Private Trust Company Alternative to Institutional Trustee
Updated: Apr 28, 2021
By: Juliya L. Ismailov and William L. Bricker
We have noticed an uptick in popularity of private trust companies to serve as a corporate trustee of family trusts. This article discusses the benefits for some clients of using such private trust companies in lieu of a traditional third-party corporate trustee.
As a background, many high net worth individuals set up dynasty trusts, to hold family assets for tax and non-tax purposes, with terms of governance that are intended to survive multiple generations. Since the family may be located in multiple foreign and U.S. jurisdictions, when the planning involves setting up a trust in a specific U.S. state, an institutional trustee is preferable and even necessary, to serve as a co-trustee with a family member or friend in order to provide nexus local with the trust’s jurisdiction, administrative oversight, and perhaps financial clout to the subject trust.
While corporate trustees provide the local presence, institutional experience and name recognition, in order to minimize any potential exposure to fiduciary liability a corporate trustee prefers to work with a directed trust, or one that appoints a primary co-trustee, a distribution committee, and/or an investment committee to exercise discretion and direct the corporate trustee’s administrative actions. Annual trust company fees can range from $15,000 up to $100,000 per year, depending on extent of the trustee’s obligations and discretion, types of underlying assets and location of the trust (domestic or foreign).
Before agreeing to serve as trustee, the trust company will request documentation to complete thorough due diligence, in compliance with both federal regulations as well as internal policies. Sometimes a trust company will decline a client based on unfavorable circumstances, such as ongoing civil litigation or country of origin. And, even if a trust passes the upfront “tests,” after a corporate trustee is appointed the due diligence requests may continue as a precondition to the trustee disclosing trust account information or taking an administrative action on behalf of the trust.
While trust companies have justifiable reasons for their thorough process, clients with U.S.-based trusts that may not qualify for a corporate trustee, or may prefer a more closely-held model of trusteeship short of appointing individual trustees, may have the alternative option of forming a “private trust company” (PTC).
States that have passed PTC legislation include Alaska, Delaware, Nevada, New Hampshire, South Dakota, Tennessee, and Wyoming. The PTC rules differ across states in various respects, such as: whether family members must own a PTC in addition to being trust beneficiaries, how “family members” are defined, whether non-family members can be trust beneficiaries (such as spouse of a family member, an affiliate company, a family charitable foundation or a non-family employee), and what regulatory requirements must be satisfied. For illustration purposes, below we delve into the PTC rules applicable in Nevada.
A PTC in Nevada is a corporation or limited liability company that only serves as a fiduciary for trusts of “family members.” A family is defined to include all lineal relatives, such as children, grandchildren and future generations. As a result, one PTC can serve as trustee of multiple family trusts, but not any third-party non-“family” trusts. This limitation helps delineate the territory of PTCs without inordinately competing with institutional trustees in the state. (Wyoming recently passed legislation, effective July 1, 2019, clarifying under the statute that was previously silent that an unregulated PTC can provide fiduciary services to non-family key employees (current or former) of entities that are majority-owned and controlled by family members.)
The tax benefits of forming a trust company (rather than relying on family members to serve directly as individual co-trustees) is that such individual co-trustee’s state of residence cannot cause the trust to be located, for state tax purposes, in another state and be subject to that state’s income tax. That said, for Nevada to be respected as the trust’s situs, all aspects of the trust other than the trustees’ residences should support a “nexus” with, or connection to, Nevada, including having at least one Nevada director, maintaining a local office and a local bank branch, and holding at least one annual board meeting in Nevada.
The PTC may be formed as an LLC, in which case it would generally make an election to be treated as C corporation for federal tax purposes. As a result, it files its own tax return, rather than being treated as a partnership with each family member having to pick up the trust’s income proportionally on his or her individual tax return. Assuming the trust company will not be making dividend distributions to the family members (other than any trustee commissions they choose to take), but rather will accumulate the trust’s income, make non-taxable distributions to beneficiaries and apply the income to the trust’s administrative expenses, the C corporation will not suffer double-taxation, first at the entity level and then again at the individual-shareholder’s level.
The PTC entity is governed by a board of directors (the “Board”), officers and committees. These positions can be filled by family or non-family members, subject to certain numerical considerations in terms of voting control (discussed below).
In addition to the tax and administrative (as well as cost) efficiencies offered by a private trust company, it provides a structured vehicle for multi-generational transition of trust governance responsibilities, in addition to flexibility for administrative trust amendments that may be needed and cannot be currently anticipated.
A PTC can operate as an unchartered trust company in Nevada. The benefits of being chartered as a trust company, at the cost of higher regulatory compliance burdens, include credibility from the state and federal authorities’ perspective and the ability to provide investment advice without being regulated by the federal Securities and Exchange Commission.
In 2008, the IRS issued Notice 2008-63 that sets forth the parameters of PTC governance, including recommending the use of the Distribution and Amendment committees. The Notice illustrates various numerical combinations of trust settlors and beneficiaries (i.e., “interested persons”) and independent persons serving on the Distribution Committee that would prevent control of the trust company’s discretion by self-interested persons. Otherwise, the trust company structure would risk triggering estate tax consequences for such interested individuals. For example, the PTC bylaws must prevent a family member from participating in a distribution decision for a trust of which he or she is a beneficiary, and from entering into reciprocal agreements with each other regarding discretionary distributions. Also, while the Distribution Committee must include one (1) independent person, the Amendment Committee cannot include interested persons at all. The goal of the Amendment Committee is to safeguard provisions in the PTC governing documents ensuring independent decision-making for the family trusts on which it serves as trustee.
For trusts holding sizeable assets, the set-up costs for filing fees and attorney time total approximately $35,000, along with annual fees for Nevada director and trust officer services, rent, and related corporate services, totaling another approximately $35,000 per year. Based on these figures, on an annualized basis, the cost of setting up and annually maintaining a private trust company can be equal to, or less than, the annual fees that an institution would charge to serve as trustee of multiple family trusts.
The benefits of forming a Private Trust Company include: (i) coordinated umbrella governance for a number of family trusts sharing the burden of the total trustee fees; (ii) ability to manage trusts holding non-marketable investments that may not qualify for traditional corporate trustee services; (iii) internal mechanism for fluid co- and successor trustee appointments; (iv) close family involvement in the trust investment and distribution decisions; (v) succession trustee training for younger generations; and (vi) entity protection from fiduciary liability for individual family members.
There is a rising wave of private trust company formation in multiple jurisdictions and we are happy to assist with a family’s consideration of this option.