Which articles appearing in student-edited law journals should estate planners and wealth advisors be familiar with? We identified six diverse articles from the second half of 2010 that we think will be of great interest to you. We then asked our board members to review them for your benefit and to determine if they are “must reads.” The articles themselves can be found on our website, www.trustsandestates.com . We hope you enjoy the reviews.
REVIEW BY: TURNEY P. BERRY, partner, Wyatt, Tarrant & Combs, LLP, Louisville, Ky.
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AUTHOR: Carter G. Bishop, professor of law, Suffolk University Law School, Boston
ARTICLE: “Forgotten Trust: A Check-the-Box Achilles Heel,” 43 Suffolk University L. Rev. 529 (2010)
Professor Carter G. Bishop has identified a problem with the 1997 check-the-box regulations, namely that they don't do much to help us determine the income tax classification of trusts. The author notes that an ordinary trust is taxed under Subchapter J and is completely outside the check-the-box regulatory scheme. In contrast, a business trust is taxed as a disregarded entity if it has only one beneficiary or as a partnership under Subchapter K if it has more than one beneficiary, unless, of course, the business trust elects under check-the-box to be taxed as a corporation. As the author states, “the regulations failed miserably to clarify distinctions between ordinary trusts and business trusts.”
Traditionally, case law provided that a business trust must have a “business objective” — that is, does the trust instrument give the trustee powers to engage in business-styled activities to protect or conserve trust property and maximize investment returns? (Usually the answer is “yes.”) Also, case law required that a business trust must have “associates,” the meaning of which isn't especially clear but typically means that two or more trust beneficiaries created a trust and controlled it. The check-the-box regulations aren't entirely silent in this area and indeed the regulations specifically discuss how investment trusts, liquidating trusts and environmental remediation trusts should be classified, with a general emphasis on the purpose of the trust rather than on the necessity of associates.
Because Prof. Bishop thinks that the number of businesses operating in trust form is increasing — he points to the new Uniform Statutory Trust Entity Act promulgated by the National Conference of Commissioners on Uniform State Laws as both a cause and effect — he's concerned that the uncertainty left under check-the-box will continue to cause confusion. Fortunately, the article outlines a “simple and elegant” solution: Amend the check-the-box regulations “to provide that all trusts, except statutory business trusts, are classified as ordinary unless the trust elects to be considered a business organization, in which case it would be classified as a commercial trust.” In other words, the default rule would be that a trust is an ordinary trust, unless it was specifically organized as a statutory trust, but it could elect to be taxed as a partnership or a corporation, if desirable. The change would bring certainty without costing significant revenue and would make the check-the-box regime complete, covering all entities.
Most trust and estate practitioners rarely engage with business trusts. This article is a helpful and coherent explanation of the history of entity classification. To the extent a practitioner does encounter business trusts or wants to consider whether the business trust is a desirable form of doing business, this article will provide a useful review of the rules.
REVIEW BY: THOMAS C. FOSTER, shareholder and director of McCandlish Holton, PC, Richmond, Va.
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AUTHOR: Nathan G. Rawling, J.D. 2010, Quinnipiac University School of Law, Hamden, Conn.
ARTICLE: “A Testamentary Gift of Felony: Avoiding Criminal Penalties From Estate Firearms,” 23 Quinnipiac Probate Law Journal 286 (2010)
Estate planners, administrators and their advisors may occasionally encounter firearms among an individual's or estate's assets and need reliable guidance on how to comply with laws regulating the possession and transfer of those firearms. Nathan G. Rawling's article provides a helpful starting point.
Of primary importance, Rawling affirms that, despite our hopes, there isn't a general testamentary transfer and legatee possession exemption from complex firearms regulations. Stated differently, those complex laws generally apply to the former firearm owner's personal representative and his legatees. The article also reminds us that criminal penalties can be severe (many years in prison) for violating laws regarding the possession and transfer of firearms, even though these laws haven't been strongly enforced against the executors of the estates of individuals who make testamentary transfers. Finally, the bulk of the article presents an approach for determining allowable transfers and possession under federal and state firearms laws.
As you would guess, the law takes into account many variables such as the nature of the firearms to be transferred (for example, pistols, rifles, shotguns, assault weapons, machine guns, sawed-off weapons and silencers) and the characteristics of the proposed transferees (for example, state of residence, age of majority/minority, criminal history and impairments). What you may not have considered, however, is that the relevant weapons features and transferee characteristics that determine transfer and possession rights vary greatly under different federal and state laws. What's a “pistol” under one law may be an “assault weapon” under another. Similarly, a disqualifying criminal history under one law may be disregarded under another. Unfortunately, because firearms laws are complex, the article doesn't present a federal law summary that will likely stick in the minds of estate planners who aren't also gun aficionados. Further, the article recognizes that firearms laws vary among the states, but it generally limits its presentation of state laws to Connecticut and New Hampshire. Connecticut is used as an example of a state with relatively restrictive gun possession and transfer laws and New Hampshire as an example of a state with relatively unrestricted gun transfers and possession. Therefore, if you have individual clients who reside in, or have potential legatees residing in states other than Connecticut and New Hampshire, you aren't given directly applicable guidance.
If you're not a firearms control expert, you may find it beneficial to keep the article in your files for reference the next time you're dealing with firearms in estate planning or administration. The article is then likely to provide useful guidance on the issues and provide a springboard to begin your analysis. However, you will also need to take into account intervening changes in federal firearms laws and the laws of the states relevant to your clients.
If you're not a firearms expert, you may find it beneficial to keep the article in your files for reference the next time you're dealing with firearms in estate planning or administration.
REVIEW BY: PAUL N. FRIMMER, partner, Loeb & Loeb, LLP, Los Angeles
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AUTHOR: Joshua C. Tate, assistant professor of law, Dedman School of Law, Southern Methodist University, Dallas
ARTICLE: “Should Charitable Trust Enforcement Rights be Assignable?” 85 Chi-Kent L. Rev. 1045 (2010)
The basic premise of Professor Joshua C. Tate's article is that the law on assignability of the right to enforce a charitable trust is now unclear, but is developing as a result of the Uniform Trust Code's (UTC's) provision allowing a settlor of a charitable trust to enforce the trust. While the article is well written and interesting in an intellectual way, it doesn't offer concrete suggestions for how the law should develop and what options settlors currently have to make it more likely that courts will uphold the assignment of the enforcement right.
To the average trust and estate lawyer, the article's analysis of a trust as partially a contract and partially a trust is most likely of academic interest only. Those of us who toil in the trenches need more concrete suggestions, especially in an area that historically excluded enforcement rights in anyone other than the attorney general of the state in which the charitable trust was located. The UTC is progress, but insufficient progress for most settlors because if a charitable trust needs to be enforced, it will most likely have to be enforced following the settlor's death.
The article discusses whether the beneficiaries of the settlor's estate have the right to enforce a charitable trust on behalf of the deceased settlor. While there appears to be one case that discusses the issue, most trust and estate lawyers instinctively would conclude that the right to enforce a charitable trust wouldn't pass automatically to the settlor's beneficiaries, absent a specific designation in the decedent's will or revocable trust that corresponds to a power to assign and enforce in the original charitable trust or gift agreement.
Many lawyers are including in charitable trusts and in charitable gift agreements a “private right of action” that gives the settlor or donor and one or more designated individuals the right to sue to enforce a charitable trust or gift agreement following the settlor's or donor's death or incompetence. Historically, that right was vested in the state attorney general, but settlors and donors increasingly have determined that with the exception of very large trusts that are high profile, attorneys general don't have the staff or the resources to carry out the charge of enforcing charitable trusts. If the attorney general won't act, there has been no effective way to enforce the trust or agreement, although some states are slowly recognizing a “private” right of enforcement even in the absence of the UTC.
The article recognizes the role of a “trust protector” in modern trust preparation, but for reasons that aren't entirely clear, concludes that granting the right of enforcement to a trust protector isn't satisfactory. Certainly, trust protectors have been useful in foreign trusts and are finding their way more and more into domestic trusts. When properly drafted, a settlor can appoint a trust protector, provide for a succession of trust protectors and delineate the trust protector's powers. If a settlor can enforce a charitable trust, the settlor should have the right to determine whether someone else standing in his place should have the same rights and whether those who follow him in this role should have the same right to perpetuate the role.
The article points out, correctly, that in the case of charitable trusts, there are public policy considerations to enforcement (for example, a trust that provides scholarships for a particular race wouldn't be enforced today), but those policy considerations shouldn't impair the ability of a settlor to designate someone to act in his place. Presumably, a settlor who tried to enforce such a provision in a trust he created would be barred from doing so for public policy reasons, so it's not surprising that anyone designated by the settlor to enforce the provisions would have the same impediment.
Overall, the article lacks a clear purpose and gives few helpful suggestions to overcome whatever issues may exist when a settlor of a charitable trust wants to assign his right of enforcement. A more helpful analysis would have been to tell us how to make the assignment right enforceable, rather than why it's not.
REVIEW BY: AL W. KING III, co-founder of the South Dakota Trust Company LLC in Sioux Falls, S.D.
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AUTHOR: Professor Iris J. Goodwin, associate professor of law, University of Tennessee College of Law, Knoxville, Tenn.
ARTICLE: “How the Rich Stay Rich: Using a Family Trust Company to Secure a Family Fortune,” 40 Seton Hall L. Rev. 467 (2010)
Professor Iris J. Goodwin's article is an excellent piece on the modern private family trust company (PFTC). She notes that PFTCs are vehicles for families with net worths of at least $200 million or more and typically, for multi-centamillionaires and billionaires.
Prof. Goodwin points out that families have traditionally chosen banks and individuals as trustees. These types of trustees have generally been family members, advisors and/or commercial trustees with whom the family has had personal, professional or business relationships with over the years. Goodwin discusses how the PFTC allows these trusted individuals to serve similar functions while serving the PFTC. She also notes that PFTCs provide a vehicle for family members to dramatically reduce their personal liability through director and officer (D&O) insurance and limited liability company (LLC) protection, versus serving as trustees in an individual capacity. Prof. Goodwin further states that the PFTC provides an answer to an individual trustee who may go on vacation, become incapacitated, die or resign. A recent Family Office Exchange (FOX) report1 indicated that the biggest concerns about a family trustee include concentration of assets, business interests (for example, lack of diversification, yield and possible conflict) and personal liability, and Prof. Goodwin illustrates how the PFTC provides a great solution for all of these issues.
The article also describes how a PFTC is generally an LLC that qualifies under state law to be a trust company. It's owned and operated by the family and provides fiduciary and wealth management services. Typically, the PFTC is located in a state with favorable trust, asset protection, tax and private trust company laws. Generally, if the single family office is located in a state different from the PFTC, the PFTC enters into a service agreement with the single family office in the other state. Alternatively, the single family office could become a subsidiary of the PFTC.
Prof. Goodwin's article examines how state PFTC laws vary but still allow for both regulated and unregulated trust companies. She notes that the regulated PFTCs generally receive a charter and the unregulated PFTCs generally receive a license. Prof. Goodwin mentions potential PFTC states. From the reviewer's experience and based upon the numbers from state banking commissions, FOX reports and many other sources, five of the most popular jurisdictions for PFTCs are Nevada, New Hampshire, South Dakota, Texas and Wyoming. Please note that although PFTC statutes were in place for some time in most of these states, PFTCs didn't become popular until around 2002. Consequently, they're a relatively new concept, but extremely popular. Both Alaska and Delaware also have PFTC statutes, but generally cater to commercial private trust companies versus PFTCs.
The article further discusses that many families select a regulated PFTC so that there's much less of an opportunity to “pierce the corporate veil” as there is with an unregulated PFTC. The formalities associated with the regulated PFTC such as capital requirements, state audits, a policy and procedures manual and compliance all help to ensure that the PFTC is a properly functioning entity and trustee. Additionally, Prof. Goodwin states that regulated PFTCs can result in fewer potential estate tax issues than unregulated PFTCs.
The article further describes how a PFTC can provide powerful opportunities for wealthy families to leverage the modern PFTC and trust laws to enhance their financial well being, as well as to provide a resource to indoctrinate future generations into the family ethos about wealth and values. Prof. Goodwin also discusses many other PFTC advantages, such as:
- Exemption from Securities and Exchange Commission (SEC) registration, since the regulated PFTC is audited by the banking division in the PFTC state;
- Liability protection (the family acts as trustee with an LLC/PFTC entity owned by the family with D&O insurance protection, versus family members serving individually as trustees with personal liability);
- Resolution of successor trustee issues;
- Convenience and accessibility;
- Improved family governance with LLC/PFTC structure;
- Enhanced ability to properly administer and operate illiquid family assets in trust (such as LLCs, family limited partnerships, real estate, oil and gas);
- Allowance for holding large concentrations of stock on any asset class;
- Extensive flexibility with asset allocations; and
- A ruling by the Internal Revenue Service that if properly established, the PFTC won't be subject to estate tax inclusion (IRS Notice 2008-63).
Some other key advantages are:
- Planning opportunities for deducting investment fees (in light of the U.S. Supreme Court decision in U.S. v. Knight, 52 U.S. 181 (2008));
- Ability to establish SEC-exempt business trust and common trust funds as an alternative to collective investment vehicles/partnerships, which are generally required to register with the SEC and limited to 99 investors; and
Note that Prof. Goodwin's article was written prior to the Wall Street Reform and Consumer Protection Act (the Act) that was signed by President Obama on July 21, 2010. The Act applies to investment advisors, which include family offices. Prior to the Act, single family offices were generally exempt from SEC registration. The Act leaves the definition of a family office to the SEC's interpretation, which may or may not result in SEC registration. This definition is expected in July 2011. However, if families establish a PFTC, it should still be exempt from SEC registration, because PFTCs are state regulated.
The article also explores in depth how the PFTC can be used to meet the estate-planning goals of wealthy families in perpetuity. These PFTCs are named as trustees for both existing family trusts as well as newly drafted trusts taking advantage of tax-minimization strategies that leverage the gift and generation-skipping transfer tax (GST) exemptions. At the time Prof. Goodwin wrote her article, the estate and GST tax exemptions were each $3.5 million, and the gift tax exemption was $1 million (2009). She referenced in a footnote the 2010 repeal of the estate and GST tax. These exemptions are currently each $5 million, which presents an even greater opportunity for the promissory note sale (PNS) strategy Prof. Goodwin discusses in her article. This PNS strategy can be used to leverage the exemption amounts to fund a perpetual trust for substantial appreciation. Prof. Goodwin also notes other popular strategies, such as the zeroed-out grantor retained annuity trust (GRAT) and the charitable lead annuity trust. Consequently, if structured properly, these trusts result in the transfer of substantial wealth between generations without transfer taxes.
Prof. Goodwin further discusses that the liberalization of the law governing investment strategy, allowing potentially more aggressive and diversified portfolios that make establishing a PFTC even more appealing. In concert with the PFTC, the family can serve as trustee and determine its own investment risk and strategy. This can be a benefit to families that want to make more aggressive investment decisions than an institutional bank trustee. This also allows many wealthy families to more easily follow a more sophisticated Yale2/Harvard3- type asset allocation model. The article also points out that this investment flexibility and sophistication can provide the family with increased investment returns, and thus, a better opportunity to exceed the Internal Revenue Code Section 1274 and IRC Section 7520 rates for the PNS and GRAT, respectively.
Another compelling argument by Prof. Goodwin in favor of the PFTC is the notion that this structure can be used to enhance the wealth and financial security of future generations, as well as enhance the way future generations understand their wealth. As she eloquently argues, the PFTC can become not only a place to govern the family's finances, but also to create a context in which the family can instill a sense of identity and a set of values concerning its wealth. She discusses how important financial parenting, financial education and a family mission statement can be to a PFTC family.
Prof. Goodwin's article provides a great overview of the PFTC and is an excellent read for anyone interested in wealth preservation, financial education and parenting and growth for future generations.
- Family Office Exchange, Introduction Speech, The Evolution of the Small Family Office: Models for Sustainability (February 2011).
- Yale University Investment Office, The Yale Endowment 2010, 25 (2010), available at www.harvard.edu/downloads/hmc_20100909.pdf .
- Harvard Management Company, Harvard Management Company Endowment Report, 6 (2010), available at http://cdn.wds.harvard.edu/hmc/2010_endowment_report_10_15_2010.pdf .
REVIEW BY: BERNARD A. KROOKS, partner at Littman Krooks LLP, New York City, White Plains and Fishkill, N.Y.
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AUTHOR: Chadwick Bothe, J.D. 2010, South Texas College of Law, Houston
ARTICLE: “The Stigma of Survival: Medicaid Estate Planning,” 51 S. Tex. L. Rev. 815 (2010)
In his comment, Chadwick Bothe defends the practice of Medicaid estate planning. Others have criticized this practice as immoral and have asserted that people should pay out-of-pocket for the cost of their own long-term care, instead of relying on Medicaid.
One of Bothe's points is that those who frown on Medicaid estate planning typically do so to pursue their own agendas; that is, for example, to promote the sale of long-term care insurance. Bothe favorably compares Medicaid estate planning to tax planning. After all, does anyone think making annual exclusion gifts is immoral? Of course not — the law says you're allowed to do this and not pay gift tax. With regard to Medicaid estate planning, the law contains strict requirements on when assets must be transferred so they don't have an adverse effect on an individual's eligibility for Medicaid. If you apply for Medicaid before the applicable penalty period ends, you'll be denied benefits. There's no free lunch here. Moreover, if Medicaid estate planning were truly immoral, why not have a 10-year or 25-year penalty period, Bothe suggests. Or, perhaps the penalty period should date back to the date that the Medicaid applicant attained the legal age of majority?
Bothe spends a fair amount of time discussing the potential criminal liability for Medicaid applicants and their advisors who improperly transfer assets or give advice in this regard. In my view, this isn't time well spent. While Congress enacted a law making it a crime for individuals to engage in Medicaid estate planning if they weren't careful about the type of planning done and the timing of the Medicaid application, that law was repealed in favor of a law making it a crime for advisors to give certain Medicaid estate planning advice. However, in New York State Bar Association v. Reno,1 the court permanently enjoined the government from enforcing this law.
Bothe acknowledges that the cost of long-term care continues to rise at a staggering pace and that something must be done to stem the tide. After dismissing universal health care and tax incentives as plausible solutions, he suggests a free market approach. His argument is based on the premise that since government helped create the problem of a health care crisis in this country, it shouldn't be part of the solution. The only government action required to help solve spiraling health care costs in this country, according to Bothe, is to remove the barriers it has erected to new market entrants in the long-term care industry. As part of the solution, Bothe advocates for allowing qualified foreign health care providers entrance to the U.S. health care industry. By doing so, he concludes that health care services will become more competitive and prices will come down, thus obviating the need for people to engage in Medicaid estate planning.
While some may agree or disagree with Bothe's proposed solution to our country's long-term health care crisis, it's refreshing to hear new ideas.
- New York State Bar Association v. Reno, 97-CV01760 (N.D.N.Y. 1998).
REVIEW BY: DOUGLAS MOORE, managing director of the Family Office of U.S. Trust, Bank of America Private Wealth Management, New York
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AUTHOR: Melanie B. Leslie, professor of law, Benjamin N. Cardozo School of Law, New York
ARTICLE: “Helping Nonprofits Police Themselves: What Trust Law Can Teach Us About Conflicts of Interest,” 85 Chi-Kent L. Rev. 551 (2010)
In her article, Professor Melanie B. Leslie identifies the serious problem of non-profit board members who have conflicts of interest and engage in self-dealing. These board members can jeopardize charities' potential fundraising due to the considerable negative public attention caused by the board members' actions. They can also end up costing the charities money if regulations are put in place in response to these actions, which charities will have to comply with (for example, reporting requirements).
Prof. Leslie argues that there's a more effective way to reduce the amount of damage resulting from conflicts of interest and self-dealing in the non-profit sector than presently exists. While Prof. Leslie states that most board members intend to act in good faith, they don't perceive conflicts in their entirety. The general state of the law and the culture of non-profit boards contribute to the situation. Conflicts of interest damage the credibility of the non-profit sector. At times, there's a call for greater government regulation, which may create untenable costs for certain nonprofits.
Prof. Leslie asserts that laws addressing conflicts and self-dealing should be reformed so the nonprofits can better police themselves or reduce damage from self-dealing. The state and federal laws have “fuzzy standards” and provide little guidance to boards on how to transact business with a board member. Current law doesn't provide procedures to ensure that the transactions advance the nonprofit's best interests and doesn't clearly delineate between acceptable and unacceptable insider transactions. Present standards allow well-meaning board members to minimize the seriousness of the conflict and fall prey to “groupthink.” “Groupthink” occurs when fiduciaries function as a group and their cognitive limitations combined with a desire for approval from other members blind them to the conflicts and their consequences.
Boards generally are left to police themselves. The boards aren't proficient in this role as many non-profit directors are generally overcommitted volunteers with limited time for governance issues. Generally, if non-profit corporations function effectively, it's because they have influential directors who have internalized fiduciary duties as norms.
Prof. Leslie argues that trust law incorporates fiduciary duties and sets forth procedures and rules that are intended to address potential conflicts of interest and self-dealing. For instance, under trust laws, the director/fiduciary must first disclose his potential benefit to the other board members and show that the transaction still is in the nonprofit's best interests. The board then determines if it will consent to the transaction. In contrast, corporate fiduciary law finds that conflicted transactions that are “fair” aren't voidable and aren't the basis for finding a breach of fiduciary duty. Prof. Leslie further details the different standards and procedures and how to enforce breaches of self-dealing under fiduciary trust law.
Prof. Leslie concludes by arguing for changes in the law tailored to minimize self-dealing by forcing prior disclosure of conflicts, which may give prospective donors greater assurance that their donations will be properly used. Rules should be clearer as to how board members are to act and avoid potential liability. Corporate law would be better able to meet these objectives by adopting the trust law requirement to disclose the potential conflict to the other board members and get their advance approval. One of the lessons that can be learned from this article is that regardless of the lesser standard of compliance under corporate law, nonprofits would be better served with a “best practices” approach using the higher standard and clearer rules under fiduciary laws.