The modern estate tax was first put in place a century ago, amid fears that the vast fortunes amassed during the Gilded Age might spawn a permanent plutocracy. Even though few now pay it, the tax is unpopular with Americans and Republicans have labeled it the “death tax.
Contributions to a dynasty trust are theoretically limited in size to the amount of a person’s estate-tax exemption, now $5.5 million. Judging from the size of Mnuchin’s trust, he’s likely to have used a combination of other legal tax-planning techniques to slip more assets into his dynasty trust without triggering a tax, according to Hesch and Edward McCaffery, a University of Southern California law professor.
One of the most common techniques is an installment sale to an intentionally defective grantor trust, sometimes known as an “I dig it” trust, McCaffery said. The transaction amounts to giving the trust “the mother of all sweetheart deals” to guarantee that its assets will grow quickly, he said.
The Obama administration has also called for tax-law changes to close the “I dig it” loophole. Mnuchin’s disclosure doesn’t say whether the dynasty trust used such an arrangement or any other technique to boost its growth.
Legal Mismatch
Dynasty trusts owe their existence to a mismatch between federal and state law. The federal estate-tax system had its last major revision in 1986, at a time when most states, drawing on English common law, limited the term of trusts to the lifetime of a living heir, plus 21 years. Congress worked out a system that policed transfers to children and grandchildren, and didn’t contemplate the possibility of a trust lasting 100 years or more.
Later, a few states saw an opportunity to attract wealthy out-of-state clients: scrap rules governing trust terms. Now, a half-dozen states including South Dakota, Delaware and Alaska vie to offer dynasty trust services and tout trusts that can last forever.
The Obama Treasury Department last February, in its proposed budget, recommended a law change that would cap such trusts at 90 years.
Dynasty trusts aren’t used exclusively for avoiding estate taxes, according to McCaffery. They might help protect a family’s assets against lawsuits or divorces, or help prevent heirs from getting huge sums before they’re mature enough to manage them. But, he added, “I’ve never seen one that didn’t have a major tax dimension.”
Charles T. Dowling, a lawyer at Sullivan & Cromwell LLP in New York, is the trustee of Mnuchin’s dynasty trust, according to securities filings by CIT Group Inc., which employed Mnuchin as a vice chairman until last year. Dowling didn’t respond to requests for comment.