On June 14, 2016, Governor Kasich signed House Bill 229 into law. The bill, which was over two years in the making, allows an Ohio family to establish its own trust company to serve as trustee for its family trusts. The legislation, co-authored by Rob Galloway of BakerHostetler’s Private Wealth Team, had been through a series of amendments to earn the acceptance of the Ohio Division of Commerce’s Department of Financial Institutions.
Family trust companies (FTCs) have seen increased use as a wealth succession planning tool in the past several years as more states have enacted FTC legislation. Currently, there are over 15 states with such legislation, the most recent being the state of Florida.
FTCs provide the benefit of a permanent trustee (in the form of a corporation or limited liability company) along with the ability of a family to substantially control its operations. Under current Ohio law, the trustee for a family trust was either (a) one or more individuals or (b) a commercial trustee. This meant that an Ohio family seeking to use an FTC was required to form and operate the FTC in another state. Such out-of-state operations resulted in increased operating costs, extra administrative effort and a loss of revenue from the state of Ohio.
Similar to laws in several other states, Ohio’s legislation allows for two types of FTCs: licensed and unlicensed. A licensed FTC is subject to the following requirements: (1) it must have a minimum capital balance of at least $200,000, and up to $500,000, at the discretion of Ohio’s superintendent of financial institutions; (2) it may provide services to “family members,” certain nonfamily members and certain affiliated entities; (3) it must maintain office space and at least one part-time employee in Ohio; (4) it must hold at least two governing board meetings per year in Ohio; (5) it must perform certain administrative activities in Ohio; and (6) it must maintain a fidelity bond and directors/officers insurance, each in the amount of $1 million. A licensed FTC is also subject to supervision by Ohio’s Department of Financial Institutions and will be audited every 18 months.
An unlicensed FTC, on the other hand, may provide services only to “family members,” and since the FTC will not be audited by the Department of Financial Institutions, it must abide by certain restrictive SEC rules in order to provide investment advice without registering with the SEC as a registered investment advisor. While an unlicensed FTC is not subject to banking regulations, it is required to submit an annual affidavit to the Department of Financial Institutions confirming its compliance with the statutory limitations.
One of the limiting features of an Ohio FTC is the definition of “family member.” This definition ensures that an FTC is not serving the general public (and, in fact, solicitation of trust business is explicitly prohibited by the bill). Family members are defined as a class, all of whom have a common ancestor who is not more than 10 generations removed. This so-called designated relative must be identified at the inception of the FTC and cannot be changed. Family members also include spouses, spousal equivalents, adopted children, stepchildren and foster children. The definition also includes the following related persons/entities: family charities, family estates, irrevocable trusts with family beneficiaries, key employees, trusts formed by key employees, and business entities wholly owned and operated by family members. These rules are intended to track the SEC’s definition of a “family office.”
Various estate tax and income tax laws also come into play. Prior to 2008, it was less clear how these laws would apply in the FTC context. The Internal Revenue Service addressed many of these questions through Notice 2008-63, in which it reviewed various FTC scenarios. In short, the tax rules permit a family to have substantial ownership and control over an FTC, so long as the governing documents of the FTC contain appropriate “firewalls” to separate family members from certain tax-sensitive decisions, such as making distributions from trusts of which they are grantors.
In sum, there are many ways in which Ohio’s FTC legislation will benefit Ohio families: there would be no need to operate outside Ohio; the capital requirements are relatively low (which is beneficial to small businesses and family farms); the licensed/unlicensed options provide a useful choice; the tax laws now have been clarified; and Ohio’s recent improvements to its trust laws provide a robust platform for operating long-term trusts with an FTC as trustee.