NATIONAL CONFERENCE OF LAWYERS AND CORPORATE FIDUCIARIES JUNE 1, 2012 DECANTING OBJECTIVES, CONSIDERATIONS, AND RESTRICTIONS HERBERT J. SLIGER, JR.

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1 NATIONAL CONFERENCE OF LAWYERS AND CORPORATE FIDUCIARIES JUNE 1, 2012 DECANTING OBJECTIVES, CONSIDERATIONS, AND RESTRICTIONS HERBERT J. SLIGER, JR. PROLOGUE Trustees administration and/or the fulfillment of a settlor s objectives may be hindered, frustrated, or restricted by the terms of irrevocable trusts. Ambiguities or errors in such trusts may make it costly or challenging for a trustee to fulfill its duties to the trust beneficiaries. The terms of some irrevocable trusts lack flexibility to adjust to unforeseen circumstances or unforeseen changes in the law that will inevitably arise. Decanting involves a trustee s discretionary decision to make a distribution for the benefit of a beneficiary into a continuing trust rather than to make an outright distribution to a beneficiary. Traditional Areas of Trustee Discretion Prior to the many recent enactments of decanting statutes, trustees, where so authorized by the terms of a trust or applicable law, have exercised discretion to: Invade principal; Accumulate income; Determine the amount and character of trust distributions; Allocate receipts and disbursements in a manner contrary to the otherwise applicable Uniform Principal and Income Act; Establish investment objectives and asset allocation, and select investment strategies and make individual trust investment decisions; Select the beneficiaries of trust distributions within, or between, classes of beneficiaries; Engage in an early termination of a trust because the trust s purposes have been fulfilled or the trust has become uneconomic to administer; 1

2 Fix the time, amount, and composition of trust distributions; Convert an income trust to a total return unitrust, or reconvert a unitrust to an income trust; Delegate investment functions to a co-trustee or investment advisor/investment agent; Exercise the power to adjust; Exercise, when applicable, any of scores of elections with respect to federal, state, local, or foreign taxes; Pay or contest any claim, settle a claim by or against the trust and release in whole or in part a claim belonging to a trust; Make decisions with respect to loaning trust funds, borrowing on behalf of a trust and pledging trust property to secure such obligations, On termination of a trust, exercise the powers appropriate to wind up the administration of the trust and distribute the trust property (distributions in cash or in-kind, non-pro rata distributions); or Exercise any of countless other powers available to the trustee. Non-Decanting Modification/Reformation of Trusts There has been a pronounced shift in the approach of modern law over the past two decades in the area of trust modification/trust reformation. The Florida Bar RPPTL Section s Comment Letter to the IRS (see fn. 13 below) observes that statutory consent or notification rights are implemented to protect the beneficiaries state law rights without any concern as to federal transfer tax law. The Comment Letter further states that such concerns should not be skewed as to impose a gratuitous transfer subject to federal transfer tax liability; to do so would encroach the state s concern for enacting the statute (e.g., the UNIFORM TRUST CODE). The following are among the non-decanting strategies available to modify /reform the terms of a trust instrument to fulfill a settlor s objectives and to provide optimal benefits to the beneficiaries. Amendment of a trust s terms by the exercise of authority granted under the terms of a trust to a trust protector, advisor, trust committee, or independent trustee to: Vary trust provisions to reflect changes in tax laws; Change trust situs/principal place of administration; 2

3 Change governing law; Direct trust investments; Remove, replace, or add beneficiaries; Modify distribution or administrative provisions; Remove and replace trustees; and Consent to, or veto, exercises of powers of appointment to beneficiaries. Amend a trust s terms by the consent of the beneficiaries. 1 Amend a trust s terms by entry of a court order; Use nonjudicial settlement agreements in states where their use extends to modification of trusts; Execute disclaimers (either qualified under IRC 2518, under the UNIFORM DISCLAIMER OF PROPERTY INTERESTS ACt, or other applicable state laws); Severance, or consolidation of trusts (see UTC 417 or similar state statutes). Twenty-four jurisdictions have adopted the UTC that contains a potpourri of provisions facilitating parties gaining court approval of trust modifications. 2 These provisions allow for a judicial modification: UTC 411(a) (Modification or termination of noncharitable irrevocable trust by consent) requires the consent of all the beneficiaries and a court determination that modification of the trust is not inconsistent with a material purpose of the trust. Some draftspersons are drafting material purposes into the terms of the trust. If not all of the beneficiaries consent to the proposed modification of the trust, the modification may, nonetheless, be approved by the court if the court is satisfied that: If all of the beneficiaries had consented, the trust could have been modified under UTC 411; and 1 See UNIFORM TRUST CODE (UTC) 111 (Nonjudicial settlement agreements) and similar state statutes. See ACTEC Website, L. Welch S. Bart, Virtual Representation Statutes Chart. 2 Alabama, Arizona, Arkansas, District of Columbia, Florida, Kansas, Nebraska, New Hampshire, New Mexico, Maine, Michigan, Missouri, Ohio, Oregon, North Carolina, North Dakota, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia, and Wyoming. See Appendix A for a list of modification of trust statutes for both UTC and non-utc states. 3

4 The interests of a beneficiary who does not consent will be adequately protected. 3 UTC 412(a) allows the court to modify the administrative or dispositive positions of a trust if because of circumstances not anticipated by the settlor, modification will further the purpose of the trust and the modification is made in accordance with the settlor s probable intention. Beneficiary consent is not required. UTC 412(b) allows the court to modify the administrative positions of a trust if continuance of the trust on its existing terms would be impracticable, wasteful, or impair the trust s administration. Beneficiary consent is not required. UTC 415 (Reformation to correct mistakes) A court may reform the terms of a trust, even if unambiguous, to conform the terms to the settlor s intention if it is proved by clear and convincing evidence that both the settlor s intent and the terms of the trust were affected by a mistake of fact or law, whether in expression or inducement. Reformation may involve the addition of language not originally in the instrument, or the deletion of language originally included by mistake, if necessary to conform the instrument to the settlor s intent. A mistake of expression occurs when the terms of the trust misstate the settlor s intention, fail to include a term that was intended to be included, or include a term that was intended to be excluded. A mistake in the inducement occurs when the terms of the trust accurately reflect what the settlor intended to be included, or excluded, but this intention was based on a mistake of fact or law. UTC 416 allows a court to modify the terms of a trust to achieve the settlor s tax objectives. The modification cannot be contrary to the settlor s probable intention. The court may provide that the modification has retroactive effect. Beneficiary consent is not required. Whether a modification of the terms of a trust will be recognized under federal tax law is a matter of federal law. Absent specific statutory or regulatory authority, binding recognition is normally given only to modifications made prior to the taxing event, for example, the death of the testator or settlor in the case of the federal estate tax. See Rev. Rul , C.B UTC 411(c). 4

5 INTRODUCTION TO DECANTING 4 A power held by a trustee to invade the corpus of a trust is analogous to a power of appointment for property law purposes. The core principle of decanting under common law, which generally has been codified by the decanting statutes, is that a decanting is the exercise of a trustee s distribution authority, which itself is the equivalent of a special power of appointment, which essentially is a power to name new beneficiaries or to change the interests of the beneficiaries. The rationale that underlies decanting is that if a trustee has the power to distribute trust property to, or for the benefit of, one or more current beneficiaries, then the trustee effectively has a special power of appointment to enable the trustee to transfer all, or part, of the assets from one irrevocable trust to another irrevocable trust for the benefit of the beneficiaries. Sources of Decanting Authority An express grant of authority under the governing instrument. Applicable decanting statute. Common law, e.g., Florida, 5 Iowa, 6 New Jersey. 7 For a discussion of these cases, see W. Culp & B. Mellen, Trust Decanting: an Overview and Introduction to Creative Planning Opportunities, REAL PROP. TRUST & EST. L. J. (Spring 2010). Many trusts permit distributions to or for the benefit of a beneficiary. Arguably, that authority permits a distribution to another trust for the benefit of a beneficiary. The Florida Bar Association RPPTL Section s March 5, 2012 Comment to the IRS Re: IRS Notice Guidance on Decanting to Another Irrevocable Trust, citing both the RESTATEMENT (THIRD) OF PROPERTY (WILLS AND OTHER DONATIVE TRANSFERS) (2003) and the RESTATEMENT (SECOND) OF TRUSTS 17, cmt. f (1959), notes that if a 4 W. Culp & B. Bennett, Use of Decanting to Extend the Term of Irrevocable Trusts, 37 EST. PLAN. 3 (Jun. 2010); A. Levin & T. Flubacher, Put Decanting to Work to Give Breath to Trust Purpose, 38 EST. PLAN. 3 (Jan. 2011); W. Culp & B. Mellen, Trust Decanting: An Overview and Introduction to Creative Planning Opportunities, REAL PROP. TRUST & EST. L. J. (Spring 2010); T. Simmons, Decanting and Its Alternatives: Remodeling and Revamping Irrevocable Trusts, 55 S.D. L. REV. 253 (2010); M. Schwartz & M. Magg, Private Settlement Agreements or Proposed Decanting Statutes: Which Will Be the Better Fit? 21 OHIO PROB. L. J. 3 (Jul./Aug. 2011); R. Wareh & E. Dorsch, Decanting: A Statutory Cornucopia, TRUSTS & ESTATES (Mar. 2012); T. Abendroth & C. ( Skip ) Fox, The Uses and Misuses of Decanting and Change of Situs, AMERICAN BANKERS ASSOCIATION TELEPHONE BRIEFING/WEBCAST (Oct. 4, 2012); C. Cacy, G. Gadarian, & S. Phillips, Fixing Old Trusts: Tax Consequences of Decanting and Other Trust Modification Techniques, AZ. BAR ASSN. Seminar (May 9, 2012); B. Jensen, Decanting as a Tool to Fix an Irrevocable Trust, IICLE 55 TH ANN. EST. PLNG. SHORT COURSE (Apr./May 2012). 5 Phipps v. Palm Beach Trust Co., 196 S. 299 (Fla. 1940). 6 In re Estate of Spencer, 232 N.W.2d 491, (Iowa 1975). 7 Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969). 5

6 trustee has the absolute power to distribute trust property among the members of a specified class of beneficiaries, absent a restriction in the terms of the trust, there is no prohibition against distributing property to a trust for some, but not all, of the beneficiaries. STATES WITH DECANTING STATUTES 8 Alaska ALASKA STAT (Effective September 15, 1998). Arizona AZ. REV. STAT (Effective September 30, 2009). Delaware DEL. CODE TIT. 12, 3528 (Effective June 30, 2003). Florida FLA. STAT (Effective July 1, 2007). Indiana IND. CODE (Effective July 1, 2010). Kentucky KY. REV. STAT (Effective July 11, 2012). Missouri - MO. REV. STAT (Effective August 28, 2011). Nevada NEV. REV. STAT (Effective October 1, 2009). New Hampshire N.H. REV. STAT. 564-B:4-418 (Effective September 8, 2008). New York N.Y. EST. POWERS & TRUSTS LAW (b) (Effective July 24, 1992). North Carolina N.C. GEN. STAT. 36C (Effective October 1, 2009). Ohio OHIO REV. CODE (Effective March 22, 2012). South Dakota S.D. CODIFIED LAWS to (Effective March 5, 2007). Tennessee TENN. CODE (b)(27) (Effective July 1, 2004). Virginia VA. CODE :1 (Approved April 4, 2012). 8 Indiana and New Hampshire are the only states with the word decant in their statutes. Alaska, Arizona, North Carolina, and Virginia statutes refer to a special power to appoint; Missouri, Nevada, and New York statutes use power to invade in their statutes headings; Ohio refers to the power to make distributions; Delaware, Florida, and Indiana statutes employ power to invade in their titles; South Dakota refers to an appointment; and Tennessee refers to both appointing and a power to invade. 6

7 2012 Pending Decanting Legislation Alaska S.B. 165 (To amend existing statute). Illinois H.B (This bill passed both Houses as of May 16, 2012, but has not been signed into law as of the submission of these materials on May 17, 2012.) Michigan S.B. 979 and S.B Rhode Island H.B and S.B Terminology State statutes, and IRS Notice , variously refer to the two trusts involved in decanting. First trust and second trust (Delaware, Florida, Indiana, Missouri, New Hampshire, Ohio, South Dakota). Invaded trust and appointed trust (Alaska, New York). Distributing trust and receiving trust (IRS). Original trust and second trust (Kentucky, Nevada, North Carolina, Virginia). The Arizona and Tennessee statutes do not expressly provide names for the trusts involved in a decanting transaction. Fiduciary Duties Related to the Exercise of Decanting Since decanting is considered the exercise of a discretionary distribution power, it should be governed by the same standard of judicial review as the exercise of discretion in other areas of trust administration, i.e., its exercise is subject to supervision by a court only to prevent abuse of discretion. 9 If a trust provides Income to A, remainder to B and C and no discretion is involved, then the trustee cannot decant, but the trustee may modify or reform the terms of the trust. The RESTATEMENT (THIRD) OF TRUSTS 50 (2003) provides some guidance with respect to the circumstances in which a beneficiary may object to decanting. 10 The benefits to which a beneficiary of a discretionary interest is entitled, and what may constitute an abuse of discretion by the trustee, depend on the terms of the discretion, including the 9 RESTATEMENT (THIRD) OF TRUSTS 87 (Judicial Control of Discretionary Powers) (2007). 10 RESTATEMENT (THIRD) OF TRUSTS 50(1) (Enforcement and Construction of Discretionary Interests) ( A discretionary power conferred upon the trustee to determine the benefits of a trust beneficiary is subject to judicial control only to prevent misinterpretation or abuse of the discretion by the trustee. ). 7

8 proper construction of any accompanying standards and on the settlor s purposes in granting the discretionary power and in creating the trust. Are there specific fiduciary duties (care, prudence, impartiality among beneficiaries, loyalty) imposed by the applicable decanting statute, or by the terms of the first trust s governing instrument, on the trustee s exercise of the power to decant? The exercise of a special power of appointment does not trigger fiduciary duties. If a trustee exercises a decanting power consistently with state law, it is unlikely that a beneficiary will be able to successfully oppose the decanting. Is a trustee who acts reasonably and in good faith in exercising the power to decant, presumed to have acted in accordance with the terms and purposes of the first trust and the interests of its beneficiaries? Florida, Indiana, New York, North Carolina, Ohio, and Virginia - The existence of a decanting statute does not create or imply a duty to exercise the power to decant, and no inference of impropriety arises as a result of a trustee s not exercising the power. Missouri, Nevada, and New Hampshire - The existence of a decanting statute does not impose a duty on a trustee to exercise the power. However, if a decanting request is received from a co-trustee, other fiduciary of the trust, or a beneficiary, by a trustee who does not exercise discretion to decant, how should the not exercise decision be documented? Virginia - If accounts of the first trust are filed with the Commissioner of Accounts, the accounts for the second trust shall be filed with the Commissioner of Accounts unless the court orders otherwise. Moreover, the exercise of the power to decant is subject to the fiduciary duties of the trustee of the original trust. DECANTING OBJECTIVES Where authorized, decanting can potentially be employed to address a wide variety of issues. Correct Drafting Errors or Ambiguities Correct drafting errors or ambiguities to avoid a reformation action or declaratory judgment action. Update or Modernize Administrative Provisions Provide for the resignation, removal, and appointment/succession of trustees. Address delegation between/among multiple trustees; include a trustee deadlock resolution procedure. 8

9 Decanting involving changing trustee mechanics or directly changing the current trustee, successor trustees or co-trustees may trigger transfer tax implications if the trustee holds tax sensitive powers that could be exercised for the trustee s individual benefit. Revise trustee compensation provisions to be consistent with the trustee s current published compensation schedules, but beware of the New York restriction on a change in the method or rate of calculating trustee s fees that result in increasing such fees, unless such change is court-approved. Require desired accounting treatment for certain classes of receipts and/or disbursements that is contrary to the Uniform Principal and Income Act, or confer on the trustee greater discretion in allocating items between income and principal. Add or Amend Investment Provisions Add or amend investment provisions, and/or change investment standards to comport with modern fiduciary investing principles, including adding investment powers to engage in sophisticated financial transactions or strategies. Remove investment restrictions or prohibitions. Grant the trustee more investment flexibility that could result in the receipt of increased trust accounting income to be distributed to mandatory income beneficiaries. Waive conflicts of interest and/or authorize affiliated investments. Add Investment Advisors/Trust Protectors Who Direct Investments Add investment advisor and/or trust protector provisions that permit advisors or trust protectors to direct investment decisions as to closely-held business interests or concentrated non-diversified investment positions, or bifurcate or fractionate trustee responsibilities, e.g., name an investment trustee and an administrative trustee. Then, directed investments can be permitted notwithstanding that they may: Be speculative; Involve substantial risk of loss; Produce little or no income; Lack marketability; Fail to eliminate diversifiable risk among particular assets or asset classes; and 9

10 The second trust can include exoneration of the directed trustee for any loss resulting directly or indirectly for following such directions except in the case of the trustee s willful misconduct or bad faith. See DEL. CODE TIT. 12, 3313 Moreover, the second trust may relieve the directed trustee of the duties to: Value directed non-publicly traded investments; Monitor the conduct of the investment advisor/trust protector/distribution advisor; Provide advice to or consult with the advisor/trust protector; or Communicate with, warn, or apprise any beneficiary or third party concerning instances in which the directed trustee would or might have exercised the trustee s discretion in a manner different from that directed by the advisor/trust protector. Id. Address Changes in Beneficiaries Family Circumstances or Dynamics Add asset protection provisions to address creditor or marital stability concerns. Disparate accumulation of wealth by beneficiaries. Estrangement of a beneficiary from the settlor. Decant into a supplemental needs trust to permit a disabled beneficiary to qualify for certain governmental benefits/public assistance. Substance abuse issues. Grant a Beneficiary a Power of Appointment Grant a beneficiary a power of appointment, presently exercisable or otherwise. Change Trust Situs/Principal Place of Administration and/or Change Governing Law Decanting may be exercised to change the situs/principal place of administration of a trust and/or to change the trust s governing law to take advantage of a favorable income tax situs and/or favorable fiduciary laws impacting matters of trust administration. If the decanting transaction includes the transfer of the trust s principal place of administration to Delaware, and the application of Delaware law as governing law for matters of trust administration, DEL. CODE TIT. 12, 3301(g) and 3301(h)(4) define willful misconduct to mean intentional wrongdoing, not mere negligence, gross negligence or recklessness and define wrongdoing to mean malicious conduct or conduct designed to defraud or seek an unconscionable advantage. 10

11 Combine or Divide Trusts Combine trusts for administrative efficiency and reduction in administrative costs, or to consolidate investment assets or other property. Divide a trust so that there are separate second trusts for respective beneficiaries with different investment objectives or income tax circumstances. Domestic portions of a foreign trust where some, but not all, beneficiaries live in foreign countries. Extend a Trust s Termination Date Decades ago, it was customary for certain trusts to contain age-attainment provisions that provided that one-third of the trust s assets be distributed to a beneficiary at age 25, onehalf of the remaining trust assets be distributed upon the beneficiary s attainment of age 30, and the balance of the trust assets be distributed when the beneficiary reached the ripe old age of 35. With many young adults maturation now occurring on a delayed basis, the trustee may, for example, decide to extend a trust s distribution dates to the beneficiary s attainment of ages 40, 45, and 50. Beware of an inter vivos limited power of appointment existing under the first trust that may be exercised to create a second trust that itself confers a limited power of appointment whose exercise could extend the beneficial interests under the second trust past the perpetuities period applicable to the first trust. Alaska, Florida, Indiana, Kentucky, New York, North Carolina, Ohio, South Dakota, and Tennessee expressly prohibit the extension of the perpetuities period beyond that of the first trust. The Missouri statute provides that the trustee shall remain subject to all fiduciary duties otherwise imposed under the trust instrument and Missouri law. Spendthrift Trust Provision Make trust interests spendthrift or eliminate a spendthrift provision. Tax Consequences of Decanting This topic is beyond the scope of these materials, but fn. 11 below cites a number of comment letters to the Service in response to IRS Notice wherein the IRS requested comments from the public regarding the submission of a definition for decanting and when, and under what circumstances, transfers by a trustee of all or a portion of the principal of an irrevocable trust to another trust that result in a change in the beneficial interests in the trust are not subject to the income, gift, estate, and/or generation-skipping transfer (GST) taxes under the 13 sets of facts and circumstances See generally D. Zeydel and J. Blattmachr, Tax Effects of Decanting Obtaining and Preserving the Benefits, JTAX 288 (Nov. 2009); Report of Individual Members of the American College of Trust and 11

12 In these transfers, the interests of one or more beneficiaries may be changed and, in some cases, the interest of a beneficiary may be terminated and/or another beneficiary who did not have an interest in the distributing trust may receive an interest in the receiving trust. While these issues are under study, the IRS will not issue private letter rulings (PLRs) with respect to such transfers that result in a change in beneficial interests. In addition to the materials cited in fn. 11 below, see M. Gordon & D. Hayward, The Tax Consequences of Decanting: A Summary of the Gift, Estate, Income and Generation- Skipping Transfer Tax Considerations When Utilizing Delaware s Decanting Statute, DELAWARE BANKERS ASSOCIATION Presentation (Apr. 13, 2012). Does a beneficiary s power to object to a decanting accompanied by the failure to object create a gift? Rev. Rul , C.B. confirms that a taxable gift can occur by permitting legal rights to expire. However, if a trustee exercises a decanting power consistently with state law, a beneficiary would be unable to oppose the exercise of the trustee s discretion. In such a case, it is not clear that the beneficiary would be required to pursue an objection which will in all likelihood fail. Tax Identification Number The income tax analysis under the ACTEC submission cited at fn. 11 generally concluded that under a valid decant, the new trust should be viewed as a continuation of the old trust for all elements of income taxation. The April 12, 2012 New State York Bar Association Tax Section and New York State Bar Association Trusts and Estates Law Section Report on Notice : Request for Comments Regarding the Income, Gift, Estate, and Generation-Skipping Transfer Tax Consequences of Trust Decanting recommends that the Service confirm that when the first trust and the second trust have substantially similar terms and the second trust receives all of the first trust s assets, the second trust should be considered a continuation of the first trust for income tax purposes. The NYSBA concludes that, in that case, the decanting transaction should be considered a non-event for income tax purposes; accordingly, the distribution to the second trust should not carry out distributable net income (or undistributable net income if the first trust is a foreign trust). Estate Counsel on the Tax Effects of Decanting submitted to the Internal Revenue Service by J. Blattmachr on behalf of himself and E. Bucher, G. Cushing, M. Gans, J. Horn, M. Mancini, D. Zeydel; AMERICAN COLLEGE OF TRUST AND ESTATE COUNSEL, Tax Consequences of the Distribution of Trust Assets from One Trust to Another Trust; FLORIDA BAR RPPTL SECTION March 5, 2012 Comment Letter to the Internal Revenue Service Re: IRS Notice Guidance on Decanting to Another Irrevocable Trust; NEW YORK STATE BAR ASSOCIATION TAX SECTION NEW YORK STATE BAR ASSOCIATION TRUSTS AND ESTATES LAW SECTION April 12, 2012 Draft Report on Notice : Request for Comments Regarding the Income, Gift, Estate, and Generation-Skipping Transfer Tax Consequences of Trust Decanting; and April 24, 2012 Comments of Bessemer Trust on Transfers by a Trustee from an Irrevocable Trust to Another Irrevocable Trust ( Decanting ) (Notice , I.R.B. 932 (December 20, 2011)); W. Paul, ABA TAX SECTION OF TAXATION Comments in Response to Notice (May 3, 2012). 12

13 The NYSBA recommends that the Service confirm that, in such cases, the second trust may continue to use the first trust s taxpayer identification number. The NYSBA further recommends that the Service confirm that, even when the first and second trusts are not substantially similar, so long as the first trust decants all of its assets, all of the tax attributes of the first trust carry over to the second trust. Change the Tax Attributes of a Trust Change a non-grantor trust to a grantor trust or a grantor trust to a non-grantor trust. As a general rule, the conversion of a non-grantor trust to a grantor trust is not an income tax realization event. See Rev. Rul IRS Chief Counsel Advice concludes that the Service should not take the position that the mere conversion of a non-grantor trust to a grantor trust results in taxable income to the grantor. Unanticipated Changes in Laws Address unanticipated circumstances such as changes in federal or state tax laws or changes in substantive trust laws. SELECTED DECANTING CONSIDERATIONS Appointment of a Special Fiduciary The District Court in Kentucky may appoint a special fiduciary with the authority to decant. Beneficiary Consent or Notice Requirements With one exception, no state requires beneficiaries to consent to a trust decanting. Nevada requires a trustee to secure a beneficiary s consent where the trustee eliminates or limits a beneficiary s interest in the first trust. See NEV. REV. STAT (2)(e). New York - A trustee may decant without the consent of the creator, or of the persons interested in the invaded trust. Is notice of the proposed decanting required and, if so, does the statute prescribe the persons to whom notice must be provided, the method of giving notice, and/or the minimum number of days by which the notice must precede the decanting? Must the notice of the proposed decanting include the terms of the proposed second trust? Where the proposed decanting transaction involves a charitable trust, is the state attorney general considered an interested party representing the public interest, and therefore entitled to notice? 13

14 Does the applicable state law contain a virtual representation statute permitting notice to be provided to a representative of a beneficiary who is a minor, an unborn, or a legally incapacitated adult beneficiary? Even when a state has a strong virtual representation statute, an expansive notice requirement can be challenging when the trust has an open class of beneficiaries. Alaska, Arizona, Delaware, New Hampshire, and Tennessee - Do not require notice to beneficiaries. Nevada - Permits, but does not require, notice to beneficiaries. Florida, Indiana, Kentucky, Missouri, North Carolina, and Virginia (including giving a copy of the written instrument setting forth the manner of the exercise of the power, the terms of the second trust, and the effective date of the exercise of the power) require 60 days advance notice to beneficiaries of the exercise of decanting. Missouri curiously requires notice to permissible distributees of the second trust, but provides for no notice to the first trust s beneficiaries. New York - A copy of the instrument exercising the decanting power and a copy of each of the first ( invaded ) trust and the second ( appointed ) trust shall be delivered (A) to the creator, if living, of the first trust, (B) to any person having the right, pursuant to the terms of the first trust, to remove or replace the authorized trustee exercising the power, and (C) to any persons interested in the first trust and the second trust (or, in the case of any persons interested in the trust, to any guardian of the property, conservator or personal representative of any such person or the parent or person with whom any such minor person resides). The exercise of the power will be effective thirty days after the date of service of the instrument. Ohio Requires the trustee of the first trust to notify all current beneficiaries of the first trust, in writing of the intended distribution to the trustee of the second trust not later than 30 days prior to that distribution. South Dakota - The trustee of the first trust shall notify all beneficiaries of the first trust, in writing, at least 20 days prior to the effective date of the decanting. If notice of decanting is required, may the notice requirement be negated by the terms of the trust, particularly where the settlor does not want some beneficiaries to know of the existence of the trust until their interests become possessory? The trustee in a UTC state must be aware of whether the statutory duties to inform and report are mandatory or default: To keep the beneficiaries reasonably informed; To respond to requests for information; 14

15 To provide a copy of the trust instrument; To notify beneficiaries of the acceptance of the trusteeship; To notify of trust existence and beneficiary rights; and To provide annual reports. Beneficiaries of the Second Trust All of the state statutes require that the authority to decant be exercised in favor of one or more of the beneficiaries of the first trust. In no event, may a trustee decant in favor of a person who is not a beneficiary of the first trust. Through decanting, the trustee may remove a beneficiary, or change a beneficiary s interest, but cannot add a beneficiary. For example, if the terms of the first trust permit only beneficiaries of a class who are related to the settlor by blood (consanguinity), then the trustee may not decant and include in the second trust s class of beneficiaries persons who are adopted. The New York statute specifies that a trustee with unlimited power to invade principal may exclude one or more beneficiaries of the first trust. Although other states statutes do not specifically refer to exclusion, the ability to decant in favor of one or more, but not all, of the permissible beneficiaries necessarily includes a power to exclude. Alaska The assets of the second trust must be held for the beneficiaries of the first trust on terms and conditions regarding the nature and extent of the interests of the beneficiaries of the first trust that are substantially identical to the terms and conditions governing the interests of the beneficiaries in the first trust. Arizona Decanting must be exercised in favor of the beneficiaries of the [first] trust. Delaware The exercise of decanting is in favor of a second trust having only beneficiaries who are proper objects of the exercise of the power. Florida The beneficiaries of the second trust may include only beneficiaries of the first trust. Indiana The trustee may decant as long as the beneficiaries of the second trust are the same as the beneficiaries of the first trust. Kentucky The beneficiaries of the second trust may include only beneficiaries of the original trust. Missouri The second trust may have as beneficiaries only one or more of those beneficiaries of the first trust to or for whom any discretionary distribution may be made from the first trust and who are proper objects of the exercise of the 15

16 power, or one or more of those other beneficiaries of the first trust to or for whom a distribution of income or principal may have been made in the future from the first trust at a time or upon the happening of an even specified under the first trust. Nevada and New Hampshire A trustee may not decant to a second trust that includes a beneficiary who is not a beneficiary of the original trust. A permissible appointee of a power of appointment exercised by a beneficiary of the second trust is not considered a beneficiary of the second trust. New York - An authorized trustee with unlimited discretion to invade trust principal may appoint part or all of such principal to a trustee of a second trust for, and only for the benefit of, one, more than one or all of the current beneficiaries of the first trust (to the exclusion of any one or more of such current beneficiaries). The successor and remainder beneficiaries of such second trust shall be one, more than one or all of the successor and remainder beneficiaries of such first trust (to the exclusion of any one or more of such successor and remainder beneficiaries). An authorized trustee with the power to invade trust principal but without unlimited discretion may appoint part or all of the principal of the trust to a trustee of a second trust, provided that the current beneficiaries of the second trust shall be the same as the current beneficiaries of the first trust and the successor and remainder beneficiaries of the second trust shall be the same as the successor and remainder beneficiaries of the first trust. North Carolina The beneficiaries of the second trust may include only beneficiaries of the first trust. Ohio The trustee may grant a power of appointment to one or more of the beneficiaries for whose benefit the property was decanted, including a power to appoint to any person, whether or not that person is a beneficiary of the first trust or the second trust, or the trustee may provide that trust property that is the subject of the decanting shall be held for the benefit of the beneficiaries of the first trust upon the terms and conditions that are substantially identical to the terms and conditions of the first trust. South Dakota The second trust may have as beneficiaries only one or more of those beneficiaries of the first trust to or for whom a discretionary distribution may be made from the first trust and who are proper objects of the exercise of the power to decant, or one or more of those other beneficiaries of the first trust to for whom a distribution of income or principal may have been made in the future from the first trust at a time or upon the happening of an event specified under the first trust. Virginia The beneficiaries of the second trust shall include only beneficiaries of the first trust. If the power to distribute principal or income in the first trust is 16

17 subject to an ascertainable standard, the same power in the second trust shall be exercisable in favor of the same current beneficiaries as in the first trust and, unless the court approves otherwise, shall be subject to the same ascertainable standard as the first trust. Creation of Second Trust under Same Instrument as the First Trust Arizona and Ohio statutes, for example, provide that the second trust may be created under the same trust instrument as the first trust. If decanting occurs by the trustee s restating the first trust, this eliminates the need to transfer assets from one trust to another and re-register, where applicable, such trust assets. Unlimited Discretion to Invade Principal vs. Discretion Limited by an Ascertainable Standard Alaska, Arizona, Delaware, Kentucky, Missouri, Nevada, New Hampshire, New York, North Carolina, Ohio, South Dakota, Tennessee, and Virginia - Unless the terms of the trust provide otherwise, these states permit a trustee to decant even where the trustee does not have unlimited discretion to invade principal. Florida and Indiana - Unless the trust expressly provides otherwise, a trustee must have absolute power to invade in order to be able to decant. File Documentation of Trustee s Exercise of Decanting Delaware, Florida, Indiana, Nevada, Tennessee, and Virginia - Require that the exercise of the power to invade the principal of the first trust must be by an instrument in writing, signed and acknowledged by the trustee and filed with the records of the first trust. Kentucky The exercise of the power to appoint (decant) must be made by an instrument in writing, signed and acknowledged by the trustee, setting forth the manner of the exercise of the power, including the terms of the second trust and the effective date of the exercise. The instrument must be filed with the records of the original trust. New York - A copy of the decanting instrument and the second trust must be sent to: (i) the creator of the first trust; (ii) any person with a right to remove the trustee of the first trust; and (iii) any person interested in the first or second trust. Virginia Requires the trustee to give a copy of the written instrument setting forth the manner of the exercise of the decanting power and the terms of the second trust, to: The grantor of the original trust, if living; Without regard to the exercise of any power of appointment, the qualified beneficiaries of the trust under VA. CODE and , other than the Attorney General; and 17

18 All persons acting as advisor or protector of the original trust. The representation provisions of VA. CODE , and , inclusive, apply to the required notice of decanting. Inclusion of Part, but Not All, of the Invaded Trust s Assets Indiana, Missouri, New York, North Carolina, Ohio, South Dakota, Tennessee, and Virginia - expressly authorize the decanting of part of the original trust s assets. Judicial Approval A trustee may desire court approval before decanting to preclude later disruptive confrontations/disputes with beneficiaries. Arizona, Nevada, New York, and North Carolina - Statutes permit, but do not require a trustee to seek judicial approval. Kentucky A current beneficiary or a beneficiary who is not a current beneficiary but is a member of the oldest generation of the remainder beneficiaries of the original trust, may, no later than 30 days from the date of receipt of the decanting notice, commence a judicial proceeding in the District Court to object to the proposed exercise of the power to decant. In such case, the trustee may not decant without the consent of the District Court. Ohio Requires court approval, from the court having jurisdiction, before a testamentary trust created by an Ohio decedent may be decanted. Virginia - A trustee or beneficiary may commence a proceeding to approve or disapprove a proposed exercise of the power to decant under VA. CODE :1. If court approval is not sought, will the trustee seek releases in connection with the exercise of discretion to decant? Subsequently Discovered Assets of the First/Invaded Trust New York The only state to address this by statute. The appointment of all of the assets comprising the invaded trust to an appointed trust includes subsequently discovered assets belonging to the invaded trust and principal paid to or acquired after the appointment to the appointed trust. Where there is an appointment of part, but not all, of the assets comprising the invaded trust, subsequently discovered assets will belong to the invaded trust and principal paid to or acquired by the invaded trust after the decanting will remain assets of the invaded trust. 18

19 RESTRICTIONS ON DECANTING 1. Does the existence, in the invaded trust, of a spendthrift provision or a trust provision that prohibits amendment or revocation preclude a trustee from exercising the discretion to decant? The answer is No in Florida, Indiana, Missouri, Nevada, North Carolina, South Dakota, or Virginia. 2. Determine whether a trustee is precluded from exercising a power to decant to: Decrease the standard of care applicable to the actions of the trustee; Increase the extent to which the trustee is entitled to indemnification from the trust, as provided in the terms of the invaded trust or under any law; Exonerate a trustee from liability for failure to exercise reasonable care, diligence, and prudence; Eliminate a provision granting another person the right to remove or replace the trustee, unless the court having the jurisdiction over the trust specifies otherwise; Make a binding and conclusive determination of the value of any asset for purposes of distribution, allocation, or otherwise; Violate the rule against perpetuities; Fails to preserve an ascertainable standard of invasion by broadening the such standard in the second trust. Change the provisions regarding the amount or method of determining the trustee s compensation (unless, in some states, the increase in, or change in the method of determining, that compensation is approved by all current beneficiaries of the second trust or is approved by the court having jurisdiction over the first trust). 3. Depending upon state statute, a trustee may not exercise a power to decant that: Jeopardizes the deduction or exclusion originally claimed with respect to any contribution to the first trust that qualified for: The gift tax annual exclusion under IRC 2503(b) if contributions to the first trust qualified for the 2503(b) gift tax annual exclusion based on the trust s qualification under IRC 2503(c), the second trust must provide that the beneficiary s remainder interest must vest no later than the date 19

20 upon which such interest would have vested under the terms of the first trust; Marital deduction under IRC 2056(a)(estate tax) or 2523(a)(gift tax), or under applicable state law; Charitable deduction under IRC 170(a)(income tax), 2055(a)(estate tax), 2522(a)(gift tax), or applicable state law; or Any other tax benefit for which a contribution originally qualified for GST purposes, including a transfer to the invaded trust treated as a gift qualifying for a zero inclusion ratio for GST purposes. Reduces, limits, or modifies: A beneficiary s current right to a mandatory distribution of income or principal in the first trust, including a mandatory annuity or unitrust interest in the first trust. Alaska, Arizona, Florida, Nevada, New York, and Tennessee do not permit a trustee to reduce a beneficiary s fixed income interest in the first trust. Delaware, Missouri, and South Dakota provide similar protection on a more limited basis in the case of certain trusts, such as trusts for which a marital deduction had been taken for federal estate tax or gift tax purposes, charitable remainder trusts, or GRATs; A beneficiary s presently exercisable right of withdrawal, or a right to a specified dollar amount from the first trust, provided that such mandatory right has come into effect with respect to the beneficiary. See the Delaware, Nevada, New York, North Carolina, and South Dakota statutes; Any income interest of any beneficiary under a first trust that is a GRAT (IRC 2702); or Any income interest of any beneficiary under an IRC 664 charitable remainder trust; If the assets of the first trust include any interest subject to the minimum required distribution rules of IRC 401(a)(9), the governing instrument of the second trust cannot include or omit any term that, if included or omitted from the trust instrument of the invaded trust, would have shortened the maximum distribution period otherwise allowable under 401(a)(9). If the assets of the first trust include any shares of S corporation stock and the first trust is, or would be, a permitted shareholder under IRC 1361, the governing instrument of the second trust cannot include or omit any term that, if included or omitted from the trust instrument of the first trust, would have prevented the first trust from qualifying as an S corporation shareholder. 20

21 4. Delaware, Florida, North Carolina, and Nevada prohibit the exercise of the power to decant in favor of the trustee, the trustee s estate, the trustee s creditors, or the creditors of the trustee s estate. IRC 2041(b)(1) or 2514(c). 5. Arizona s statute provides as a condition of the exercise of discretion to decant that the decanting Does not adversely affect the tax treatment of the trust, the trustee, the settlor or the beneficiaries. 21

22 APPENDIX A TRUST MODIFICATION STATUTES STATE CITATION TITLE Alabama Ala. Code 19-3B-411 Modification or termination of noncharitable Ala. Code 19-3B-412 Modification or termination because of Ala. Code 19-3B-415 Reformation to correct mistakes Ala. Code 19-3B-416 Modification to achieve settlor s tax objectives Alaska Alaska Stat Modification or termination of irrevocable trusts because of unanticipated circumstances Alaska Stat Reformation to correct mistakes in irrevocable trusts Alaska Stat Construction or modification of trust to achieve settlor s tax objectives Arizona Ariz. Rev. Stat Modification or termination of noncharitable Ariz. Rev. Stat Modification or termination because of Ariz. Rev. Stat Reformation to correct mistakes Ariz. Rev. Stat Modification to achieve settlor s tax objectives Arkansas Ark. Code Modification or termination of noncharitable Ark. Code Modification or termination because of Ark. Code Reformation to correct mistakes Ark. Code Modification to achieve settlor s tax objectives California Cal. Prob. Code Modification of trust Cal. Prob. Code Modification or termination of irrevocable trust by all beneficiaries Cal. Prob. Code Modification or termination by settlor and all beneficiaries Cal. Prob. Code Modification or termination in changed circumstances Colorado Connecticut Colo. Rev. Stat Reformation to correct mistakes Colo. Rev. Stat Modification to achieve transferor s tax objectives Delaware Del. Code tit. 12, 3541 Administration of charitable trusts or noncharitable purpose trusts District of D.C. Code Modification or termination of noncharitable 22

23 Columbia D.C. Code Modification or termination because of D.C. Code Reformation to correct mistakes D.C. Code Modification to achieve settlor s tax objectives Florida Fla. Stat Reformation to correct mistakes Fla. Stat Modification to achieve settlor s tax objectives Georgia Hawaii Idaho Illinois 760. Ill. Comp. Stat. 5/16.1(d)(4)(K) Virtual representation/nonjudicial settlement Agreements/modification of the terms of the trust pertaining to administration of the trust Indiana Ind. Code Modification of terms Ind. Code Rescission and reformation Iowa Kansas Kan. Stat. 58a-411 Modification or termination of noncharitable Kan. Stat. 58a-412 Modification or termination because of anticipated circumstances or inability to Kan. Stat. 58a-415 Reformation to correct mistakes Kan. Stat. 58a-416 Modification to achieve settlor s tax objectives Kentucky Louisiana La. Rev. Stat Delegation of right to terminate or to modify administrative provisions La. Rev. Stat Change of circumstances La. Rev. Stat Accomplishment of purposes becoming impossible or illegal La. Rev. Stat Form Maine Maryland Me. Rev. Stat. tit. 18B, 411 Modification or termination of noncharitable Me. Rev. Stat. tit. 18B, 412 Modification or termination because of Me. Rev. Stat. tit. 18B, 415 Reformation to correct mistakes Me. Rev. Stat. tit. 18B, 416 Modification to achieve settlor s tax objectives Massachusetts Michigan Mich. Comp. Laws Modification or termination of trust; changed circumstances, continuation of trust on existing terms impractical Mich. Comp. Laws Modification or termination of trust Mich. Comp. Laws Reformation of trust terms 23