By Diane Ring
Perhaps you heard a chorus of joyous barking across the state of Minnesota recently — now you know why. Until just over two weeks ago, every state in the U.S., plus Washington, D.C., recognized statutory pet trusts, except Minnesota. But on May 22, 2016, the Minnesota Governor signed legislation approving pet trusts. The legislation, which had been sponsored in the House by Rep. Dennis Smith and in the Senate by Sen. Scott Dibble, allows the creation of a legally enforceable trust that provides for the care of an animal that was alive during the grantor’s lifetime. The terms of the trust can be enforced by a person appointed in the trust, or if no one is appointed, the court may appoint someone. Moreover, anyone having an “interest in the welfare of the animal” may petition the court to appoint someone to enforce the trust or remove the person so designated in the trust document. The trust would terminate on the death of the last surviving animal (or 90 years if shorter). Any remaining proceeds would be distributed pursuant to the trust’s terms, or if the trust fails to specify, then to the “grantor’s heirs-at-law determined as if the grantor died intestate domiciled in [Minnesota] at the time of distribution.”
This all seems pretty straightforward, so why was Minnesota the last state?
Certainly the concept of a pet trust calls to mind the controversial tale of Leona Helmsley (of tax evasion fame) and her pet trust. Helmsley left her Maltese $12 million (although the amount was later reduced to $2million by a court), leading to a tremendous backlash against the four and a half pound canine. However, pet trusts are not the exclusive purview of the extremely wealthy. A broader array of pet owners, concerned about the care of their pets after their own death, now seek to make arrangements in advance.
I was curious whether there had been extensive controversy regarding the issue of pet trusts in Minnesota. Based on a quick review, I found only one reference to concerns about the potential abuse of pet trusts by owners who would seek to “shelter money and claim more medical assistance.” A passing reference hardly constitutes a major debate. Well, perhaps Minnesota is not a top state for pet companionship? Here the information was a bit more promising as an explanation – but only a bit. According to the American Veterinary Medical Association Statistics on pet ownership, as reported by dogtime.com, Minnesota ranked in the top ten of states with the lowest pet ownership (i.e. lowest percentage of households owning a pet) and also in the top ten of states with the lowest dog ownership (i.e. lowest percentage of households owning a dog). However, Minnesota was not at the bottom; in fact my own state of Massachusetts was the lowest in both categories and yet Massachusetts enacted pet trust legislation in January 2010. Regardless of why the path to statutory pet trusts took longer in Minnesota, when it came time to vote everyone seems to have been on board. In the House, the vote was 123 in favor, and zero against; and in the Senate the vote was 55 to zero.
Now that pet trusts are available everywhere in the U.S., I wondered about their taxation. Unsurprisingly, it turns out to be a bit complicated because there are three major versions of pet trusts, each with a slightly different tax treatment. The older versions of “pet trusts” lacked some of the protections and benefits of the newer statutory trusts that Minnesota has just embraced. Gerry Beyer of Texas Tech, in a series of papers addressing pet trusts, explains that there are three different ways to use a trust to care for a pet: (1) a traditional pet trust – which is not really a pet trust per se, but rather a trust in which an individual (who will care for the pet) is named the beneficiary and receives distributions from the trustee who is directed to make such distributions as are necessary to cover the care of the pet; (2) an honorary trust which is a trust with a pet beneficiary but without a mechanism for enforcement under state law; and (3) a statutory pet trust (i.e. what Minnesota just enacted) – a true pet trust recognized under state law with a pet “beneficiary” and with mechanisms for legal enforcement of trust terms. Traditional pet trusts have faced scrutiny in court unless they were carefully drafted by estate planning lawyers familiar with the accepted techniques for drafting such trusts. Honorary trusts, as the name suggests, are those that may be recognized as trust instruments by state law but for which no enforcement mechanism of trust terms is provided. Statutory pet trusts, however, provide the legal basis for acceptance by courts and for the enforcement of trust terms.
Regardless of the form of a pet trust, a primary question is who will be taxed on trust income? Given that Fido has no obligation (or capacity) to file a tax return, the tax law wants to make sure that some taxable person is reporting the income and that it does not escape taxation. Thus, in Rev. Rul. 76-486, the IRS mapped out a path for taxing pet trusts that lack a human beneficiary (such as Minnesota’s new pet trusts). The IRS first concluded that the term “beneficiary” as defined in the tax law means a “person”, which a dog (or other pet) is not. This observation poses problems for application of basic trust taxation which envisions the existence of such beneficiaries. But rather than not recognize the trust for tax purposes and risk causing the “income on the bequest to escape taxation altogether,” Rev. Rul. 76-486 specified that the income of such a trust should be taxed to the trust, and that the trust distributions would not be deductible to the trust.
Beyond income taxation, estate and gift taxation issues arise depending on the size of the pet owner’s estate and the nature of the trust disposition. In Rev. Rul. 78-105, the Service, again noting that fact that pets are not “persons” under the tax law, concluded that “no deduction is allowable with respect to a charitable remainder interest where the specified distribution of the trust is for the care of a pet animal.”
Of course there are more tax details and interesting differences between and among the various pet trust strategies, but a major appeal of the statutory pet trust is the ability to provide for one’s pet in an enforceable manner with relatively clear tax treatment.
Now Fido is just waiting for you to visit your lawyer.