When deciding which trust jurisdiction to use to situs a trust, Nevada is often the chosen jurisdiction for a multitude of reasons. It excels in nearly every desired attribute that one would want in selecting a state situs. Arguably, those attributes are: (1) strong dynasty trust laws; (2) strong domestic asset protection trust (DAPT) laws; (3) a flexible decanting statute; and (4) no state income tax.
Let’s focus on each of these attributes with a special emphasis on more recent updates to the Nevada laws, including case law and statutory changes.1
Strong Dynasty Trust Laws
Nevada passed its 365-year dynasty trust statute in its 2005 legislative session, which was effective for trusts that became irrevocable on or after Oct. 1, 2005. There haven’t been any statutory changes since then, but certain case law took center stage in 2015.
In a unanimous opinion issued on March 26, 2015, the Supreme Court of the State of Nevada made a bold statement by ratifying the Nevada 365-year rule against perpetuities (RAP) in Bullion Monarch Mining, Inc. v. Barrick Goldstrike Mines, Inc. (Bullion Monarch).2
Although the 365-year RAP law was already firmly engraved in the Nevada statutes, and therefore, this court case should have gone largely unnoticed, it was the message sent by the Nevada Supreme Court justices to a small group of anti-Nevada promoters that made this case the final nail in the coffin after a spectacular series of events.
It all started with an article published in 2014 in the Vanderbilt Law Review titled “Unconstitutional Perpetual Trusts,”3 wherein the co-authors called the constitutionality of certain longer term dynasty trust statutes into question. Their primary claim was that dynasty trusts set up under the laws of a state with a state constitutional ban on perpetuities, but a long statutory term-of-years perpetuities period, violate the state’s RAP. Nevada was one of the targeted states, along with Wyoming, North Carolina, Tennessee and Arizona.
The article was heavily criticized because its conclusion was contrary to substantial case law and treatises. The article was incorrect in asserting that the state legislature and courts couldn’t alter the constitutional prohibition of perpetuities with changing circumstances and changing policy considerations. The constitutional prohibition is a general statement of policy and doesn’t freeze the constitutional provision. Over time, the application of the ban on “perpetuities” set forth in the state constitution can change.
At that point, the issue seemed to have gone away. However, only a matter of months after the article was published, the Nevada Supreme Court, in Bullion Monarch, laid down the hammer and ruled contrary to the law review article’s conclusion.
According to the court:
In Nevada, the rule is codified in our Constitution: ‘No perpetuities shall be allowed except for eleemosynary purposes.’ Nev. Const. art. 15, § 4. But in 1987, Nevada adopted a statutory rule against perpetuities. See NRS 111.1031; 1987 Nev. Stat., ch. 25, §§ 2-8, at 62-65. The new statutes added a wait-and-see provision, which, as amended, gives contingent property interests 365 years to vest before they are invalidated. See NRS 111.1031(1)(b).4 (Emphasis added.)
Thus, the Nevada Supreme Court went out of its way, in a unanimous decision, to confirm the 365-year statute in this very pointed paragraph. How do you argue with a quote? Especially a quote that’s supported by so much analysis and context. And, especially one made by the Nevada Supreme Court, which has the final say over the interpretation of the Nevada laws.
Most importantly, the Nevada Supreme Court demonstrated its desire to protect Nevada’s laws.
Strong DAPT laws
One of Nevada’s advantages has always been that it’s the only top-tier DAPT jurisdiction that has no statutory exception creditors, meaning classes of creditors that can bust through a DAPT despite the DAPT’s protection from creditors. Practitioners from competing states have suggested that Nevada DAPT laws are “too protective” and, therefore, won’t work as advertised.
However, on May 25, 2017, the Nevada Supreme Court, in a unanimous opinion, issued a written ruling in Klabacka v. Nelson5 leaving no doubt that Nevada DAPTs are protected from spousal support and child support claims, at least for Nevada resident settlors, because there was no specific analysis for non-Nevada residents.
The appeal involved a divorce and a division of assets held in two separate Nevada DAPTs, one set up by the husband and the other set up by the wife. In 2009, the parties began divorce proceedings and subsequently added the DAPTs as necessary parties.
As part of the divorce, the Nevada district court “ordered [husband’s] Trust to satisfy [husband’s] personal obligations—specifically, [husband’s] child—and spousal-support arrears.”6
The court analyzed the issues by noting the public policy that many DAPT jurisdictions have against protecting assets from spousal and child support creditors. There’s nothing wrong with this position. In fact, to most people, it’s the more easily defensible position. However, Nevada is well known as a debtor’s haven that has laws that go beyond the protections offered in other states, thus giving it a claim along with a few other states for the fictional title as “top U.S. trust jurisdiction.”
Specifically, the court noted:
(On the other hand, there is a strong public policy argument which favors subjecting the interest of the beneficiary of a trust to a claim for alimony .... [T]he obligation to pay alimony is a duty, not a debt.’ (internal quotation marks omitted)); see also S.D. Codified Laws § 55-16-15(1) (2016) (providing that many of South Dakota’s statutory spendthrift trust protections ‘do[ ] not apply in any respect to any person to whom at the time of transfer the transferor is indebted on account of an agreement or order of court for the payment of support or alimony in favor of the transferor’s spouse, former spouse, or children, or for a division or distribution of property in favor of the transferor’s spouse or former spouse, to the extent of the debt’); Wyo. Stat. Ann. § 4-10-503(b) (2015) (‘Even if a trust contains a spendthrift provision, a person who has a judgment or court order against the beneficiary for child support or maintenance may obtain from a court an order attaching present or future distributions to, or for the benefit of, the beneficiary.’).7
The court concluded that an order made by the district court directing support payments to be made from the DAPT runs contrary to Nevada law. The court also added to this analysis by looking at the legislative history behind the Nevada DAPT statutes:
The legislative history of SSSTs [self-settled spendthrift trusts] in Nevada supports this conclusion…When crafting the language to allow SSSTs, the Legislature contemplated a statutory
framework that protected trust assets from unknown, future creditors, as opposed to debts known to the settlor at the time the trust was created. See id. The legislative history explicitly mentions child support as an example of a debt that would not be free from attachment if known at the time the trust was created. Id. However, the trust assets would be protected from attachment as to debts unknown at the time the trust was created—presumably, this protection extended to child—and spousal support obligations unknown at the time the trust was created.8
The court even brought back memories of the 2013 legislative session when a small group of Nevada family law attorneys turned on the rest of the Nevada community and attempted to reduce the utility of Nevada trusts by adding exception creditors that may have knocked Nevada off of its perch as arguably the top DAPT jurisdiction.
It’s rare for state supreme court justices to point out a failed legislative attempt to change the law in a court opinion. But, presumably this was done to make a very loud statement that the court is in favor of Nevada maintaining its lofty status as a trust haven.
Specifically, the court noted:
Additionally, in 2013, the Legislature proposed changes to NRS Chapter 166 that would have allowed a spouse or child to collect spousal support or child support from otherwise-protected spendthrift trust assets. See Hearing on A.B. 378 Before the Senate Judiciary Comm., 77th Leg. (Nev., May 8, 2013 statement of Assemblywoman Marilyn Dondero Loop). However, the proposed changes to NRS Chapter 166 did not pass, and, as a result, the Nevada spendthrift trust statutes were not amended to allow for an exception for child- and spousal-support orders of a beneficiary to be enforced against a spendthrift trust.9
The Nevada Supreme Court once again demonstrated its willingness to protect Nevada as a leading trust jurisdiction.
Flexible Decanting Statute
There are 29 states that have statutes allowing the distribution trustee of an irrevocable trust to decant the trust. The trustee decants the trust by distributing the trust assets into a different trust with different terms for one or more of the same beneficiaries of the original trust. In most cases, this second trust is a brand new trust. Essentially, this gives the trustee a “do-over” to make changes to the trust terms that traditionally wouldn’t have been permitted prior to the ability to decant without a judicial modification.
Some of the states with decanting statutes allow for greater flexibility than others. Nevada has traditionally been one of the most innovative states when it comes to decanting. As a result of the passage of SB484 in the 2015 Nevada legislative session, there are even more opportunities to change the situs of a trust to Nevada to take advantage of the new legislation that’s effective for any trusts decanted on or after Oct. 1, 2015.
Removing Mandatory Income Interest
Prior to SB484, a trustee wouldn’t have been permitted to decant a Nevada trust into a second trust if the result of appointing the property from the original trust would be to reduce a current fixed income interest, annuity interest or unitrust interest of a beneficiary. For example, if a parent or child established a trust that provided that the child was to receive all income, the trustee of the original trust would be permitted to decant the property into a second trust that modified the terms as it relates to the principal, but the second trust would still have to require that all of the income be payable to the child.
SB484 modified this restriction. Under the new Nevada law, a trustee is permitted to decant a Nevada trust into a second trust that removes the fixed income interest, so long as the original trust from which the trustee is decanting didn’t qualify for a marital deduction or charitable deduction and wasn’t one that paid a qualified interest pursuant to Internal Revenue Code Section 2702. If the original trust that’s being decanted did qualify for a marital or charitable deduction or is one that pays a qualified interest under IRC Section 2702, the same limitation prior to the modification applies, and the trust may be decanted, so long as the second trust doesn’t reduce the income interest of an income beneficiary of the original trust.10
Nevada is one of only six of the 29 decanting jurisdictions that allows this flexibility.
Most notably, the ability to decant an irrevocable trust to remove a mandatory income distribution affects two important areas: (1) creditor protection, and (2) federal and state income tax bracket shifting opportunities.
Creditor protection advantages: Unless there’s a compelling reason to design a trust to force all income to be distributed out to a beneficiary, from a creditor protection standpoint, this gives that beneficiary a property right over all of the income, and having that property right can open the income stream up to a creditor or a divorcing spouse. It’s likely that most of our clients, if they could go back in time, would prefer to have used a trust that didn’t force the income out, especially because so many of the beneficiaries may go through a divorce. The new Nevada statutory changes enable the advisor to help the client enhance the creditor and divorce protection of a trust by decanting it to remove the mandatory income distributions.
Income tax advantages: Nobody can accurately predict future irrevocable trust federal and state income tax brackets, individual federal income tax brackets or where the beneficiaries will be domiciled for state income tax purposes and their state income tax brackets. If the trust is drafted to force all of the income out to one particular beneficiary, there’s no ability to shift income to the lower federal and state income tax brackets of other trust beneficiaries, nor is there the ability to retain income in the trust if the beneficiary is in the same federal bracket as the trust, but subject to a state income tax that can be avoided by retaining the income in the trust. The flexibility of a discretionary trust that doesn’t force out all of the income to one particular beneficiary provides these potential advantages, which is yet another reason to decant the trust to remove the mandatory income interest.
Ability to accelerate a beneficiary’s interest in the trust: As is the case with all 29 state decanting statutes, a trustee may not effectively add a beneficiary to a trust by appointing property from the original trust to a second trust that includes a beneficiary that wasn’t a beneficiary of the original trust. SB484 gives greater flexibility to a trustee to modify the timing of a beneficiary’s interest in the trust. Under the revised statute, the second trust may have as beneficiaries any current beneficiaries of the original trust or any future beneficiaries of the original trust.11
This opens up additional income shifting opportunities along the same lines as discussed above. The difference here is that there’s also an ability to move future beneficiaries up to be present beneficiaries to have more potential low income tax brackets to use to reduce the family’s overall income tax liability.
Nevada is one of only four of the 29 decanting jurisdictions that allows this flexibility.
No State Income Tax
One last material attribute of Nevada is that it’s one of only seven states that has no state income tax. Note that there are other states that do have a state income tax but no fiduciary state income tax that applies to a non-grantor trust. This is a necessary ingredient for any trust jurisdiction to attract out-of-state trust business.
Endnotes
1. For more details about the material differences and rankings among the leading trust jurisdictions, seewww.oshins.com/state-rankings-charts.
2. Bullion Monarch Mining, Inc. v. Barrick Goldstrike Mines, Inc., 131 Nev., Advance Opinion 13 (2015).
3. Steven J. Horowitz and Robert H. Sitkoff, “Unconstitutional Perpetual Trusts,” 67 Vanderbilt Law Review (Aug. 8, 2014).
4. See supra note 2, at pp. 3-4.
5. Klabacka v. Nelson, 394 P.3d 940 (Nev. 2017).
6. Ibid., at p. 950.
7. Ibid.
8. Ibid., at p. 951.
9. Ibid.
10. NRS Section 163.556.3(a).
11. NRS Section 163.556.2.