the structure when the founder or benefactor dies? How will the DNA of the trust purpose be carried forward? What happens in 50 or 100 years when the cause or purpose is no longer relevant? Can the purpose trust adapt? If so who does the adapting? These concepts are also addressed in the alternative approach suggested below that is built on more traditional trust building blocks.
- What happens to the earnings of the business held by the purpose trust? If there are no profit motivated shareholders who is watching that cookie jar?
- If an active business is held in the purpose trust who is managing the business? How will succession of those persons be handled? What mechanism and in what legal documents will this be addressed?
- How is governance of the structure handled? Is the governance structure based on new concepts created for the specific situation? How will those work?
An Alternative To a Purpose Trust
Can your advisers create a structure that mimics some of the valuable consequences of a purpose trust but using more known and recognizable legal “building blocks?” Can more traditional succession planning documents and techniques be used? Can the gift (and perhaps GST) tax issues of funding a purpose trust be avoided? The alternative to the purpose trust may in some instances be built using a non-charitable trust that benefits, family and other individuals, named charities and charities to be named. The trust can flexibly fund charitable and family gifts in a manner that can adapt and change as appropriate over time. That may be far more flexible then a purpose trust. The governance and preservation of and transmission of the purpose DNA may be achieved by creative adaption of special purpose limited liability companies (LLCs”. These can create, using common legal documents and techniques the framework to operate the businesses into the future.
Steps to Create an Alternative to a Purpose Trust Using Common Building Blocks.
- Ereated a non-charitable perpetual grantor trust in a trust friendly jurisdiction (e.g., DE, AK, NV, SD). This trust is largely a complex, modern dynastic trust that would include an independent institutional trustee, direction provisions that name people other than the institutional trustee to handle key trust functions and in particular distributions and investment decisions, a trust protector to serve as a check and balance on the trust operations. The trust protector may even be a committee and the powers given to the protector can be tailored to support the overall purpose and goals of the plan.
- The trust is a spray or sprinkle trust has a mix of both charitable and non-charitable beneficiaries. So, the trust can benefit, as decided by the distribution trustee or adviser (discussed below) family, other named individuals, charitable causes and even non-charitable non-human organizations to fulfil the donor’s purpose.
- The trust included some framing of the client’s goals, but he also wrote separate letters of instruction as to goals, distribution intent, etc.
- I used note sales and related planning to shift the business interests into the trust. This addressed the uncertainty of the tax status of a purpose trust and the concerns over how to shift large values into a purpose trust.
- The trust investment decisions are made by a special purpose South Dakota LLC formed solely to address the management of trust investments. The LLC has a board of managers (I used corporate language eg board of directors but each was a manager etc. so it was more familiar for the client). The succession of managers and the structure for making business decisions was embodied in a tailored LLC operating agreement.
- Trust distribution decisions are made by a second special purpose SD LLC with a similar structure but different people were named to the board to address distribution decisions and the settlor was expressly prohibited from serving in any capacity.
The idea was to use known building blocks of LLCs and a completed gift grantor trust to create the structure to perpetuate the business, benefit family but mostly charities, and have it last in perpetuity.
