Decanting and Its Alternatives: Remodeling and Revamping Irrevocable Trusts

Article excerpt

Trust decanting is the process of distributing a trust estate of an irrevocable trust to the trustee of a new trust. Recognized under the common law and now statutorily by ten states, decanting can achieve a number of goals and objectives, from correcting drafting errors to responding to beneficiaries' changed circumstances or objectives. Procedural requirements, fiduciary considerations, and tax issues will be explored.

   I. INTRODUCTION

  II. WHY DECANT?

 III. COMMON LAW BASIS
      A. PHIPPS
      B. SPENCER
      C. WIEDENMAYER
      D. RESTATEMENT
      E. UNIFORM TRUST CODE

 IV. SOUTH DAKOTA STATUTORY BASIS

  V. ALTERNATIVES TO DECANTING
      A. REFORMATION
      B. JUDICIAL CY PRES
      C. TERMINATION OF SMALL TRUSTS
      D. COMBINATION OR DIVISION OF TRUSTS
      E. NON-JUDICIAL UNITRUST CONVERSIONS
      F. DECLARATORY ACTIONS
      G. TRUST PROTECTORS

 VI. OTHER STATES' STATUTORY SCHEMES
      A. NEW YORK
      B. ALASKA
      C. DELAWARE
      D. TENNESSEE
      E. FLORIDA
      F. NEW HAMPSHIRE
      G. ARIZONA
      H. NORTH CAROLINA

 VII. HOW TO DECANT (IN SOUTH DAKOTA)
      A. OPTIONAL COURT SUPERVISION
      B. NOTICE AND VIRTUAL REPRESENTATION

VIII. TAX ISSUES
      A. GST
      B. GIFT TAX
      C. FEDERAL INCOME TAX
      D. ESCAPING STATE TAXES

  IX. FIDUCIARY ISSUES

   X. CONCLUSION

I. INTRODUCTION

The concept of decanting port wine is based on the need to filter out leaves or stems from an otherwise excellent alcoholic beverage. To decant, the port is poured from one container to another, with the aim of improving the drinkability of the wine held in the new vessel in the process. The process is easy to visualize and understand, and provides an excellent analogy for the more cerebral concept of trust decanting.

Trust decanting simply means the act of a trustee making a distribution to a new trust with different terms from the original trust. It is, in some ways, a "backdoor" way of approaching trust reformation. But decanting has also been called the "ultimate" in trust amendment powers for otherwise irrevocable trusts. (1) "Irrevocable"--more and more in the trust world, Des not mean immutable. In South Dakota in particular, the relative ease with which changes can be undertaken to an irrevocable trust is quite surprising, perhaps even alarming.

Trusts are arguably English lawyers' greatest idea and creation. (2) Trusts have been in use going back to the Norman conquest of 1066. (3) Today, trusts are widely used as an infinitely flexible property and estate planning tool. (4) With the new tool of decanting, the flexibility--and future uncertainty--of even irrevocable trusts have increased exponentially.

II. WHY DECANT?

There are many potential reasons that would motivate a trustee to pursue decanting. At least three broad categories of reasons, however, can be identified: (1) achieving state or federal tax benefits; (2) improving the administrative provisions of a trust; and (3) adding asset protection advantages.

The list of possible reasons to decant is almost as limitless as the list of reasons why a trust might be created in the first place. A partial illustrative list would include:

(1) Modifying powers of appointment;

(2) Amending administrative provisions of a trust;

(3) Adding spendthrift protections;

(4) Adding (or removing) grantor trust provisions;

(5) Qualifying a trust as a qualified subchapter S trust, a QDOT, an IRA conduit trust, etc.;

(6) Combining trusts for greater efficiencies;

(7) Separating trusts to allow investment philosophies to be "fine tuned" for beneficiaries;

(8) Segregating higher risk assets;

(9) Avoiding state and local taxes;

(10) Reducing distribution rights for Medicaid eligibility planning purposes;

(11) Amending trustee succession provisions, removing or replacing a trustee;

(12) Extending the term of a trust;

(13) Changing the governing law provisions of a trust;

(14) Correcting a scrivener's error or ambiguity; and

(15) Decanting a beneficiary's share of a trust to a supplemental needs trust in order to preserve or obtain eligibility for public benefits. …