The mechanics of decanting.

• Author: Young, Audrey G.
• Position: A trust in estate and tax planning

By analogy to decanting a bottle of wine or spirits, decanting a trust involves a metaphorical pouring of trust assets from one trust into another. The receiving trust is an updated and improved trust that continues to express the grantor's intent. Applying the analogy, this item addresses the mechanics of decanting and provides guidance on how not to spill or otherwise compromise the trust assets.

Estate planning advisers have spent considerable time elevating decanting from a potential strategy for clients seeking to fix a broken trust to a routine solution for trusts that have grown problematic due to changed circumstances. Through these efforts, much has been gleaned regarding the boundaries and requirements of state decanting statutes, as well as the protocols required for best practices.

Even after seeking and receiving comments on decanting from national legal and tax groups, the IRS omitted decanting from its 2013-2014 Priority Guidance Plan, thus indicating that it would not issue a revenue ruling on the tax aspects of decanting this year. Advisers are left to sift through private letter rulings and regulations on trust mergers, modifications, and severances to gauge the likely tax impacts of decanting. The most popular uses of decanting appear to be postponing or eliminating withdrawal rights; modifying or inserting powers of appointment; altering successor trustee provisions; creating a special needs trust; resolving drafting ambiguities; and changing trust situs to avoid state income taxes.

Background

Decanting statutes have proliferated over the past three years. Largely as a result of the efforts of state bar groups, who sought options for updating trusts short of clogging courts with amicable petitions to fix broken trusts, 21 states now have decanting statutes. These states codified and expanded upon what many believed already existed at common law. The right to decant was first outlined by the Florida Supreme Court in Phipps v. Palm Beach Trust Co., 142 Fla. 782 (1940). The court ruled it was within the trustee's discretion to invade trust principal and pay it over to another trust established for the benefit of the original trust beneficiary.

While the details vary greatly among the states with decanting statutes, the basic premise is the same. A trustee's discretion to make distributions includes the lesser power to move the trust assets to a second trust. Some states, such as Florida and Indiana, require that the trustee have full discretion in order to decant. Other states, such as South Dakota, Nevada, and Delaware, allow decanting where the trustee has the discretion to make distributions based on a reasonably definitive standard. Still other state statutes, especially a few of the 2013 statutes, in effect combine these approaches and require absolute discretion for certain trust changes, but not for others. Illinois, Michigan, Ohio, Texas, and Virginia fall into this latter category. In some statutes, such as those in place in New York and Delaware, the power to invade the first trust and decant to a second trust is described as the exercise of a limited power of appointment.

Most statutes expressly prohibit the modification or elimination of an income interest. Though most statutes preclude a trustee from using decanting to add new beneficiaries, many statutes indirectly permit the addition of beneficiaries by allowing the second trust to include a limited power of appointment that theoretically could be used by the power holder to expand the class of beneficiaries. For example, Illinois (760 111. Comp. Stat. 5/16.4), North Carolina (N.C. Gen. Stat. [section] 36C-8-816.1), Nevada (Nev. Rev. Stat. [section] 163.556), and New York (N.Y. Est. Powers & Trusts Law [section] 10-6.6) have such statutes. Extending the trust beyond the original trust term is often prohibited, and advisers should be wary of triggering Sec. 2514(d) ("the Delaware tax trap") by unintentionally lengthening the trust term. In addition, most statutes direct the trustee to consider the intent of the settlor when deciding whether to decant or state positively that the new trust must carry forth the grantor's purpose. As practitioners decant more and more trusts, consensus is building on the basic concepts.

Providing Notice and...