The state of Oklahoma has enacted the Family Wealth Preservation Trust Act 1 (the "Act"), effective November 1, 2004. 2 The Act offers significant wealth protection benefits, 3 as the income and corpus of an Oklahoma "preservation trust" will be exempt from the claims of creditors of a "grantor" for up to $1,000,000 in value. 4 Furthermore, any "incremental growth derived from income retained by the trustee" in excess of the $1,000,000 amount is considered exempt from the claims of the grantor's creditors. 5 The preservation trust can be revocable by the grantor; however, exercise of the right to revoke is tantamount to forfeiture of the exemption. 6
To qualify as a preservation trust a trust must be established under Oklahoma law and at "all times" must have an Oklahoma institutional trustee within the meaning of the statute. 7 Only certain individuals and charities may be "qualified beneficiaries." 8 Additionally, the corpus of the trust must consist solely of "Oklahoma assets," and the terms of the trust must provide that the income produced by its corpus is subject to Oklahoma income tax. 9
An Oklahoma-based bank or trust company that qualifies as a trustee is one chartered under Oklahoma law or a nationally chartered bank or trust company that has a place of business at a physical location in Oklahoma. 10
According to the Act, "Oklahoma assets" are stocks, bonds, or debentures issued by an Oklahoma-based company, bonds or other obligations issued by the state of Oklahoma or subdivisions of the state, bonds or other obligations issued by a county or municipal government located in Oklahoma, accounts at Oklahoma-based banks or trust companies, and real property in Oklahoma. 11
An Oklahoma-based company is a corporation, limited liability company, limited partnership, or limited liability partnership formed or domesticated in Oklahoma 12 and having its principal place of business at a physical location in Oklahoma. 13
Qualified beneficiaries include the grantor's natural children and grandchildren, or the descendants of deceased natural children or grandchildren of the grantor. 14 A spouse of the grantor can also be a qualified beneficiary, as may a nonprofit organization within the meaning of §501(c) (3) of the Internal Revenue Code. 15 Curiously, the grantor is not included in the class of individuals who can qualify as a qualified beneficiary. 16 Presumably, however, the grantor could exercise the grantor's power to revoke the trust in the grantor's favor. 17
The Act provides that no judicial body will have the authority to compel a person holding the power to revoke a preservation trust to exercise that power. 18
Interestingly, the Act refers to the protection afforded to the assets held in the preservation trust as an "exemption." 19
There appear to be numerous interpretation questions that cause uncertainty in the application of the provisions of the Act. Among the issues:
- Can a resident of another state create a preservation trust in Oklahoma? The act is silent on this question. 20 Under general trust law principles, non-residents should be able to establish such a trust, however, specific legislation addressing this issue would be comforting. Other exemptions under Title 31 of the Oklahoma Statutes appear to apply only to residents of Oklahoma. 21
- Can the preservation trust have a co-trustee and if so who can serve as the co-trustee? 22
- Does "incremental growth derived from income" include capital gain? 23
- Does the $1,000,000 limitation take into consideration valuation discounts?
In addition to the foregoing, the legal and practical limitations of the Act remain to be explored, and drafting issues abound. For example, use of generic language permitting the trustee to make distributions to the grantor's "descendants" may disqualify the trust under the Act. 24 Also, the Act does not permit the creation of a classic self-settled asset protection trust as available in Alaska, Delaware, Nevada, Rhode Island and Utah permit. 25 To the contrary, other than the power to revoke the trust (presumably in the grantor's favor), the grantor apparently is not permitted to retain a discretionary interest in a preservation trust. 26 Although the power to revoke or maintain ultimate control over the assets in this type of trust is superior in many respects to some of the powers or interests permitted by the acts of states such as Alaska and Delaware, the Act clearly states that the exemption is forfeited immediately upon the exercise of such power. 27 At least three offshore jurisdictions expressly allow a settlor to retain the power to revoke the trust and remain a discretionary beneficiary as to both income and principal. 28 Assuming an asset protection trust established in states such as Delaware or Alaska can accomplish its objectives of protecting the wealth held in the trust, the terms of such a trust can give the trustee the authority to use the trust assets for the benefit of the grantor at any time. 29 A preservation trust may be much more limiting. Consider the following practical examples:
Example 1: G creates a preservation trust in Oklahoma retaining the power to revoke the trust at any time for any reason. The sole trustee, an Oklahoma trust company, is given the power to distribute income and principal to any one or more of the grantor's children and grandchildren. G cannot be included in the class of beneficiaries eligible to receive a distribution from the trust. 30 G commits an act of malpractice in his professional practice after the creation of the trust and his client obtains a $2,000,000 judgment against him. G has no assets that this creditor can attach or other liquid wealth except the assets in the preservation trust. If G exercises his power to revoke the trust to access such wealth his creditor can attach that wealth. 31 Nonetheless, the trustee has no authority to distribute any part of the assets in the trust to G. 32 This situation can create serious problems for G if he needs to access such wealth for his daily subsistence. Of course, G's spouse, if any, can be a designated beneficiary of such trust perhaps building in some additional flexibility. 33
Example 2: G creates a preservation trust in Oklahoma retaining the power to revoke the trust at any time for any reason. The sole trustee, an Oklahoma trust company, is given the power to distribute income and principal to any one or more of the grantor's children and grandchildren. G cannot be included in the class of beneficiaries eligible to receive a distribution from the trust. 34 G is declared incompetent by a state court, therefore, he can no longer exercise his power to revoke the trust and access the wealth for his personal consumption. Unless the revocation power can be exercised by G's guardian, the wealth in the trust cannot be used for G's benefit.
Finally, three more points about the Act are worth mentioning. Potentially subjecting assets in the preservation trust to a state income tax that might not otherwise be subject to the tax does not seem prudent. Is the protection of the trust's assets worth incurring the future tax liability--whatever that may be? Also, the "principal place of business" and "physical location" requirements to qualify as an Oklahoma-based company seem problematic. What constitutes a "physical location?" Mere formation of an entity in Oklahoma or qualifying a foreign entity to do business in the state will not suffice for the company to qualify as Oklahoma-based company. What type of physical location will qualify under the statute? From a practical perspective these two requirements may prove too expensive to initially protect only $1,000,000, especially after considering annual trustee's fees and expenses. Furthermore, there is no significant benefit available to a grantor who creates an irrevocable trust under the Act that is not available in any other common law jurisdiction.
After many of the foregoing issues are resolved by additional legislation, "Sooner Trusts" 35 may become an attractive wealth protection option for nonresidents of Oklahoma. In appropriate circumstances, and after due consideration of the present limitations of the Act, Oklahoma residents could certainly take advantage of this legislation. For now, it is not worth the risk for non-residents to play a guessing game when a quality wealth protection plan should mandate certainty.
This commentary also will appear in the September 9, 2004, issue of the Tax Management Estate, Gifts and Trusts Journal. For more information, in the Tax Management Portfolios, see 810 T.M., Asset Protection Planning, and in Tax Practice Series, see ¶6180, Introduction -- The Estate and Gift Taxation System.
1 Okla. Stat. tit. 31, §10.
2 H.R. 2135, 49th Leg., 2d Reg. Sess. §8 (Okla. 2004).
3 Okla. Stat. tit. 31, §12.
4 Id., §12.
5 Id., §12.
6 Id., §13.
7 Id., §11.5.a., b.
8 Id., §11.5.c.
9 Id., §11.5.d., e.
10 Id., §11.3.
11 Id., §11.2.
12 Id., §11.4.
13 Id., §11.4.
14 Id., §11.6.a.
15 Id., §11.6.b., c.
16 Id., §11.6.
17 Id., §13.
18 Id., §16.
19 Id., §§12, 14. Note that this appears fundamentally different from the self-settled asset protection trust acts in states such as Alaska, Delaware, Nevada, Rhode Island, and Utah.
20 Id., §11.1.
21 Id., §§1-3, 7.
22 Id., §11.5.b.
23 Id., §12.
24 Id., §11.6.a.
25 See e.g., 1997 Alaska Sess. Laws, Ch. 6 (H.B. 101), Alaska Stat. §§13.12.205(2), 13.36.035, 13.36.310, 13.36.390, 34.40.010, 34.40.110(a), 34.40.110 (Michie 2003); Col. Rev. Stat. §38-10-111 (2003); The Qualified Dispositions in Trust Act, Del. Code Ann. tit. 12, §§3570-3576 (2003); Mo. Rev. Stat. §§428.005-428.059, 456.020, 456.080 (2003); Nev. Rev. Stat. 166.040 (2003); The Qualified Dispositions in Trust Act, R.I. Gen. Laws §18-9.2 (2003); 2003 Utah Laws Ch. 301 (H.B. 299), Utah Code Ann. §25-6-14(1)(a) (2003).
26 Okla. Stat. tit. 31, §11.6.
27 Id., §13.
28 See, e.g., Nevis International Exempt Trust Ordinance, 1994, §47(a), (b) (Nevis); International Trusts Act 1984, §13C(a), (c) (Cook Is.); Trusts Act, §43(1) (Belize). From a practical planning perspective, such a power would be used rarely because it undermines the protection that the settlor is seeking.
29 See Alaska Stat. §34.40.110 (Michie 2003); Col. Rev. Stat. §38-10-111 (2003); Del. Code Ann. tit. 12, §3570(10) (2003); Mo. Rev. Stat. §456.040(2) (2003); Nev. Rev. Stat. 166.040 (2003); R.I. Gen. Laws §18-9.2-2 (2003); Utah Code Ann. §25-6-14(1)(a) (2003).
30 Okla. Stat. tit. 31, §11.6.
31 Id., §13.
32 Id., §11.6.
33 Id., §11.6.b.
34 Id., §11.6.
35 Or "Cowboy Trusts" so as not to offend our colleagues who are alumni of O.S.U.
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