By: Bob Lock

Decanting an Irrevocable Trust: A Comprehensive Guide to Navigating Challenges and Tax Implications

I. Introduction

Trust decanting has emerged as a powerful tool for modifying irrevocable trusts, allowing trustees to adapt to changing circumstances and correct drafting errors. This process, akin to pouring wine from one bottle to another, involves transferring assets from an existing irrevocable trust (the “distributing trust”) to a new trust (the “receiving trust”) with different terms. As the legal landscape continues to evolve, understanding the intricacies of trust decanting becomes increasingly crucial for trustees, beneficiaries, and legal professionals alike.

II. Understanding Trust Decanting

Trust decanting can be employed for various purposes, including:

1. Updating or modernizing trust provisions
2. Addressing changed circumstances of beneficiaries
3. Improving tax planning strategies
4. Modifying administrative provisions
5. Extending the trust’s duration
6. Changing the trust’s governing law or situs
7. Correcting drafting errors or ambiguities
8. Consolidating multiple trusts
9. Dividing a single trust into separate trusts
10. Modifying powers of appointment

The flexibility offered by decanting allows trustees to adapt trusts to unforeseen circumstances, potentially enhancing the trust’s effectiveness in meeting its objectives. However, this flexibility must be balanced against the potential risks and legal complexities involved in the decanting process.As of 2023, 29 states have enacted decanting statutes, while others rely on common law principles. This variation in legal frameworks adds complexity to the decanting process, requiring trustees to be well-versed in the applicable laws of their jurisdiction.[Insert chart summarizing state statutory schemes and requirements here]

III. Common Law Basis for Decanting

The common law foundation for trust decanting stems from the principle that a trustee’s power to distribute trust assets includes the lesser power to distribute those assets to a new trust. This concept was first articulated in the seminal 1940 Florida Supreme Court case Phipps v. Palm Beach Trust Co., which held that a trustee with discretionary distribution authority could appoint trust property to a new trust for the same beneficiary.Several subsequent cases have reinforced and expanded on this common law principle:

1. Wiedenmayer v. Johnson: The New Jersey Superior Court upheld a trustee’s decanting of trust assets to a new trust with modified terms, emphasizing the trustee’s broad discretionary powers. This case expanded the scope of decanting by allowing changes to beneficial interests when the trustee had absolute discretion.
2. Morse v. Kraft: The Massachusetts Supreme Judicial Court affirmed the common law decanting power, finding it inherent in the trustee’s authority to distribute property for the benefit of beneficiaries. This case is significant because it recognized decanting in a state without a specific decanting statute.
3. In re Estate of Spencer: The Iowa Supreme Court recognized a trustee’s implied power to distribute trust property to a new trust when acting in the best interests of beneficiaries. This case demonstrates the potential breadth of common law decanting authority.

The common law approach, however, is not without uncertainties. Courts may differ on how much discretion is required to justify decanting without express authorization, whether beneficiary consent or notice is required, and the extent to which decanting can alter beneficial interests. These uncertainties have led many states to codify decanting authority through legislation.

IV. Statutory Decanting Frameworks

As the popularity of trust decanting has grown, many states have enacted statutes to provide clearer guidelines and protections for trustees. These statutes vary significantly in their requirements and limitations. Key variations among state statutes include:

1. Trustee discretion required:
   • Full discretion: e.g., Florida, Indiana
   • Limited discretion allowed: e.g., South Dakota, Nevada, Delaware
   • Tiered approach based on proposed changes: e.g., Illinois, Michigan, Ohio, Texas, Virginia
2. Notice requirements:
   • Mandatory beneficiary notice: e.g., New York (60 days), Florida (60 days)
   • Optional notice: e.g., Delaware, South Dakota
3. Consent requirements:
   • No consent required: e.g., Nevada, South Dakota
   • Settlor consent for tax-sensitive changes: e.g., New Hampshire
4. Restrictions on changing beneficial interests:
   • Prohibition on adding beneficiaries: e.g., New York
   • Allowing broader changes with sufficient discretion: e.g., South Dakota
5. Tax-related provisions:
   • Explicit preservation of tax benefits: e.g., Delaware, Nevada
   • Limitations on decanting GST-exempt trusts: e.g., New York

A summary guide to all state decanting statutes can be found at the end of this post.

The Uniform Trust Decanting Act (UTDA), promulgated in 2015, aims to standardize decanting laws across states. As of 2023, several states have adopted versions of the UTDA, providing a more consistent framework for trust decanting.

V. Successful Case Studies of Trust Decanting

Several court cases demonstrate successful applications of decanting:

1. Ferri v. Powell-Ferri: The Connecticut Supreme Court upheld a decanting that moved assets from a trust accessible to the beneficiary at certain ages to a fully discretionary trust, protecting the assets in a divorce proceeding. This case illustrates the potential of decanting to enhance asset protection.
2. Morse v. Kraft: The Massachusetts Supreme Judicial Court recognized the trustees’ common law power to decant, allowing them to transfer assets to new trusts that gave the beneficiaries more control and flexibility. This case demonstrates how decanting can be used to update trust provisions to better suit beneficiaries’ needs.
3. In re Peierls Family Inter Vivos Trusts: The Delaware Supreme Court approved the decanting of several trusts to change their situs to Delaware, showcasing the use of decanting for jurisdictional changes to take advantage of more favorable trust laws.
4. Hodges v. Johnson: While not a successful decanting case, this New Hampshire Supreme Court decision provides important guidance on the limits of decanting. The court invalidated a decanting that removed certain beneficiaries, emphasizing the trustee’s duty of impartiality and the importance of adhering to the settlor’s intent.

These cases highlight the potential benefits of decanting while also underscoring the importance of careful planning and adherence to fiduciary duties.

VI. Potential Risks and Mitigation Strategies

While decanting offers significant flexibility, it also presents several risks that trustees must carefully navigate:

1. Breach of Fiduciary Duty: Trustees must ensure that decanting aligns with their fiduciary obligations. To mitigate this risk:
   • Document the rationale for decanting thoroughly
   • Obtain beneficiary consent or court approval for significant changes
   • Consider appointing a special trustee to handle the decanting process
   • Conduct a comprehensive analysis of how the decanting affects all beneficiaries
2. Tax Consequences: Decanting can trigger unintended tax liabilities. To minimize tax risks:
   • Obtain a private letter ruling from the IRS for significant changes
   • Preserve GST grandfathering by adhering to Treas. Reg. § 26.2601-1(b)(4)
   • Consider decanting to a trust with identical terms and then modifying the new trust
   • Consult with tax professionals to assess potential income, gift, estate, and GST tax implications
3. Creditor Claims: Decanting could be challenged as a fraudulent conveyance. To address this:
   • Ensure the decanting complies with state law and the trustee’s fiduciary duties
   • Maintain adequate trust assets to satisfy known creditor claims
   • Document the non-fraudulent purpose of the decanting
   • Consider obtaining creditor clearance or court approval in high-risk situations
4. Beneficiary Disputes: Changes to beneficial interests can lead to litigation. To mitigate:
   • Provide clear notice and explanation to beneficiaries
   • Consider using a nonjudicial settlement agreement in conjunction with decanting
   • Explore separating the trust into subtrusts before decanting
   • Engage in open communication with beneficiaries throughout the process
5. Unintended Consequences: Decanting may have unforeseen effects on trust administration or beneficiary rights. To minimize this risk:
   • Conduct a thorough review of all trust documents and related agreements
   • Consult with legal experts in trust law and estate planning
   • Consider the long-term implications of proposed changes
   • Draft clear and comprehensive new trust documents

VII. Academic Perspectives on Trust Decanting

Trust decanting has been the subject of significant academic discussion. Some key perspectives include:

1. Sterk, S. E., & Leslie, M. B. (2016). Retroactive Hall Taxes. Yale Law Journal, 126, 208: This article discusses the potential for decanting to undermine settlor intent and suggests limitations on decanting power.
2. Ausness, R. C. (2017). Sherlock Holmes and the Problem of the Dead Hand: The Modification and Termination of ‘Irrevocable’ Trusts. Quinnipiac Probate Law Journal, 28(3), 237-303: This comprehensive analysis explores various methods of modifying irrevocable trusts, including decanting.
3. Sitkoff, R. H. (2014). Trusts and Estates: Implementing Freedom of Disposition. St. Louis University Law Journal, 58, 643: This article discusses trust decanting in the context of broader trends in trust law towards increasing flexibility.

These academic perspectives provide valuable insights into the theoretical underpinnings and potential implications of trust decanting.

VIII. Conclusion

Trust decanting offers significant flexibility in modifying irrevocable trusts, but it comes with complex challenges and potential pitfalls. Trustees must carefully navigate the legal landscape, whether operating under statutory or common law authority, and take proactive steps to protect themselves from liability. By understanding these challenges and implementing appropriate safeguards, trustees can effectively use decanting to adapt trusts to changing circumstances while minimizing legal and tax risks. When considering decanting an irrevocable trust, it’s crucial to work closely with experienced legal and tax professionals to ensure compliance with applicable laws and to avoid unintended consequences. The goal is to enhance the trust’s effectiveness in meeting its objectives while preserving its tax advantages and asset protection features.

I hope that you have found value in this brief analysis, and look forward to your thoughts on my Telegram chat! If you enjoy this content, please consider donating to support our research, by clicking on the “Donate” button on this site. Should you wish to create your own trust(s) for Estate Planning purposes, let’s discuss my Common Law Trust materials. Just send me an email to: debtlawyer@gmail.com and I’ll send you some information.

All my best,

Bob Lock

© 2024 Bob Lock – Anti-Radicals Blog

References:

1. American College of Trust and Estate Counsel. (2023). State Decanting Statutes.
2. Uniform Law Commission. (2015). Uniform Trust Decanting Act.
3. Internal Revenue Service. (2011). Notice 2011-101 on Decanting.
4. American Bar Association. (2018). Trust Decanting: A Critical Perspective.
5. Phipps v. Palm Beach Trust Co., 142 Fla. 782, 196 So. 299 (1940).
6. Wiedenmayer v. Johnson, 106 N.J. Super. 161, 254 A.2d 534 (App. Div. 1969).
7. Morse v. Kraft, 466 Mass. 92, 992 N.E.2d 1021 (2013).
8. In re Estate of Spencer, 232 N.W.2d 491 (Iowa 1975).
9. Ferri v. Powell-Ferri, 326 Conn. 438, 165 A.3d 1137 (2017).
10. In re Peierls Family Inter Vivos Trusts, 77 A.3d 249 (Del. 2013).
11. Hodges v. Johnson, 170 N.H. 470, 177 A.3d 86 (2017).
12. U.S. Department of the Treasury. (2023). Treasury Regulations § 26.2601-1(b)(4).
13. Sterk, S. E., & Leslie, M. B. (2016). Retroactive Hall Taxes. Yale Law Journal, 126, 208.
14. Ausness, R. C. (2017). Sherlock Holmes and the Problem of the Dead Hand: The Modification and Termination of ‘Irrevocable’ Trusts. Quinnipiac Probate Law Journal, 28(3), 237-303.
15. Sitkoff, R. H. (2014). Trusts and Estates: Implementing Freedom of Disposition. St. Louis University Law Journal, 58, 643.
16. Cottage Savings Assn. v. Commissioner, 499 U.S. 554 (1991).
17. In re Huber, 493 B.R. 798 (Bankr. W.D. Wash. 2013).

Here is a summary guide that provides some details on the elements of different state decanting laws for decanting.

Decanting Rankings 2021 chart in PDF

© 2024 Bob Lock – Anti-Radicals Blog

Disclaimer
The contents of this post are provided for educational and entertainment purposes only. The information, content, and materials available in this post do not constitute legal, financial, accounting, or other professional advice. The authors and publishers of this post are not engaged in rendering legal, financial, or other professional services.