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Questions and Answers about Alaska Native Settlement Trusts

As the rest of website indicates, a primary focus of our law firm is the use of “settlement trusts” to hold a portion of our ANCSA clients’ assets.  From time to time, we are asked questions about the settlement trusts, and as a service to the Alaska Native community, the following general questions and answers are made available. The following is not intended to be legal advice, and if you have specific questions, we encourage you to call or email us. 

1.         Exactly what is a Settlement Trust? 

Answer:         A Settlement Trust is a trust organized under the provisions of the Alaska Native Claim Settlement Act (ANCSA) and Alaska law to provide certain benefits to the shareholders of a specific Native corporation. 

2.         Have very many settlement trusts been established? 

Answer:         As of December 31, 1999, just under 20 settlement trusts have been established by Alaska Native corporations.  In the aggregate, these trusts hold over $300 million in assets.  Not every Native Corporation has established a settlement trust, but those that have established trusts have placed substantial assets in them. 

3.         What benefits can be provided through a Settlement Trust? 

Answer:         A Settlement Trust is to promote the “health, education and welfare of its beneficiaries and preserve the heritage and culture of Natives.” 

4.         What are examples of these benefits? 

Answer:         A Settlement Trust can provide educational scholarships.  It could also sponsor Native dance groups.  Or it could sponsor traveling shows of native art.  The standard is very broad.  At least five Settlement Trusts of which we are aware provide straight cash distributions to the beneficiaries on a pro rata basis.  This is being done to promote the “welfare” of the recipients.  The Internal Revenue Service (IRS) has approved all these Trusts.  At least three other Corporations have implemented settlement trusts to provide benefits for their elders.  Two other trusts have been established to provide educational benefits, and the IRS has ruled that distributions by these trusts will qualify for both the Hope and Lifetime Learning Credits.  One of these trusts provides funeral benefits in addition to the educational benefits.  Still another settlement trust has been created to hold cutover timberland in anticipation of the eventual harvest of the second growth. 

5.         Who may be the trustee(s) of the Settlement Trust? 

Answer:         Section 39 of ANCSA says that the trustee(s) of the Settlement Trust must be individuals.  Thus a bank or trust company cannot serve as trustee. 

6.         Does this mean a bank or other financial institution cannot advise the Settlement Trust? 

Answer:         No.  The individual trustees would be free to hire professional advisors, including investment advisors or managers.  The basic fiduciary responsibility for overseeing the Settlement Trust could not, however, be delegated by the trustee(s) to some third party. 

7.         Who appoints the trustees? 

Answer:         ANCSA provides that the Native Corporation which establishes the Settlement Trust has the “exclusive authority” to appoint and remove trustees.  Presumably, this power can be exercised by the Board itself or by shareholders in the form of elections. 

8.         Is there a limit on the number of trustees? 

Answer:         No. 

9.         Could the Board of Directors of the Native Corporation be the trustees of the Settlement Trust? 

Answer:         Yes. 

10.       What about potential conflicts of interest? 

Answer:         Under Alaska law, a director must always act in good faith for the benefit of the shareholders, exercising the same judgment a reasonable and prudent person would exercise.  Alaska law requires a trustee to act in the same manner.  Alaska law does not necessarily prohibit a director or trustee from serving as a fiduciary for another organization, and in fact, actually recognizes that fiduciaries may serve on more than one board that may have to deal with each other.  In general, what Alaska law does prohibit are transactions in which a fiduciary will derive a material financial benefit from one or both of the organizations of which he or she is a fiduciary.  If no such benefit is received by the fiduciary personally, the transaction in question would usually be permissible.  In the usual situation, the Settlement Trust and the Native Corporation will not have ongoing transactions between them; instead, their relationship will consist of a one way flow of assets from the Native Corporation to the Settlement Trust. 

                      Recognize, too, that Alaska law allows the shareholders of a corporation to ratify a transaction which presents a potential conflict of interest.  This is another avenue by which potential conflicts can be solved.  In this regard, too, it is also relevant that the shareholders of the Native Corporation must also be the beneficiaries of the Settlement Trust.  Thus, even if a transaction between the Native Corporation and the Settlement Trust benefits one entity disproportionately, usually the same people will be benefited as are harmed.  Thus, there is really no one who will receive an unfair advantage at someone else’s expense. 

                      Finally, if the ANCSA corporation does have ongoing relationships with the settlement trust (for example, a contractual relationships for compensation to provide services to the trust), there will likely be a tax issue whether the relationship is sufficiently “fair market value”  to the trust.  If not, the consequence could be that the arrangement could violate the grantor trust rules discussed below, and therefore, important tax advantages could be lost. 

11.       Does this mean that you don’t have to worry about conflicts of interest if the whole ANCSA board serves as the trustees of the Settlement Trust? 

Answer:         No, you should never ignore possible conflicts of interest.  However, it does mean that the possibility of conflicts should be explored on a case by case basis, rather than being a reason that members of the Native Corporation’s Board should not serve as trustees of the Settlement Trust. 

12.       Are there limitations as to the investments which a Settlement Trust may make? 

Answer:         Yes.  ANCSA provides that a Settlement Trust cannot engage in the “operation of a business”, and prohibits the conveyance to the trust of certain assets (primarily assets subject to the 7(i) revenue sharing obligations).  Beyond that, all assets of the Settlement Trust would need to be invested under the “prudent person” rule discussed above.  That is, the trustees would need to invest the Settlement Trust’s assets in the same manner as would a prudent person.  The trust agreement itself could contain other restrictions on investments.  An example of this would be a prohibition on loans to individuals.  Often times the trustees will establish investment policies and guidelines, which often further restrict investments. 

13.       What will constitute “operation of a business” by the Settlement Trust? 

Answer:         As to what constitutes “operation of a business”, there will be gray areas.  Timber harvest operations conducted by the Settlement Trust’s own employees, would probably be prohibited.  A timber management arrangement (where all the Trust does is own the timber and some third party manages the timber) would probably not be prohibited.  Similarly, leasing operations, where all the Settlement Trust does is own the assets and collect rent (i.e., a net lease situation) would probably not be deemed a business.  Under the Tax Code, managing one’s investment portfolio is not a trade or business, unless one actively trades securities on a day to day basis. 

                      The critical questions in determining whether a business is being operated by the Settlement Trust will probably include (i) the amount of activity (including number of employees) in which the trust must engage to generate the income in question, and (2) whether a recurring loss by the trust is possible from the activity. 

14.       How long may a Settlement Trust last? 

Answer:         A Settlement Trust will last only as long as is specified in the trust agreement which establishes the trust.  There is no limit on how long a Settlement Trust may last: in theory, the Settlement Trust could last forever. 

15.       Can the creditors of a Native Corporation go after the assets of the Settlement Trust to satisfy the debts of the Native Corporation? 

Answer:         The answer here is both “yes” and “no”.  The assets of a Settlement Trust are subject to the claims of corporate creditors if the claims arose before the assets were placed in Settlement Trust.  Put differently, a Settlement Trust cannot be used to defeat the claims of already existing corporate creditors (including those who have contractual relationships with the Native Corporation). 

                      On the other hand, if a creditor’s claim against arises against the Native Corporation after the assets are transferred to the Settlement Trust, then the Settlement Trust is not liable for that claim. 

16.       May the creditors of a shareholder sue the Settlement Trust to recover the shareholder’s debt? 

Answer:         The answer here should be no.  The Settlement Trust usually can be sued for its own debts, not those of the shareholder-beneficiaries. 

17.       Are there exceptions to this? 

Answer:         The answer here is “perhaps”.  It is not clear whether a distribution otherwise payable to a beneficiary could be seized by a beneficiary’s creditor before that distribution is actually paid to that beneficiary.  ANCSA expressly protects corporate distributions from being seized by a shareholder’s creditor before distribution, but does not specify whether the same protection applies to pending distributions from a Settlement Trust.                     

                      An open issue is whether the Child Support Enforcement Division (CSED) can reach settlement trust assets to satisfy a beneficiary’s child support obligation.  The position of the state of Alaska is that it is in fact able to reach the settlement trust assets through an administrative enforcement order.  This issue is in the process of being litigated, so no final answer exists.                     

                      With this in mind, it may be preferable for a Settlement Trust to not require specified distributions (such as 100% of all income earned by the trust in a particular year), but instead to leave distributions in the discretion of the trustees.  This would probably limit the period during which a distribution is payable, and thus the potential period during which a beneficiary’s creditors could try to seize a pending trust distribution. 

                      There may be a tax problem, though, in leaving income and principal distributions completely at the discretion of the trustees, because this could cause the Settlement Trust to become taxable as a “grantor trust”.  Various IRS private rulings have approved a trustee’s discretionary power to accumulate or distribute a portion (e.g., 25% of the annual income) without the trust being a granter trust, but it is unclear whether a discretionary power to distribute or accumulate 100% of the income would cause the trust to be taxable as a “grantor trust”.  Although the grantor trust rules are discussed in more detail at question 26 below, a grantor trust is generally a trust in which the person or entity establishing the trust retains certain powers over the trust that are listed as impermissible by the Tax Code.  If grantor trust status exists, it means that the trust’s earnings will become taxable to the grantor. 

                      Also, no provision of law automatically prohibits a creditor from trying to seize a beneficiary’s interest in the Settlement Trust.  Thus, it also makes sense for the Settlement Trust Agreement to contain clauses prohibiting a beneficiary from assigning his or her interest in the trust.  This is a so-called spendthrift clause; in most states (including Alaska), these clauses are enforceable.                      

18.       Can ANCSA land placed in a settlement trust be seized by creditors of the Native Corporation or subjected to bankruptcy? 

Answer:         In general, as noted above, the Settlement Trust only has to answer for its own debts and the debts and obligations of the Native Corporation at the time the Native Corporation establishes the Settlement Trust.  Corporate debts and obligations which arise after assets are conveyed to the Settlement Trust cannot be recovered from the Settlement Trust. 

                      Moreover, even as to those debts and obligations for which a Settlement Trust would be liable, ANCSA land in a settlement trust has all the same protections that land could have if owned by the Native Corporation itself.  The automatic land bank protections provided by ANILCA automatically apply to ANCSA land so long as the land is not developed, or leased or sold to third parties.  Additionally, such land cannot be seized by a creditor unless the Native Corporation or Settlement Trust gives up in writing its protection from such seizures.  One advantage to having ANCSA land in a settlement trust is that such land cannot be sold to third parties even voluntarily.  An ANCSA corporation, on the other hand, is free to sell its ANCSA lands. 

19.       How is the transfer of assets to a Settlement Trust taxed? 

Answer:         Our answer here is based on the numerous private letter rulings which the IRS has already issued to ANCSA corporations. 

                      First, the IRS’ view is that the transfers by the Native Corporation to the Settlement Trust are functionally  the same as distributions by the Native Corporation directly to its shareholders.  This means that the “present value” of the amounts transferred to the settlement trust are taxable to the extent the Native Corporation has earnings and profits. 

                      Second, again according to the IRS, the Settlement Trust itself should not have gain or loss when it receives assets from the Native Corporation. 

                      Third, says the IRS, the Native Corporation which establishes the Settlement Trust will have to recognize any gain in the assets when it transfers assets to the settlement trust.  This rule applies if the actual assets being transferred have appreciated (that is, gone up in value).  If cash is being transferred, there would not be any gain to the Native Corporation. 

                      Fourth, legislation has been proposed in Congress which would change all this, but at this writing, has not been adopted. 

20.       What is the tax basis of assets transferred to the Settlement Trust? 

Answer:         The IRS has now ruled in the various private rulings that assets transferred to the Settlement Trust have the same basis to the Settlement Trust that those assets had in the hands of the Native Corporation, adjusted for any gain or loss recognized by the Native corporation.  The IRS has also repeatedly ruled that for tax purposes, the period in which the settlement trust has held its assets includes any period the Native corporation held the same assets. 

21.       How is a Settlement Trust taxed on its earnings? 

Answer:         A Settlement Trust is to be taxed as are most other trusts, i.e., the Settlement Trust is taxable as its own entity, independently of the Native Corporation which established it, and independently from the beneficiaries of the Settlement Trust.  A trust normally receives a deduction for any earnings it distributes during the year; this has the practical effect of making the trust nontaxable to the extent of the earnings it actually distributes.  To the extent they receive taxable earnings in the form of trust distributions, the trust’s beneficiaries are taxed at normal individual rates. 

                      The effect of all this is to allow a trust to eliminate what would otherwise be a corporate level tax, i.e., to convert the two-level corporate tax structure into only one level of tax. 

                      This assumes the Native Corporation does not retain any forbidden powers over the trust, which could make the trust a “grantor trust”.  Special tax rules apply to grantor trusts, as discussed in question 26 below.  Assuming the Settlement Trust is taxed as a trust, under present law the trust’s ordinary income which is not distributed will in general be subject to a 39.6% tax rate and undistributed capital gains at a 28% rate.  These rates are generally the same as those for an individual person, although the maximum trust tax rates start at a lower level than for individuals. 

                      Legislation has been proposed in Congress which would permit a settlement trust to retain a portion of its annual income without taxation to “inflation proof” the trust, but at this writing, has not been adopted.  This legislation was not adopted.  Other legislation is pending which would subject ANCSA settlement trusts to a flat 15% tax on ordinary income, with distributions being tax free to beneficiaries. 

22.       Does this mean that the Settlement Trust is not consolidated with the Native Corporation in the same way that a subsidiary is? 

Answer:         Yes, that is exactly what it means.  Thus, losses that the Native Corporation might have (such as from depletion) would not offset the income of the Settlement Trust.  The only way the Settlement Trust could avoid taxation is first from its own losses and expenses (if any) and second, by making taxable distributions to its beneficiaries. 

23.       Does this also mean that income from the Settlement Trust is not taxable to the Native Corporation? 

Answer:         Yes, subject to the discussion below about “grantor trusts”. 

24.       Are there circumstances in which the earnings of a Settlement Trust could be subject to more than one level of tax? 

Answer:         Unfortunately, the answer is yes.  This could arise if the IRS views the Settlement Trust as either a “grantor trust” or as an “association”, rather than a “true” trust.  It also could occur if tax rates change so that income accumulated by the trust (and taxed once to the trust) is then taxed again to the beneficiaries when that accumulated income is distributed to them.  The rules under which this occurs are called the “throwback rules” (because the income is “thrown back” to earlier tax years of the beneficiaries and taxed at those rates.  However, as long as the income tax rates are the same (or higher) for the trust than it is for beneficiaries, the throwback rules should not cause a second level of tax beyond the trust’s own tax. 

25.       What is a grantor trust? 

Answer:         A grantor trust is a trust in which the entity which establishes the trust retains certain prohibited powers.  In essence, the powers are the kind which would make the trust illusory.  An example of such a power would be an unlimited power in the Native Corporation to revoke the trust.  To avoid this, the Settlement Trust should provide that it is irrevocable. 

26.       How is a grantor trust taxed? 

Answer:         A grantor trust is usually ignored for tax purposes, and its assets are treated as owned by the “grantor” (the person or entity which established the trust in question). 

27.       What is an association, and how is it taxed? 

Answer:         An “association” is an entity which has characteristics  which are so similar to a corporation that the entity should be taxable as a corporation.  As to a “Settlement Trust”, that issue could arise (according to the IRS) because the trust has a large number of beneficiaries, who have supposedly joined together to allow the trustees to make “profits” using the beneficiaries’ assets, and because the assets which are being used to generate the trust income has formerly been held in corporate ownership.  While we think this is not an issue on which the IRS should prevail, especially given the importance of the Settlement Trust within the 1991 Legislation, it is an issue the IRS could raise on an audit.  Because of this, most of the private rulings listed above specifically addressed this issue. 

28.       Is there any requirement that a Settlement Trust distribute a particular percentage of its annual income? 

Answer:         No.  Subject to the fact that undistributed trust earnings will be taxed to the trust, and further subject to whatever the trust agreement requires as to annual distributions, and further subject to any change in the law which may result from the “inflation proofing” legislation referred to above, a Settlement Trust would not necessarily have to distribute any of its annual income. 

29.       How are the beneficiaries of the Settlement Trust taxed?                     

Answer:         Beneficiaries will only be taxed, in general, to the extent the trust’s income is actually distributed to them each year.  Beneficiaries are to receive a “K-1 form” from the trustees.  The K-1 is an IRS required form and will tell the beneficiaries the amount of taxable distributions they have received during the year, in much the same manner as the form 1099-Div that a corporation’s shareholders already receive.  Typically, a “substitute Form K-1” is prepared for the settlement trust which will convey this information based upon the specific circumstances of that ANCSA settlement Trust.  Legislation is pending that would permit Form 1099 reporting for all taxable settlement trust distributions.  

30.       Will the amount of corporate earnings affect the taxability to the shareholders? 

Answer:         No, assuming the settlement trust is actually taxable as a trust and not a “grantor trust” (see questions 24-26 for a discussion of “grantor trusts”).  Only the taxable income (or loss) of the trust itself affects taxation of the beneficiaries. 

31.       Do settlement trusts have to benefit all beneficiaries at the same time in the same amount? 

Answer:         No.  Although this “no” answer would seem clear from the ANCSA provisions which authorize settlement trusts, this issue was formally litigated relative to the Sealaska settlement trust which provides elders benefits.  In Broad v. Sealaska Corporation, 85 F.3d 422 (9th Cir. 1996), cert. denied, 117 S.Ct. 768 (1997), the federal courts concluded that settlement trusts can be established to provide “disproportionate benefits” such as elders benefits or educational benefits.   This is an important advantage to settlement trusts, since present Alaska corporate law is clear than in general such benefits could not be directly provided by the ANCSA corporation itself.  See Hanson v. Kake Tribal Corporation, 939 P.2d 1320 (AK. 1997). 

32.       Will use of a settlement trust disqualify a beneficiary from federal needs-based eligibility programs (such as food stamps)? 

Answer:         The answer again is “maybe”.  It is clear from ANCSA that the beneficiary’s interest in the Settlement Trust is not to be counted in determining eligibility.  However, it is not clear whether cash distributions from a Settlement Trust can be excluded in the same way that the first $2,000 of cash distributions from a Native Corporation are excluded.  The language allowing the $2,000 exclusion refers only to distributions by a Native Corporation.  This may be a technical clarification which Congress might be willing to make.  The Native corporations with which we work take the position that the $2000 exclusion includes settlement trust distributions. 

33.       There still seem to be a number of uncertainties, especially regarding the tax status of the Settlement Trust.  Is there a way these uncertainties can be resolved? 

Answer:         Many of the original uncertainties regarding settlement trusts have now been resolved by the several IRS private rulings which have now been issued.  

                      Other tax uncertainties (such as association status or grantor trust status of a specific proposed settlement trust) could be resolved through a private ruling by the IRS, in the same way most Native Corporations have resolved these issues as to their specific Settlement Trusts with their own private rulings.                    

34.       What would you say are the principal advantages we should remember regarding settlement trusts? 

Answer:         We have been involved with the substantial majority of the settlement trusts which have been established or actively considered by Native Corporations.  Our clients have found a variety of advantages to settlement trusts, but the most important advantages are:

(a)  Permanence

(b)  Limited Risk

(c)  Tax Advantages

(d)  Protection from Creditors

(e) Lower Expenses than with operating companies

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Last modified on 05/19/05