Modification of Irrevocable Trusts. National Conference on Special Needs Planning and Special Needs Trusts October 20, 2017

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1 Modification of Irrevocable Trusts National Conference on Special Needs Planning and Special Needs Trusts October 20, 2017 Amy J. Fanzlaw, Esq. Boca Raton, Florida 1 Amy J. Fanzlaw (2017)

2 I. Introduction At common law, and traditionally in many states, a trust is presumed to be irrevocable unless the trust terms expressly reserve the right to modify or revoke the trust. 1 This presumption is reversed with the Uniform Trust Code and many of those states that have adopted it. Under the Uniform Trust Code, a trust is presumed to be revocable unless the trust terms expressly state that the trust is irrevocable. 2 There is an interesting relationship between the concept of revocability and alterability. Revocability necessarily means a trust may be amended or altered, 3 but irrevocability does not necessarily preclude alterability. If this is not recognized and instead irrevocability is equated with inalterability, the tools available to help clients are severely limited, which leads to draconian consequences, 4 which often fall squarely on the shoulders of beneficiaries. This article will focus on the variety of options available to modify or change an irrevocable special needs trust. Focus will be on trust law with a national perspective. In this regard, the Uniform Trust Code is instructive. The Uniform Trust Code provides a comprehensive model for codifying the law on trusts for the purpose of aiding state legislatures in passing laws governing the creation, administration, and modification of trusts. 5 The Uniform Trust Code has been enacted in Alabama, Arizona, Arkansas, District of Columbia, Florida, Kansas, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oregon, Pennsylvania, South Carolina, Tennessee, Utah, Vermont, Virginia, West Virginia, Wisconsin, and Wyoming, 1 See UNIF. TRUST CODE 602 cmt. (2010). 2 See UNIF. TRUST CODE 602(a). 3 See UNIF. TRUST CODE 602 cmt.; cf. RESTATEMENT (THIRD) OF TRUSTS 62 (2003). 4 Stuart D. Zimring, Rebecca C. Morgan, & Bradley J. Frigon, The Fundamentals of Special Needs Trusts 3.03(8), at Completed by the Uniform Law Commissioners in 2000, it was amended most recently in See Code. A complete copy of it may be found at The Uniform Trust Code is simply a model or recommendation; it must be promulgated by individual states in order to become law there. 2

3 with the most recent introduction in Illinois in Thus, even though the laws of a specific state are not the focus of this article, the principles discussed are applicable to many states. Still, it is critical to check the laws of a specific state, as even those states that have adopted the Uniform Trust Code have often put their own twist on certain provisions. The Uniform Trust Decanting Act will also be examined. The Uniform Trust Decanting Act is narrower in scope than the Uniform Trust Code, in that it pertains only to decanting trusts, whereas the Uniform Trust Code pertains to nearly every aspect of trust administration. The Uniform Trust Decanting Act is also newer than the Uniform Trust Code; it was finalized in 2015, so it has not been around long enough to have been adopted by nearly as many states as the Uniform Trust Code has. Still, in the long run, the Uniform Trust Decanting Act may ultimately have as much impact as the Uniform Trust Code has had on individual state s legislation. In contrast to these uniform laws, which set forth models or recommendations for promulgated statutes prospectively, the Restatement (Third) of the Law of Trusts purport[s] to state an authoritative or recommended view of current American common law. 6 As a result, the Restatement (Third) is persuasive authority on the laws of the country, not as they should be, but as they currently are. As such, the Restatement offers guidance regarding trust administration and modification by illustrating common principles of governing laws and by discussing relevant cases, statutes, and secondary sources. In considering modification of special needs trusts in particular, inquiry should not be limited to trust law. Where a beneficiary is receiving needs-based public benefits, the rules and regulations governing eligibility must of course also be considered. While examination of these various laws is outside the scope of this article, thorough analysis of a particular matter must include it. 6 Edward C. Halbach, Jr., Uniform Acts, Restatements, and Trends in American Trust Law at Century s End, 88 CAL. L. REV (2000). 3

4 II. Decanting Options for Changing Trusts Terms: Reformation, Modification & I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail. 7 With limited tools, it is easy to become single-minded and apply tools indiscriminately or even inappropriately. When considering how to change the terms of an irrevocable trust, the inquiry should not be limited. There are a variety of tools available. One such tool is reformation. Reformation of a trust is a judicial action that seeks to fix errors in a trust, so that the reformed trust relates back in time to the creation of the trust. 8 It is sometimes helpful to think of reformation as a narrow (and specifically defined) subset of trust modifications in general, but only in the sense that a reformed trust is actually a modified (or changed) trust. Apart from a reformation action, trusts may be modified in a variety of other ways, both judicially and nonjudicially. Unlike reformation, which allows changes to relate back to the creation of the trust, modification changes the terms of the trust going forward. Decanting is yet another option. Decanting is often described in terms of the fine wine metaphor the term evokes: It is the pouring of a trust from one trust instrument into another trust instrument. 9 While the trust instrument itself (the bottle) is different, the contents of the trust (the fine wine) remain the same, leaving behind the undesirable material (the sediment). Unlike reformation and many types of modification methods, decanting generally does not require court involvement. 7 Abraham Maslow, TOWARD A PSYCHOLOGY OF BEING (1962). 8 See Kathleen R. Sherby, It May Not Be Broken, But It May Need Fixing: Validity, Construction, Instruction, Reformation, Modification, and Termination Actions, at 15 (2015). 9 It is hard to determine who first used this metaphor, but it has been developed masterfully by many, including Harry S. Margolis and Robert Fleming. 4

5 Each of these tools has subtle nuances. Some are more appropriate than others in certain circumstances, but all should be considered in any given circumstance in order to ensure the best possible solution to any given problem. Approaching this process with some sort of structure is helpful. First, consider the express terms of the trust, which will generally control. Even though there are many provisions that cannot be drafted around, 10 the trust document is the first place to start. It is amazing what can be learned by reading (actually reading, not skimming) a trust document, even one that you drafted. Provisions long-since forgotten as boilerplate might contain provisions that allow modification of some type by a fiduciary or third party, decanting of a trust, or merger of the trust with another trust in existence. Thoughtful and careful drafting can provide a wealth of tools that are available to keep a trust as flexible and meaningful as possible. If an issue cannot be resolved by the express terms of the trust, then review the governing statutory authority. If the statutes of the state in which the trust is being administered are not helpful, consider moving the situs of the trust to a state with more favorable statutes that might allow greater flexibility in modifying the trust or otherwise achieving the desired effect. Before undertaking a transfer of situs, however, be mindful of how such a move would impact other aspects of trust administration, including the benefits available to the beneficiary, income tax consequences (whether the trust will be subject to state income tax in the new jurisdiction and how that will ultimately affect the beneficiary and the trust corpus), 11 accounting requirements, trustee compensation, beneficiary notification requirements, and other statutory requirements impacting the 10 Under the Uniform Trust Code, there are certain mandatory provisions that cannot be changed by the terms of the trust, including the duty of a trustee to act in good faith, the requirement that the trust have a lawful purpose and not be contrary to public policy, the power of the court to modify or terminate a trust, the effect of a spendthrift provision and creditor rights, the power of the court to adjust trustee compensation, the duty to provide certain notification to and information about the trust to the trust beneficiaries, and subject matter jurisdiction of the court. See UNIF. TRUST CODE 105(b)(2005). 11 For non-grantor trusts, a handy reference (although by no means a substitute for advice from a qualified attorney licensed in the state in question) is the Annual Non-Grantor Trust State Income Tax Chart compiled by Steve Oshins of Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, which can be found on the firm s website at 5

6 administration of the trust. In order to avoid the unauthorized practice of law in another jurisdiction (not to mention malpractice due to failure to understand the nuances of an unfamiliar state s trust laws), it is prudent to seek the advice of a qualified attorney practicing in the state being considered. If applicable state statutes are unhelpful and moving the trust situs for more favorable treatment is not an option, then consider whether options are available at common law. Sometimes, statutory modifications expressly state that they do not supersede available common law remedies. 12 When that is the case, additional options under common law may be available. For example, judicial modification for inter vivos trusts may be possible in an emergency situation to preserve the trust 13 or to correct a scrivener s error. 14 A court may also be authorized under common law to terminate a trust when trust s purpose has been accomplished or becomes impossible to accomplish. 15 Nonjudicial modification (even termination) may even be possible by unanimous consent of the settlor and all beneficiaries For example, modification of trusts in Florida under FLA. STAT (Judicial Modification of Irrevocable Trust When Modification Is Not Inconsistent with Settlor s Purpose), (Judicial Modification of Irrevocable Trust When Modification Is in Best Interests of Beneficiaries), and (Nonjudicial Modification of Irrevocable Trust) are expressly in addition to, and not in derogation of, rights under common law to modify, amend, terminate, or revoke trusts. See FLA. STAT (4), (5), (6) (2017). 13 See, e.g., Pentland v. Pentland, 13 So. 2d 872 (Fla. 2d DCA 1959) (allowing judicial modification in an emergency situation when court action is indispensable to the preservation of the trust). 14 See, e.g., In re Estate of Robinson, 720 So. 2d 540 (Fla. 4th DCA 1998) (allowing judicial modification due to unilateral mistake in drafting where reformation was not contrary to settlor s interest). 15 See, e.g., Featherston v. Tompkins, 339 So. 2d 306 (Fla. 4th DCA 1976) (testamentary trust); City of Islandia v. Metro. Dade Cnty., 362 So. 2d 385 (Fla. 3d DCA 1978) (inter vivos trust); but see Schwarzkopf v. Am. Heart Ass n of Greater Miami, Inc., 541 So. 2d 1348 (Fla. 3d DCA 1989) (trust may not be terminated before expiration of specific term or duration expressed in trust). 16 See, e.g., Preston v. City Nat l Bank, 294 So. 2d 11 (Fla. 3d DCA 1974) (modification by unanimous consent of grantor and beneficiaries); Bieley v. Bieley, 398 So. 2d 932 (Fla. 3d DCA 1981) (grantor may modify distribution provisions without beneficiary consent by surrendering privileges or rights in favor of trust beneficiaries); Smith v. Mass. Mut. Life Ins. Co., 156 So. 498 (Fla. 1934) (grantor and beneficiaries may terminate by unanimous consent). 6

7 III. Reformation of Trusts Trust reformation involves rewording a trust to correct a mistake in the document so that it accurately reflects what the settlor intended it to state. Trust reformation may also involve rewording a trust document when the settlor s intent was based on a mistake. While reformation was available in many jurisdictions either statutorily or through common law, the remedy was not available to courts in a minority of jurisdictions until the adoption of the Uniform Trust Code. 17 Section 415 of the Uniform Trust Code provides as follows: SECTION 415. REFORMATION TO CORRECT MISTAKES. The court may reform the terms of a trust, even if unambiguous, to conform the terms to the settlor s intention if it is proved by clear and convincing evidence what the settlor s intention was and that the terms of the trust were affected by a mistake of fact or law, whether in expression or inducement. Reformation is a mandatory provision of the Uniform Trust Code, meaning it cannot be precluded or modified by the settlor. 18 The types of mistakes that can be corrected through reformation are varied. For example, the mistake might be one of expression, such that the scrivener failed to include a provision the settlor intended (or included a provision that the settlor did not intend to be included). In public benefits planning, this may occur where the scrivener inadvertently omits special needs trust provisions for a disabled beneficiary even though the settlor s clear intent was that the beneficiary maintain eligibility for needs-based benefits. The mistake might also be one of inducement, i.e., the settlor intended for a provision to be included or excluded, but such intention was based upon a mistake of law or fact. An example here might be where the trust directs discretionary payment of income to a disabled beneficiary based upon the ascertainable standard upon the mistaken 17 See Sherby, supra note 8, at See UNIF. TRUST CODE

8 belief that income paid for health, support, maintenance, and education would not affect that beneficiary s eligibility for needs-based benefits. It is important to distinguish reformation from a court proceeding to resolve an ambiguity. Resolving an ambiguity involves the interpretation of language already in the instrument. Reformation, on the other hand, may involve the addition of language not originally in the instrument, or the deletion of language originally included by mistake, if necessary to conform the instrument to the settlor s intent. 19 Still, the court may consider evidence relevant to the settlor s intent even though it may contradict an apparent plain meaning of the trust text. 20 In a reformation action, the court rewrites portions of the trust to add or omit words that were mistakenly included or excluded. A petition for reformation should set out the exact provisions to be changed, the exact language to be added or deleted, and the final corrected version of the trust the petition is seeking to have the court adopt. 21 All beneficiaries whose interests are affected should be joined in the court proceeding. While specific state statutes may vary, 22 under the Uniform Trust Code, the settlor s intent must be established by clear and convincing evidence in order for the court to reform the trust, so extrinsic evidence of the settlor s intent must be introduced through testimony or documentary evidence. 23 The higher standard of proof of clear and convincing evidence helps guard against the possibility of unreliable or contrived evidence. 24 Reformation cannot fix all mistakes. Reformation is not available where a wouldbe settlor mistakenly believed a trust was unnecessary to achieve his or her intent, i.e., where there is no trust to reform. Reformation is also not available where the settlor had a 19 See UNIF. TRUST CODE 415 cmt. 20 See id. 21 Sherby, supra note 8, at Always check the applicable state s statutes! 23 See UNIF. TRUST CODE 415 cmt. 24 Id. At least one state has modified this standard to preponderance of the evidence. See W. VA. CODE 44D

9 change of heart after executing the trust. Finally, reformation is not available where there is no mistake to fix, only an unanticipated change in circumstances. 25 An interesting question remains as to whether wills may be reformed in those minority jurisdictions that did not otherwise permit the reformation of wills. Even if one of those minority jurisdictions adopted the Uniform Trust Code, the Uniform Trust Code applies to, well, trusts. It does not apply to wills. In the last couple of years, however, at least one jurisdiction (California) has reasoned that wills should be treated the same as trusts are under the Uniform Trust Code and that courts should consider extrinsic evidence when determining a testator s intent just as statutes allow the courts to do for trusts. 26 According to the California Supreme Court, a broad, categorical prohibition of reformation of unambiguous wills cannot be justified provided that clear and convincing evidence supports reformation because this higher level of proof adequately protects against those evidentiary concerns that led to the prohibition in the first place. 27 The tax consequences of any reformation or modification should be carefully considered prior to undertaking the action, particularly if the assets involved are substantial, any of the parties involved may have estate or gift tax issues, or reformation shifts beneficial interests in a way that affects a marital or charitable deduction. 28 Generally, the federal tax consequences of a reformation action will depend upon the rights and interests of the parties under state law, and state estate tax consequences generally follow suit. To the extent possible, practitioners should attempt to establish that the error was one of drafting, rather than one of planning, as the IRS appears to be more inclined to allow retroactive reformation in cases where the errors are directly tied to drafting See I. Mark Cohen, nd T.M., Uniform Trust Code, at A-69; cf. UNIF. TRUST CODE 412 (allowing modification for change in circumstances). 26 See In re Estate of Duke, 61 Cal. 4th 871 (2015). 27 See id. 28 Merely obtaining a judicial reformation does not assure favorable tax treatment. Howard M. Zaritsky, Trust Reformation Is Not Always a Good Solution, 40 Est. Plan. 47 (Jan. 2014); see PLR Zaritsky, supra note 28, at 47. 9

10 Gift tax issues are generally not implicated so long as beneficiaries do not consent to the relief requested, and even then, gift tax issues may be avoided. If reformation involves shifts in beneficial interests between generations or involves a generationskipping tax exempt trust, reformation will not cause a trust exempt from generationskipping tax to lose its GST tax-exempt status so long as the reformation concerns a bona fide issue and the court order is consistent with applicable state law. 30 IV. Modification Unlike reformation, which corrects mistakes to modify a trust nunc pro tunc so that the trust terms carry out the settlor s intention, modification of a trust is generally viewed as a change of the trust terms going forward in a way that is different from what the settlor intended in order to achieve a different result. 31 If a settlor s intent is such an untouchable precept of trust administration and construction, why would modification of a trust especially an irrevocable trust ever be entertained or needed? Sometimes drafting issues are to blame, but usually modification is sought due to some sort of change in circumstances: a change in the primary beneficiary s needs, a change in a special needs beneficiary s state of residence, a change in laws regarding eligibility for needs-based benefits, a change in family dynamics, or even a change in tax laws. For as many circumstances as there are that might call for modification, there are nearly as many options for methods of modification. The methods for modifying irrevocable trusts are varied in scope, purpose, and procedure. Some involve judicial proceedings, and others rely only upon the actions of the parties. Some are authorized by statute only, while others might be authorized by the terms of the trust document or common law or all of the above. Choosing the appropriate method will require careful 30 See TREAS. REG (b)(4)(i)(C). If the reformation action is settled, settlement must be a product of arm s length negotiations and within the range of reasonable outcomes. 31 Because of this, modification of a trust with a beneficiary who receives or wants to preserve needsbased benefits should be approached carefully, deliberately, and thoughtfully, as the risk of challenge by Social Security Administration may be greater. 10

11 analysis of the given facts and circumstances, especially where preservation of eligibility for needs-based benefits is involved. A. Nonjudicial Settlement Agreements Among Interested Parties Many states, including those jurisdictions that have not adopted the Uniform Trust Code, have procedures through which trust issues can be settled without court intervention. This option can informally resolve issues, including modification or construction issues, without the time and cost of litigation. Under Florida common law, for example, the settlor and all beneficiaries may modify an inter vivos irrevocable trust by consent, 32 and the settlor may (without the beneficiaries consent) amend a trust by surrendering privileges or rights in favor of trust beneficiaries, 33 but there is no mechanism under Florida common law by which the trustee and all beneficiaries may modify a trust so there is no common law modification after the death of the settlor. The Uniform Trust Code provides authority for all interested parties to modify trust provisions in 111. Section 111 of the Uniform Trust Code provides that interested persons that is, those whose consent would be required to bind a court-approved settlement may enter into a binding agreement with respect to any matter involving a trust, including but not limited to interpreting and construing trust terms, directing a trustee not to act, granting a trustee power to act, transferring the trust s principal place of administration, and determining the trustee s liability for an action taken in the trust administration. 34 Interested parties thus would include the trustee, but not necessarily the settlor. A nonjudicial settlement agreement under 111 may not violate a material purpose of the trust and cannot include terms or conditions that could not be approved by a court. 35 To the extent it does either of those things, the agreement is invalid. 36 While 32 See Preston, 294 So. 2d at See Bieley, 398 So. 2d at See UNIF. TRUST CODE See UNIF. TRUST CODE 111(c). 11

12 court approval is specifically not required, it may be sought. 37 Seeking court approval, however, will likely implicate other provisions of the Uniform Trust Code that pertain to court approval, thus parlaying a nonjudicial settlement into a judicial settlement agreement. Under the Restatement view, all beneficiaries of an irrevocable trust may, by unanimous consent, compel modification of an irrevocable trust, unless modification would be inconsistent with a material purpose of the trust. 38 However, even where modification would be inconsistent with a material purpose of the trust, modification by unanimous consent of the beneficiaries is still possible if either the settlor consents or if after the settlor dies a court authorizes modification after determining that the reasons for modification outweigh the material purpose of the trust. 39 B. Nonjudicial Modification by Consent of Beneficiaries & Settlor Section 411 of the Uniform Trust Code contains several options for modification by consent. Under section 411(a), if the settlor is alive and the settlor and all beneficiaries consent, an irrevocable trust may be modified in any way whatsoever, even if modification is inconsistent with a material purpose of the trust. 40 Thus, section 411(a) may be used to modify a trust for just about any reason, including reducing or eliminating some beneficiaries interests and increasing others and changing times and amounts of distributions to beneficiaries. 36 See UNIF. TRUST CODE 111(c). 37 See UNIF. TRUST CODE 111(e). 38 See RESTATEMENT (THIRD) OF TRUSTS 65(1) (2003). Beneficiaries may also terminate a trust under the same conditions. 39 See id. In states with similar laws to this, this can be lethal to a special needs trust for purposes of determining eligibility for needs-based benefits. Careful drafting may avoid this result by ensuring that the material purpose of the trust is clearly delineated in the terms of the trust, i.e., the purpose of this trust is to ensure that the beneficiary qualifies for needs-based public benefits, so that the material purpose of the trust need not be inferred. It may also be desirable in some circumstances to specifically prohibit beneficiaries from modifying the trust by unanimous consent. 40 See UNIF. TRUST CODE 411(a). 12

13 A settlor s consent may be given by an agent under a power of attorney if such authority is specifically conferred in the power of attorney or the trust, or by a conservator (or guardian) if local law allows the exercise of such authority. 41 The trustee s consent is not required, but the trustee has standing to object. 42 Where a beneficiary lacks capacity to consent, modification under section 411(a) may still be possible. While common law did not readily permit representation of beneficiaries who were not sui juris, 43 consent on behalf of a beneficiary may be given under the concepts of representation or appointed representatives. 44 It cannot be overemphasized that specific state statutes must be consulted, even in Uniform Trust Code jurisdictions, as there is a lot of variance among the provisions of 411 ultimately adopted by different states. For example, while 411 as drafted does not require court approval where the settlor and all beneficiaries consent, this is a minority position, with only ten of the twenty-six jurisdictions that allow for modification by consent allowing it without court approval. 45 In other states that have enacted this provision, a court finding that all beneficiaries and the settlor have consented to the modification is required. 46 In some states, only qualified beneficiaries need to consent to the modification. 47 Tennessee allows only a veto by the settlor, rather than consent, See UNIF. TRUST CODE 411(a) & cmt. 42 See UNIF. TRUST CODE 411 cmt. (stating that the trustee has standing to object to a proposed modification under 410). 43 See RESTATEMENT (THIRD) OF TRUSTS 65 cmts. b, c (2003). 44 See UNIF. TRUST CODE, art. 3. Virtual representation of one beneficiary by another may be of limited use because representation will not be allowed where there is a conflict of interest among the beneficiaries, see UNIF. TRUST CODE 304, but in a conflict of interest case, a representative may be appointed by the court, see UNIF. TRUST CODE See Cohen, supra note 25, at A In states that previously required court approval for modification but then later removed the requirement for court approval, additional issues pertaining to the inclusion of the trust corpus in the settlor s gross estate for federal estate tax purposes may be implicated. See Cohen, supra note 25, at A- 60. Closer scrutiny of this issue in those jurisdictions may therefore be prudent. 47 See MICH. COMP. LAWS ; FLA. STAT (1); KAN. STAT. ANN. 58a-411(a); TENN. CODE. ANN (a). 48 See TENN. CODE ANN (a). 13

14 but in other states, a settlor is not a party at all. 49 At least four states (Arizona, Michigan, New Hampshire, and North Dakota) do not permit modification that would violate a material purpose of the trust under any circumstances. 50 Using this provision should not implicate adverse tax consequences, as the settlor s right to join the beneficiaries in modifying a trust under 411 does not constitute a taxable power, 51 and if the beneficiaries agree to distribute the trust property without shifting beneficial interests, no gift tax consequences should result. 52 C. Judicial Modification by Consent If the settlor is not alive or does not consent, and if the trustee for whatever reason does not wish to consent, modification is still possible. However, court involvement becomes necessary and the material purpose of the trust becomes relevant. Under section 411(b), the beneficiaries may act unanimously to modify an irrevocable trust if a court determines that the modification would not be inconsistent with a material purpose of the trust. 53 As with nonjudicial modification by consent, the trustee s consent is not required, but the trustee has standing to object. 54 Because the settlor need not be involved, this provision is often used in third-party trusts where the settlor has died, thus rendering the trust irrevocable. The material purpose of the trust must be of some significance. In this, the Uniform Trust Code and the Restatement (Third) of Trusts are aligned: 49 Settlors in Florida do not participate, but the court must consider the terms of purposes of the trusts, the facts and circumstances surrounding the creation of the trust, and extrinsic evidence relevant to the proposed modification. See (3), Fla. Stat. 50 See Cohen, supra note 25, at A See TREAS. REG (a)(2). 52 See UNIF. TRUST CODE 411 cmt. Of course, doing so will likely lead the Social Security Administration to consider the modified trust to be self-settled under 42 U.S.C. 1396p(d)(4)(A) (assuming all other requirements of a d4a trust can be met) because the beneficiary had existing rights with regard to the trust property and/or exercised control over the assets by consenting to the modification. 53 See UNIF. TRUST CODE 411(b). 54 See id. 14

15 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 concern with regard to the beneficiary s management skills, judgment, or level of maturity. Thus, a court may look for some circumstantial or other evidence indicating that the trust arrangement represented to the settlor more than a method of allocating the benefits of property among multiple beneficiaries, or a means of offering to the beneficiaries (but not imposing on them) a particular advantage. Sometimes, of course, the very nature or design of a trust suggests its protective nature or some other material purpose. 55 According to the drafters of the Uniform Trust Code, spendthrift provisions are often added to instruments with little thought. 56 Therefore, there is an optional provision available in the Uniform Trust Code that a spendthrift provision in the trust is not presumed to constitute a material purpose of the trust. 57 A majority of jurisdictions, however, have not enacted this presumption, and many states do not address this presumption at all. 58 If all of the beneficiaries do not consent to a proposed modification under either Uniform Trust Code 411(a) or (b), modification may still occur with court approval if the court determines that the trust could have been modified if all beneficiaries had consented and the interests of the non-consenting beneficiaries will be adequately protected. 59 Thus, while unanimous agreement among the beneficiaries is not necessary, it is helpful in that it expedites modification under 411. Common law generally provides that beneficiaries may modify a trust by unanimous consent only if doing so would not violate a material purpose of the trust. 60 The Restatement view is similar; the Restatement (Third) of Trusts allows beneficiaries to compel termination of a trust after the settlor s death if termination serves a material purpose and a court determines that the reasons for termination outweigh those in favor 55 See UNIF. TRUST CODE 411 cmt. (quoting RESTATEMENT (THIRD) OF TRUSTS 65 cmt. d). 56 See UNIF. TRUST CODE 411 cmt. 57 See UNIF. TRUST CODE 411(c). 58 See Cohen, supra note 25, A-60, See UNIF. TRUST CODE 411(e). 60 See Cohen, supra note 25, A

16 of continuing the trust. 61 Absent language in the trust permitting the settlor to modify a trust (and absent fraud, duress, mistake, impossibility, or illegality), a settlor generally has no standing under common law to modify an irrevocable trust. D. Modification for Unanticipated Consequences Section 412(a) of the Uniform Trust Code authorizes courts to modify any administrative or dispositive provisions of a trust without the beneficiaries consent upon a finding that there are changed circumstances not anticipated by the settlor at the time of the trust s creation and modification will further the purposes of the trust. 62 The modification must also be in accordance with the settlor s probable intention. 63 The beneficiary s consent is not required. Under 412(a), the unforeseen or unanticipated circumstances must be truly unforeseen. Two of the most common circumstances in which modification might be sought include the failure of the settlor to anticipate economic changes and the failure of the settlor to anticipate the changing needs of a beneficiary. 64 According to the comments of the Uniform Trust Code, modification might be appropriate under 412 to support a beneficiary who has become unable to be self-sufficient due to poor health or serious injury. 65 Of course, the opposite could also be true: a trust might be modified to include appropriate special needs trust provisions in order to allow that same beneficiary to become eligible for needs-based benefits. Section 412(a) of the Uniform Trust Code is similar to Restatement (Third) of Trusts 66, which states, The court may modify an administrative or distributive provision of a trust, or direct or permit the trustee to deviate from an administrative or distributive provision, if because of circumstances not anticipated by the settlor the 61 See RESTATEMENT (THIRD) OF TRUSTS 65(2) (2003). 62 See UNIF. TRUST CODE 412(a). 63 See id. 64 See UNIF. TRUST CODE 412 cmt. 65 See id. 16

17 modification or deviation will further the purposes of the trust. 66 However, the Restatement (Third) of Trusts goes a bit further in that it imposes an affirmative duty on the trustee who knows or should know of circumstances that justify judicial action to petition the court for modification. Note, however, that this affirmative duty on the trustee is limited to modification with respect to an administrative provision; a trustee has no duty to petition the court to modify a dispositive provision of a trust, although the trustee certainly may do so. 67 In contrast to 411 of the Uniform Trust Code, the purpose of modifying a trust to deviate from the original terms under 412(a) is not to disregard the settlor s intent, but rather to modify inopportune details to effectuate better the settlor s broader purposes. 68 Unlike an action for reformation under 415, while the circumstances may not be anticipated by the settlor, the circumstances may in fact have been in existence when the trust was created. 69 Section 412 thus complements 415, which allows for reformation of a trust based on mistake of fact or law at the creation of the trust. E. Modification to Prevent Impairment of Trust Administration The court may also modify the administrative terms of a trust under 412(b) of the Uniform Trust Code if continuation of the trust on the current terms would be impracticable or wasteful or would impair the trust s administration. 70 Under 412(b), it is not necessary that the court find that unanticipated circumstances prevent the trust from serving its purpose. 71 However, the court s powers under 412(b) are limited to modification of administrative provisions only; dispositive provisions may not be modified. 72 The beneficiary s consent is not required. 66 See RESTATEMENT (THIRD) OF TRUSTS 66(1) (2003). 67 See RESTATEMENT (THIRD) OF TRUSTS 66(2) & cmt. (2003). 68 See UNIF. TRUST CODE 412 cmt. 69 See id. 70 See UNIF. TRUST CODE 412(b). 71 Cf. UNIF. TRUST CODE 412(a). 72 See Shriners Hosps. For Children v. Firstar Bank, N.A., 89 P.3d 898 (Kan. 2004), for an illustration of the distinction between UNIF. TRUST CODE 412(a) and (b). 17

18 This provision does not have a common law counterpart. 73 As with other provisions of the Uniform Trust Code, various jurisdictions put unique spins on the requirements under this section, so consultation of a specific state s laws is advisable. 74 While the Uniform Trust Code specifically provides that 412 is a mandatory provision that cannot be modified, 75 at least one state allows the drafter of a trust to circumvent these modification provisions by inserting a clause prohibiting modification under these circumstances. 76 F. Modification of Charitable Trust Under 413 of the Uniform Trust Code, if a particular charitable purpose becomes unlawful, impracticable, impossible to achieve, or wasteful, the court may apply the cy pres doctrine to modify or terminate the trust by directing that the trust property be applied or distributed, in whole or in part, in a manner consistent with the settlor s charitable purposes. 77 This power may be applied to modify an administrative or a dispositive term of the trust. Like the Restatement (Third) of Trusts 67, there is a presumption under 413 that the settlor had a general charitable intent when a particular charitable purpose becomes impossible or impracticable to achieve. The traditional doctrine of cy pres did not supply that presumption, leaving it to the courts to determine whether the settlor had a general charitable intent See Cohen, supra note 25, at A See, e.g., FLA. STAT , (limiting application of similar modification sections to trusts not subject to 360-year rule against perpetuities and providing that modification is in addition to and not in derogation of common law); N.D. CENT. CODE (specifically prohibiting the settlor from modifying a trust under this section); N.M. STAT. ANN. 46A-4-412(A) (providing that the standard of proof for modification is clear and convincing ); MICH. COMP. LAWS (3) (requiring specific notification of modification proceedings). 75 See UNIF. TRUST CODE See FLA. STAT , See UNIF. TRUST CODE See UNIF. TRUST CODE 413 cmt. 18

19 Charitable purpose means the relief of poverty, the advancement of education or religion, the promotion of health, governmental or municipal purposes, or other purposes the achievement of which is beneficial to the community. 79 If the terms of a charitable trust do not indicate a particular charitable purpose, the court may select one, but the selection must be consistent with the settlor s intention to the extent it can be ascertained. 80 An action under this section may be brought by a settlor, a trustee, the state attorney general, or a person having a special interest in the charitable disposition. 81 G. Modification of Uneconomic Trust Section 414(b) of the Uniform Trust Code allows a court to modify a trust or remove the trustee and appoint a different trustee if the court determines that the value of the trust is insufficient to justify the cost of administration, even if the settlor has forbidden it. 82 Regardless of the total value of the trust corpus, judicial modification may be allowed. 83 Section 414(a) of the Uniform Trust Code also provides a nonjudicial procedure for the trustee to terminate a trust with a total value of less than $50, if the trustee concludes that the value of the trust property is insufficient to justify the cost of administration. 84 The amount may be changed from $50, to something higher or 79 See UNIF. TRUST CODE 405(a). 80 See UNIF. TRUST CODE 405(b). 81 See UNIF. TRUST CODE 405(c); see also UNIF. TRUST CODE 413 cmt. (citing RESTATEMENT (SECOND) OF TRUSTS 391). 82 See UNIF. TRUST CODE 414(b) & cmt; UNIF. TRUST CODE 105(b)(4). 83 See UNIF. TRUST CODE 414 cmt. In addition to modification, 414(b) also allows termination of a trust if the court determines that the value of the trust property is insufficient to justify the cost of administration. Of course, termination of a special needs trust may not be desirable due to the adverse consequences to a beneficiary who relies upon needs-based benefits. Accordingly, the better option is modification in a manner that alleviates the burdensome costs, such as through appointment of a different trustee, or perhaps even to transfer the trust assets to an ABLE account, assuming this is otherwise available. 84 See UNIF. TRUST CODE 414(a). Including a provision such as this in a special needs trust or even in a trust that may later have special needs provisions due to a trigger provision can be deadly to maintaining eligibility for needs-based benefits. In addition, in those jurisdictions that have enacted the 19

20 lower by the enacting jurisdiction or the settlor. Section 414(a) does not provide a mechanism for the trustee to nonjudicially modify an uneconomic trust, as the most obvious solution for the trustee to undertake with regard to an uneconomic trust probably does not involve modification at all: the trustee could simply resign. H. Modification to Achieve Settlor s Tax Objectives Under 416 of the Uniform Trust Code, the court may modify the terms of a trust in a manner that is not contrary to the settlor s probable intention with regard to tax objectives, and such modification may be given retroactive effect. 85 This section is distinguishable from reformation because there is no mistake to be proven and corrected. Whether the IRS will accept the modification is a matter of federal law. Even though the court s modification order may be applied retroactively, the desired federal tax result still may not be achieved unless the modification is completed prior to a particular taxing event. 86 While Congress has specifically sanctioned post-taxing event modification in three specific areas in which application of the rules were not grandfathered charitable split-interest trusts, qualified domestic trusts, and qualified personal residence trusts this is the exception, not the rule. 87 I. Combination and Division of Trusts While not traditionally viewed as a modification or amendment of a trust in the same way as other modification provisions of the Uniform Trust Code, under 417, a trustee may combine trusts or divide a trust after notice to qualified beneficiaries if the result does not impair any beneficiary s rights or adversely affect achievement of the trust Uniform Trust Code or a similar uneconomic trust statute, it may be prudent to include an express provision in a trust specifically disallowing the application of such a termination provision to a special needs trust. 85 See UNIF. TRUST CODE See Sherby, supra note 8, at 20; see also Van der Wymelenberg v. U.S., 397 F.2d 443 (7th Cir. 1968), cert. denied, 393 U.S. 953 (1968); Cohen, supra note 25, at A See I.R.C. 2055(e)(3), 2056(d)(5); TREAS. REG (a)(2). 20

21 purposes. 88 Advance notice to the beneficiaries is required, 89 but notice does not mean that the beneficiaries must consent or that they have veto power. 90 Rather, notice provides beneficiaries an opportunity to be heard so that the trustee can consider their views prior to taking action. 91 Similarly, court approval is not required. However, beneficiary consent and/or court approval might be prudent, particularly if combination or division will result in any differences that impact the beneficiaries. 92 This section is subject to any contrary provisions in the terms of the trust, 93 so application of this provision can be superseded by the terms of the trust itself. To combine trusts under this 417, the terms of the trusts to be combined do not have to be identical. 94 However, the more that the dispositive provisions of the trusts are different, the less likely they are able to be combined because differences in disposition will necessarily imply that combination of the trusts will impair beneficial rights. Administrative economy is likely the primary reason to combine trusts. If the trust terms are identical, then it may be that the trustee actually has a duty to combine them. 95 The trustee should consider available alternatives as well. For example, while combining trusts may be beneficial to obtain access to a particular class of investments or investment advisor, the same result might be obtained in a simpler manner by linking investment accounts or creating a partnership between the several trusts. While some statutes in jurisdictions that have adopted the Uniform Trust Code may provide clearer guidance, the Uniform Trust Code itself provides no guidance as to 88 See UNIF. TRUST CODE Of course, advance notice may provide the beneficiary an opportunity to object through a court proceeding, as would be the case with any similar administrative change in accordance with 813 of the Uniform Trust Code, which requires a trustee to keep a beneficiary reasonably informed of the particulars of the administration. See UNIF. TRUST Code 417 cmt; see also RESTATEMENT (THIRD) OF TRUSTS 68 cmt. (2003). 90 See RESTATEMENT (THIRD) OF TRUSTS 68 cmt. (2003). 91 See RESTATEMENT (THIRD) OF TRUSTS 68 cmt. (2003). 92 See UNIF. TRUST CODE 417 cmt.; Cohen, supra note 25, at A See UNIF. TRUST CODE See UNIF. TRUST CODE 417 cmt. 95 See UNIF. TRUST CODE 417 cmt & 805 (duty to incur only reasonable costs). 21

22 what the administrative terms of the merged trust should be. Since this is a provision that may be altered by the settlor, it would be prudent for the drafter to include specific provisions as to this in the trust document itself. Trusts may be divided for several reasons, some of which are almost routine, such as obtaining maximum advantage of available generation-skipping tax exemptions. Division may also be warranted in cases where some but not all beneficiaries reside in states that might subject the entire trust to income taxation. If tax savings can be achieved by division, a trustee s failure to divide a trust may be a breach of fiduciary duty. Breach of fiduciary duty may also be implicated if the trustee pursues division simply to increase fees or to fit the divided trusts into the small trust termination provision. 96 Division of trusts may also be beneficial where differing investment objectives is desirable or where conflicts among beneficiaries exist. 97 Beneficiaries might also have different distribution needs, and division of the trust in this circumstance may allow the investment and distribution policies of the trust to better meet the beneficiaries needs. As with combined trusts, the trusts that result after division may be dissimilar. Again, however, the more that the terms of the divided trusts diverge from the original estate plan, the less likely it is that the settlor s purposes would be achieved and thus the more likely it is that the division is inappropriate. 98 While the Uniform Trust Code does not provide guidance as to the logistics of dividing trusts, it may be prudent to embody the terms of division into a written document that specifies how the division is to be accomplished and what the terms of the continuing trusts will be. By providing such a document to the beneficiaries as part of the required notice, the beneficiaries (and the trustee) can be assured with a measure of certainty as to how the administration will proceed. Such a document may also help alleviate any concern a beneficiary may have and thus head-off and avoid a challenge by 96 See UNIF. TRUST CODE See UNIF. TRUST CODE 417 cmt. 98 See id. 22

23 a beneficiary out of fear or panic. This type of document might also avoid future disputes among beneficiaries and the trustee. 99 Neither income tax nor gift tax issues should be implicated for combined trusts. Similarly, where divided separate trusts contain substantially similar provisions for the beneficiaries and the original trust is divided on a pro rata basis, neither income tax nor gift tax should be an issue. If, however, beneficial interests are divided on a basis other than pro rata, this might constitute a transfer of property by the beneficiaries, thus subjecting them to gift tax under 2501 of the Internal Revenue Code. For trusts that may have grandfathered status for generation-skipping tax purposes or that may otherwise implicate generation-skipping tax, the tax issues should be carefully scrutinized prior to any action being taken. With regard to division of trusts, different rules apply depending upon whether a trust is divided with or without a court order. Division pursuant to a court order must, among other things, not result in a shift of beneficial interest in the trust to any beneficiary occupying a lower generation. With regard to combination of trusts, a simple merger that does not shift beneficial interests or extend the time for vesting will retain grandfathered status, but it may be prudent to ensure that any court-ordered combination of trusts is contingent on obtaining a favorable IRS ruling that combination will not affect GST-exempt status or otherwise result in any unfavorable gift, estate, or income tax consequence. Most states have enacted statutory provisions authorizing combination and/or division of trusts by some method, although again, specific statutory requirements vary. 100 Inquiry for authority to combine or divide trusts should not stop there, however. 99 See Sherby, supra note 8, at For example, Kansas provides a procedure for giving notice and effecting the trust combination or division, see KAN. STAT. ANN. 58a-417; Ohio allows combination or division only so long as beneficiary rights are not substantially impaired or no materially adverse effects on the trust purposes results, see OHIO REV. CODE ANN ; Arkansas specifies that court approval is not required, see ARK. CODE ANN ; Virginia and Oregon allow for combination or division of trusts only where it does not materially impair the rights of any beneficiary, see OR. REV. STAT , VA. CODE ANN ; North Carolina allows combination or division if terms are substantially similar 23