PORTFOLIO

Trust Decanting (Portfolio 871)

Tax Management Portfolio, Trust Decanting, No. 871, discusses the distribution of trust property further in trust pursuant to a trustee's power to distribute property to trust beneficiaries, commonly referred to as trust decanting.

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DESCRIPTION

Tax Management Portfolio, Trust Decanting, No. 871, discusses the distribution of trust property further in trust pursuant to a trustee's power to distribute property to trust beneficiaries, commonly referred to as trust decanting.
Trust decanting generally refers to the exercise of a trustee's discretionary power to distribute trust property to trust beneficiaries by distributing such property to another trust for the benefit of one or more of such beneficiaries. Although trust decanting may be authorized under common law, many states have enacted trust decanting statutes allowing a trustee to appoint trust property in favor of another trust.
This portfolio examines the common law background of trust decanting, trust decanting statutes, potential uses or applications of trust decanting, and potential tax consequences of trust decanting. Examples are used to illustrate and discuss various issues.
This portfolio may be cited as Culp & Bennett Mellen, 871 T.M., Trust Decanting.


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AUTHORS

WILLIAM R. CULP, JR., ESQ.
William R. Culp, Jr., B.S., University of North Carolina; J.D., University of North Carolina School of Law; LL.M (Taxation), New York University School of Law; member, North Carolina Bar Association; member, Legislative Committee, Estate Planning and Fiduciary Law Section, North Carolina Bar Association; contributor to various legal publications on tax and estate planning matters and lecturer at various tax and estate planning institutes; Fellow, American College of Trusts and Estates Counsel.

BRIANI BENNETT MELLEN, ESQ.
Briani Bennett Mellen, B.A., Emory University; J.D., magna cum laude, University of South Carolina School of Law; LL.M (Taxation), New York University School of Law; member, South Carolina Bar Association; member, North Carolina Bar Association; contributor to various legal publications on estate planning matters and lecturer at various tax and estate planning institutes.

TABLE OF CONTENTS

Portfolio 871-1st: Trust Decanting

Portfolio Description

Authors

Technical Advisors

Description

Detailed Analysis

I. Introduction

A. General Definition

B. Rationale Supporting Decanting

C. History of Decanting

II. Decanting Under Common Law

A. Generally

B. Restatement of Property

1. Restatement (First) of Property

2. Restatement (Second) of Property: Donative Transfers

a. Description of a Power of Appointment

b. Trustee's Discretionary Power to Distribute as a Power of Appointment

c. Power to Transfer in Further Trust

3. Restatement (Third) of Property: Wills and Other Donative Transfers

a. Definition of a Power of Appointment

b. Power of Appointment Held in Nonfiduciary Capacity

c. Exercise of Special Power by Appointing Property in Trust

d. Creation of a New Power in Another

4. Restatement (Third) of Trusts

C. Case Law

1. Phipps v. Palm Beach Trust Co.

2. In re Estate of Spencer

3. Wiedenmayer v. Johnson

4. Lahti v. Comr.

5. Two-Step Decanting Under State Law: Division and Merger of Trusts

III. State Decanting Statutes

A. In General

B. Statutory Requirements for Decanting

1. Trustee's Discretionary Authority to Invade Trust Assets

a. Absolute Power to Distribute Property

b. Discretionary Power to Distribute Property

c. Fiduciary Duties Imposed on Decanting

d. Property Subject to Currently Exercisable Power of Appointment

e. Decanting by Trustee-Beneficiary

f. Fixed Interests in Trust Property

g. Powers of Appointment

h. Modifications Affecting Trustee Powers or Duties

2. Procedural Requirements and Mechanics of Decanting

3. Beneficiary Consent and Court Approval

C. Miscellaneous Rules Governing Decanting

1. Treatment as Special Power of Appointment

2. Spendthrift Provision

3. Trustee's Duty to Exercise Decanting Authority

4. No Abridgement of Rights Under Trust Instrument or Common Law

5. Acceleration of Beneficial Interests in Trust

D. Interpretive Case Law

IV. Tax Treatment of Decanting

Introductory Material

A. Generation-Skipping Transfer Tax

1. Decanting from Grandfathered Trusts

a. Pre-2000 PLRs — The “No Change” Test

b. Regulatory Safe Harbors

c. Failure to Satisfy Regulatory Safe Harbors

d. Exercise of a Special Power of Appointment

e. Trust Decanting Not Treated as Exercise of Special Power of Appointment

f. The Discretionary Distribution Safe Harbor

(1) Requirements in General

(2) Decanting Authorized When Trust Became Irrevocable

(3) Beneficiary Consent or Court Approval

(4) Change in Administrative Provisions

(5) Shift of Beneficial Interests

(6) Modifying the Trust Term Under the Discretionary Distribution Safe Harbor

g. The Trust Modification Safe Harbor

(1) Requirements in General

(2) Beneficiary Consent or Court Approval

(3) Decanting Authorized on Date Trust Became Irrevocable

(4) Change in Administrative Provisions

(5) Shift of Beneficial Interests

(6) Extending the Trust Term Under the Trust Modification Safe Harbor

h. Consequences of Loss of Grandfathered Status

2. Decanting From GST or Zero Inclusion Ratio (ZIR) Trusts

a. Qualified Severance Rules

(1) Requirements in General

(2) Inclusion Ratio of Resulting Trusts

(3) Same Succession of Beneficial Interests

b. Decanting of ZIR Trust Within the Discretionary Distribution Safe Harbor and the Trust Modification Safe Harbor

c. Extending the Term of GST or ZIR Trusts Outside of the Discretionary Distribution Safe Harbor and the Trust Modification Safe Harbor

(1) In General

(2) Exercise of Power of Appointment

(3) Trust Decanting

B. Estate Tax Issues

C. Gift Tax Issues

1. In General — Decanting by a Nonbeneficiary Trustee

2. Shift in Beneficial Interest Required for Gift

3. Decanting by a Trustee Who Is a Beneficiary

4. Beneficiary Consent or Court Approval to Decanting

a. Beneficiary Consent or Acquiescence

(1) Beneficiary Consent Not Required

(2) Beneficiary Consent Required and Provided

(3) Beneficiary Failure to Object

b. Release and Indemnification

(1) By Beneficiaries

(2) By Settlor

c. Court Approval

5. Elimination or Reduction of a Presently Exercisable Power of Appointment

6. Elimination of a General Power of Appointment that Is Not Presently Exercisable

7. Elimination of a Special Power of Appointment

8. Adding a Beneficiary

9. Granting a Special Power of Appointment in the Second Trust

10. When Taxable Shift of Beneficial Interests Occurs — Illustrative Cases and PLRs

a. Lahti v. Comr.

b. Estate of Hazelton v. Comr.

c. PLR 200917004

d. PLR 199922045

e. PLR 199912027

11. Planning to Avoid Taxable Gift

12. Delaware Tax Trap

a. Trustee's Power to Distribute as Power of Appointment Under § 2514(d)

b. Decanting by Independent Trustee

(1) Suspension or Postponement of Vesting or Alienation

(2) Decanting as a Transfer by Gift

13. Disclosure of Decanting on Gift Tax Return

D. Income Tax Issues

1. Sale or Exchange of Materially Different Property

a. In General

b. “Material Difference” Standard: Change in Legal Entitlements and Interests of Trust Beneficiaries

c. Pro-Rata Decanting

d. Non-Pro-Rata Decanting Permitted by Trust Instrument or State Law

e. Non-Pro-Rata Decanting Not Permitted Under Governing Instrument or State Law

2. Transfers of Property with Debt in Excess of Basis

3. Decanting To and From Different Types of Trusts

a. Decanting from a Grantor Trust to a Grantor Trust

(1) Identity of the Grantor

(2) Tax Consequences

b. Decanting from a Complex Trust to a Grantor Trust

(1) In General

(2) Whether Recapture Gain Is Recognized

c. Decanting from a Complex Trust to a Complex Trust

d. Decanting from a Grantor Trust to Complex Trust

4. Transfers Carrying Out Distributable Net Income

5. Decanting of All Property to Another Trust

a. Receiving Trust Treated as Continuation of Distributing Trust

b. Carryover of Distributing Trust's Tax Attributes

c. Same Tax Identification Number

6. Decanting Authority as a Power to Add Beneficiaries Under § 674

E. Special Tax Issues

1. Decanting from Trusts Qualifying for the Marital Deduction

a. Qualified Terminable Interest Trusts

(1) Qualifying Income Interest for Life

(2) Entitlement to All Income for Life

(3) Power to Appoint to Spouse

(4) Taxable Gift Upon Disposition of Spouse's Interest in QTIP

b. Life Estate with General Power of Appointment in Surviving Spouse

(1) In General

(2) Entitlement to Income for Life

(3) Power Exercisable in All Events

c. Duty of Consistency

(1) In General

(2) QTIP Trusts

(3) General Power of Appointment Trusts

2. Decanting from § 2503(c) Trusts

a. In General

(1) Inclusion of Trust Property in Donee's Estate at Death

(2) Trustee's Power to Expend Property for Minor's Benefit

(3) Extension of Term of Trust

(4) Disposition of Property in Default of Minor's Exercise of General Power of Appointment

b. Trustee's Power to Modify the Trust or Decant Property to Another Trust

c. Duty of Consistency

3. Decanting from Charitable Remainder Trusts

a. Charitable Remainder Trusts: In General

b. Modifications Permitted Under § 664 and the Regulations

c. Impermissible Modification and Termination of Exempt Status

d. Impermissible Modification as an Act of Self-Dealing

e. Pro Rata Divisions of Charitable Remainder Trusts

f. Qualified Reformation of Charitable Remainder Trust

4. Decanting from Charitable Lead Trusts

a. In General

(1) Irrevocable Right to Payment for a Term of Years or the Life of Certain Individuals

(2) Payments in Excess of Annuity or Unitrust Amount

(3) Payments for Private Purposes

b. Decanting to Non-Charitable Lead Trust

c. Decanting from a Grantor to a Non-Grantor Charitable Lead Trust

d. Self-Dealing

e. Qualified Reformation of Charitable Lead Trust

5. Decanting from Grantor Retained Income Trusts

a. In General

b. Qualified Annuity or Unitrust Interest

c. Decanting from GRATs or GRUTs

d. Qualified Remainder Interests

6. Decanting from a QSST to a QSST

a. General Requirements of a QSST

b. Decanting to a Second Trust that Is Also a QSST

c. When Decanting to a Non-QSST Second Trust May Be Possible

d. Fiduciary Duty of Trustee of Original Trust Should Prevent Ability of Trustee to Decant to Non-QSST Second Trust

7. Decanting from Trust to Extend Retirement Plan Payouts

8. Decanting to or from Foreign Trusts

a. Decanting to Foreign Trust

(1) In General

(2) Reporting Requirements

b. Decanting from Foreign Trust to Domestic Trust

(1) Throwback Rule

(2) Section 6048 Disclosure

c. Decanting from Foreign Trust to Another Foreign Trust

V. Fiduciary, Ethical, and Practical Considerations

A. Fiduciary and Ethical Issues

B. Protecting the Trustee

1. Consent or Release and Indemnification of Trustee

a. By Beneficiary

b. By Settlor

2. Court Approval

3. Receipt and Refunding Agreements

4. Private Letter Rulings

C. Practical Considerations

1. Decanting Provisions in Trust Agreement

2. Change in Situs Provision

3. Trust Modification

4. Independent Third Party with Power to Decant

D. Mechanics of Decanting

1. Trustee Resolution to Decant

2. Transfer of Property from Original Trust to Second Trust

3. Methods of Creating Second Trust

a. Existing Trust Created by Settlor or Third Party

b. New Trust Created by Settlor or Third Party

c. New Trust Created by Trustee of Original Trust

E. Changing a Trust's Governing Law and Conflicts of Law

1. Reasons to Change Governing Law

a. Maintaining Grandfathered Trust Status for GST Purposes

b. Avoiding Absolute Discretion Decanting Prerequisites

c. Enjoying Longer Perpetuities Period

d. Example in Regulations: Change in Situs and Applicable Perpetuities Period

2. Governing Law

a. Trust Instrument Provides Which Governing Law Applies

b. Trust Instrument Does Not Provide Which Governing Law Applies

c. Moving Trust Situs as a Prerequisite to Changing Governing Law

d. Appointing an Alaska or New York Co-Trustee

3. Conflicts of Law

F. Fraudulent Conveyance Risk

1. General Fraudulent Conveyance Issues Involving Decanting

a. Creditors of Settlor

b. Creditors of the Original Trust

c. Creditors of a Beneficiary

2. Dominion and Control

VI. Comparison to Trust Modifications, Mergers, or Divisions

Introductory Material

A. Trust Modifications and Reformations

1. Modifications Without Court Approval

2. Modifications with Court Approval

3. Modification Because of Unanticipated Circumstances

4. Modification to Achieve the Settlor's Tax Objectives

5. Reformation to Correct Mistakes

6. Trust Decanting Compared

7. Fiduciary Duty to Seek Trust Modification

B. Trust Combinations and Divisions

1. In General

2. Trust Decanting Compared

3. Fiduciary Duty to Seek Combination or Division of Trusts

C. Ability to Bind IRS Through Trust Modification

VII. Planning Opportunities

Introductory Material

A. Update, Modernize, or Amend Trust Administrative Provisions

1. Improving Trust Administration or Management

2. Reduce Administrative Costs

3. Address Provisions Regarding Trustees

4. Changing Trust Situs or Governing Law

5. Facilitate Investment Decisions

B. Update, Modernize, or Amend Trust Dispositive Provisions

1. Extending the Term of the Trust

2. Amending Distributive Provisions

a. Modifying Mandatory Distributive Provisions

b. Modifying Standards for Trust Distributions

c. Acceleration of Beneficiary's Interest in Trust

3. Address Clarifications in Governing Law

4. Correct Drafting Errors or Omissions

5. Creation of Special Needs Trust

6. Address Permissible Perpetuities Periods

7. Granting or Modifying Powers of Appointment

a. General Powers of Appointment

b. Special Powers of Appointment

8. Granting or Modifying Powers of Withdrawal

9. Decanting Pursuant to Ascertainable Standard

10. Eliminate, Modify, or Include Spendthrift Provisions

C. Combining or Dividing Trusts

D. Federal or State Tax Planning

1. Generation-Skipping Planning

2. Achieve State Income Tax Savings

3. Address Tax Planning for Beneficiaries

4. Grantor Trust Planning

5. Decanting from Trust to Extend Retirement Plan Payouts

E. Creditor Protection Planning

1. Extending the Term of the Trust

2. Removal of General Power of Appointment

3. Move Investment Away from High Risk Business

4. Protecting or Shielding the Trust of Beneficiaries from Liabilities Associated With Trust Property


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Sample Short Form Trust Decanting Provision

Worksheet 2 Sample Long Form Trust Decanting Provision

Worksheet 3 Trustee Resolution to Exercise Trustee's Special Power to Appoint Trust Property to Second Trust and Waiver of Notice by Qualified Beneficiaries (North Carolina Law)

Worksheet 4 Beneficiary Consent and Release and Indemnification of Trustee (North Carolina Law)

Worksheet 5 Disclosure of Non-Gift Completed Transfer

Worksheet 6 Non-Tax Trust Decanting Issues Checklist

Worksheet 7 Summary of Tax Implications of Decanting

Worksheet 8 Illustrative Examples of the Tax Implications of Decanting

Worksheet 9 Alaska Stat. § 13.36.157 (2013)

Worksheet 10 Del. Code Ann. tit. 12, § 3528 (2012)

Worksheet 11 Fla. Stat. Ann. § 736.04117 (West Supp. 2008)

Worksheet 12 NY EPTL § 10-6.6 (McKinney 2012)

Worksheet 13 N.C. Gen. Stat. § 36C-8-816.1 (2013)

Worksheet 14 S.D. Codified Laws § 55-2-15 (2013)

Bibliography

Miscellaneous

Treatises

Periodicals

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