A Primer on Decanting 2015 Trust and Estate Planning Series

Transcription

1 ABA BRIEFING PARTICIPANT S GUIDE A Primer on Decanting 2015 Trust and Estate Planning Series Thursday, September 3, 2015 Eastern Time 1:00 p.m. 3:00 p.m. Central Time 12:00 p.m. 2:00 p.m. Mountain Time 11:00 a.m. 1:00 p.m. Pacific Time 10:00 a.m. 12:00 p.m.

2 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET DISCLAIMER This Briefing will be recorded with permission and is furnished for informational use only. Neither the speakers, contributors nor ABA is engaged in rendering legal nor other expert professional services, for which outside competent professionals should be sought. All statements and opinions contained herein are the sole opinion of the speakers and subject to change without notice. Receipt of this information constitutes your acceptance of these terms and conditions. COPYRIGHT NOTICE USE OF ACCESS CREDENTIALS 2015 by American Bankers Association. All rights reserved. Each registration entitles one registrant a single connection to the Briefing by Internet and/or telephone from one room where an unlimited number of participants can be present. Providing access credentials to another for their use, using access credentials more than once, or any simultaneous or delayed transmission, broadcast, re-transmission or re-broadcast of this event to additional sites/rooms by any means (including but not limited to the use of telephone conference services or a conference bridge, whether external or owned by the registrant) or recording is a violation of U.S. copyright law and is strictly prohibited. Please call BANKERS if you have any questions about this resource or ABA membership.

3 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET Table of Contents TABLE OF CONTENTS... II SPEAKER & ABA STAFF LISTING... III PROGRAM OUTLINE... IV-V CONTINUING EDUCATION CREDITS INFORMATION... VI CPA SIGN-IN SHEET & CERTIFICATE OF COMPLETION REQUEST... VII CFP SIGN-IN SHEET & CERTIFICATE OF COMPLETION REQUEST... VII INSTRUCTIONS FOR REQUESTING CERTIFICATE OF COMPLETION. VIII PROGRAM INFORMATION... ENCLOSED PLEASE READ ALL ENCLOSED MATERIAL PRIOR TO BRIEFING. THANK YOU. The Evaluation Survey Questionnaire is available online. Please complete and submit the questionnaire at: Thank you for your feedback. II

4 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET Speaker and ABA Staff Listing Speakers Thomas W. Abendroth Partner Schiff Hardin LLP 233 South Wacker Drive Chicago, IL (312) tabendroth@schiffhardin.com Charles Skip D. Fox, IV Partner McGuireWoods LLP Court Square Building 310 Fourth Street, NE, Suite 300 Charlottesville, VA (434) cfox@mcguirewoods.com ABA Briefing Staff Cari Hearn Senior Manager (202) chearn@aba.com Linda M. Shepard Senior Manager (202) lshepard@aba.com American Bankers Association 1120 Connecticut Avenue, NW Washington, DC III

5 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET TIMES PROGRAM OUTLINE SESSION AND SPEAKERS 12:45 1:00 p.m. ET Pre-Seminar Countdown 1:00 1:03 p.m. Welcome and Introduction 1Source International 1:03 1:25 p.m. Introduction Approaches of Different States to Decanting Skip Fox, McGuireWoods LLP 1:25 1:55 p.m. Uniform Decanting Act Judicial Review of Decanting Tom Abendroth, Schiff Hardin LLP 1:55 2:05 p.m. Questions and Answers 2:05 2:30 p.m. Potential Uses and Limitations on Decanting Skip Fox, McGuireWoods LLP 2:30 2:55 p.m. Potential Uses and Limitations on Decanting (continued) Estate and GST Consequences of Decanting Tax Planning Opportunities of Decanting Tom Abendroth, Schiff Hardin LLP 2:55 3:00 p.m. Questions and Answers Wrap-up IV

6 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET Continuing Education Credits Information The Institute of Certified Bankers (ICB) is dedicated to promoting the highest standards of performance and ethics within the financial services industry. The ABA Briefing, A Primer on Decanting has been reviewed and approved for 2.5 continuing education credits towards the CTFA (FID) designation. To claim these continuing education credits, ICB members should visit the Member Services page of the ICB Website at You will need your member ID and password to access your personal information. If you have difficulty accessing the Website and/or do not recall your member ID and password, please contact ICB at ICB@aba.com or American Bankers Association is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: CPE credit hours (Taxes) will be awarded for attending this group-live Briefing. Participants eligible to receive CPE credits must sign in and out of the group-live Briefing on the CPA Required Sign-in/Sign-out Sheet included in these handout materials. A CPA/CPE Certificate of Completion Request Form also must be completed online. See enclosed instructions. The Certified Financial Planners Board has granted 2.0 credits for this briefing. Instructions on how to receive your CFP credits are included. See enclosed instructions. Continuing Legal Education Credits This ABA Briefing is not pre-approved for continuing legal education (CLE) credits. However, it may be possible to work with your state bar to obtain these credits. Many states will approve telephone/ audio programs for CLE credits; some states require proof of attendance and some require application fees. Please contact your state bar for specific requirements and submission instructions. V

7 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET CPA Required Sign-in/Sign-out Sheet CPAs may receive up to 2.0 hours of Continuing Professional Education (CPE) credit for participating in this group-live Briefing. INSTRUCTIONS: 1. Each participating CPA must sign-in when he/she enters the room and sign-out when he/she leaves the room. 2. Name and signature must be legible for validation of attendance purposes as required by NASBA. 3. Unscheduled breaks must be noted in the space provided. 4. Each participating CPA must complete, online a CPA/CPE Certificate of Completion Request Form (instructions found on the next page.) 5. Individuals who do NOT complete both forms and submit them to ABA will not receive their Certificate of Completion. This CPE Sign In/Out Sheet must be scanned and uploaded with the CPE/CPA Request for Certificate of Completion form (instructions found the next page) and submitted in order for the CPA to receive his/her certificate of completion. FULL NAME (PLEASE PRINT LEGIBLY) SIGNATURE TIME IN TIME OUT UNSCHEDULED BREAKS American Bankers Association is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: Please note: CPE credits are ONLY awarded to those who have listened to the live broadcast of this Briefing. VI

8 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET Instructions for Receiving Certificates of Completion CPA / CPE Certificate of Completion Submission of a sign-in/sign-out sheet AND electronic request for a Certificate of Completion are required for the validation process to be completed. NASBA requires ABA to validate your attendance BEFORE you will receive your certificate of completion. 1. COMPLETE a CPA / CPE Certificate of Completion Request Form online at: 2. SCAN and UPLOAD the completed CPA / CPE Required Sign-in/Sign-out Sheet (enclosed) and include it with the Request for CPE / CPA Certificate of Compliance form found in Step SUBMIT completed Request form and Sign-in/out Sheet 4. ABA staff will VALIDATE your attendance upon receipt of the Certificate of Completion Request Form and Sign-in/out Sheet. 5. A personalized certificate of completion will be ed to you within 10 business days once your attendance is validated. 6. QUESTIONS about your certificate of completion? Contact us at briefingcertificates@aba.com General / Participant Certificate of Completion 1. REQUEST a General / Participant Certificate of Completion at: 2. A personalized certificate of attendance will be ed to you within 10 days of your request. 3. QUESTIONS about your certificate of completion? Contact us at briefingcertificates@aba.com VII

9 American Bankers Association Trust and Estate Planning Briefing Series A Primer on Decanting Thursday, September 3, :00 3:00 p.m. ET ATTENTION: NEW PROCESS FOR CFPs Certified Financial Planner Sign-In Sheet Program ID #: The Certified Financial Planners (CFP) Board has granted 2.0 credits for this program. The participant MUST MAIL the sign-in sheet AND a copy of the CFP approved Certificate of Completion (Request for Certificate of Completion instructions found below) in order to receive continuing education credits for attending this live program. Please mail both the sign-in sheet and Certificate of Completion to: Michelle M. Wynter, American Bankers Association, 1120 Connecticut Ave., NW, Ste. 600, Washington, DC Please note: CFP credits are ONLY awarded to those who have listened to the live broadcast of this Briefing. Last Name Please Print LEGIBLY First Name Middle Name SSN Last four digits only xxx-xx- CFP Registrant ID SMITH JOHN WILLIAM XXX-XX CFP Certificate of Completion Instructions 1. REQUEST a CFP Certificate of Completion via the online Certificate Request Form at: 2. A personalized certificate of completion will be ed to you within 10 days of your request. 3. MAIL CFP Sign-in Sheet AND a copy of the Certificate of Completion to the address found above 4. QUESTIONS about your CFP Certificate of Completion? Contact us at briefingcertificates@aba.com ABA offers many opportunities for you to earn CFP credits. Please complete the form found at so we can add you to promotions and keep you informed. VIII

10 8/31/2015 A Primer on Decanting 2015 Trust and Estate Planning Briefing Series American Bankers Association Briefing/Webinar Thursday, June 4, :00 3:00 p.m. ET aba.com1-800-bankers Disclaimer This briefing is being recorded with permission and is furnished for informational use only. Neither the speakers, contributors nor ABA is engaged in rendering legal nor other expert professional services, for which outside competent professionals should be sought. All statements and opinions contained herein are the sole opinion of the speakers and subject to change without notice. Receipt of this information constitutes your acceptance of these terms and conditions. aba.com1-800-bankers 2 1

11 8/31/2015 Presenters Thomas W. Abendroth, Partner, Schiff Hardin LLP Charles D. Fox IV, Partner, McGuireWoods, LLP aba.com1-800-bankers 3 Agenda Introduction Approaches of Different States to Decanting Uniform Decanting Act Judicial Review of Decanting Potential Uses and Limitations on Decanting Estate and GST Consequences of Decanting Tax Planning Opportunities of Decanting aba.com1-800-bankers 4 2

12 8/31/2015 Introduction Decanting Page 1 2 Decanting is the term generally used to describe the distribution of trust property to another trust pursuant to the trustee s discretionary authority to make distributions to or for the benefit of one or more beneficiaries of the original trust Theory Behind Decanting aba.com1-800-bankers 5 Different State Law Approaches Common Law and Statutory Evolution of Decanting Common Law Origins and Continued Relevance of Common-Law Authority Phipps v. Palm Beach Trust Co. (1940) Wiedenmayer v. Johnson (1960) Morse v. Kraft (2013) Page 2 8 aba.com1-800-bankers 6 3

13 8/31/2015 Different State Law Approaches Page 8 21 Statutory Decanting Trend Toward Enactment of Statutes In recent years numerous states have enacted a specific statute to authorize a trustee to decant Although widespread, not universal Decanting Statutes 22 states now have statutes under which a trustee, pursuant to a power to distribute trust assets outright, may appoint trust assets in favor of another trust If a trust is governed by the laws of a state without a decanting statute, the trustee could consider using a change of situs provision in the current trust to move the trust to a jurisdiction with a decanting provision. aba.com1-800-bankers 7 Uniform Decanting Act Page Uniform Decanting Act National Conference of Commissioners on Uniform State Laws (NCCUSL) has drafted a Uniform Trust Decanting Act If NCCUSL adopts and promulgates this act, it is not clear what effect, if any the promulgation will have Provisions of Uniform Act Governing Law Notice Court Approval and Direction Section 301 of the Draft Uniform Decanting Act Beneficiaries and Powers of Appointment Partially Impermissible Decanting aba.com1-800-bankers 8 4

14 8/31/2015 Judicial Review of Decanting under Decanting Statutes Courts have had limited opportunity to review a decanting under a state statute Matter of Johnson (2015) In the Matter of Kroll (2013) Ferri v. Powell-Ferri (2013) These few cases highlight the importance of a trustee complying with the strict terms of the decanting statute. Page aba.com1-800-bankers 9 Questions and Answers If you are participating on the Web: Enter your Question in the Box Below and Press ENTER / SUBMIT. If you are participating by Phone: your Question to: aba@1source-intl.net OR Press *1 on your Telephone Keypad aba.com1-800-bankers 10 5

15 8/31/2015 Potential Uses and Limitations of Decanting Page Decanting is a useful tool in modifying the terms of a trust, particularly in order to respond to changed circumstances to update the terms of a trust over time, or to provide for a more efficient or tailored administration of the trust Correct Drafting Errors and Ambiguities Improve Trust Management of Administration or Update or Modernize Trust Provisions aba.com1-800-bankers 11 Potential Uses and Limitations of Decanting Address Changed Circumstances of the Trust or Beneficiaries Change Trust Situs Combine or Divide Trusts Fiduciary Risk Page aba.com1-800-bankers 12 6

16 8/31/2015 Estate and GST Consequences Before decanting, trustees must keep in mind the potential tax implications of decanting Page Gift Tax Estate Tax Generation-Skipping Transfer Tax aba.com1-800-bankers 13 Tax Planning Opportunities Tax Opportunities Examples of the particular tax planning opportunities Decant to allow distributions for other purposes, such as to carry out capital gains Decant to provide for step-up in basis Decant to change situs for state income tax purposes Page aba.com1-800-bankers 14 7

17 8/31/2015 Conclusion Page 51 Decanting provides a helpful tool for modifying an irrevocable trust. Decanting has certain advantages over other methods of modification, particularly because of lack of beneficiary consent or judicial participation. These same advantages also should give a trustee pause over whether the trustee is full protected, particularly in the absence of case law addressing these issues in detail. Fiduciaries, beneficiaries, and advisors should be aware of the potential benefits of decanting, and its limitations and potential pitfalls. If viewed in the proper context, decanting can be an important tool of the fiduciary, beneficiary, settlor, and advisor in providing for the efficient administration of a trust, and one which can respond to change over time. aba.com1-800-bankers 15 Questions and Answers If you are participating on the Web: Enter your Question in the Box Below and Press ENTER / SUBMIT. If you are participating by Phone: your Question to: aba@1source-intl.net OR Press *1 on your Telephone Keypad aba.com1-800-bankers 16 8

18 8/31/ ABA Trust and Estate Planning Series Briefing Date October 1 November 5 December 3 Recordings Available Briefing Topic Choose Your Weapon: The Advantages & Disadvantages of Corporations The Alphabet Soup of Planning and Trust Acronyms and Service Marks Recent Developments in Estate and Trust Administrations Hot Button Tax Issues for the IRS Ethical Challenges for Trust Professionals Show Me the Money: The Focus of States on Tax Revenues and its Impact on Estate Planning Fiduciary Litigation Roundtable Critical Concepts in Understanding Community Property vs. Common Law A Primer on Decanting aba.com1-800-bankers 17 Sneak Preview 2016 Trust Series Briefing Date Feb 4, 2016 Mar 3, 2016 Apr 7, 2016 May 5, 2016 Jun 2, 2016 Sep 8, 2016 Oct 6, 2016 Nov 3, 2016 Dec 1, 2016 Briefing Topic The New Paradigm in Trusts and Estate Valuation Uniform Fiduciary Access to Digital Assets Act (UFADAA) and Digital Assets Life Insurance in a 21 st Century Estate Plan Fiduciary Litigation Roundtable Charitable Tales from the Crypt Issues with Art and Other Collectibles in the Administration of Trusts and Estates Are You a Fiduciary? Twenty Steps to Avoid Fiduciary Litigation Recent Developments in Estate and Trust Administration Mark Your Calendar and Plan to Attend! Registration Information Available Soon at aba.com1-800-bankers 18 9

19 American Bankers Association Briefing A Primer on Decanting September 3, :00 p.m. to 3:00 p.m. E.T. Charles D. Fox IV McGuireWoods LLP Court Square Building 310 Fourth Street, NE, Suite 300 Charlottesville, Virginia (434) cfox@mcguirewoods.com Thomas W. Abendroth Schiff Hardin LLP 233 S. Wacker Drive, Suite 6600 Chicago, Illinois (312) tabendroth@schiffhardin.com Copyright 2015 by Schiff Hardin LLP and McGuireWoods LLP All rights reserved

20 CHARLES D. ( SKIP ) FOX IV is a partner in the Charlottesville, Virginia office of the law firm of McGuireWoods LLP and head of its Private Wealth Services Industry Group. Prior to joining McGuireWoods in 2005, Skip practiced for twenty-five years with Schiff Hardin LLP in Chicago. Skip concentrates his practice in estate planning, estate administration, trust law, charitable organizations, and family business succession. He teaches at the American Bankers Association National Trust School and National Graduate Trust School where he has been on the faculty for over twenty-five years. Skip was an Adjunct Professor at Northwestern University School of Law, where he taught from 1983 to 2005, and is currently an Adjunct at the University of Virginia School of Law. He is a frequent lecturer across the country at seminars on trust and estate topics. In addition, he is a co-presenter of the long-running monthly teleconference series on tax and fiduciary law issues sponsored by the American Bankers Association. Skip has contributed articles to numerous publications and is a regular columnist for the ABA Trust Letter on tax matters. He was a member of the editorial board of Trusts & Estates for several years and was Chair of the Editorial Board of Trust & Investments from 2003 until Skip is a member of the CCH Estate Planning Advisory Board. He is co-editor of Making Sense of the 2010 Estate Tax Legislation (CCH 2011) and Estate Planning Strategies after Estate Tax Repeal: Insight and Analysis (CCH 2001). He is also the author of the Estate Planning With Life Insurance volume of the CCH Financial Planning Library, and a co-author of four books, Estate Planning Manual (3 volumes, 2002), Tax Law Guide, Glossary of Fiduciary Terms, and Fiduciary Law and Trust Activities Guides, published by the American Bankers Association. Skip is a Fellow of the American College of Trust and Estate Counsel (for which he is Treasurer) and is listed in Best Lawyers in America. In 2008, Skip was elected to the NAEPC Estate Planning Hall of Fame. He is also Chair Emeritus of the Duke University Estate Planning Council and a member of the Princeton University Planned Giving Advisory Council. Skip has provided advice and counsel to major charitable organizations and serves or has served on the boards of several charities, including Episcopal High School (from which he received its Distinguished Service Award in 2001) and the University of Virginia Law School Foundation. He received his A.B. from Princeton, his M.A. from Yale, and his J.D. from the University of Virginia. Skip is married to Beth, a retired trust officer, and has two sons, Quent and Elm.

21 THOMAS W. ABENDROTH is a partner in the Chicago law firm of Schiff Hardin LLP and practice group leader of the firm s Private Clients, Trusts and Estates Group. He concentrates his practice in the fields of estate planning, federal taxation, and business succession planning. Tom is a 1984 graduate of Northwestern University School of Law, and received his undergraduate degree from Ripon College, where he currently serves on the Board of Trustees. He has co-authored a two-volume treatise entitled Illinois Estate Planning, Will Drafting and Estate Administration, and a chapter on sophisticated value-shifting techniques in the book, Estate and Personal Financial Planning. He is co-editor of Estate Planning Strategies After Estate Tax Reform: Insights and Analysis (CCH 2001). Tom has contributed numerous articles to industry publications, and served on the Editorial Advisory Board for ABA Trusts & Investments Magazine. He is a member of Duke University Estate Planning Council. Tom is a frequent speaker on tax and estate planning topics at banks and professional organizations. In addition, he is a co-presenter of a monthly teleconference series on estate planning issues presented by the American Bankers Association. Tom has taught at the American Bankers Association National Graduate Trust School since He is a Fellow of the American College of Trust and Estate Counsel. ii

22 TABLE OF CONTENTS Page INTRODUCTION... 1 DIFFERENT STATE LAW APPROACHES TO DECANTING... 2 POTENTIAL USES AND LIMITATIONS OF DECANTING ESTATE, GIFT AND GST TAX CONSEQUENCES OF DECANTING TAX PLANNING OPPORTUNITIES INVOLVING DECANTING CONCLUSION iii

23 A PRIMER ON DECANTING INTRODUCTION I. Decanting A. By analogy to the pouring of wine from one container to another in order to remove sediment or other impurities, decanting is the term generally used to describe the distribution of trust property to another trust pursuant to the trustee s discretionary authority to make distributions to or for the benefit of one or more beneficiaries of the original trust. B. A trustee with decanting power has the ability to amend an unamendable trust, in the sense that the trustee may distribute the trust property to a second trust with terms that differ from those of the original trust. Similarly to the process of decanting wine, decanting a trust enables a trustee to remove any old, unwanted provisions, while breathing new life into the trust s purpose. C. To date, 22 states 1 have enacted decanting statutes that allow a trustee, without court approval, to appoint trust assets in favor of another trust with new or modified terms that may better address changes in the tax law. D. Decanting provides the trustee of an irrevocable trust with flexibility to update old or outdated trust provisions, to incorporate new issues or provisions to address developments in the law, and to address changed circumstances regarding the trust and beneficiaries. E. However, trustees must be mindful of the limitations and pitfalls of decanting, in order to properly discharge their duties while minimizing conflict with beneficiaries and adverse tax consequences. II. Theory Behind Decanting A. Trusts that are potential candidates for trust decanting are irrevocable, either because they were initially irrevocable, or because they have become irrevocable 1 Alaska, Arizona, Delaware, Florida, Illinois, Indiana, Kentucky, Michigan, Missouri, Nevada, New Hampshire, New York, North Carolina, Ohio, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Virginia, Wisconsin, and Wyoming have enacted decanting statutes. See M. Patricia Culler, List of States with Decanting Statutes Passed or Proposed (updated March 25, 2014), available on the ACTEC website; see also Steve Oshins, 2nd Annual Trust Decanting State Rankings Chart (Updated) (January 2015), available at

24 upon the death of the settlor. 2 The rationale behind decanting is that if a trustee has the discretionary power to make an outright distribution to or for the benefit of one or more beneficiaries, then the trustee has, in effect, a special power of appointment that enables the trustee to distribute assets to a second trust for the benefit of one or more of such beneficiaries. 3 B. The result is the ability to modify the terms of an otherwise irrevocable trust without the judicial process and proof otherwise necessary for traditional options such as equitable division, modification, or reformation. C. As discussed below, the common law and state statutes have refined and developed this concept, to produce a complex common-law and statutory scheme. DIFFERENT STATE LAW APPROACHES TO DECANTING I. Common Law and Statutory Evolution of Decanting A. Common Law Origins and Continued Relevance of Common-Law Authority 1. As noted above, the power to decant is now granted to trustees by statute in 22 states. However, decanting originated under the common law, based on a trustee s discretionary power to distribute income or principal These common-law cases remain important. a. While 22 states have enacted decanting statutes, 28 states and the District of Columbia do not grant a trustee the power to decant by statute. A trustee in one of those states could only decant based on the trustee s common-law authority (or, if possible, by first changing the governing law of the trust to a state whose statute does allow decanting). b. In addition, even if a trustee is acting under the laws of a state which has enacted a decanting statute, the trustee might also need to know whether he or she had the authority to decant when the trust was initially created. 2 See Thomas E. Simmons, Decanting and Its Alternatives: Remodeling and Revamping Irrevocable Trusts, 55 S.D. L. Rev. 253, 254 (2010) ( [D]ecanting has also been called the ultimate in trust amendment powers for otherwise irrevocable trusts. ). 3 See, e.g., Phipps v. Palm Beach Trust Co., 142 Fla. 782, 196 So. 299 (1940). 4 See Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940); Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969); Morse v. Kraft, 992 N.E.2d 1021 (Mass. 2013); see also In re Estate of Spencer, 232 N.W. 2d 491 (Iowa 1975). 2

25 c. For example, a trustee seeking to decant a trust that is exempt from GST tax must act carefully to ensure that the decanting does not jeopardize the trust s GST-exempt status. As discussed in more detail below, one of the two safe harbors granted by the Treasury Regulations for decanting a GST-exempt trust requires that the trustee have the authority to decant under applicable law at the time that the trust first became irrevocable. 5 Because many trusts were established long before the development of state decanting statutes, the trustee s common-law authority to decant remains important in this inquiry. d. Finally, the courts reasoning in these cases remains relevant in reviewing a trustee s exercise of decanting power under a statute. These cases remain some of the only cases in which courts have reviewed a trustee s exercise of its discretionary power to decant, to determine whether the trustee s exercise was consistent with the trustee s fiduciary duties. Thus, these few cases may serve as the only guideposts for a trustee seeking to determine how a court might review his or her exercise of the decanting power. 6 e. Accordingly, these common-law origins of decanting remain important, and not only for historical reasons. 3. Phipps v. Palm Beach Trust Co. (1940) 7 a. In Phipps v. Palm Beach Trust Co., the Supreme Court of Florida was the first American court to consider whether a trustee authorized to distribute trust property to trust beneficiaries could, in his sole discretion, create a second trust for the benefit of the beneficiaries funded with property distributed from the original trust. 8 b. Under the facts in Phipps, Margarita Phipps created a trust in 1932 for the benefit of her children, John, Hubert, Margaret, and Michael. John was the primary beneficiary of the trust. The initial trustees were Palm Beach Trust Company as corporate trustee and Margarita s husband as individual trustee. The trust instrument authorized the trustee to pay over the remaining principal and income of the trust to the children and their descendants in such shares and proportions as the said Individual Trustee, in his or her sole and absolute discretion, shall determine and fix even to the 5 See Treas. Reg (b)(4)(i)(A). 6 See, e.g., Morse v. Kraft, 992 N.E.2d 1021 (Mass. 2013); Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969). 7 Phipps, 196 So. at Id. 3

26 extent of directing the payment of the entire trust estate to one of said parties. 9 c. The individual trustee sought to pay over the remaining assets to a second trust. This second trust would have Margarita s children and descendants as beneficiaries, but it would also grant John a testamentary power of appointment, to allow him to appoint an income interest to his wife. The corporate trustee was unsure of whether this action would be consistent with its duties under the trust, and it asked the court to review the proposed action. 10 d. Reviewing prior case law, the court determined generally that the power vested in a trustee to create an estate in fee includes the power to create or appoint any estate less than a fee unless the donor clearly indicates a contrary intent. The court concluded that here, the trustees had the absolute power to pay over the trust estate to the beneficiaries, and unlimited discretion as to the manner and terms of that payment. e. The court concluded that because the trustees had this power and discretion, the trustees had the power to create this second trust. But the court noted that in this case, the beneficiaries of the second trust were also beneficiaries of the first trust. The court concluded that there was no doubt that the trustees could create this second trust, provided one or more of the descendants of the donor of the original trust are made the beneficiaries. The court further reasoned, If the second trust had gone outside the descendants of the donor of the first trust to find a beneficiary, there might be substance to this [challenge to the decanting], but so long as they are limited to this class, the power of the donee is absolute. 11 f. The reasoning of the Phipps case represents three key concepts in decanting that remain true today. (1) Typically, a trustee s power to decant under the common law is based on the breadth of discretion granted to the trustee under the trust instrument and applicable law. In this case, the trust instrument gave the individual trustee sole and absolute discretion to pay over the assets, and the court concluded that the trustee s power to appoint the assets was absolute and unlimited. 9 Id. at Id. 11 Id. 4

27 (2) Many decanting statutes prohibit a trustee from adding beneficiaries to the second trust. (3) Many decanting statutes allow a trustee to grant beneficiaries a power of appointment, and allow the beneficiaries to appoint the assets to individuals who are not beneficiaries of the first trust. 4. Wiedenmayer v. Johnson (1969) 12 a. Wiedenmayer represents another development in the common-law power to decant. b. Under the facts in Wiedenmayer, John Seward Johnson (a son of Robert Wood Johnson, a co-founder of Johnson & Johnson, Inc.) established six substantially similar trusts in 1944 for each of his six children. At issue in this case was the trust established for John Seward Johnson, Jr. ( Seward ). The trust was funded with common stock in Johnson & Johnson, which was valued at $18,000,000 by the time of the litigation at issue. 13 c. Under the terms of the trust, the trustees were to pay to Seward so much of the net income in any year as the trustees in their absolute and uncontrolled discretion may deem to be for his best interests, and principal whenever in their absolute and uncontrolled discretion they deem it to be for his best interests, any or all of the [principal]. 14 d. The trustees proposed to transfer the trust assets to a second trust that would remove two of the current beneficiary s children as default remainder beneficiaries, and which would grant him a power to appoint those assets to other descendants. 15 e. The court approved the transfer. The court noted that the trustees were only required to make distributions for Seward s best interests, and that this term was not defined in the trust document. The court concluded that the term best interests was not limited to the son s pecuniary interests, and that such might be served without regard to his personal financial gain. f. The court concluded that the beneficiary s best interests may be served by the peace of mind, already much disturbed by matrimonial problems, divorce and the consequences thereof, 12 Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969). 13 Id. at Id. 15 Id. at 536; id. at 537 & n.1 (Conrad, J., dissenting in part). 5

28 which the new trust would support. The court reasoned, Of what avail is it to rest one s best interests on a purely financial basis, and without regard to the effect upon a man s mind, heart and soul, if the end result would produce a wealthier man, but a sufferer from mental anguish? That is, the court concluded that the trustees had reasonably determined that Seward s peace of mind would be disturbed if those two children were eligible remainder beneficiaries, so the trustees acted within their discretion in removing them. 16 g. The dissent argued that the trustees had not acted in good faith in exercising their power to distribute the assets. The dissent argued, I do not believe that what the trustees propose to do constitutes a distribution at all, within the fair intent of the trust instrument, but rather an impermissible alteration of the substantive trust terms. 17 h. Two holdings of the court in Wiedenmayer remain particularly important in decanting law. (1) First, the trustees permissibly removed remainder beneficiaries from the first trust. (2) Second, the court provided that a trustee s consideration of the best interests of a beneficiary could include factors beyond the beneficiary s pure financial gain. 5. Morse v. Kraft (2013) 18 a. Under the facts in Morse, four separate subtrusts were created in 1982 for the four sons of Robert and Myra Kraft. Under each subtrust, a particular son is the current beneficiary, and at that son s death, he may appoint the trust assets among the descendants of Robert and Myra. In default of exercise of the power of appointment, at the son s death the remaining trust assets pass to the son s descendants. The 1982 trust permits only Disinterested Trustees, in that the trust prohibits the grantors and any current beneficiary from serving as trustee. That is, a given son could not serve as trustee of his own subtrust. Robert Morse was named as sole initial trustee of the subtrusts, and he was still serving as trustee of the subtrusts at the time of the action Id. at Id. at 537 (Conrad, J., dissenting in part). 18 Morse v. Kraft, 992 N.E.2d 1021 (Mass. 2013). 19 Id. at

29 20 Id. at Id. at Id. at Id. at 1023 n.6. b. The trust instrument provided that the trustees shall pay to [the son] from time to time such portion or portions of the net income and principal thereof as the Disinterested Trustee shall deem desirable for the benefit of [the son]. The trust instrument also gave the trustee the power to pay assets to or for the benefit of a beneficiary, and it also gave the trustee discretion to take actions without order or license of court. 20 c. By the time of the action, however, Robert Morse was 81, and he was contemplating retirement. He proposed to transfer the assets of each subtrust to a new trust. The new trust would apparently contain the same dispositive provisions as the 1982 subtrust. However, under the new trusts, the son could serve as trustee. Robert Morse petitioned the court to approve of the proposed transfer; he argued that the new trust would be in the best interests of the beneficiaries from a management perspective, because it would allow the son to serve as trustee of his own trust, but he was sought court approval because he concluded that the transfer would only be in the best interests of the beneficiaries from a financial perspective if the transfer was proper under state law, which was required for the transfer to not jeopardize the subtrusts exemption from GST tax. 21 d. The court concluded that the trustee s proposed transfer was proper under state law. The court reasoned that the trust instrument gave the trustee power to make distributions for the benefit of the beneficiaries, and the trust instrument contemplated that the trustee could do so without court order. 22 The court therefore concluded that the trustee could properly distribute those assets to this second trust, without court order or beneficiary consent. e. Unlike in Wiedenmayer, the court in Morse did not review whether the decanting would serve the beneficiaries best interests or was consistent with the trustee s fiduciary duties. The court reasoned, We pass no judgment on whether transfer of assets to the new subtrusts is, in fact, in the beneficiaries best interests or in keeping with the plaintiff s fiduciary duties. We only consider the question whether the 1982 Trust authorizes such a transfer. 23 But the court did note that while the trusts in Phipps and Wiedenmayer had given the trustees absolute discretion, and while the instant trust did not, the inclusion of this adjective did not mean that those trustees were granted substantively greater discretion. The court 7

30 concluded that the key was that the trustee in Morse was granted broad discretion to make distributions for the benefit of the beneficiaries, which included the power to transfer the assets to the second trust. 24 II. Statutory Decanting A. Trend Toward Enactment of Statutes. 1. While there is limited authority on the ability of a trustee to decant a trust under common-law authority, in recent years numerous states have enacted a specific statute to authorize a trustee to decant. 2. New York enacted the first decanting statute in 1992 allowing a trustee to appoint trust property in favor of another trust Since then, 21 other states have enacted decanting statutes. The trend toward enacting decanting statutes, although widespread, is not universal. Not every state that has considered allowing trust decanting has enacted a statute. Colorado considered a decanting statute, but enactment has been stalled due to concerns over potential abuses of power, especially in divorce situations. 26 B. Decanting Statutes Twenty-two states now have statutes under which a trustee, pursuant to a power to distribute trust assets outright, may appoint trust assets in favor of another trust. These states are the following: a. Alaska 28 b. Arizona 29 c. Delaware Id. at 1026 n See N.Y. Est. Powers & Trusts (b). 26 See Colo. Bar Ass n Trust & Estate Section Statutory Revisions Comm., Minutes (Oct. 15, 2009), available at Inside Bar/TrustEstate/SRC/SRC%20October%20Minutes.pdf; Richard I. Zuber, Greetings from the Chair, Fam. L. Newsl. (Colo. Bar Ass'n, Denver, Colo.), May 2011, available at 27 For more detail, see Alan S. Haleperin. You May Not Need to Whine About Problems with Your Irrevocable Trust: State Law and Tax Considerations in Trust Decanting, 42d University of Miami Heckerling Institute on Estate Planning (2008), pp et seq. 28 Alaska Stat Ariz. Rev. Stat

31 d. Florida 31 e. Illinois 32 f. Indiana 33 g. Kentucky 34 h. Michigan 35 i. Missouri 36 j. Nevada 37 k. New Hampshire 38 l. New York 39 m. North Carolina 40 n. Ohio 41 o. Rhode Island 42 p. South Carolina 43 q. South Dakota 44 r. Tennessee 45 s. Texas Del. Code tit Fla. Stat ILCS 5/ Ind. Code KRS MCL a. 36 Mo. Rev. Stat Nev. Stat N.H. Rev. Stat. 564-B: N.Y. EPTL (b). 40 N.C. Gen. Stat. 36C Ohio Rev. Code Ann R.I. Gen. Laws S. Car. Stat A. 44 S.D. Codified Laws to Tenn. Code (b)(27). 9

32 t. Virginia 47 u. Wisconsin 48 v. Wyoming Below is a summary of selected provisions of the decanting statutes of those 22 states. 3. Alaska 50 a. The original Alaska statute was similar to the New York statute. The Alaska statute was amended in 2006 to make it less restrictive than the New York statute. b. Unlike New York, as long the invasion standard is the same in the new trust as the original trust, the trustee only needs the authority to invade principal in order to decant. c. No court approval is required under the Alaska statute, nor is notice or consent of the beneficiaries required. 4. Arizona 51 a. Arizona permits a trustee, if the trustee has the power to make distributions, to transfer part or all of the trust to a new trust. The trustee may do so whether subject to a standard or not. No court approval is needed. b. The following limitations are placed on transfers to a new trust: (1) The new trust must not reduce any fixed nondiscretionary income payment to a beneficiary. (2) The new trust may not alter any nondiscretionary annuity or unitrust payment. (3) The new trust must be in favor of the beneficiaries of the current trust. 46 Texas Property Code Va. Code Wis. Trust Code W.S (a)(xxviii). 50 Alaska Stat Ariz. Rev. Stat

33 (4) If the trustee exercising the decanting power as a possible beneficiary, the exercise must result in an ascertainable standard for distributions, being the same or more restrictive for distributions than from the recipient trust. (5) The decanting may not adversely affect the tax treatment of the trust, the trustee, the settlor or the beneficiaries. (6) The second trust may not violate any rule against perpetuities. c. Arizona specifically provides for the decanting statute to apply to a trust when the governing jurisdiction of that trust is transferred to Arizona. d. The exercise of power to invade the principal of the trust is considered the exercise or the special power of appointment to avoid adverse tax treatment. 5. Delaware 52 a. Like the current law in Alaska, a trustee of a Delaware trust needs only the authority to invade trust principal. There is no requirement of absolute discretion. b. In 2015, Delaware revised its decanting statute in certain respects. 53 In particular, the statute now allows a trustee to decant income to the same extent that it could have previously decanted principal, so that the trustee may now decant income of a trust without first accumulating that income to principal. c. The Delaware statute differs from the Alaska statute in that the invasion standard of the new trust need not be the same as original trust. d. Exercise of the decanting power in Delaware does not require court approval or notice of consent of the beneficiaries. 6. Florida 54 a. Like New York, the trustee must have the absolute power to invade trust principal. The Florida statute states that a power to invade for best interests, welfare, or happiness shall be an absolute power. 52 Del. Code tit See Del. S.B. 42 (effective August 1, 2015). 54 Fla. Stat

34 This would preclude a trustee from decanting in Florida if the power to invade principal is limited to an ascertainable standard. b. Beneficiaries of the new trust must come from beneficiaries of the original trust. c. The Florida statute explicitly states that a spendthrift clause or clause preventing amendment or revocation of the original trust will not prevent a trustee from exercising the power to decant. d. The Florida statute does not require court approval. It does require prior notice of at least sixty days to all qualified beneficiaries. If all qualified beneficiaries waive the notice, the trustee can exercise the decanting power immediately. 7. Illinois 55 a. The Illinois statute applies to any trust administered under, or governed by, Illinois law, unless the decanting power is expressly prohibited by the governing instrument of the trust. b. The Illinois statute distinguishes between a trust in which the trustee has the absolute discretion to distribute trust principal (which includes distributions for a beneficiary s best interests, welfare, or happiness) and a trust in which the trustee does not have such absolute discretion. c. When a trustee has absolute discretion to distribute trust principal, the terms of the second trust may benefit one, more than one, or all the beneficiaries of the first trust. The trustee may also grant the second trust s beneficiaries powers of appointment over the second trust, and the beneficiaries of the exercise of such power may be broader than and different from the beneficiaries of the first trust. d. If a trustee does not have absolute discretion to distribute a trust principal, then the current and successor beneficiaries of the second trust must be the same as the beneficiaries of the first trust. The distribution standards and a beneficiary s power of appointment over the first trust must remain the same in the second trust. e. A trustee can exercise the decanting power without the consent of the settlor or beneficiaries and without court approval, so long as the trustee provides notice of the trustee s intention to decant the first trust to a second trust to all the current and presumptive ILCS 5/

35 remainder beneficiaries and no such beneficiary objects within sixty days. f. The second trust may not in any way disqualify a trust from the marital or charitable deductions 8. Indiana 56 a. To decant, the trustee must have the absolute power under the terms of the trust to invade the principal of the trust. b. The beneficiaries of the new trust must be the same as the beneficiaries of the first trust. c. The new trust may not reduce any income, annuity, or unitrust interest in the assets of the first trust. d. The second trust may not in any way disqualify a trust from the marital or charitable deduction. e. No court approval is required. The trustee must notify the qualified beneficiaries of the existing trust 60 days before the effective date of the trustee s exercise of the decanting power. Qualified beneficiaries may waive the notice in writing. This permits the trustee s decanting power to be exercised immediately. f. The Indiana statute states specifically that decanting is not prohibited by either a spendthrift clause or a provision that prohibits amending or revoking the original trust. 9. Kentucky 57 a. Trustees who have the discretionary power to distribute principal or income are given the power to appoint all or part of the principal of income to the trustee of another trust, including a trust created by the trustee of the first trust. b. The beneficiaries of the second trust may only include beneficiaries of the original trust. c. The terms of the second trust cannot reduce any fixed interest of the beneficiary in the original trust. d. The second trust may confer upon a beneficiary of the original trust a power of appointment and include the ability to exercise the 56 Ind. Code KRS

36 power to appointees who are not beneficiaries of the original or second trust. e. Sixty days notice must be given to the beneficiaries of the original trust. 10. Michigan 58 a. In order to have the power to decant, the trustee must have the discretion to distribute income and principal. If so, the trustee may decant provided that the terms of the new trust do not materially change the beneficial interests of the beneficiaries of the first trust. b. Decanting under the Michigan statute may not be done in a way to disqualify a trust for a tax benefit. 11. Missouri 59 a. Missouri, like many other state decanting statutes, permits decanting simply if the trustee has discretion to make distributions of income or principal to one or more beneficiaries. There is no requirement of a non-ascertainable standard. b. The new trust may only have as beneficiaries one or more beneficiaries of the existing trust. c. Trustees who are also beneficiaries are limited in how they can exercise the decanting powers that benefit themselves. d. Protection is provided for annual exclusion gifts, the marital deduction, charitable remainder trusts, grantor retained annuity trusts, and subchapter S trusts. e. A spendthrift clause or provision prohibiting amendment or revocation of the trust does not preclude the trustee from exercising the decanting power. f. The trustee must give 60 days notice to the permissible distributes. The 60 day notice requirement may be waived. g. Like many other states, Missouri does not impose a duty on the trustee to exercise the authority. 58 MCL a. 59 Mo. Rev. Stat

37 12. Nevada 60 a. Nevada amended its decanting statute in 2015, to clarify certain provisions and to give the trustee additional flexibility in decanting. 61 b. As revised, the statute provides the following: (1) The decanting may remove a mandatory income interest of a beneficiary, so long as the income interest did not qualify for a marital, charitable, or other tax benefit. (2) The second trust may accelerate future or remainder beneficiaries to be current beneficiaries. However, as with all other decanting statutes, the second trust may not add a beneficiary who was not a beneficiary of the first trust. (3) The statute applies to any trust that is sitused in, administered in, or governed by the laws of Nevada, whether the trust was first established there or was moved to Nevada. c. The Nevada statute specifically provides for granting a special or general power of appointment to one or more beneficiaries. 13. New Hampshire 62 a. New Hampshire, like many of the decanting states, permits decanting simply if the trustee has the discretion to make distributions to one or more beneficiaries. There is no requirement of a non-ascertainable standard. New Hampshire s decanting statute is similar to Delaware s. b. Thirty days notice must be given to charities that are beneficiaries of the first trust. 14. New York 63 New York was the first state to enact a decanting stature when it did so in New York amended its law effective August 17, 2011, to broaden its scope. a. Requirements 60 Nev. Stat Nev. SB484 (2015). 62 N.H. Rev. Stat. 564-B: N.Y. EPTL (b). 15

38 (1) The trustee does not have to have unfettered discretion to invade trust principal. Instead, a trustee with any authority to invade the principal of a trust may decant to a new trust as long as the new trust retains the same standard of distribution as the existing trust. 64 (2) Any fixed income right of a beneficiary cannot be reduced or eliminated. (3) The power can only be exercised in favor of proper objects of the trust. Note that the statute does not define proper objects. (4) The new trust may not contain any provisions that violate public policy. (5) The trustee s exercise of the power may not violate the rule against perpetuities. The perpetuities period is measured by reference to the original trust. b. Exercise of Decanting Power. (1) The exercise must be in writing which is signed and acknowledged by the trustee. (2) The trustee must serve the written exercise on all persons with an interest in the trust. c. There is no duty imposed on the trustee to exercise the power. d. The power can be exercised even if there is a spendthrift clause or a provision prohibiting amendment or revocation. 15. North Carolina 65 a. North Carolina revised its decanting statute in (1) Effective October 1, 2015, North Carolina s decanting statute will allow decanting to a trust that is a qualified special needs trust or supplemental needs trust if a beneficiary is disabled. 64 For more discussion, see Pamela Ehrenkranz, Michael I. Frankel and Lindsay N. O Donnell, New York Enacts Important New Law Governing a Trustee s Power to Pay Trust Assets to a New Trust, NYSBA JOURNAL (November/December 2011). 65 N.C. Gen. Stat. 36C

39 16. Ohio 67 (2) The revised statute also allows the trustee to decant to a second trust that has certain different tax characteristics, including changing whether the trust is a grantor trust for income tax purposes. 66 b. Like the current law in Alaska, the trustee of a North Carolina trust needs only the authority to invade trust principal. c. If the distribution standard of the old trust is ascertainable, the invasion standard of a new trust must be ascertainable. d. Exercising of the decanting power in North Carolina does not require prior court approval. e. The trustee must give 60 days written notice to all beneficiaries of the trust. The beneficiaries may waive the notice. a. If a trustee has an absolute power to make distributions, the trustee may exercise that power to decant to a new trust. If the trustee s powers are limited, the trustee may exercise that power only if the governing instrument of the second trust does not materially change the interest of the beneficiaries of the first trust. b. Like the other decanting statutes, the Ohio statute contains provisions to save the marital and charitable deductions and preserve favorable estate and gift tax treatment for trusts, including protecting the ability of a trust to be a qualified shareholder in an S corporation. c. The trustee must notify the beneficiaries of the first trust in writing 30 days prior to the distribution. The distribution may be made prior to the expiration of 30 days if all current beneficiaries waive the notice. Like other statutes, no duty of acting is created for the trustee. 17. Rhode Island 68 a. The law was enacted in Rhode Island on June 23, N.C. Senate Bill 336 (2015); see Andrea C. Chomakos and E. Graham McGoogan Jr., North Carolina Changes Trust Code and Permits Living Probate, McGuireWoods LLP Fiduciary Advisory Services Alerts, available at Resources/Alerts/2015/8/North-Carolina-Changes-Trust-Code-Permits-Living-Probate.aspx. 67 Ohio Rev. Code Ann R.I. Gen. Laws

40 b. The trustees must have the absolute power to invade the principal of a trust to appoint all or part of the principal to a second trust. Absolute power includes the power to invade principal that is not limited to a specific or ascertainable purpose such as health, education, maintenance or support. c. The beneficiaries of the second trust may only include beneficiaries of the first trust. d. The second trust cannot reduce any fixed income, annuity, or unitrust interest in the assets of the first trust. e. The current beneficiaries of the first trust must be given sixty days notice. 18. South Carolina 69 a. The South Carolina statute became effective on January 1, b. A trustee who has discretionary distribution authority over principal or income may decant. However, a trustee who is a beneficiary of the original trust may not decant. c. The new and old trusts require the same distribution standard if the old trust is subject to an ascertainable standard. d. There are certain tax saving provisions but not specific provision with respect to the marital deduction or charitable deduction. There is an implicit savings provision with respect to the rule against perpetuities. e. Ninety days notice to interested parties is required prior to decanting. 19. South Dakota 70 a. South Dakota states the trustee must have the power to invade the principal or distribute the income of the trust. Until Delaware revised its decanting statute in 2015, it was the only state to mention the power to distribute income. b. Limits are placed on the ability of trustees who are beneficiaries or who may be removed by beneficiaries to increase distributions in the new trust to the trustee or the beneficiaries with the removal power. 69 S. Car. Stat A. 70 S.D. Codified Laws to

41 20. Tennessee 71 a. The Tennessee statute is almost identical to the pre-2015 Delaware statute. b. Like the current law in Alaska, a trustee of a Tennessee trust needs only the authority to invade trust principal. There is no requirement of absolute discretion. c. The Tennessee statute differs from the Alaska statute in that the invasion standard of the new trust need not be the same as original trust. d. Exercise of the decanting power in Tennessee does not require court approval or notice of consent of the beneficiaries. 21. Texas 72 a. The Texas statute permits a trustee to exercise a discretionary distribution power by appointing the trust principal to the trustee of a second trust. The trustee may do so either with full discretion or a limited discretion to distribute principal. b. The Texas statute took effect on September 1, c. The Texas statute does not permit the elimination of the beneficiary s mandatory distribution rights with respect to income, an annuity, or a unitrust. d. The new and old trust beneficiaries must be identical if the trustee does not have unlimited discretion. e. There are the standard provisions to preserve the marital deduction and the charitable deduction. 22. Virginia 73 a. The Virginia statute permits a trustee to exercise a discretionary distribution power by appointing the trust principal to the trustee of a second trust. b. Unless expressly prohibited by the terms of the trust governing instrument, it is available to any trust administered under Virginia law. 71 Tenn. Code (b)(27). 72 Texas Property Code Va. Code

42 c. The Virginia statute limits the trustee s decanting power by requiring the beneficiaries of the second trust to include only beneficiaries of the original trust, prohibiting the addition of beneficiaries. d. Where the trustee s power to distribute income or principal is subject to an ascertainable standard, then distributions from the second trust must be limited by the same ascertainable standard, and such distribution power must be exercisable in favor of the same current beneficiaries. e. Second trust may not accelerate the interests of beneficiary as only future interests in the original trust. f. Virginia s decanting statute also includes several tax savings provisions addressing the application of the rule against perpetuities and preserving the marital and charitable deduction. 23. Wisconsin 74 a. The Wisconsin statute permits a trustee to decant if the discretionary distribution power is either unlimited or limited. b. The Wisconsin legislation became effective on July 1, c. Similar to other statutes, the new trust may not eliminate any mandatory distribution rights with respect to income, annuity, or unitrust payments. d. The new and old trust beneficiaries must be identical if the trustee only has limited discretion to appoint principal. e. Wisconsin s decanting statute also includes several tax saving provisions addressing the application of the rule against perpetuities and preserving the marital and charitable deductions. 24. Wyoming 75 a. The Wyoming statute permits a trustee to exercise the discretionary distribution power by appointing the trust principal to the trustee of a second trust. There does not appear to be a distinction between an unlimited or a limited power to make discretionary distributions. 74 Wis. Trust Code W.S (a)(xxviii). 20

43 b. The Wyoming statute does not have tax savings provisions with respect to the rule against perpetuities, and the marital and charitable deductions. 25. For an excellent summary of all of the decanting statutes, see Summaries of State Decanting Statutes prepared by Susan T. Bart of Sidley Austin LLP, which can be found on the Sidley Austin LLP website ( or the website for the American College of Trust and Estate Counsel ( C. If a trust is governed by the laws of a state without a decanting statute, the trustee could consider using a change of situs provision in the current trust to move the trust to a jurisdiction with a decanting provision. D. Uniform Decanting Act. 1. The National Conference of Commissioners on Uniform State Laws (NCCUSL) has drafted a Uniform Trust Decanting Act. This is currently in draft form for discussion by the conference If NCCUSL adopts and promulgates this act, it is not clear what effect, if any, the promulgation would have. Nearly one half of states have already adopted decanting statutes. But the promulgation of such a statute may lead other states to adopt such statutes, and may lead to further uniformity in the states that have adopted such statutes. 3. Governing Law a. The Draft Uniform Decanting Act recognizes that there may be doubt concerning which state s laws should govern a trustee s proposed exercise of the power to decant. b. The Restatements and Uniform Trust Code note potential conflicts regarding which state s laws would govern a trust s construction, the powers of its trustee and its administration, and its effect on beneficial interests. 77 The comments to the Draft Uniform Decanting Act cite these authorities and confirm that decanting could be considered dependent on the validity or construction of a trust, or it could be an administrative power, or it could be a power to affect beneficial interests of a trust. And each of these 76 National Conference of Commissions on Uniform State Law, Trust Decanting Act, (draft 2014), available at [hereinafter Draft Uniform Trust Decanting Act ]. 77 See Restatement (Second) of Conflict of Laws ; Uniform Trust Code 107 & cmt., 108 & cmt. 21

44 4. Notice. perspectives on decanting might lead a court to conclude that a different state s decanting laws should govern. 78 c. For this reason, the Draft Uniform Decanting Act, if enacted by a given state, provides that it would apply in any of the following cases: (1) If the trust is governed by the laws of that state for purposes of administration; (2) If the trust is governed by the laws of that state for purposes of determining meaning or effect; or (3) If the trust has a principal place of administration in that state. 79 a. The Draft Uniform Decanting Act does not require a trustee to get beneficiary consent or court approval before decanting. b. But the Act does require the trustee to provide 60 days notice of a proposed decanting, which would include a copy of the first and second trust instruments, to each of the following: (1) the settlor, if living, (2) each qualified beneficiary of the first trust, (3) each person with authority to remove or replace the trustee, (4) all other trustees of the first trust, (5) the trustees of the second trust, and (6) a successor beneficiary, if the decanting materially and adversely affects the interests of that successor beneficiary. 80 c. Qualified and Successor Beneficiaries. (1) Notably, the Draft Uniform Decanting Act also requires notice to be given to a successor beneficiary. 78 See Draft Uniform Trust Decanting Act 103, cmt. 79 Draft Uniform Trust Decanting Act 103, cmt. 80 Draft Uniform Trust Decanting Act

45 (2) The Draft Uniform Decanting Act and the Uniform Trust Code give rights to a qualified beneficiary, which is defined as a beneficiary who is a permissible distributee of trust income or principal, who would be a permissible distributee of trust income or principal if the current beneficiaries interest terminated. 81 (3) The Draft Uniform Decanting Act defines a successor beneficiary as a beneficiary who is not yet a qualified beneficiary, but who may become a qualified beneficiary in the future by reason of inclusion in a class. 82 The comments clarify that this includes unborn beneficiaries and beneficiaries who might be second line or more remote. (4) This inclusion of successor beneficiaries in the notice provisions recognizes that decanting can have a substantial impact on a future beneficiary s interest, and that those beneficiaries should be included in any proposal to decant. And as noted below, successor beneficiaries have the right to petition a court to consider whether the decanting is permissible. 5. Court Approval and Direction a. The Draft Uniform Decanting Act also provides more robust provisions regarding the judicial remedies and options available to a trustee. A typical decanting statute would authorize a trustee or beneficiary to commence a proceeding to approve or disapprove a proposed exercise of the power under this section. 83 b. But the Draft Uniform Decanting Act would allow a trustee or any person entitled to notice of the decanting (including successor beneficiaries) to petition the court for a range of direction, or would allow the court to reach a number of conclusions, including the following: (1) Providing instructions to the trustee of whether the proposed decanting is permitted under the Act and consistent with the trustee s fiduciary duties; 81 See Draft Uniform Trust Decanting Act 102(19) & cmt.; Uniform Trust Code 103(13). 82 Draft Uniform Trust Decanting Act 102(28) & cmt. 83 Va. Code (I) ( A trustee or beneficiary may commence a proceeding to approve or disapprove a proposed exercise of the power under this section. ). 23

46 (2) Approving the decanting; (3) Proceeding with provisions of the Act, discussed below, regarding a partially impermissible decanting; and (4) Ordering other appropriate relief Under Section 301 of the Draft Uniform Decanting Act, the trustee may only decant the assets of the trust if the trustee may distribute principal. That is, a trustee may not decant based on the trustee s ability to distribute income only Beneficiaries and Powers of Appointment. a. The Draft Uniform Decanting Act contains provisions regarding beneficiaries and powers of appointment that in many ways help to clarify existing statutes treatment of these issues. 86 b. Of particular relevance are the following. (1) The Draft Uniform Decanting Act provides that a decanting may not be used to include as a current beneficiary any individual who is not a current beneficiary of the first trust. 87 (2) The Act also provides that a decanting may not include a remainder beneficiary (that is, a future beneficiary who is not a qualified beneficiary) who is not a current, remainder, or successor beneficiary of the first trust. This helps to clarify a potential ambiguity under some states decanting statutes, some of which had simply provided that [t]he beneficiaries of the second trust shall include only beneficiaries of the original trust. 88 Such general reference to beneficiaries seemed to cover remainder beneficiaries as well as current beneficiaries, but the use of more specific terms in the Draft Uniform Decanting Act helps to remove potential uncertainty regarding the ability to add future beneficiaries in a decanting. 84 Draft Uniform Trust Decanting Act 203(a). 85 Draft Uniform Trust Decanting Act 301(b), 302(b). 86 See generally Draft Uniform Trust Decanting Act 301(c)(1). 87 See generally Draft Uniform Trust Decanting Act 301(c)(3). 88 See, e.g., Va. Code (C)(1). 24

47 c. The Draft Uniform Decanting Act goes further than most statutes, and also provides that a decanting may not modify or eliminate a presently exercisable general power of appointment. 89 d. Under the Act, if the first trust only grants the trustee limited discretion to distribute principal, such as if the trustee may only distribute assets to a beneficiary under an ascertainable standard, then the trustee may only decant in such a way that the second trust in the aggregate, grant[s] each beneficiary beneficial interests in the second trusts that are substantially similar to the beneficial interests of the beneficiary in the first trust. 90 This is a less mechanical approach than under many current statutes; for example, in Virginia, a trust that must distribute under an ascertainable standard may only decant to a second trust with the same current beneficiaries and subject to the same ascertainable standard. 91 The Draft Uniform Decanting Act provides the trustee with more flexibility in decanting under an ascertainable standard. In particular, the comments to the Act note that this approach allows severance of a trust; this would not be permissible under Virginia s statute, which requires that the second trust be for the same beneficiaries. 92 e. The Act also allows the second trust to grant a power of appointment to beneficiaries, which can include the power to appoint assets to an individual who is not a beneficiary of the first trust Partially Impermissible Decanting. Section 310 of the Act provides that a decanting is effective to the greatest extent permissible, and provides some procedure for addressing a decanting which includes impermissible actions by the trustee. 94 Notably, Section 203(a) allows the court to instruct a trustee regarding the remedies under Section III. Judicial Review of Decanting under Decanting Statutes A. Courts have had limited opportunity to review a decanting under a state statute. This may be a product of the fact that many of these decanting statutes were enacted within the past several years, and the fact that many decantings would be done privately, without giving rise to litigation and court review. These few cases 89 Draft Uniform Trust Decanting Act 301(c)(3). 90 Draft Uniform Trust Decanting Act 302(c). 91 Va. Code (C)(2). 92 Draft Uniform Trust Decanting Act 302(c), cmt. 93 Draft Uniform Trust Decanting Act 301(e). 94 Draft Uniform Trust Decanting Act Draft Uniform Trust Decanting Act 203(a). 25

48 provide some guidance to trustees who seek to decant but who are planning to comply with statutory law, rather than a broader common-law authority to decant. B. Matter of Johnson (2015) Under the facts of Johnson, two trusts were created for the partial benefit of Katharine A. Johnson. The first trust was created in 1985 by her mother, and the second was created in 1997 by her father. In 1997 her mother and father divorced. 2. Under both the 1985 trust and 1997 trust, the trust distributes the remaining assets to Katharine at age 35. The initial trusts provided for certain remainder beneficiaries, which included descendants of Katharine s mother. 3. In 2011, the trustees of the two trusts, who were presumably aligned with the father s interests and family, decanted the assets of the trusts and distributed them to a third trust, established in At the time of the decanting, the value of the 1985 trust was $900,000, and the value of the 1997 trust was $1,000, The terms of the 2011 trust differed from the terms of the 1985 trust and the 1997 trust. Rather than making a distribution to Katharine at age 35, the 2011 trust continued for her lifetime. The decanting also revised the remainder beneficiaries of the trust assets. Under the 1985 trust, Katharine could only appoint the assets to Katharine s mother s descendants, and the remainder would pass to Katharine s issue, otherwise her mother s issue. But under the 2011 trust, Katharine could only appoint among her father s issue, and the remainder would pass to her father s issue. 5. Katharine filed a petition challenging the decanting and seeking to have the trust assets returned to the original trusts. Her mother supported the petitions to undo the decanting. 6. The court concluded that the decanting was improper. It concluded that the classes of remainder beneficiaries under the 2011 trust included individuals who were not remainder beneficiaries under the 1985 and 1997 trusts. Because the decanting added beneficiaries, it was invalid under New York law. 7. Johnson provides that a trustee who decants a trust should be careful to not overreach. The court did not take issue with the trustee s attempt to extend the term of the trust, to last for Katharine s lifetime rather than to terminate when she reached 35. However, the court concluded that the 96 Matter of Johnson, 2015 N.Y. Slip Op (N.Y. Surr. Ct., Jan. 13, 2015). 26

49 decanting impermissibly added remainder beneficiaries. And this feature of the second trust invalidated the decanting. C. In the Matter of Kroll (2013) In Kroll, a New York Surrogate s Court reviewed whether a trustee had properly decanted assets from one trust to a supplemental needs trust. The trustees petitioned the court for approval of the decanting. The New York Attorney General objected, arguing that the decanting would prejudice the New York Medicaid program. 2. The original beneficiary of the first trust was a recipient of Medicaid. The trust provided that until the beneficiary turned age 21, the trustee had full discretion in distributing income and principal. But when the beneficiary reached age 21, the beneficiary was entitled to receive all income from the trust, and could withdraw principal. The trustee was to distribute 1/3 of the trust principal to the beneficiary at age 25, 1/2 of the principal at age 30, and the remaining principal at age Six days before the beneficiary s 21st birthday, the trustees decanted the trust to a second trust, which would qualify as a supplemental needs trust, and which would allow the beneficiary to receive Medicaid benefits without requiring the beneficiary to exhaust trust assets. Importantly, New York s decanting statute required 30 days notice of a decanting, but allowed persons entitled to notice to waive that requirement. 4. The court concluded that the provisions of the decanting statute had been met, and thus the trust was not a countable resource for purposes of Medicaid. 5. This case serves as an important reminder that compliance with the terms of the statute is important. In this case, had the trustee waited until after the beneficiary had turned 21, or if the trustee had not strictly complied with the notice provisions, then the beneficiary and the trust would have suffered an adverse result and missed an opportunity to preserve the trust as otherwise allowed by statute. D. Ferri v. Powell-Ferri (2013) The case of Ferri arose in the context of a divorce action between a beneficiary, Paul, and his wife, Nancy. A trust was established in 1983, and authorized the trustees to distribute income or principal as the trustees shall deem desirable for [Paul s] benefit. Paul could withdraw 1/4 of 97 In the Matter of Kroll, 971 N.Y.S.2d 863 (2013). 98 Ferri v. Powell-Ferri, 2013 WL (Conn. Super. August 23, 2013); see also Ferri v. Powell-Ferri, No. MMXCV , 2014 WL (Conn. Super. June 5, 2014) (addressing remedy resulting from finding that decanting was improper). 27

50 the trust principal at age 35, 1/2 at age 39, 3/4 at age 43, and the remainder at age 47. At the time of the action, Paul could withdraw 3/4 of the trust assets. But while the action was pending, he became entitled to withdraw all of the trust assets. 2. In 2011, the trustees decanted the trust. Under the terms of the second trust, Paul was not given the opportunity to withdraw the trust assets; instead, the trust was to exist for his life, and he was given a lifetime, limited power of appointment that could not be exercised in favor of his creditors or his wife. 3. The wife brought a claim against the trustees for intentional interference with an equitable interest. She argued that if the assets of the trust were included in any calculation of the husband s assets in the divorce action, she would receive substantially more in the property division. 4. The court concluded that because Paul was already entitled to withdraw the trust assets, the trustee could not decant the trust to put restrictions on the beneficiary s (and the beneficiary s creditors) right to access the property. The court concluded that the decanting was a radical departure from the terms of the original trust and the intent of the settlor that Paul have full access to the trust assets. Accordingly, the court denied the decanting. E. These few cases highlight the importance of a trustee complying with the strict terms of the decanting statute. 1. In Johnson, the decanting probably could have permissibly extended the term of the trust, and the trustees could have used other means to exercise their discretion in a way to achieve their goals. But because the trustees added remainder beneficiaries, the decanting was held to be improper. 2. And in Kroll, the trustee was careful to comply with the procedural and notice requirements of the decanting statute, and therefore preserved the trust assets for the beneficiary s benefit in a special needs trust. 3. Meanwhile, Ferri demonstrates further the limits of decanting generally. Because the beneficiary was entitled to withdraw all of the trust assets, the court concluded that the decanting to leave the assets in trust would violate the settlor s intent. The court may have found relevant the surrounding circumstances of the decanting, in that the court could have also determined that the decanting was simply an attempt to preserve the assets of the divorcing husband. 4. In decanting under a state statute, the trustee must be careful to comply with the specific provisions of the decanting statute, and the trustee must also be careful to consider the surrounding facts and circumstances as they may be viewed by the court. 28

51 POTENTIAL USES AND LIMITATIONS OF DECANTING I. Decanting can be a useful tool to consider in modifying the terms of a trust, particularly in order to respond to changed circumstances, to update the terms of a trust over time, or to provide for a more efficient or tailored administration of the trust. A. These include the following: 1. Correcting drafting errors and addressing ambiguities; 2. Improve the administrative provisions of the trust, by modifying trustee provisions (such as removal powers, appointment of successor trustees, and trustee compensation) or investment provisions; 3. Addressing changes in a beneficiary s or trust s financial status; 4. Consolidating or dividing trust assets for administrative purposes; and 5. Changing the situs or governing law of the trust. B. State law might provide some significant limitations on the ability of a trustee to decant to address any of these issues. For example, as discussed in detail above, different state statutes take different positions with respect to the similarity required between the beneficiaries and their interests in the old and new trust, whether an interested trustee may decant a trust, and the notice and procedural requirements to decant. C. Nevertheless, even if decanting is limited in some respects, decanting can often be helpful to provide further flexibility, and decanting may have tax advantages and other advantages over other means of modifying a trust. II. Correct Drafting Errors and Ambiguities A. Trust decanting can be useful if the terms of the trust contain drafting errors or ambiguities that are not discovered until the trust has become irrevocable. By decanting, a trustee may correct administrative, substantive and distributive errors, as well as revise the terms to accurately reflect the settlor s intent. B. Of course, the Uniform Trust Code already provides a means of correcting errors in a document. Section 415 allows a court to reform the terms of a trust, even if unambiguous, to conform the terms toe the settlor s intention, if proved by clear and convincing evidence Uniform Trust Code 415 (2010). 29

52 C. The comments to the Uniform Trust Code note that this remedy is longestablished, and it applies both in situations in which the trust document misstates the settlor s intention or contains a scriveners error, or in situations in which the trust instrument expresses the settlor s intent, but the settlor s intent was formed based on a mistake of fact or law. 100 D. But reformation of a trust suffers from two disadvantages compared to decanting. 1. First, reformation is a judicial remedy, and the time and money of a judicial proceeding may not be warranted. Decanting, by contrast, may be undertaken without court approval. 2. Second, reformation is not available to resolve an ambiguity in the text. Resolving an ambiguity involves the interpretation of language that is already in the trust document, and one whose meaning is not clear. 101 Decanting is available to modify the terms of a trust altogether, to clarify such an ambiguity, provided that the trustee is confident that the resolution of the ambiguity in this way is consistent with its fiduciary duties. III. Improve Trust Management or Administration, or Update or Modernize Trust Provisions A. Trust decanting may be used to make changes to trust governance provisions to improve the management or the structure of the trust administrator. B. Update Administrative Provisions 1. Decanting can be used to simply update provisions of a trust that have become outdated because of the passage of time, such as provisions regarding a specific individual to serve as trustee. 2. One example of such a decanting is found in the facts of Morse, discussed above. 102 Recall that in that case, a grantor established four separate subtrusts in 1982 for his sons, and he named an attorney as trustee. The subtrusts prohibited a beneficiary from serving as trustee, and thus precluded a son from serving as trustee of his own trust. Nearly 30 years later, the trustee was nearing retirement and wanted to name a successor, and because the sons had matured, the trustee believed it was in the beneficiaries best interests to decant the trust to allow them to serve. 3. The trustee s solution in that case was to decant to a new trust, which contained the same dispositive provisions as the first trust, but which would allow a beneficiary to serve as trustee. 100 Uniform Trust Code 415 (2010), cmt. 101 Id. 102 Morse v. Kraft, 992 N.E.2d 1021 (Mass. 2013). 30

53 C. Modernize Trust Provisions 1. Decanting can also be used to modify the terms of a trust not only to address changed circumstances of the beneficiaries or trustees, but also to incorporate more modern and efficient trust provisions. 2. For example, a trustee could wish to decant a trust to create a directed trust relationship, in which a third party, or perhaps even a beneficiary, directs trust investments, and the trustee has not responsibility for investments. Directed trusts may be helpful to address changes in circumstances in which a trust owns a concentrated asset; but directed trusts also may serve a purpose for other trusts, because a directed trustee relationship can properly align the interests of risk and return between a beneficiary/investment advisor and the directed trustee. As discussed below, decanting might be the simplest means of a trustee to achieve this result. D. Advantages of Decanting 1. Decanting has certain advantages over other methods of updating the administrative provisions of a trust. 2. Judicial Modification. a. A judicial modification of a trust can also be used to modify the administrative provisions of a trust. The Uniform Trust Code allows a trust to be modified by consent of the beneficiaries, if the modification is not inconsistent with a material purpose of the trust. 103 The Uniform Trust Code also allows modification of the dispositive or administrative terms of a trust because of unanticipated circumstances. 104 b. But judicial modification has some disadvantages. (1) It requires court approval, which can take time and money. (2) The court may not approve of the trust modification. In one recent Delaware case, the court refused to allow modification of a testamentary trust to a directed trust. The court found that the testator intended for the trustee to exercise investment authority, and that the modification was not permissible, even with the beneficiaries approval. 105 While the court in that case focused on the 103 Uniform Trust Code 411 (2010). 104 Id. 105 See In re Trust under Will of Wallace B. Flint for the Benefit of Katherine F. Shadek, C.A. No VCL (Del. Ch. June 17, 2015). 31

54 particular language of the trust instrument, this case nevertheless might give a trustee pause of whether a court would necessarily agree to modify a trust to create a directed trustee relationship. (3) Judicial modification by beneficiary consent requires consent of the beneficiaries, which can have adverse tax consequences for gift, estate, and generation-skipping transfer tax, discussed below. These adverse tax consequences may be rare, however, in the case of a modification of the administrative terms of a trust; but in light of the potentially large adverse tax consequences, the trustee might be wise to seek court approval. For example, the trustee in Morse was careful to use decanting to modify the provisions for successor trustee, presumably in part to avoid requiring the beneficiaries to consent and to jeopardize the trust s exemption from generation-skipping transfer tax Nonjudicial Settlement Agreements a. The administrative terms of a trust can also be modified by a nonjudicial settlement agreement. Section 111 of the Uniform Trust Code allows such an agreement to address various provisions of the trust, including the resignation or appointment of a trustee, and the granting of a particular power to a trustee. 107 b. However, a nonjudicial settlement agreement is valid only to the extent it does not violate a material purpose of the trust. c. There is limited authority on whether a given modification would violate a material purpose, and this would depend on the facts and circumstances of a particular case. Available case law typically addresses the termination of a trust, and not whether a given modification would violate a material purpose. 108 (1) On the one hand, the comments to the Uniform Trust Code state that a material purpose must be of some significance. 109 The Restatement adds, Material purposes are not readily to be inferred. A finding of such a purpose generally requires some showing of a particular concern or objective on the part of the settlor, such as 106 Morse v. Kraft, 992 N.E.2d 1021 (Mass. 2013). 107 Uniform Trust Code 111(d)(4), (3). 108 See, e.g., In re Estate of Brown, 529 A. 2d 752 (Vt. 1987). 109 Uniform Trust Code 411, cmt. 32

55 concern with regard to the beneficiary s management skills, judgment, or level of maturity. 110 (2) The Restatement continues that the line between a material purpose and other intentions is not always easy to draw. When such an expression of a material purpose is not contact in the document itself, the identification and weighing of purposes under this Section frequently involve a relatively subjective process of interpretation and application of judgment to a particular situation, much as purposes or underlying objectives of settlors in other respects are often left to be inferred from specific terms of a trust, the nature of the various interests created, and the circumstances surrounding the creation of the trust. 111 (3) The Restatement suggests that a revision regarding who might serve as trustee are to be particularly (although sympathetically) reviewed. The comment explains, a proposed modification might change the trustee or create a simple, inexpensive procedure for appointing successor trustees, or it might create or change procedures for removing and replacing trustees. Modifications of these types may well improve the administration of a trust and be more efficient and more satisfactory to the beneficiaries without interfering with a material purpose of the trust. 112 (4) The comment to the Restatement continues that repeated modifications to change trustees or even a particular change of trustee, or an amendment of provisions relating to the trusteeship, might have the effect of materially undermining the contemplated qualities or independence of trustees. A given change might even have the effect of shifting effective control of the trust in such a way as to be inconsistent with a protective management purpose or other material purpose of the trust. Thus, changes of trustees or in trustee provisions are to be particularly but sympathetically scrutinized for possible conflict with a material trust purpose. 113 (5) The Restatement cites a thoughtful and interestingly illustrative opinion from a trial court in South Dakota from In that case, the judge approved a change of 110 Restatement (Third) of Trusts Section 65 cmt. d. 111 Id., cmt. b. 112 Id., cmt. f. 113 Id. 33

56 trustee from one bank to another, since it is not necessary that [the initial corporate trustee] invest the trust assets and distribute the income. Another trustee can do this function and it is not a material purpose of the [trust] that [the initial corporate trustee] complete this function. But the judge denied a change in the trustee provisions to allow the beneficiaries to substitute future trustees. The court explained, [u]nlike the first petition to substitute trustees, it cannot be presently ascertained whether a future substitution will cause a material change to the Hogan Trust. If this petition is granted, the Beneficiaries can substitute trustees until they find a sympathetic trustee who complies with their demands. 114 (6) In light of this concern of whether a given modification even one that only addresses the changing of the procedures to identify a successor trustee would violate a material purpose of a trust, a trustee might prefer to ask a court to validate a nonjudicial settlement agreement, or might prefer to use the decanting process, which is not keyed to a material purpose of the trust. d. In addition, because a nonjudicial settlement agreement necessarily requires consent of the beneficiaries, it can have adverse consequences for gift, estate, and generation-skipping transfer tax. IV. Address Changed Circumstances of the Trust or Beneficiaries A. Decanting can also be used to address changed circumstances of the beneficiaries. This would include the following. 1. Extending the term of a trust a. A decanting can allow the second trust to hold trust assets for the lifetime of a beneficiary, rather than terminating upon a certain age. So long as the beneficiary does not already have the power to withdraw the assets of the trust, such a decanting would typically be permitted under the statute. b. This can have numerous benefits, including shielding the assets of the trust from a beneficiary s creditors for a longer time period. c. It appears that a trustee could decant to extend the term of a trust consistent with his or her fiduciary duties, so long as the decanting satisfied the other requirements of the statute, and so long as the 114 Restatement (Third) of Trusts 65, cmt. f, Reporter s Notes (2003). 34

57 trust assets were not yet subject to a beneficiary s right of withdrawal. As discussed above, in Matter of Johnson, 115 a New York court invalidated a decanting, that, among other changes, extended the trust term for the life of the beneficiary, but the court presumably would have allowed the decanting to only include this revision, without any of the other changes that the court found impermissible. And in Ferri v. Powell-Ferri, 116 a Connecticut court also disallowed a decanting to extend the duration of a trust, but in that case the beneficiary had the unrestricted right to withdraw the trust assets. 2. Addressing the disability of a beneficiary a. Decanting typically can allow a trustee to create a second trust that is a special needs trust or supplemental needs trust, which would allow the beneficiary to receive government assistance without first exhausting the assets of the trust. b. In In the Matter of Kroll, discussed above, a New York court approved of a decanting to create a special needs trust when otherwise the trust would have allowed the beneficiary certain unrestricted rights at age In that case, the decanting was completed before any of those rights vested in the beneficiary, so the court allowed the decanting without affecting the beneficiary s ability to qualify for government assistance. c. States increasingly recognize the importance of decanting in creating a special needs trust. As noted, above, North Carolina recently amended its decanting statute 118 in 2015 to allow the decanting of a trust to a special needs trust, provided that the beneficiary is disabled. 119 d. Decanting has certain advantages over other methods of creating such a special needs trust. 115 Matter of Johnson, 2015 N.Y. Slip Op (N.Y. Surr. Ct., Jan. 13, 2015). 116 Ferri v. Powell-Ferri, 2013 WL (Conn. Super. August 23, 2013); see also Ferri v. Powell-Ferri, No. MMXCV , 2014 WL (Conn. Super. June 5, 2014) (addressing remedy resulting from finding that decanting was improper). 117 In the Matter of Kroll, 971 N.Y.S.2d 863 (2013). 118 N.C. Gen. Stat. 36C N.C. Senate Bill 336 (2015); see Andrea C. Chomakos and E. Graham McGoogan Jr., North Carolina Changes Trust Code and Permits Living Probate, McGuireWoods LLP Fiduciary Advisory Services Alerts, available at Resources/Alerts/2015/8/North-Carolina-Changes-Trust-Code-Permits-Living-Probate.aspx. 35

58 (1) Modifying the trust in a way that would require the beneficiary s consent could be particularly problematic. Medicaid might argue that the beneficiary consented to give up a beneficial interest in the trust, that interest should be treated as a resource of the beneficiary. (2) Judicial modification could also be problematic in such a case because timing might be of the essence. In In the Matter of Kroll, the trustee was able to decant the trust in just a few days, and just days before the beneficiary turned A judicial modification of the trust would have taken far longer. 3. Changing beneficiaries or distribution standards a. Decanting can also be used to remove beneficiaries. While a trustee might be concerned that removing a beneficiary would violate the trustee s duty of impartiality, in Wiedenmayer the court allowed the removal of remainder beneficiaries in order to serve the primary beneficiary s peace of mind. 121 b. However, no decanting statute to date allows a decanting to add a current or remainder beneficiary. In Johnson, a New York court invalidated a decanting because the second trust added certain contingent remainder beneficiaries from the father s side of the family, and removed those remainder beneficiaries from the mother s side. 122 c. The trustee should be mindful, however, that removing beneficiaries may be prohibited by state law based on the terms of the trust. In many states, if a trustee decants a trust which is subject to an ascertainable standard, the second trust must have the same beneficiaries and the same ascertainable standard. 123 d. But some states, including Delaware, Nevada, and South Dakota, allow a trustee of a trust that is subject to an ascertainable standard to decant to a second trust that is discretionary, provided certain requirements are met. Virginia s statute, for example, only allows such a decanting if the court approves In the Matter of Kroll, 971 N.Y.S.2d 863 (2013). 121 Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969). 122 Matter of Johnson, 2015 N.Y. Slip Op (N.Y. Surr. Ct., Jan. 13, 2015). 123 See, e.g., Va. Code (C)(2). 124 Va. Code (C)(2). 36

59 V. Change Trust Situs 4. Granting or revising a power of appointment a. Decanting can also grant a beneficiary the power to appoint the assets among certain remainder beneficiaries, which can give the beneficiary flexibility in distributing the assets to the remaindermen. b. And while a decanting itself cannot add current or remainder beneficiaries in the second trust, a trustee s common-law authority to decant or a state decanting statute may allow a beneficiary to be granted the power to appoint the assets among individuals who are not beneficiaries of the first trust. The court in Phipps approved of a decanting to a second trust that granted a power of appointment to a beneficiary to enable the beneficiary to appoint to his spouse, who was not a beneficiary of the first spouse. 125 Many state statutes, such as Delaware, Nevada, and South Dakota, expressly allow the granting of such a power of appointment to appoint among non-beneficiaries. For example, Virginia s statute provides that [t]he permissible appointees of the power of appointment may include persons who are not beneficiaries of the original trust or the second trust Of course, the trustee s decanting must presumably still be conducted consistent with the trustee s fiduciary duty. As noted above, there is little case law available regarding a trustee s ability to decant consistent with his or her fiduciary duty. A. Decanting can also be a simpler and clearer option for changing the situs of a trust. The trustee would decant the trust under the laws of the first state, and create a second trust in a second state under the laws of that state. Decanting to change situs and governing law can often be clearer that determining the extent the interplay of two states laws following the change of situs and principal place of administration. B. But not all states have decanting statutes. Since states with decanting statutes still are in the minority, a trustee seeking to change a trust might first move the trust to a state with a decanting statute, using a change of situs provision, and then decant the trust under the new state s law. Similarly, the trustee may move the trust situs if the state of the original trust has a decanting statute but it lacks certain provisions or protections that the parties wish to use. 125 Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940). 126 Va. Code (C)(8). 37

60 C. Many commentators note that the new state normally would apply its decanting law on the grounds that it is a power of administration. However, an explicit provision in the state s decanting statute will provide additional comfort. Several states, including Alaska, Arizona, Delaware, Missouri, New York, Ohio and South Dakota, have helpful provisions. D. However, in changing the situs of a trust, the trustee must be particularly mindful of the income tax consequences of the change, and the extent to which the prior situs might still seek to tax income of the trust even after the change. The potential to avoid state income tax from the first state is discussed later in these materials. E. The trustee should be particularly careful about changing governing law in such a way as to jeopardize a trust s exemption from GST tax. 1. As discussed in more detail below, under the Treasury Regulations a trustee may decant a trust that is grandfathered from GST tax, without affecting that GST-exempt status. But to do so, the decanting may not extend the vesting of any beneficial interest beyond the common-law Rule Against Perpetuities, 127 and the decanting may not extend the time for vesting beyond the period provided in the first trust A decanting of a trust that changes applicable law, however, could inadvertently violate these provisions and jeopardize GST-exempt status. For this reason, some trustees choose to decant to a second trust that expressly provides that the vesting and duration of the trust will continue to be governed by the law of the original forum state. 129 VI. Combine or Divide Trusts A. Decanting can also be helpful to combine or divide trusts, without the necessity of a judicial proceeding. B. As noted above, Delaware recently amended its applicable statutes; one of those changes was to clarify the consequences of a merger of two trusts, including a merger by decanting. 130 C. The trustee should be mindful, however, that decanting to divide a trust may not be available in certain cases. 1. For example, certain state statutes provide that if a first trust is subject to an ascertainable standard, then it can only be decanted to a second trust 127 Treas. Reg (b)(4)(i)(A). 128 Treas. Reg (b)(4)(i)(D)(1). 129 See, e.g., In re Trust under Will of Wallace B. Flint for the Benefit of Katherine F. Shadek, C.A. No VCL (Del. Ch. June 17, 2015). 130 See Del. S.B. 42 (effective August 1, 2015). 38

61 that is in favor of the same beneficiaries and subject to the same ascertainable standard. This restriction would prohibit such a trust from being divided through decanting, as the second trusts would not have the same beneficiaries as the first. 2. In some states, such as Virginia, the court can approve of such a decanting that would only be in favor of certain beneficiaries, and this mechanism could be used to divide such a trust. But requiring court approval might remove some of the advantages of decanting as an option for such a modification or division. 3. Also as noted above, the Draft Uniform Decanting Act would allow a trust to be decanted if the second trust or trusts, in the aggregate, grant[s] each beneficiary beneficial interests in the second trusts that are substantially similar to the beneficial interests of the beneficiary in the first trust. 131 The comments to this Act note that this flexibility was built into the draft in order to allow division of a trust that is subject to an ascertainable standard Thus, while decanting might seem to be an attractive and simplified means to divide a trust, the trustee must consider carefully whether decanting is available in such circumstances. D. Decanting can also be advisable to achieve certain tax benefits. These are discussed in more detail below, regarding Planning Opportunities and Decanting. VII. Fiduciary Risk A. But while the common law or a statute might give a trustee the authority to decant the assets of one trust to a second trust, the trustee should also consider carefully whether that decanting is consistent with the trustee s duties. In particular, the trustee must ensure that the decanting is consistent with the trustee s duty of impartiality. The comments to Uniform Trust Code clarifies, however, that the trustee only has the duty to treat the beneficiaries equitably, not equally: The duty to act impartially does not mean that the trustee must treat the beneficiaries equally. Rather, the trustee must treat the beneficiaries equitably in light of the purposes and terms of the trust. 133 B. There is little case law available regarding a trustee s ability to decant consistent with his or her fiduciary duties. But the cases of Phipps 134 and Wiedenmayer, 135 discussed above, suggest that a trustee may, consistent with his or her fiduciary 131 Draft Uniform Trust Decanting Act 302(c). 132 Draft Uniform Trust Decanting Act 302(c). 133 Uniform Trust Code 803, cmt; see also Restatement (Third) of Trusts Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940). 135 Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969). 39

62 duties, decant in order to provide a beneficiary with the power to appoint the trust assets to non-beneficiaries, or in order to modify the remainder beneficiaries. C. Because a trustee typically would not have a duty to decant a trust, the trustee should be cautious in undertaking a decanting, and should only do so if it felt assured that such an action is permissible and is consistent with its fiduciary duties. Below are some ways that a trustee can mitigate the risk inherent in a decanting. 1. Obtain beneficiary consent, approval, and release agreements a. The trustee could ask all of the beneficiaries to consent to the decanting, either through a consent, release, and ratification agreement under Section 1009 of the Uniform Trust Code, or through a nonjudicial settlement agreement under Section 111 of the Uniform Trust Code. b. However, as discussed below, seeking beneficiary consent may have adverse tax consequences to the trust. 2. Obtain judicial approval a. The trustee could also see judicial approval, as the trustee did in Morse. However, judicial approval of the decanting could take time and money, and it would run counter to one of the benefits of decanting, regarding the ability of the trustee to act without court approval. 3. Disclose decanting and rely on statute of limitations a. The trustee could also disclose the decanting to the beneficiaries through Section 1005 of the Uniform Trust Code, or an analogous state statute regarding the statute of limitations. Under such a provision, if a beneficiary is given certain notice of a trustee s action, then the beneficiary may only bring a claim regarding that action within a certain time period, which is one year under the Uniform Trust Code. b. But because the statute of limitations is backward-looking and requires the trustee to act first, this may not provide sufficient assurance to a trustee. To address potential claims by a beneficiary in the future, a trustee might also insert provisions in the second trust that would provide for a refunding of the trust assets to the first trust in the event that a beneficiary brings a claim against the first trustee, and the first trustee might also require a release and indemnification from the second trustee. 40

63 ESTATE, GIFT AND GST TAX CONSEQUENCES OF DECANTING I. Before decanting, trustees must keep in mind the potential tax implications of decanting. That is, the trustee must be careful that in decanting to avoid certain adverse state income taxes, the trustee is not also triggering other adverse tax consequences related to gift, estate, or GST tax. II. Gift Tax A. For tax purposes, one of the key features of a decanting is that the consent of the beneficiaries is typically not required. Thus, at least in theory, the other beneficiaries would not have made a taxable gift in the case of modification of the trust, because their consent or active participation is not required. 136 Instead, any action in favor of one individual is a result of the trustee s own action. B. The only ability of the beneficiaries to object to the decanting would be to argue that the trustee s act was an abuse of discretion. 137 C. Nevertheless, the gift tax consequences of decanting are not always clear. In Private Letter Ruling , the IRS summarily concluded that a decanting would not result in gift tax, but the IRS briefly noted that the dispositive and beneficial interests in Trust 2 will be identical to those in Trust 1. D. The IRS sought public comment in 2011, but has not yet issued any further guidance. The American College of Trust and Estate Counsel issued its proposed ruling in 2012, and this proposal by ACTEC contains helpful research, citations, and reasoning regarding the potential tax implications of a decanting. The IRS has yet to publish formal guidance on the gift tax consequences of decanting. 138 E. The ACTEC memorandum suggests that even if the trustee does get beneficiary approval (for example, to release the trustee of liability), then the decanting is still not a taxable gift, so long as beneficiary consent is not required. 139 While the reasoning of the memorandum is sound, a trustee might still be concerned of seeking beneficiary approval of a decanting in the absence of formal IRS guidance. III. Estate Tax 136 See Jonathan G. Blattmachr, et al., An Analysis of the Tax Effects of Decanting, 47 Real Prop., Tr. & Est. L.J 141, , (2012). 137 Restatement (Third) of Trusts, 50; Blattmacher, et al., An Analysis of the Tax Effects of Decanting, at p ACTEC Comments on Transfers by a Trustee from an Irrevocable Trust to Another Irrevocable Trust (Sometimes called Decanting ) (Notice ) (Released December 21, 2011), available at ACTEC website 139 Id. 41

64 A. The trustee and settlor should also be aware of the potential that the assets of a trust or a decanted trust may be included in the settlor s or a beneficiary s estate for estate tax purposes. B. If a decanting triggered a taxable gift by a beneficiary, then that interest may also be included in the beneficiary s estate, under, for example, Internal Revenue Code Sections 2035, 2036, and C. Estate tax issues might also arise if a trustee who is not adverse to the beneficiary can participate in the decanting; such a power by the trustee could be treated as a power by the settlor or the beneficiary to remove and replace a trustee with a party who is related or subordinate, which could trigger inclusion under IRS guidance. 140 D. Many state statutes require that only an independent trustee may decant that is, that a trustee may not decant if the trustee is a beneficiary or if a beneficiary has the power to remove the trustee and to replace the trustee with a related or subordinate party. This restriction helps to avoid a potential estate tax issue based on a beneficiary s ability to participate in the decanting. E. These provisions of applicable law could trigger inclusion by their mere existence, even if not exercised. F. Moreover, the settlor should be particularly careful not to take any steps that would suggest that the settlor was directing the decanting, as this could be construed as a retained power over the trust, triggering inclusion under Section 2036 or G. The trustee should also be mindful of the terms of the second trust. Granting a beneficiary a general power of appointment under the second trust would trigger inclusion in the beneficiary s estate under Section As noted below, however, occasionally a trustee may wish to trigger such inclusion in a beneficiary s estate based on a general power of appointment, in order to provide for a step-up in basis of the assets upon the beneficiary s death. But such inclusion should only be triggered deliberately, after a careful review of the advantages and disadvantages of such an approach. IV. Generation-Skipping Transfer Tax. A. The Treasury Regulations provide two methods to ensure that a grandfathered trust will not lose its GST-exempt status following a decanting. 1. First Safe Harbor: Exercise of power inherent in original instrument which does not violate Rule against Perpetuities. 140 See Blattmachr, at 164; see Rev. Rul , CB See William R. Culp, Jr. & Briani L. Bennett, Trust Decanting: An Overview and Introduction to Creative Tax Planning Opportunities, at Part V.C. 42

65 a. First, Treas. Reg (b)(4)(i)(A) provides that a distribution from one trust to another trust will not cause the loss of GST exempt status if the following two tests are met: (1) the distribution is pursuant to a power under the original trust instrument or state law as it existed at the time the trust was created, and (2) (2) the terms of the second trust do not extend the vesting of any beneficial interest beyond a period measured by 21 years after the death of any life in being at the time the original trust became irrevocable. b. The second prong of this safe harbor may be straightforward to satisfy. This simply requires that the second trust not extend the vesting of any beneficial interest beyond the common-law perpetuities period. The trustee of the second trust can typically ensure that this test is met, by including specific provisions in the second trust regarding vesting of interests. c. However, it is the first prong of this test that may prove elusive, or at least difficult to prove without a court order. (1) While the first decanting case, Phipps, was decided in Florida in 1940, it is far from clear that any trustee has the power to decant a trust without statutory authority. (2) It is true that Phipps drew on the common-law powers of a trustee. 142 The court in Phipps reasoned, [T]he power vested in a trustee to create an estate in fee includes the power to create or appoint any estate less than a fee unless the donor clearly indicates a contrary intent. 143 (3) However, the court in Phipps reasoned that the trustee s common-law power to decant is measured by the facts and circumstances of each case; so even if the trustee generally has such authority, it is highly fact-specific. In Phipps, the court focused on the facts of the particular case and the terms of the instrument creating the trust, and it reasoned that [t]here is no fixed rule by which all are determined See Blattmacher, at p. 143 (arguing that under this case, a decanting power likely is held by trustees under the common law of all states, and noting that [n]o court has held that such fiduciary power does not exist under common law ). 143 Phipps, 196 So. at Phipps, 196 So. at 301 (citing cases). 43

66 d. Meanwhile, many decanting statutes were only enacted in the last several years. At least in the case of an outdated trust that needs updating, it appears unlikely that a state decanting statute was in place when the trust was first created. e. But meeting this test is not impossible; in Morse, the trustee brought an action to confirm that the decanting was permissible under the trustee s authority, in part to ensure that the decanting did not jeopardize the GST-exempt status of the trust under this first safe harbor. 145 f. Nevertheless, given the uncertainty in case law regarding the inherent authority of a trustee to decant, and given that such an inquiry is highly fact-specific, most trustees who seek to satisfy these regulations would seek to satisfy the second safe harbor, discussed below. 2. Second Safe Harbor : vesting of trust is not postponed and assets do not pass to lower generation. a. There is a more general safe harbor provision in the regulations that would allow the continuation of GST exemption. 146 This safe harbor provision expressly applies to a modification that does not meet the test of (b)(4)(i)(a), discussed above. b. This provision exempts the trust from GST tax, if the following two requirements are met in the decanted trust: (1) there must be no shift of beneficial interest to a lower generation, and (2) the modification must not extend the time for vesting beyond the period provided in the first trust. c. As early as 2002, a Private Letter Ruling provides that so long as these requirements are met, the decanting would not affect GST exemption. 147 d. Treas. Reg (b)(4)(i)(D)(1) provides the following: A modification of the governing instrument of an exempt trust (including a trustee distribution, settlement, or construction that does not satisfy 145 Id. at See Amy Erenrich Heller, Decanting and the Generation-Skipping Transfer Tax: Pitfalls and Possibilities, American Bar, pp See Priv. Ltr. Rul

67 paragraph (b)(4)(i)(a), (B), or (C) of this section) by judicial reformation, or nonjudicial reformation that is valid under applicable state law, will not cause an exempt trust to be subject to the provisions of chapter 13, if the modification does not shift a beneficial interest in the trust to any beneficiary who occupies a lower generation (as defined in section 2651) than the person or persons who held the beneficial interest prior to the modification, and the modification does not extend the time for vesting of any beneficial interest in the trust beyond the period provided for in the original trust. 148 e. The regulations example 2 is precisely on point in many decanting cases: Example 2 Trustee s power to distribute principal pursuant to state statute. In 1980, Grantor established an irrevocable trust (Trust) for the benefit of Grantor's child, A, A's spouse, and A's issue. At the time Trust was established, A had two children, B and C. A corporate fiduciary was designated as trustee. A=A [permissive Bs] B, C [remainder Bs] 148 Treas. Reg (b)(4)(i)(D)(1). Under the terms of Trust, the trustee has the discretion to distribute all or part of the trust income or principal to one or more of the group consisting of A, A s spouse or A s issue. Trust will terminate on the death of A, at which time, the trust principal will be distributed to A s issue, per stirpes. Under a state statute enacted after 1980 that is applicable to Trust, a trustee who has the absolute discretion under the terms of a testamentary instrument or irrevocable inter vivos trust agreement to invade the principal of a trust for the benefit of the income beneficiaries of the trust, may exercise the discretion by appointing so much or all of the principal of the trust in favor of a trustee of a 45

68 trust under an instrument other than that under which the power to invade is created, or under the same instrument. The trustee may take the action either with consent of all the persons interested in the trust but without prior court approval, or with court approval, upon notice to all of the parties. The exercise of the discretion, however, must not reduce any fixed income interest of any income beneficiary of the trust and must be in favor of the beneficiaries of the trust. Under state law prior to the enactment of the state statute, the trustee did not have the authority to make distributions in trust. In 2002, the trustee distributes one-half of Trust s principal to a new trust that provides for the payment of trust income to A for life and further provides that, at A s death, one-half of the trust remainder will pass to B or B s issue and one-half of the trust will pass to C or C s issue. Because the state statute was enacted after Trust was created and requires the consent of all of the parties, the transaction constitutes a modification of Trust. However, the modification does not shift any beneficial interest in Trust to a beneficiary or beneficiaries who occupy a lower generation than the person or persons who held the beneficial interest prior to the modification. In addition, the modification does not extend the time for vesting of any beneficial interest in Trust beyond the period provided for in the original trust. The new trust will terminate at the same date provided under Trust. Therefore, neither Trust nor the new trust will be subject to the provisions of chapter 13 of the Internal Revenue Code Treas. Reg (b)(4)(i)(D)(1), Ex

69 B. At least in the case of GST tax, the IRS has continued to issue private letter rulings that provide that certain modifications do not cause a GST-grandfathered or GST-exempt trust to lose its GST-exempt status. 150 C. But as in the case of gift tax, the IRS has not provided further guidance regarding the implications of decanting for GST tax. The ACTEC memo and proposed ruling, issued in 2012, remains an important source of authority and reasoning regarding potential GST tax implications of decanting. 151 TAX PLANNING OPPORTUNITIES INVOLVING DECANTING I. Tax Opportunities A. As discussed above, decanting can allow the trustee to update and modernize a trust, and to respond to changed circumstances regarding the trust, its assets, governing law, or the beneficiaries. B. But in particular, the flexibility provided by a decanting provides important opportunities for planning, particularly to address tax implications of an irrevocable trust. II. Below are just a few examples of the particular tax planning opportunities available: A. Decant to allow distributions for other purposes, such as to carry out capital gains. 1. Recent developments in tax law have made more attractive the distribution of income, and particularly capital gains, to a beneficiary. 2. Under current law, a trust must pay ordinary income tax at the top marginal rate of 39.6% upon reaching $12,150 in income for Moreover, the trust must pay capital gains at the top marginal rate of 20% upon reaching $12,150 in income for The trust typically would also be subject to the 3.8% net investment income tax for taxpayers in the highest tax bracket, such that a trust s total marginal capital gains rate might be expected to be 23.8%. 3. But distributing such income or capital gains to a beneficiary would shift the income tax burden to the individual beneficiary, so that the income is 150 See, e.g., Private Letter Rulings , , , and (November 8, 2013) (proposed modifications will not ungrandfather pre-september 25, 1985 irrevocable trusts); Private Letter Ruling (May 17, 2013) (agreement to modify GST exempt trust will not cause the trust to lose GST exempt status). 151 ACTEC Comments on Transfers by a Trustee from an Irrevocable Trust to Another Irrevocable Trust (Sometimes called Decanting ) (Notice ) (Released December 21, 2011), available at ACTEC website. 47

70 taxed to the beneficiary, and not to the trust. If the individual beneficiary has income below the top marginal rate for individuals, the beneficiary would pay ordinary income tax at a lower rate, would pay capital gains tax at 15%, and if the beneficiary s income is below certain amounts (such as $250,000 for joint return filers and $125,000 for single filers), then the individual would not be subject to the 3.8% net investment income tax. For example, a distribution of capital gains to a beneficiary could result in immediate overall tax savings, perhaps reducing the overall tax burden from 23.8% to 15%. 4. However, distribution for these tax purposes is not always permitted under the terms of the trust and applicable law. Many trusts only allow a distribution of income for a beneficiary s support, and a trustee may not feel comfortable making distributions solely for overall tax savings. In addition, generally capital gains are not deemed to be distributed to a beneficiary, and thus the capital gains tax is borne by the trust, not by any beneficiary. 5. A trust could be decanted to a second trust that expands the trustee s authority to make distributions of income to the beneficiary, and to allow the trustee to consider income tax savings when making such a distribution. In addition, the second trust could grant the trustee express powers, including the authority to allocate capital gains to income, which would allow the trust to distribute capital gains and include capital gains in distributed income Such a decanting could result in significant tax savings over the life of the trust, although it would also require beneficiaries to bear that tax, rather than the trust. B. Decant to provide for step-up in basis 1. Many trusts were established at a time when the estate tax exemption was much lower than in the current environment. Estate planning under prior tax law was often designed to pass assets into an irrevocable trust to avoid inclusion in the estate of a later beneficiary or surviving spouse. But current tax law may weigh in favor of decanting to increase the amount included in a beneficiary s estate, in order to allow for a step-up in basis and income tax savings upon the beneficiary s death. 2. Assets included in a beneficiary s estate are entitled to a step-up in basis, thereby resulting in an overall savings of capital gains. 152 See Treas. Reg (a)-3(b). 48

71 3. Meanwhile, with an estate tax exemption currently at $5,430,000 for 2015, and indexed for inflation, many individuals can pass additional assets through their estates without increasing their estate tax liability. 4. A trustee who holds low-basis assets might adopt the following approach. The trustee would decant to a second trust, which would grant a current beneficiary a general power of appointment over all or a portion of the assets. The general power of appointment could also apply only to a fraction of the trust assets, to be determined based on the beneficiary s unused estate tax exemption. Upon the beneficiary s death, the assets would be included in the beneficiary s estate under Section But assuming that the total value of the beneficiary s estate does not exceed his or her estate tax exemption, the beneficiary s estate would owe no estate tax. And the assets that pass through the beneficiary s estate would receive a step-up in basis. 5. Other tactics could also pass additional assets to the beneficiary, but these seem to have some disadvantages when compared to decanting. a. For example, a trustee could increase distributions to the beneficiary, which over time would decrease the value of the trust increase the amount in the beneficiary s gross estate for estate tax purposes. b. However, that approach is irrevocable, in that if the trustee distributes too much, the beneficiary cannot transfer the assets back to the trustee without further tax consequences. c. Moreover, this approach would tax time, and many trustees may prefer to put such a plan in place now, particularly if a beneficiary is of advanced age. 6. While decanting to grant a beneficiary a general power of appointment may seem favorable in theory, trustees should be careful in adopting it. a. First, the trustee should be careful to weigh the potential risks of including additional assets in the beneficiary s estate. If in the future the estate tax exemption decreases, then the trustee will have subjected additional assets to a high rate of estate tax. b. Second, the trustee should be aware that this tactic is not necessarily reversible. Under the Draft Uniform Trust Decanting Act, if the first trust grants a beneficiary a general power of appointment, then the decanting may not remove that general power of appointment. And even without such a specific statutory prohibition, a beneficiary with a general power of appointment may have standing to object to a later attempt to limit that power of appointment. 49

72 c. Third, assets that are subject to an individual s general power of appointment may be subject to claims of that individual s creditors, whereas retaining the assets in trust may shield those assets from such creditors. 7. Thus, while decanting may provide an opportunity to reduce income tax, the trustee should be wary of potential pitfalls. C. Decant to change situs for state income tax purposes 1. The trustee could also decant the trust to attempt to avoid state income tax on the trust in the future. It is not clear if this approach would be effective in avoiding state income tax of the state of the original trust. 2. State income tax is levied on a trust based on a wide range of rates; some do not charge any income tax at all, while some states tax trust income at 13.3 percent If a trustee simply moved the trust from one state to another, the first state might still attempt to levy state income tax on that trust, based on applicable statutes in the first state. 4. Recent cases have suggested that when a trustee moves a trust from one state to another, and severs ties with that prior state, the first state may be unable to levy income tax on the trust in the future. 154 However, these cases are in flux, and depend on the circumstances of the trust and applicable law. For example, these cases seem to allow a state to continue to tax a testamentary trust that has changed its situs, based on the principle that the trust was established under a judicial process of the first state that follows the trust But if the trustee decanted the first trust to a second trust, with its situs, principal place of administration, and trustee in a second state, then the trustees of the second trust would have a stronger argument that the income of the second trust may not be taxed by the first state. 153 The following jurisdictions have the highest trust income tax rates as of 2014: California (13.3%); Hawaii (11%); Oregon (9.9%); Minnesota (9.85%); Iowa (8.98%); and New Jersey (9.97%). See Peter J. Melcher, Robert S. Keeler, & Steven J. Oshins, A Guide to Trust Decanting: When to consider this strategy and the potential tax consequences, Tr. & Est. (May 2015), at p.15 & n.2. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state income tax. Id. 154 See. e.g., Linn v. Department of Revenue, 2003 Ill. App. 4th (December 18, 2013). 155 See id. (citing cases). 50

73 6. Trustees should carefully review their duties in this regard, to ensure that they are fulfilling their obligations to state taxing authorities. Trustees should also carefully monitor this developing case law. III. Thus, decanting provides particular opportunities for tax savings, and particularly savings of income tax. And if the decanting is properly planned and executed, then the trustee may be able to reduce or eliminate such income tax without triggering gift, estate, or generation-skipping transfer tax. CONCLUSION I. Ultimately, decanting provides a helpful tool for modifying an irrevocable trust. Decanting has certain advantages over other methods of modification, particularly because of lack of beneficiary consent or judicial participation. II. III. IV. However, these same advantages also should give a trustee pause over whether the trustee is fully protected, particularly in the absence of case law addressing these issues in detail. Fiduciaries, beneficiaries, and advisors should be aware of the potential benefits of decanting, and its limitations and potential pitfalls. If viewed in the proper context, decanting can be an important tool of the fiduciary, beneficiary, settlor, and advisor in providing for the efficient administration of a trust, and one which can respond to changes over time. \ _6 51

74 2015 Trust and Estate Planning Briefing/Webcast Series The American Bankers Association announces the 2015 Trust and Estate Planning Briefing/Webcast Series. Our featured speakers, Charles D. Fox IV, partner, McGuireWoods LLP and Thomas W. Abendroth, partner, Schiff Hardin LLP are nationally-recognized trust and estate attorneys and tenured teachers from the ABA Trust Schools. They will provide you and your staff with critical information on estate planning and trust administration topics. This series provides you with an excellent business development opportunity; invite outside counsel to attend these informative programs at your location. New this year programs will be streamed over the Internet. Reserve 1:00 3:00 p.m. ET on these dates In order to provide listeners with timely information, the presenters reserve the right to alter the content or emphasis of the programs. Choose Your Weapon: The Advantages and Disadvantages of Corporations (C and S), LPs and LLCs October 1, CTFA (FP) credits, 2.0 CPEs for CPAs (Taxes); 2.0 CFP credits This briefing will examine the tax and non-tax advantages of different types of entities. Topics to be discussed include: The structure of corporations, partnerships, limited liability companies, and sole proprietorships Factors in deciding which type of entity to use The tax consequences of C and S Corporations Structural and operational differences between limited partnerships and LLCs The choice in the tax treatment of LLCs The Alphabet Soup of Planning and Trust Acronyms and Service Marks November 5, CTFA (FID), 2.5 CISP credits, 2.0 CPEs for CPAs (Taxes); 2.0 CFP credits Well-known and less well-known acronyms in the trust field and the advantages and disadvantages will be examined. Among the types of trusts to be discussed are: The Supercharged Credit Shelter Trust ILITS SLATs GRATS or its cousin, the GRUT GRITs QPRTs IDGTs BING DINGs Charitable techniques such as CRTs and CLTs Recent Developments in Estate and Trust Administration December 3, CTFA (TAX), 2.5 CISP credits, 2.0 CPEs for CPAs (Taxes); 2.0 CFP credits A review of recent legislation, regulatory developments, cases, and public and private rulings in the estate, gift, generation-skipping tax, fiduciary income tax, and charitable giving areas will be provided. Some of the subjects to be discussed include: Marital Deduction Planning Portability Valuation Issues Availability of Discounts Gifts Charitable Planning Post Mortem Planning The Generation- Skipping Tax Asset Protection Insurance Fiduciary Income Tax ot Button Tax Issues for the IRS Aired: Feb 5, CTFA (TAX), 2.5 CISP, 2.5 CRSP credits Recording Now Available This session will examine those areas on which the IRS is currently focusing in both audits and litigation. Among the topics to be discussed are: Adequate Disclosure on Estate and Gift Tax Returns Challenges to the Charitable Façade Easement Reciprocal Trusts Material Participation for Trusts to Avoid the 3.8% Net Investment Income Tax Graegin Loans Defined Value Clauses Valuation of Self-Canceling Installment Notes Limits on Valuation Discounts Ethical Challenges for Trust Professionals Aired: Mar 5, CTFA (Ethics), 2.5 CISP, 2.5 CRSP, 2.5 CSOP credits Recording Now Available Different ethical rules and situations will be addressed during this briefing. The duty of loyalty The duty of impartiality The duty to invest prudently The fiduciary exception and communications with lawyers for the trust or estate Handling conflicts of interest

75 Show Me the Money: The Focus of States on Tax Revenues and Its Impact on Estate Planning Aired: Apr 2, CTFA (TAX), 2.5 CISP, 2.5 CRSP credits, ) Recording Now Available This program will look at state tax systems for taxing the income of trusts and estates, and the impact they have on estate planning. Some of the topics to be discussed are: Constitutional challenges to a state s ability to tax trusts Examples of techniques to minimize exposure to state income taxation The possible exposure to taxation by multiple states The basic rules for the state income taxation of non-grantor trusts and estates as compared to the federal rules The different points of nexus used by states to justify taxation irrevocable non-grantor trusts State efforts to limit the ability of resident individuals and trust to move for tax purposes Fiduciary Litigation Roundtable Aired: May 7, CTFA (FID), 2.5 CISP, 2.5 CRSP credits Recording Now Available A panel of attorneys will discuss current trends in fiduciary litigation and how to minimize a trustee s exposure. Topics will include: Current fiduciary litigation cases Diversification and Other Investment Disputes Keeping Beneficiaries Informed Decanting Closely-Held Assets in Trust Critical Concepts in Understanding Community Property vs. Common Law Aired: Jun 4, CTFA (FP) credits Recording Now Available This session will be a primer on what trust professionals need to know about community property vs. common law states. Topics to be covered include: The basics of community property and distinctions from common law property rights What is quasi-community property How to plan for clients who move from a community property state to a common law state How to opt out or into community property The income, estate, and gift tax consequences of community property Community Property Trusts, LLPs and LLCs A Primer on Decanting Aired: Sept 3, CTFA (FID) credits Recording Now Available Twenty-two states now permit a trustee to decant an existing trust to a new trust if certain requirements are met. Topics to be discussed include: What is decanting The theory behind decanting Different state law approaches to decanting Changes permitted in decanting Planning opportunities involving decanting The estate, gift, and generation-skipping tax consequences of decanting Who Should Attend? Trust Officers Estate Planners Trust Counsel Trust Dept. Managers Wealth Managers Private Bankers Trust Tax Professionals Financial Planners CTFAs, CPAs, CFPs Registration/Site License Fee PER Briefing Purchased ABA/FIRMA/ICB Member/Service Member: $265 Non-Member: $395 These ABA Briefings/Webcasts includes streaming audio over the Internet, where an unlimited number of listeners can participate at one location. Audio over the telephone can be provided as an alternative. Any transmission, retransmission or publishing of these briefings is strictly prohibited. Register Today! Register online at or call BANKERS ( ). Need Continuing Education Credits? The Institute of Certified Bankers (ICB) approved each of the 2015 programs listed for various continuing education credits as indicated in this flyer. You are eligible to receive ICB credits by listening to the live program or the recording. CFPs and CPAs must listen to the LIVE program in order to receive continuing education credits. Questions? Contact Linda Shepard at lshepard@aba.com. Or, call BANKERS ( ). American Bankers Association is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional educational on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: learningmarket.org.