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February 24, 2020
Tax & Estate Perspectives
Taxes
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What is Decanting? Good Wine and Effective Trusts
A rapidly growing subject of estate planning is the use of a technique labeled “decanting.” For those who are wine aficionados, it might be a puzzling term to be part of contemporary estate planning. For those thinking about estate planning, not wine, the reference is to a now common technique that moves trust property from administration under the terms of an old irrevocable trust to a new irrevocable trust.
Establishing a new irrevocable trust to replace one in existence is typically driven by a desire to achieve more favorable trust terms. Decanting is becoming a more popular move where the old trust has objectionable terms that no longer best fit the administration and distribution of the trust property, and modifications are sought in the least costly manner. This ability to make changes is being driven by various states updating their trust laws to allow for modifications to irrevocable trusts without going to court to get approval.
As with many planning techniques that grow in popularity, misconceptions can develop as to what can and cannot be accomplished with this technique. Here are some issues to consider in pursuing modifications to irrevocable trusts.
What Does it Mean to Decant a Trust?
On its face, an irrevocable trust is, after all, irrevocable. After the trust is created, the trustee must administer the trust property under the terms of the trust document, until the property is wholly distributed or exhausted. But “irrevocable” has come to have a different, diluted meaning under modern trust laws.
Under an action to decant trust property, the trustee transfers ownership of the trust property in the old “decanting” trust to a new “decanted” trust. The new decanted trust does not have identical terms as the old irrevocable decanting trust, and therein lies the planning opportunity.
The trustee of the existing trust completes a decanting. This is an advantage of a decanting action over other actions such as a judicial reformation of a trust or “private settlement agreements.” With decanting, only the trustee is involved in the action. The trustee does not have to obtain the consent of the trust beneficiaries, and there is no approval needed by a local court of law. Under most state laws, however, notice to the beneficiaries is required when the decanting action is enacted.
Beyond the attorney preparing the new decanted trust agreement, there is not much else involved, procedurally. That being said, careful planning is required when developing the terms of the new decanted trust. There are potential income, estate and gift tax ramifications to consider in the decanting transfer. A collaborative effort between the tax and legal advisors is needed to achieve a result that does not fall into any such traps.
Opportunities and Limitations in Using Trust Decanting
Almost half the states in the U.S. have some version of decanting law. The irrevocable trust in existence must be governed by one of these state’s laws to do this type of planning. There will be variations between the states in what is required or what changes are allowed in a decanting action.
Depending on the amount of discretion the trustee already has in the existing trust for making distributions to the trust beneficiaries, a decanting transfer might be used to eliminate or limit the interests in the trust of one or more of the current beneficiaries. Thus, trusts that give trustees full discretion to consider the timing and amount of distributions, even to the extent of all or none of the trust income and principal, might be decanted to new trusts that eliminate the interests of certain beneficiaries (but not to add new beneficiaries who were not beneficiaries of the old trust). On the other hand, existing trusts that require income or principal to be distributed each year, or at certain ages, or for specific purposes such education and costs of living, likely cannot be decanted to change and restrict those provisions.
When creating and funding an irrevocable trust, it is difficult at best to project all the scenarios that could affect the beneficiaries and the trust property decades into the future. It is not uncommon for the trust document to lack certain trustee powers that could assist the trustee in administering certain types of trust property or carry on desired investment activity. The list of successor trustees might require change due to the death or unavailability of persons or corporations who had been designated to fill that role.
A decanting action is very effective for addressing these types of trust administration issues. Many clients have irrevocable trusts that have been in existence for years. In some cases, changes in law or family circumstances might have rendered an old trust less than ideal for current estate planning goals and tax issues. We can coordinate with legal counsel to review the status of the trusts, the past distribution activity, and consult on the underlying family dynamics, in order to see if a decanting action merits attention. But it must be remembered, decanting is not a free pass to make any change desired. The trust is, after all, irrevocable.