Delaware is one of the premier jurisdictions for personal trusts. The state is at the forefront of trust law innovations and the infrastructure supporting Delaware’s trust industry is difficult to match, with distinguished courts, a proactive legislature, a deep pool of professional advisors, and the presence of almost every major financial institution. Delaware’s status as a favorable trust jurisdiction has attracted a considerable amount of non-Delaware trust business to the First State, resulting in a positive impact on Delaware’s economy through fiduciary fees, job creation, tax revenues, and additional economic activity in support of the trust industry.[1]
How we got here
Over the past half-century, the role of trustees has evolved rapidly along with the trust industry itself. We have seen a transition in the investment standards guiding trustees from a “prudent man” using legal lists to a “prudent investor” employing modern portfolio theory. Jurisdictional considerations for a wealthy family have progressed from inter-state to multinational during this time as well; trustees are now required to understand concepts of foreign taxation and foreign property law regimes and remain compliant with strict federal Know Your Customer laws put in place to combat money laundering and terrorist financing. There has also been an unbundling of the trustee’s role where co-fiduciaries take on the responsibility for directing certain aspects of a trust’s administration in a directed trust. Finally, today’s beneficiaries often request their inheritances in trust to obtain protection from creditors and to minimize transfer taxes. These changes have spurred the evolution of the trust industry and increased the competition among the states for personal trust business.
Increased complexity of trust investments
Historically, trust laws evolved with the development of the common law as each new fiduciary issue was resolved by the courts. A trustee’s duties and obligations were often determined based upon standards of prudence and loyalty litigated after the fact. The result of judging fiduciary conduct using 20/20 hindsight was that a trustee’s default standards of care were very conservative. Statutes that attempted to modify the common law were strictly construed and, ultimately, may not be enforced by the court if there were appropriate grounds for the court to craft an exception. These circumstances required the trust industry to maintain a very conservative approach.
In the investment realm, the investment process was initially driven by “legal lists” of permissible investments including government bonds and first mortgages. By the 1940s, legal lists were replaced in most states by the prudent man rule which characterized investment in “speculative” stocks, discounted bonds, or buying any securities on margin as presumptively improper. Not until the late 1980s did states, starting with Delaware, begin to repeal their prudent man rules in favor of a prudent investor rule that embraced modern portfolio theory[2]. Until this time, it was generally not seen as proper to invest in a diverse portfolio of securities.
Modern trust laws require a sophisticated trustee
Trust-friendly laws allowing for directed trustees and perpetual trusts are not new concepts, but their proliferation in recent years and broad acceptance in many states have expanded the scope of trustees who must administer these complex structures. Starting in the mid-1980s, states began to compete for trust business using favorable trust laws as a lure to bring trust assets into their states.[3] Many states began to repeal their common law rules against perpetuities to allow for perpetual trusts[4] and to codify laws allowing the role of the trustee to be unbundled so advisors could direct how the trustee exercised its fiduciary powers, the so-called directed trust[5]. Beginning with Alaska and Delaware in 1997[6], certain states began to apply spendthrift protections to self-settled trusts allowing for the creation of domestic asset protection trusts. Until this time, wealthy individuals had to use offshore asset protection trusts if they wanted creditor protection while retaining access to their assets.
During this period of evolution in the trust laws, differences in state income tax laws created opportunities for residents of one state to explore the use of personal trusts administered in another trust-friendly state for the purpose of minimizing their overall state income tax burden. The situs of trust administration became a compelling reason to seek a trustee located in a favorable jurisdiction like Delaware, South Dakota, or Alaska. State income tax arbitrage lead to complex trust structures used to mitigate taxes upon the recognition or receipt of income (a so-called “ING” trust)[7] so the taxpayer remains a resident of his or her high-tax home state while exporting the assets to a trust in a low or no-tax jurisdiction to limit state income taxes.
As trust and tax laws changed and investments became more complex, successful families sought the services of professional fiduciaries located in favorable jurisdictions who were adept at navigating these complex trust laws and able to take advantage of these modern investment options. The demand for fiduciary services made trust departments an attractive source of revenue to financial institutions and some states began to compete to attract trust assets into their states[8]. Some innovations in trust laws that states used to bring assets into their state (such as perpetual trusts, directed trustees, and self-settled spendthrift trusts (a.k.a., asset protection trusts, or APTs)) made the role of a trustee so complex that only a professional fiduciary skilled at navigating these complex trust laws was able to carry out the basic duties of the fiduciary. However, as the sophistication in the role of the trustee evolved to this point, pricing demands created by fierce competition for this fiduciary business put a strain on operating margins.
Dispelling the myths
Because the personal trust business is a lucrative one, the competition among the states for this business is fierce and sometimes filled with misinformation. Other states claim to have the same favorable laws and similar advantages to lure in prospective clients, often at lower fees.
While promoting their own trust services, other states at times present subjective information as fact. There are even cases where an attorney from a competing state creates charts purporting to rank the trust-friendly states on key features of trust law, such as the duration of a trust (dynasty trusts), domestic asset protection trusts, and the ability to modify a trust through a so-called “decanting” process[9]. By self-selecting the criteria and assigning arbitrary weights to these factors, these rankings elevate competing states to the top of the list and correspondingly move Delaware down in the ranks. Unfortunately, after the charts are published in the popular press and on an annual basis in professional publications (by the charts’ own author)[10], these subjective rankings begin to gain some legitimacy.
Consequently, it is important for participants in Delaware’s trust industry to be able to answer the question “Why Delaware?” when clients are deciding where to have their personal trusts administered.
The Delaware Advantage
The objective facts tell a different story—that of Delaware as a premier trust jurisdiction. In a 2011 empirical study, Northwestern University law professor Max Schanzenbach determined that a conservative estimate of the impact of the out-of-state trust business on Delaware’s economy was between $600 million and $1.1 billion[11]. With the trust industry growing at a rapid pace and Delaware capturing a disproportionate share of this business, these amounts have likely risen substantially since 2011. Moreover, Delaware’s state income tax revenue attributable to its excess trust business was estimated in this study to be between $19 million and $33 million per year.
As we know, Delaware is called the First State because it was the first to ratify the U.S. Constitution. However, it was also the first state to develop many of the innovative trust laws that sanctioned directed trusts[12], perpetual trusts[13] and asset protection trusts[14], as well as laws permitting modern and flexible investment standards for trustees[15]. The First State also pioneered the ING trust structure that allows residents of some high-tax states to mitigate state income taxes on income generated by assets held inside a properly structured trust administered in Delaware[16].
There are no objective rankings of state trust laws generated by an unbiased source because every client’s needs are unique, thereby making a ranking of the states’ laws misleading for a given client. However, Delaware has all the flexible tools permitting perpetual trusts, directed trustees, modern trust investment rules, flexible income distribution standards, along with rigorous asset protection laws, which make it a top choice for practitioners looking to find the right home for their clients’ personal trusts.
Selecting Delaware to take advantage of these favorable laws has the backing of the state’s courts, which routinely enforce these laws as written[17]. When advising clients on where to administer trust structures used to carry out a family’s wealth management goals over multiple generations, practitioners want confidence that the trust will function as intended. Delaware’s long history of court cases, and the state’s sophisticated judiciary willing to enforce the laws as written, helps to provide this comfort.
Delaware’s physical location also puts it at the deep end of the talent pool. The state’s geographic proximity to D.C., Baltimore, Philadelphia, and the financial hub of New York City provides access to leading professionals in the legal, tax, accounting, and investment industries. The size and complexity of the trust business in Delaware draws many talented professionals who provide administrative services for these trusts. The synergy created among these professionals promotes the innovation that helps Delaware remain the First State for trust business.
The First State remains the premier personal trust jurisdiction
This evolution of the trust industry has highlighted the fact that modern trusts require the services of robust professional trustees adept at navigating complex legal, tax, investment, and regulatory issues. Trustee services are not a commodity because each trust relationship is unique. Advisors who regularly counsel families on these decisions understand the value a sophisticated trustee found in Delaware brings and can help families find the right fit. Sophisticated wealth planners demand the use of robust trustees in preferred jurisdictions, like Delaware, who have in-house legal, tax, and administrative talent to deliver these complex fiduciary services. The First State has the tools and talent to remain on top.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, investment, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
Note that financial and estate planning strategies require individual consideration, and there is no assurance that any strategy will be successful.
Wilmington Trust is not authorized to and does not provide legal or tax advice. Our advice and recommendations provided to you are illustrative only and subject to the opinions and advice of your own attorney, tax advisor or other professional advisor.
The information in this article has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. The opinions, estimates and projections constitute the judgment of Wilmington Trust and are subject to change without notice.
Note that a few states, including Delaware, have special trust advantages that may not be available under the laws of your state of residence, including asset protection trusts and directed trusts.
[1] See, Robert H. Sitkoff & Max M. Schanzenbach, Jurisdictional Competition for Trust Funds: An Empirical Analysis of Perpetuities and Taxes, 115 Yale LJ 356, 375 n.62, 393‒94 (Nov. 2005).
[2] See, 12 Del. C. Section 3302 (1986) and Uniform Prudent Investor Act (1994).
[3] Sitkoff & Schanzenbach supra note 1.
[4] Since 1933, Delaware permitted “perpetual” trusts through the exercise of a series of limited powers of appointment (38 Del. Laws c. 198 (April 6, 1933); 25 Del. C. § 503). South Dakota enacted the first statute that sanctioned perpetual trusts. See, S.D. Codified Laws §§ 43-5-1–43-5-9 (1983).
[5] In 1986, Delaware codified the longstanding practice of trust advisers directing trustee actions. See, 65 Del. Laws 422, § 5 (1986). See, also, Uniform Trust Code, Section 808 (2000) and Uniform Directed Trustee Act (2017).
[6] See, Alaska Stat. § 34.40.110, 12 Del. C. §§ 3570‒3576.
[7] The IRS has ruled repeatedly that properly structured self-settled trusts would be treated as incomplete gifts and nongrantor trusts – i.e., “ING trusts”. See, e.g., PLRs 201653001‒006 (Aug. 16, 2016); 201650005 (Aug. 26, 2016); 201636027‒032 (May 23, 2016); 201628010 (Apr. 11, 2016); 201614006‒008 (Dec. 4, 2015); 201613007 (Dec. 4, 2015).
[8] See, Sitkoff & Schanzenbach, supra note 1.
[9] See, e.g., www.oshins.com/state-rankings-charts
[10] See, e.g., Steve Oshins, Steve Oshins Releases 8th Annual Trust Decanting State Rankings Chart with 31 Decanting Jurisdictions Ranked, LISI Est. Plan. Newsl. #2878 (April 13, 2021), www.leimbergservices.com.
[11] Professor Schanzenbach’s report may be viewed at www.leimbergservices.com/docs/report-5-25-11b.pdf (last visited Oct. 20, 2022)
[12] See supra note 5.
[13] See supra note 4.
[14] See supra note 6.
[15] See supra note 2.
[16] See, Private Letter Ruling 200148028. See, also, Todd A. Flubacher, Thomas R. Pulsifer, “Eliminate a Trust’s State Income Tax,” Trusts & Estates Magazine (May 2006).
[17] See, e.g., Duemler v. Wilmington Tr. Co., 2004 WL 5383927 (Del. Ch. Nov. 24, 2004)(directed trusts), In re Peierls Family Testamentary Tr., 77 A.3d 223 (Del. 2013); In re Peierls Charitable Lead Unitrust, 77 A.3d 232 (Del. 2013); In re Peierls Family Inter Vivos Tr., 77 A.3d 249 (Del. 2013)(court jurisdiction and conflict of laws); Ravet v. N. Tr. Co. of Del., 2015 WL 631588 (Del. Feb. 12, 2015)(lifetime validation of trust); TrustCo Bank v. Mathews, 2015 WL 295373 (Del. Ch. Jan. 22, 2015) (DAPT statute of limitations)
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