Part I of this article reviewed the 2018 changes to Florida's trust decanting statute, discussing in particular the expanded authority for a trustee to decant to a supplemental needs trust for the benefit of a beneficiary with a disability. In this part, I will delve into the mechanics of successfully decanting a trust and explore how decanting might affect a trust beneficiary with special needs beyond the obvious change in the provisions of the trust itself.
Options for Decanting
As discussed in Part I, the scope of changes that can be effectuated through decanting is defined by the breadth of an authorized trustee's power to invade and appoint principal among the beneficiaries. An authorized trustee with absolute power to distribute principal may decant under [section] 736.04117(2), which allows the broadest changes to the terms of the first trust, whereas an authorized trustee whose power is limited by an ascertainable standard, i.e., health, support, maintenance, and education, also known as the "HEMS" standard, will be limited to decanting under [section] 736.04117(3), which allows fewer options for change. If decanting will benefit a beneficiary with a disability and further the purposes of the first trust, then an authorized trustee may decant to a supplemental needs trust for the benefit of that disabled beneficiary under [section] 736.04117(4), regardless of whether the authorized trustee's power to distribute principal is limited.
Note, then, that an authorized trustee seeking to decant to a supplemental needs trust for the benefit of a beneficiary with a disability may have some options and is not necessarily limited to decanting only under [section] 736.04117(4). For example, where an authorized trustee seeks to decant in favor of a disabled beneficiary and has the absolute power to invade principal, then decanting under [section] 736.04117(2) might be preferable to decanting under [section] 736.04117(4) because the decanting would be subject to fewer restrictions and the authorized trustee could exercise broader power. In making this determination, special consideration must be taken to ensure that the provisions of [section] 736.04117(2)(a)2 prohibiting a reduction in the second trust of any vested interest are not violated. "Vested interest" is rather narrowly defined in [section] 736.04117(1)(k) to exclude the mandatory right to withdraw or receive distribution of income, a specific pecuniary amount, or percentage of the trust's value that is dependent upon the occurrence of a specific event, passage of time, or exercise of discretion. In other words, a beneficiary's unconditional and immediate right to withdraw 50% of the trust's value would be a vested interest, while the beneficiary's right to withdraw 50% of the trust's value at age 40 would not be a vested interest at the time the beneficiary is age 35.1 Considering this, an interest of a beneficiary with a disability that is "vested" as defined by statute would probably not be eligible for decanting to a supplemental needs trust under subsection (2) since the terms of a supplemental needs trust would almost certainly (and necessarily) reduce that vested interest, but an interest that is not "vested" may be.
In other words, nothing requires an authorized trustee to use subsection (4) to decant for the benefit of a disabled beneficiary if the requirements of subsection (2) can be met. Under the right circumstances, it may even be possible to decant certain beneficiaries' interests under subsection (2) while decanting the beneficial interest for a disabled beneficiary under subsection (4) in a separate act of decanting.
Obstacles to Decanting
In addition to the restrictions inherent in subsections (2), (3), and (4), the provisions of [section] 736.04117 may present other obstacles and restrictions to decanting, whether decanting to a supplemental needs trust under [section] 736.04117(4) or not. These obstacles include the following:
* An authorized trustee may not decant a trust that expressly prohibits it. (2) This is important to remember not only in determining whether decanting a particular trust is possible, but also when drafting. While decanting offers tremendous flexibility in dealing with uncertain future circumstances, which is often welcomed from a drafter's perspective, the breadth of that flexibility may be unsettling to a settlor. Some settlors may be uneasy knowing that the express terms of a trust they thoughtfully and painstakingly crafted with their personal values in mind may be later changed in the trustee's discretion. Therefore, it is prudent to review with clients whether the possibility of decanting under [section] 736.04117 should be eliminated through drafting. For settlors who are not opposed to the concept of decanting but wish to limit its application, the drafter may consider language that grants the power to decant under certain circumstances and prohibits it under others. Be warned, however, that where decanting provisions are drafted in trust documents separate and apart from [section] 736.04117, the failure to comprehensively address all possible issues might later prove problematic, particularly if the decanting provisions in the trust document are viewed as completely supplanting [section] 736.04117.
* An authorized trustee may not decant if doing so would interfere with a federal tax exclusion, deduction, or benefit that was or could have been claimed, including a marital deduction, charitable deduction, generation-skipping tax direct skip treatment, or any other tax benefit for income, gift, estate, or generation-skipping transfer (GST) tax purposes. (3)
* An authorized trustee may not decant if doing so would interfere with the trust being considered a permitted shareholder of S corporation stock or prevent the trust from being a qualified subchapter S trust. (4) This requires an authorized trustee who seeks to decant a trust to consider not only the dispositive terms of the trust but also the assets funding the trust.
* While the first trust's status as a grantor trust under I.R.C. [section] [section] 671679 has no bearing on whether an authorized trustee may decant, decanting cannot be used to obtain grantor trust status over a nongrantor trust unless the settlor at all times has the power to cause the second trust to cease being treated as if it were owned by the settlor.5 This provision focuses on the grantor of a trust from an income tax perspective, which is a distinct concept, from who is treated as settlor of a trust under federal law for public benefits purposes. For example, a third-party supplemental needs trust, which by definition is funded with assets originating from someone other than the disabled beneficiary, may be drafted either as a grantor trust by including one of the grantor trust powers of [section] [section] 671-679 or as a nongrantor trust by omitting all grantor trust powers, while a self-settled supplemental needs trust, which is funded with assets originating from the disabled beneficiary, is treated as a grantor trust for income tax purposes. Grantor trust status, however, has (or should have) little if any bearing on whether a trust is treated as being settled by the disabled beneficiary or being settled by a third party for public benefits eligibility...