40th Annual Midwest –Midsouth Estate Planning Institute
University of Kentucky Office of Legal Education
THE NEW KENTUCKY DECANTING STATUTE
(HOW AND WHEN TO USE IT . . . AND TAX CONSEQUENCES)
by Jeffrey S. Dible
Frost Brown Todd LLC
[email protected]
Lexington, Kentucky
July 26, 2013
© 2013 Frost Brown Todd LLC
All rights reserved.
DISCLAIMER AND ACKNOWLEDGEMENTS
The writer gratefully acknowledges the assistance of Barton T. Rogers
and M. Todd Lewis in the review and revision of these materials with
specific emphasis on Kentucky law.
The writer has used his best efforts to include accurate and up-to-date
information in these materials. These materials primarily address
Kentucky law and federal law on a topic where only 18 states have
statutes, and where the law is still evolving. The author makes no
warranties about the legal conclusions stated or implicit in these
materials. These materials are not intended as legal advice to any specific
individuals or fiduciaries. The sample form provisions are offered merely
as illustrative guidance for drafting and issue-spotting.
Jeffrey S. Dible
Mr. Dible is a member of the law firm of Frost Brown Todd LLC and practices in
that firm's Indianapolis office. Mr. Dible is a Fellow of the American College of Trust
and Estate Counsel (ACTEC) and has been certified as an Indiana Trust and Estate
Lawyer by the Trust and Estate Specialty Board (TESB), on which he currently serves as
the co-chair. He has lectured frequently throughout Indiana to other estate planning
professionals, nonprofit organizations, and groups of retirees and business owners on
estate planning and tax-related topics, including 2010 and 2012 federal estate and gift
tax reform and the modification and early termination of trusts.
In 2011 and 2012, Mr. Dible testified at several legislative committee hearings in
support of the repeal of Indiana’s inheritance tax and continues to testify regarding
current bills of interest to estate planners. Mr. Dible served on the committee that
drafted the current (2012) Marion County Local Probate Rules and Forms. In December
2011, the Estate Planning and Administration Section of the Indianapolis Bar
Association gave Mr. Dible the Patricia Paxton Wagner Award for Excellence in Estate
Planning and Administration.
Mr. Dible is immediate past president (2011-2012) of the Estate Planning Council
of Indianapolis, and a past chairperson of the Taxation Section of the Indiana State Bar
Association (ISBA. Mr. Dible is admitted to practice law in Indiana (1979) New York
(1986), in the United States Tax Court (1986), and in the U. S. District Courts in Indiana
and New York. Mr. Dible received his law degree from the Indiana University Maurer
School of Law at Bloomington in 1979 (magna cum laude, Order of the Coif). His
undergraduate degree was in economics at Purdue University, where he graduated
“with highest distinction,” Phi Beta Kappa, in 1976.
TABLE OF CONTENTS
I.
What is a Decanting Power? ............................................................................................1
II.
What is the Source of a Decanting Power? ....................................................................2
(A)
Non-Statutory Decanting Power Implied in Law from
Trustee’s Discretionary Power to Invade Principal. ........................................2
(B)
State Statutes that Explicitly Permit Decanting. ...............................................4
(C)
Provisions in the Trust Instrument that Explicitly Permit
Decanting. ..............................................................................................................6
III.
What Purposes Could Be Accomplished if a Trustee Decants? .................................7
IV.
An Annotated Walk Through the Kentucky Decanting Statute ..............................10
V.
What are the Potential Tax Consequences if Decanting Occurs? ............................23
VI.
(A)
For Now, Nobody Knows (Most Trust Decanting is a NonRuling Area).........................................................................................................23
(A)
Private Letter Ruling 201134017 .......................................................................25
(B)
IRS Notice 2011-101 and General Questions About Tax
Consequences. .....................................................................................................26
(C)
Can the Tax Risk Be Minimized While We Wait for IRS
Guidance? .............................................................................................................27
(D)
Loss of Grandfathered GST Exempt Status or Loss of Zero
Inclusion Ratio. ....................................................................................................28
(E)
What is the “Delaware Tax Trap,” and Should We Worry
About It? ...............................................................................................................31
What Other Issues Should a Trustee Worry About, in Deciding
Whether or Not to Decant? ............................................................................................33
(A)
Excessive Involvement by the Settlor of the Original Trust. ........................33
(B)
Frustrating the Settlor’s Intent (Being Too Eager to Please
Some Beneficiaries). ............................................................................................34
(C)
An Attempted Change of Situs or Governing Law for the
Second Trust May Not Work.............................................................................34
(D)
The Risk of Beneficiary Objections to Decanting AND from
Soliciting Releases or Consents from Beneficiaries. .......................................35
(E)
What If a Trustee is Also a Beneficiary of the Original Trust? .....................38
i
(F)
VII.
Dealing With Later-Arising Liabilities or Problems of the
First (Original) Trust. ..........................................................................................38
Final Comments ..............................................................................................................40
Appendix 1: Text of Kentucky Trust Decanting Statute (2012) .........................................41
Appendix 2: IRS Notice 2011-101 ...........................................................................................45
Appendix 3: ACTEC’s suggested answers to open tax issues ...........................................48
Appendix 4: Sample form provisions for decanting ...........................................................51
ii
THE NEW KENTUCKY DECANTING STATUTE
Decant. [transitive verb] Gradually pour (liquid, typically wine or a
solution) from one container into another, esp. without disturbing the
sediment.
New Oxford American Dictionary, 2nd edition.
Power of appointment. [noun] A power or authority conferred by one
person by deed or will upon another (called the “donee”) to appoint,
that is, to select and nominate, the person or persons who are to
receive and enjoy an estate or an income therefrom or from a fund,
after the testator’s death, or the donee’s death, or after the termination
of an existing right or interest. . . . A general power is in trust when any
person or class of persons, other than the grantee of such power, is
designated as entitled to the proceeds, or any portion of the proceeds,
or other benefits to result from the alienation.
Black’s Law Dictionary, 4th edition.
All panaceas become poison.
Stewart Brand
I.
What is a Decanting Power?
A “decanting power” is simply a power of appointment that is explicitly granted
to or held by a trustee, who can exercise the power in favor of one or more beneficiaries
of an existing trust, by distributing (decanting or pouring) assets out of the existing
trust and into a new trust for the same beneficiary or beneficiaries. The new trust has
favorable provisions or features that the existing trust lacks, or, conversely, the new
trust lacks provisions that make the existing trust problematic, in light of the needs or
changed circumstances of one or more beneficiaries. “Decanting” assets from old trust
into new trust therefore fits the metaphor of pouring old wine into a new bottle (contra
Mark 2:22), so that the unwanted provisions, the sediment, remain in the old bottle (the
old trust).
A decanting power is classifiable as a limited power of appointment, because the
trustee, as the holder of the power, cannot exercise the power in favor of the trustee in
his, her, or its individual capacity, unless the trustee also happens to be one of the
beneficiaries of the old or existing trust.
In this paper, “original trust” refers to the original or source trust from which a
decanting distribution is or may be made, and “second trust” refers to the other trust
(existing or newly created) that receives a decanting distribution. This terminology is
consistent with the Kentucky statute, KRS § 386.175, and with the terminology in many
1
other state decanting statutes (Some other state statutes use “first trust” to refer to the
original trust).
II.
What is the Source of a Decanting Power?
There are three potential sources of a trustee’s decanting power.
(A) Non-Statutory Decanting Power Implied in Law from Trustee’s Discretionary
Power to Invade Principal.
The first source of decanting power is common law. Originally, a trustee’s power
to appoint trust assets from one existing trust to a different trust for the same
beneficiary was implied from the breadth of the trustee’s discretion to invade and
distribute principal. This implied power to distribute from one trust to another trust
was based on three common-sense notions:

If a power of appointment can be exercised by appointing property directly and
outright to some appointee (recipient), who could do whatever he wanted with
the appointed property, then that appointee should be able to expand the class of
persons who could benefit from the property by creating and granting a further
power of appointment.1

If a broad power of appointment allows property to be appointed for the benefit of
an individual, the holder of that power should be able to appoint property to a
new or existing trust under which that individual is a beneficiary.

A trustee’s broad power to invade principal and to distribute it to or for the benefit
of a beneficiary is similar to or the equivalent of a power of appointment. And
even if such a distribution power is not classified as a limited power of
appointment, making a distribution from one trust to another trust with the same
beneficiary is one of the ways to benefit that beneficiary.
Most commentators agree that there is a difference between a limited power of
appointment held and exercisable by a beneficiary in a non-fiduciary capacity and a
limited power of appointment held and exercisable by a trustee in a fiduciary capacity,
even if both the beneficiary and the trustee could exercise the power by appointing
property to a new trust. The difference is that the trustee has a general rule to
administer the subject trust (and to exercise the trustee’s powers) only in ways that are
consistent with the settlor’s intent, the purposes of the trust, and the trustee’s general
fiduciary duties of loyalty and impartiality toward the beneficiaries. This distinction led
See Restatement (Second) of Property: Donative Transfers, §§ 11.1, comment d and 19.3
(1983-1986).
1
2
the drafters of the Third Restatement to take the strange position that a trustee’s broad
and flexible power to invade and distribute principal is not a power of appointment.2
The following are summary of some of the early court decisions that applied
common law principles to validate or to invalidate decanting:
In re Kennedy’s Will, 279 N.Y. 255, 18 N.E. 146 (1938). A testamentary trust
gave an adult daughter a life income interest and a testamentary power to appoint the
remaining assets among her children and descendants of deceased children. The
daughter purported to exercise this power of appointment to create a pair of trusts for
her only two children, where each child had a life income interest and a testamentary
limited power of appointment regarding the corpus of his or her trust. The New York
Court of Appeals reversed the Surrogate (probate court judge) and held that the
daughter’s power to appoint the remaining trust assets did not give her the power to
create interests for her children that delayed the vesting of their respective shares, and
to that extent, she did not have the power to create further trusts to receive her
children’s shares of the original trust assets after the daughter’s death.
Matter of Fiske, 195 Misc. 1017, 88 N.Y.S.2d 446 (N.Y. Sur. 1949). The testator
gave his surviving spouse a legal life estate and a testamentary power to direct the
manner in which his five children’s shares of net income and principal from the
remainder would be distributed or disposed of; this power explicitly included the
power to create trusts for those children. The surviving spouse exercised this power to
create a trust to receive each child’s share, and she added that the remaining assets of a
child who died without issue or who predeceased her should be distributed to that
child’s “heirs.” The Surrogate determined that this last provision exceeded the scope of
the power of appointment that the surviving spouse received from her late husband.
Phipps v. Palm Beach Trust Co., 142 Fla. 782, 196 So. 299 (1940). The irrevocable
trust instrument gave an individual trustee (the settlor’s spouse) the broad power to
direct the co-trustees (the spouse and a corporate fiduciary) to make distributions in
particular amounts, shares or proportions to any one or more of the settlor’s children
and their descendants, with the individual trustee controlling the timing of
distributions and also having the power to give such written directions in his last will.
The individual trustee (settlor’s spouse) gave the trust company a written direction to
distribute the entire trust property to a new but slightly different trust with the same
descendants as the beneficiaries, except that the new trust, among other things,
permitted one son to appoint income from his share to his wife. The Florida Supreme
Court upheld a decision by a chancellor, holding that the individual trustee’s broad and
absolute power to direct and control distributions gave him the power to create a
second trust estate for the benefit of the same beneficiaries, with distributions from the
second trust to occur at times and in a manner determined by the individual trustee.
Restatement (Third) of Property: Donative Transfers, §17.1, comment g (Tentative Draft
No. 5, 2006).
2
3
Wiedenmayer v. Johnson, 106 N.J. Super. 161, 254 A.2d 534 (1969). The founder
of Johnson & Johnson established trusts in 1944 for each of his six children. The trust for
one son (John Seward Johnson III) authorized the trustee to “use for or distribute and
pay over” to that son “any or all of the Trust Property . . . from time to time and
whenever in their absolute and uncontrolled discretion [the trustees] deem it to be for
his best interests,” with the Trust assets so distributed to be the absolute property of the
son. If the son died at a time when his trust still contained assets and had not exercised
his limited testamentary power of appointment, the remaining trust assets would pass
to the son’s issue in equal shares per stirpes. The trustees proposed to distribute all of
the trust assets (about $18 million) outright to son J. Seward Johnson III, but on the
condition that he immediately transfer those assets to a new trust, with himself as the
primary beneficiary and with a content proposed by the trustees. J. Seward Johnson III
himself approved of the condition and the provisions of the new or second trust; two of
his children objected. The New Jersey appellate court held that the distribution of the
trust assets and the funding of the second trust were valid, and that the contingent
remainder interests of the two objecting children were at risk of being lost under the
original trust as well, if their father could receive only unconditional “outright”
distributions.
In re Estate of Spencer, 232 N.W.2d 491 (Iowa 1975). Fern Spencer died in 1944,
and her Will gave her husband (L. J.) a power of appointment that he could exercise
during his lifetime or by Will to grant life estates in certain real estate to their four
named children, with the remainders to their respective children. L. J. Spencer died in
1972 without having exercised the lifetime power of appointment, but in his Will, he
devised the subject farm real estate to the trustee of a trust for the benefit of L. J.’s and
Fern’s four children and other descendants, with the trust to continue for the longest
period permitted by the Iowa Rule Against Perpetuities. The trial court found that L. J.’s
purported devise of the real estate in trust was a violation of the scope of the power of
appointment he received from Fern. The Iowa Supreme Court held that L. J.’s devise of
the real estate to a trust for the children and other descendants was consistent with
Fern’s intent and was a valid exercise of L. J.’s power of appointment, but that L. J.’s
trust provisions were invalid to the extent that they postponed the vesting of each
child’s fractional interest in the trust assets as that child died.
Some trustees — especially banks and trust companies that have a more finelyhoned sense of rational paranoia — have been reluctant to act without the protection of
court approval or a state statute, i.e., to exercise a discretionary power to invade
principal by distributing assets from one trust into another trust, unless it appeared
extremely unlikely that any beneficiary would object to the distribution to the second
trust.
(B) State Statutes that Explicitly Permit Decanting.
The second source of decanting power is statutory. New York was the first U. S.
state to enact a decanting statute, effective July 24, 1992. The passage of Section 10-6.6(b)
4
of the Estates, Powers and Trusts Law (EPTL) was originally motivated largely by a
desire to allow trustees of existing (pre-September 26, 1985) generation-skipping trusts
to adapt to changing circumstances without losing the “grandfathered” exemption from
the re-tooled and re-enacted GST tax provisions that were added to the Internal
Revenue Code, effective for transfers on or after October 23, 1986.
As of March 2013, the eighteen (18) state statutes3 that currently permit decanting
are as follows (Effective dates are stated in parentheses):
Kentucky: KRS § 386.175 (July 12, 2012)
Ohio: Ohio Rev. Code § 5808.18 (March 22,
2012)
Indiana: I.C. § 30-4-3-36 (July 1, 2010)
Illinois: 760 Ill. Comp. Stat. 5/ § 16.4
(January 1, 2013)
North Carolina: N.C. Gen. Stat. § 36C8-816.1 (October 1, 2009; amendment
effective July 20, 2010)
Tennessee: Tenn. Code Ann. § 35-15816(b)(27) (July 1, 2004)
Delaware: 12 Del. C. § 3528 (June 30,
2003; amendments effective June 24,
2004, June 27, 2006, July 5, 2007, July 6,
2009, and July 13, 2011)
New York: EPTL § 10-6.6(b) (January 24,
1992; amendment effective August 17,
2011)
Florida: Fla. Stat. § 736.04117 (January
1, 2007)
New Hampshire: N.H. Rev. Stat. Ann.
§ 564-B: 4-418 (September 9, 2008)
Michigan: Mich. Comp. Laws
§§ 700.7820a, 556.115a, and 700.7103
(December 28, 2012)
Alaska: Alaska Stat. § 13.36.157 (September
15, 1998; amendments in 2006; proposed
amendments in most recent session failed)
Rhode Island: R.I. Gen. Laws § 18-4-31
(June 23, 2012; 2013 amendments
possible)
Virginia: Va. Code § 55-548.16 and (after
recodification) § 64.2-778-1 (July 1, 2012)
Missouri: Mo. Rev. Stat. § 456.4-419
(August 28, 2011)
South Dakota: S.D. Codified Laws §§ 55-215 to 55-2-21 (2007)
Nevada: 13 Nev. Rev. Stat. § 163-556
(2009)
Arizona: Ariz. Rev. Stat. Ann. § 14-10819
(2009)
In February 2013, a Texas state senator introduced SB 648, which would amend § 112
of the Texas Property Code to add trust decanting provisions. As of mid-June 2013, that
bill was either stalled in committee or dead.
3
5
(C) Provisions in the Trust Instrument that Explicitly Permit Decanting.
The third source of a trustee’s decanting power is a provision in the trust
instrument for the original trust (first trust) that explicitly permits distribution from that
trust to a second trust (new trust) for the same beneficiary or beneficiaries.
In 2013, with the exception of standard “facility of payment” or “flexible
distribution” clauses that typically apply to trust beneficiaries who are minors or
incapacitated,4 trust provisions that specifically allow decanting (either with or without
using the word “decant”) are relatively rare in trust instruments.
A specific decanting provision in a Kentucky trust instrument could permit
decanting in a wider range of situations than Indiana’s statute would permit, because of
the general ability of a settlor to create trust provisions that apply instead of or in
addition to the “gap-filling” rules of law in the Kentucky Uniform Trustees’ Powers Act
and UPIA (e.g., KRS §§ 386.805 and 386.452(1)(a) and (b)).
This writer suggests that an explicit decanting provision in a trust instrument
should be custom-tailored to the settlor’s purposes and to the particular characteristics
and foreseeable future needs and circumstances of the trusts’ beneficiaries.
If a trust instrument contains a broad, general decanting provision that
purportedly allows the trustee to decant for a wide variety of purposes and to “second
trusts” with widely-varying potential structures, the trustee may become paralyzed or
confused by having “too many” choices and too little guidance, and a particular
decanting distribution may violate the principles in KRS § 386.175 — with uncertain
legal, practical, and tax consequences.
However, purely as an illustration of the kinds of purposes that could be served
by a specific decanting provision in a trust instrument, Appendix 4 contains a general
sample provision.
For example, a provision in the trust instrument that authorizes the trustee to
distribute the share of a minor beneficiary to a “minor’s trust” that fits the requirements
of Code § 2503(c). Under KRS § 386.810(3)(v), a trustee’s general statutory powers
include the power:
4
“(v) To pay any sum distributable to a beneficiary under legal disability,
without liability to the trustee, by paying the sum to the beneficiary or by
paying the sum for the use of the beneficiary either to a legal
representative appointed by the court, or if none, to a relative.”
This statutory power is arguably not worded broadly enough to allow the trustee to
make a distribution on behalf of a disabled or incapacitated beneficiary to the trustee of
an existing or newly-created trust for that beneficiary.
6
III.
What Purposes Could Be Accomplished if a Trustee Decants?
Trust decanting is a tool with uses similar to statutory remedies (such as courtapproved modifications or deviations or extra-judicial settlements in Uniform Trust
Code jurisdictions), severances and mergers of trusts (either statutory or with court
approval),5 disclaimers, instrument-based tools such as trust protector or trust advisor
action or limited amendment powers, or common-law remedies of reformation. Like
these other tools, a decanting power can be used to achieve roughly the same variety of
end results—to update administrative provisions, to modify the interests of one or more
beneficiaries, or to change the pattern of permitted or required distributions, in order to
circumvent inflexible provisions or to deal with changes in circumstances that the
settlor of the original trust did not anticipate.6
The objectives that can be achieved through decanting vary from state to state,
and some of the end results listed below would not be permitted under some state
decanting statutes. But all of the following objectives either are theoretically achievable
through decanting in at least one state or have been accomplished in particular cases:

Changing purely administrative
provisions, or adding new ones, to
make changes of situs easier or to
keep abreast of changes in state law

Creating more specific or up-to-date
rules in the second trust for trustee
compensation, trustee powers,
accountings, beneficiary access to
information, and more flexible
procedures for trustee replacement

Changing the trustee “management
structure” e.g., to provide for a
division of labor between multiple cotrustees or to create the position(s) of
directed trustee, distribution
committee, trust protector or
supervisor, trust advisor, investment
manager, etc.
For example, the IRS determined that a severance of trusts into separate trusts under
state law, followed by a merger of some of those trusts into existing trusts —achieving
the same end result as decanting — would not have adverse estate, gift or GST tax
consequences. See PLR 200451021 (July 30, 2004).
5
However, unlike those other remedies, which usually require either the approval of a
court or notice to or the consent of interested beneficiaries, a decanting power is
generally exercisable without court approval (In Kentucky, court approval is not
required unless a beneficiary files a timely objection proceeding after receiving notice).
6
7

Delay or eliminate the time at which
a beneficiary of the original trust
acquires a vested right to receive the
“outright” distribution of all (or a
stated fraction of) the trust assets
[not possible in Kentucky if that
beneficiary’s interest in the original
trust was funded with “non-taxable
gifts” under Code §§ 2503(c) or (b)]

Eliminate the mandatory income
interest of a non-spouse beneficiary
who is also entitled to receive or
benefit from discretionary
distributions of trust principal [not
possible in Kentucky to eliminate or
reduce a beneficiary’s fixed income,
annuity, or unitrust interest]

Getting rid of a HEMS standard that
constrains or applies to the trustee’s
discretionary distribution powers
under the original trust
[not possible in Kentucky to remove an
ascertainable standard if the trustee is
also a beneficiary; otherwise, a standard
in the original trust can be removed or
made more or less restrictive in the
second trust]

Give a current or future beneficiary of
the original trust a testamentary
limited power of appointment under
the second trust

Add (in the second trust)
spendthrift restrictions to the
interest(s) of one or more
beneficiaries of the original trust, to
react to problems of substance
abuse, financial irresponsibility, or
the objective of maintaining
eligibility for government benefits

Following the severance (division) of
one multi-beneficiary (“pot”) trust
into separate trusts, transfer the trust
assets for one (or fewer than all) of
the beneficiaries to a new trust(s) that
contains appropriate “special needs”
or spendthrift restrictions

Eliminating the interests of some
contingent remainder beneficiaries
under the original trust
[Kentucky’s statute arguably permits
the elimination of one or more
beneficiaries in the second trust so long
as they do not have fixed income,
unitrust, or annuity interests in the
original trust]

Adding contingent remainder
beneficiaries in the second trust
[Kentucky’s statute does not permit the
second trust to add beneficiaries who are
not beneficiaries of the original trust, but
if beneficiaries of the second trust are
given powers of appointment, nonbeneficiaries could be permissible
appointees]
8

Postponing the date on which the
original trust must terminate (under
the trust instrument for the original
trust or under the applicable state
Rule Against Perpetuities) [In
Kentucky, possible only so long as
vesting or the right of alienation is not
postponed beyond the statutory RAP
period]

Addressing long-term GST tax
problems with a multi-generation
trust by giving skip-person
beneficiaries general testamentary
powers of appointment under the
second trust, to deliberately cause
estate inclusion under Code § 2041

Converting a grantor trust to a nongrantor trust, or accomplishing the
reverse (see Chief Counsel Advice
200923024)

Eliminating the Crummey
withdrawal power of one beneficiary
when a second ILIT is created to
receive a decanting distribution from
the first ILIT 7
[not possible in Kentucky unless the
withdrawal power being eliminated is a
one-time power and unless sufficient
assets are left inside the original trust]
Many of the above objectives could be achieved through limited amendments, if the
original trust instrument gives a special amendment power to a trustee or other person, or if a
court could be convinced to approve or authorize an amendment. Frequently, however,
no trustee has an explicit amendment power; or the factual basis for court approval of
an amendment is weak; or it is not possible to obtain waivers of notice and consents
from all (or a sufficient majority) of the interested beneficiaries of the trust.
The use of decanting to achieve one of the above-listed results could, in a
particular situation, (a) cause unfavorable tax consequences, or (b) be outside the scope
of the relevant state statute, or (c) attract objections or claims of breach of trust from one
or more beneficiaries, on the grounds that the decanting was contrary to the settlor’s
intent or the purposes of the original trust.
A trustee has a general obligation to defend and carry out the settlor’s known
intent. Even if a proposed decanting would make only administrative changes to the
original trust, it may be wise or even essential for the trustee to seek advance court
approval for the proposed decanting, if the resulting changes would reduce or narrow
the standard of care or tend to limit the trustee’s future liability to the beneficiaries.
See Matter of Ould, New York Law Journal, 11-28-2001, p. 21, col. 5 (Surr. Ct. N.Y.
County).
7
9
IV.
An Annotated Walk Through the Kentucky Decanting Statute
Kentucky’s statute, KRS § 386.175 (see Appendix 1 for the text without
annotations), only applies to decanting by trustees. If a trust instrument gives a nonfiduciary, such as a beneficiary, a suitably broad limited power of appointment to
appoint trust assets to another (second) trust, that non-fiduciary could exercise the
power of appointment within its stated limits and conditions, but without regard for the
conditions and restrictions in § 386.175.
In the table below, the left column contains the verbatim text of the subsections
and paragraphs in Kentucky’s statute and the right column contains explanatory
comments.
Text of KRS § 386.175
Comments
(1)
For the purposes of this
section, the following definitions apply:
A “current beneficiary” can have the
right to receiver or benefit from either
discretionary or mandatory distributions
of either income or principal.
(a) “Current
beneficiary”
means a person who is a permissible
distributee of trust income or
principal;
The definition of “current beneficiary” is
important in testing whether the
“second trust” is a trust to which a
decanting distribution can be made.
(b) “Original trust” means a
trust
established
under
an
irrevocable
trust
instrument
pursuant to the terms of which a
trustee has discretionary power to
distribute principal or income of the
trust to or for the benefit of one (1) or
more current beneficiaries of the
trust;
and
Decanting distributions are permitted
only if the trustee of the “original trust”
has the discretion to distribute principal
OR income to or for the benefit of at
least one current beneficiary. No
particular distribution standard is
specified and the trustee need not have
“unlimited” or “absolute” discretion (see
subsection
(4)(h)
below).
10
Text of KRS § 386.175
Comments
(c) “Second trust” means a trust
established under an irrevocable
trust
instrument,
the
current
beneficiaries of which are one (1) or
more of the current beneficiaries of
the original trust. The second trust
may be a trust created under the
same trust instrument as the original
trust or under a different trust
instrument.
The second trust’s current beneficiaries
must consist of one or more of the
current beneficiaries of the original
trust. This language and subsection
(4)(a) allow the second trust to eliminate
the interest of one or more beneficiaries
of the current trust (so long as at least
one beneficiary remains) but not to add
any “new” beneficiaries.
This prohibition on adding beneficiaries
to the second trust may help to prevent
a taxable gift from occurring as a result
of decanting.
(2) A trustee of an original trust
may, without authorization by the
court, exercise the discretionary
power to distribute principal or
income to or for the benefit of one
(1) or more current beneficiaries of
the original trust by appointing all or
part of the principal or income of the
original trust subject to the power in
favor of the trustee of a second trust.
The trustee of the original trust may
exercise this power whether or not
there is a current need to distribute
principal or income under any
standard provided in the terms of
the original trust. The trustee’s
special power to appoint trust
principal or income in further trust
under this section includes the
power to create the second trust.

The decanting distribution is made
to the trustee of the second trust.

Either income OR principal OR both
can be decanted to the second trust.

Even if the original trust instrument
prescribes a distribution standard
under which there is arguably no
current “need” for a distribution, the
trustee can still decant.

The trustee’s decanting power is
classified or characterized as a
special power of appointment.

The trustee of the original trust can
create the second trust to which the
decanting distribution will be made.
Multiple “second trusts” may receive
different decanting distributions.
The second trust may accomplish a
change of situs or governing law
(compared to the original trust).
(3)
The second trust may be a
trust created or administered under the
laws of any jurisdiction, within or
without the United States.
11
Text of KRS § 386.175
Comments
(4)
The terms of the second trust
shall be subject to all of the following:
Subsection (4) places limits on what
would otherwise be a broad power to
decant.
(a) The beneficiaries of the
second trust may include only
beneficiaries of the original trust;
The second trust instrument cannot add
beneficiaries who are not beneficiaries of
the original trust, but current or future
beneficial interests that are purely
discretionary could be eliminated.
(b) A beneficiary who has only a
future beneficial interest, vested or
contingent, in the original trust
cannot have the future beneficial
interest accelerated to a present
interest in the second trust;
A beneficiary’s future interest in the first
trust cannot be replaced with a present
interest in the second trust (to prevent a
taxable gift).
(c) The terms of the second
trust may not reduce any fixed
income, annuity, or unitrust interest
of a beneficiary in the assets of the
original trust, including an interest
which is to take effect in the future;
Similar to many other state decanting
statutes: If a beneficiary of the original
trust has a non-discretionary income
interest, annuity interest, or unitrust
interest, that interest must be preserved
in the second trust.
(d) If any contribution to the
original trust qualified for a marital
or charitable deduction for federal
income, gift, or estate tax purposes
under the Internal Revenue Code,
then the second trust shall not
contain any provision that, if
included in the original trust, would
have prevented the original trust
from qualifying for the deduction or
that would have reduced the amount
of the deduction;
Subsection (4)(d) is intended to prevent
the loss of a charitable or marital
deduction as a result of a decanting
distribution.
12
Text of KRS § 386.175
Comments
(e) If contributions to the
original trust have been excluded
from the gift tax by the application
of Sections 2503(b) and 2503(c) of the
Internal Revenue Code, then the
second trust shall provide that the
beneficiary’s remainder interest in
the contributions shall vest and
become distributable no later than
the date upon which the interest
would have vested and become
distributable under the terms of the
original trust;
Subsection (4)(e)’s reference to “the
beneficiary’s remainder interest” is
slightly odd.
(f) If any beneficiary of the
original trust has a currently
exercisable power of withdrawal
over trust property, then either:
A currently exercisable withdrawal power
under the original trust must be
protected using either of the two
methods in a and b.
a.
The terms of the second trust
shall provide a power of
withdrawal in the second
trust identical to the power
of withdrawal in the original
trust; or
b.
Sufficient trust property shall
remain in the original trust to
satisfy the currently exercisable power of withdrawal;
Example 1: The “original trust” is a
§ 2503(c) “minor’s trust” under which
the child beneficiary has a one-time
withdrawal right for a 30-day period
beginning at age 21 AND the right to
receive mandatory distributions of trust
principal at ages 30, 35, and 40. The
second trust must provide that child
beneficiary with the same withdrawal
right at age 21 AND the right to receive
mandatory distributions at those ages or
at earlier ages. The times for vesting and
for mandatory distributions can be
accelerated but not postponed further in
the second trust.
Method a could be used if a decanting
distribution is being made from an
existing ILIT or from some other type of
§ 2503(b) trust into a new trust, when
future gifts will be made to the new trust
and when it is important to preserve the
exclusion from taxable gifts.
Method b may be suitable if the
currently exercisable withdrawal power
in the original trust is a one-time power.
Example 2: The original trust is an ILIT
in which all 3 of the settlor’s children
13
Text of KRS § 386.175
Comments
have Crummey withdrawal powers
with respect to all gift additions to the
ILIT. Neither Method a nor Method b
could be used to eliminate the
withdrawal power of 1 or 2 of those
children under the second trust’s terms.
Example 3: The original trust has Child
C as its sole current beneficiary and has
never received annual exclusion gifts. C
is 20 years old and has the right to
receive or benefit from discretionary
income and principal distributions.
Immediately after reaching ages 30 and
35, C has the right to demand and
withdraw one- third and one-half of the
remaining trust principal. These two
withdrawal powers are not currently
exercisable, and so trustee could make a
decanting distribution to a new second
trust for C, under which C’s withdrawal
rights are postponed or eliminated.
(g) If the original trust holds
stock of an S corporation, the terms
of the second trust shall not prevent
or eliminate an election to be a
qualified subchapter S trust or an
electing small business trust or result
in the termination of the S election of
such corporation;
After decanting, the second trust
probably can use a QSST election to
replace the original trust’s ESBT
election, but the reverse probably cannot
be done via decanting unless the second
trust preserves the “all net income”
interest of each income beneficiary
under the original trust. See 26 C.F.R.
§ 1.1361-1(j)(12) and (m)(7) for the
preconditions for IRS approval of a
QSST-to-ESBT
or
ESBT-to-QSST
“conversion.”
14
Text of KRS § 386.175
Comments
(h) If the power to distribute
principal or income in the original
trust is subject to an ascertainable
standard, then the power to
distribute income or principal in the
second trust shall be subject to the
same
or
a
more
restrictive
ascertainable standard as in the
original trust when the trustee
exercising the power described in
subsection (2) of this section is a
possible beneficiary under the
standard;
and
Subsection (4)(h) arguably applies only if
the trustee is also a beneficiary, and
seems intended to prevent the
accidental creation of a general power of
appointment in the hands of the trustee
if he or she remains a trustee under the
second trust.
If (4)(h) applies and if the original trust
contains an ascertainable standard such
as HEMS language to limit or guide the
trustee’s discretion, that standard must
be preserved or made more restrictive in
the second trust (To prevent the
occurrence or appearance of a taxable
gift, the second trust cannot eliminate or
delete the ascertainable standard).
Conversely, the second trust can ADD
an ascertainable standard and/or
spendthrift
restrictions
to
any
beneficiary’s discretionary interest, and
if the trustee is not a beneficiary, an
ascertainable standard can be removed.
Example 4: The original trust gives
daughter beneficiary D the right to
benefit from wholly discretionary
distributions from trust income and
principal. D has a serious substance
abuse problem and the trustee wishes to
give D an incentive to get and stay
“clean.” Because D does not have a
mandatory income interest in the
original trust, the trustee could decant
assets into a second trust under which
D’s entitlement to receive distributions
would be conditioned on passing
periodic drug screenings.
15
Text of KRS § 386.175
Comments
(i) The second trust may confer
a power of appointment upon a
beneficiary of the original trust to
whom or for the benefit of whom the
trustee has the power to distribute
principal or income of the original
trust. The permissible appointees of
the power of appointment conferred
upon a beneficiary may include
persons who are not beneficiaries of
the original or second trust. The
power of appointment conferred
upon a beneficiary shall be subject to
KRS 381.224, 381.225, and 381.226
covering the time at which the
permissible period of the rule against
perpetuities and suspension of
power of alienation begins and the
law that determines the permissible
period
of
the
rule
against
perpetuities and suspension of
power of alienation of the original
trust.
Even if the original trust does not confer
a power of appointment on a
beneficiary, the second trust can give
that
beneficiary
a
power
of
appointment, and that power could
allow appointment of trust assets to
persons “who are not beneficiaries” of
either trust.
(5) The court may appoint a special
fiduciary with the authority to exercise the
power to appoint principal or income
under subsection (2) of this section.
If the current trustee or co-trustees of the
original trust is or are “gun-shy” and
reluctant to exercise the statutory
decanting power (e.g., the trustee is also
a beneficiary and perceives a conflict of
interest), the court can appoint a special
trustee with one-time or (presumably)
continuing authority to make decanting
distributions.
The cross-references are to the Kentucky
statutory rule against perpetuities (RAP)
as it applies to interests in trusts. See the
discussion of the “Delaware Tax Trap”
on Page 31 below. With respect to trusts
from which decanting distributions can
be made, KRS § 381.225(1)(c) should
prevent the Delaware Tax Trap by
causing the “permissible [RAP] period”
to start running when the original trust
was created.
Reformation or modification proceedings should be available under KRS
§ 381.226(2) to cure a real or apparent
RAP problem that is created by
decanting from an original trust.
16
Text of KRS § 386.175
Comments
(6) The exercise of the power to appoint
principal or income under subsection (2) of
this section:
Subsection (6) confirms how a decanting
distribution should be characterized.
(a) Shall be considered an
exercise of a power of appointment,
other than a power to appoint to the
trustee, the trustee’s creditors, the
trustee’s estate, or the creditors of
the trustee’s estate;
Consistent with case law and the Second
and Third Restatements, a decanting
distribution is treated as the trustee’s
exercise of a special (non-general) power
of appointment. Also relevant under the
second half of KRS § 381.225(1)(c).
See the discussion of subsection (4)(i)
above and the discussion of the
Delaware Tax Trap below.
(b) Shall be subject to KRS
381.224,
381.225,
and
381.226
covering the time at which the
permissible period of the rule against
perpetuities and suspension of
power of alienation begins and the
law that determines the permissible
period
of
the
rule
against
perpetuities and suspension of
power of alienation of the original
trust; and
(c) Is not prohibited by a
spendthrift provision or by a
provision in the original trust
instrument
that
prohibits
amendment or revocation of the
trust.
A spendthrift restriction on a beneficiary’s interest in the original trust
does not prohibit decanting. This
Kentucky statute does not explicitly
prohibit the removal of a spendthrift
restriction in the second trust.
17
Text of KRS § 386.175
Comments
(7)
To effect the exercise of the
power to appoint principal or income
under subsection (2) of this section, all
of the following shall apply:
Subsection (7) specifies the required
documentation, notice, and procedure
for
making
a
valid
decanting
distribution.
(a) The exercise of the power to
appoint shall be made by an
instrument in writing, signed and
acknowledged by the trustee, setting
forth the manner of the exercise of
the power, including the terms of the
second trust and the effective date of
the exercise of the power. The
instrument shall be filed with the
records of the original trust;
(a) requires that the “terms of the second
trust” be stated in the signed record of
the exercise of the decanting power.
18

The trustee of the original trust (or
the
court-appointed
special
fiduciary) must sign the record of
exercise before a notary or other
officer authorized to take acknowledgements.

Presumably, a copy of the entire
trust instrument for the second trust
could be attached to the signed
record.

The record of exercise arguably
should cite the provision in the
original trust instrument that gives
the trustee the discretionary power
to
distribute
income
and/or
principal, and that is being relied on
as the source of the decanting power.

The record of exercise arguably must
specify the amount of money or
describe the other assets being
distributed out of the original trust
(as part of the “manner of exercise of
the power”).

Unless there is a later objection or
dispute, the record of exercise need
not be filed with any court, but a
copy of the record of exercise must
be provided to certain beneficiaries,
under subsection (7)(b) [next page].
Text of KRS § 386.175
Comments
Under (7)(b), 60 days’ advance notice is
mandatory.
(b) The trustee shall give
written notice of the trustee’s
intention to exercise the power to all
current beneficiaries of the original
trust and all beneficiaries of the
oldest generation of remainder
beneficiaries of the first [sic] trust, by
certified mail with restricted delivery
and return receipt, at least sixty (60)
days prior to the effective date of the
exercise of the power to appoint. The
notice shall include a copy of the
instrument described in paragraph
(a) of this subsection;
19

Any beneficiary currently eligible to
receive mandatory or discretionary
distributions of income OR principal
from the original trust must be sent
written notice.

Remainder beneficiaries of the
original trust in the first generation
(e.g., the children of a life income
beneficiary) must be sent notice, but
a contingent remainder beneficiary
(who would not be a “qualified
beneficiary” under UTC §103(13)(B)
or (C)) need not be sent notice.

Can principles of “virtual representation” be used to send written
notice to representatives on behalf of
beneficiaries who are minors or who
are otherwise under a legal
disability?

If mailing by certified mail “with
restricted delivery and return
receipt” is not effective to deliver the
statutory notice to a beneficiary,
subsection (7)(e) implies that the
trustee may not seek the court’s
approval to use a different method of
service; the only recourse is for the
trustee to seek court approval of the
proposed decanting under (e).
Text of KRS § 386.175
Comments
The 60-day lead time between the
service of notice and the effective date
for decanting can be shortened if ALL
beneficiaries who are entitled to notice
have received the certified mail notice
and sign written waivers of the rest of
the lead time.
(c) If all beneficiaries entitled to
notice have received the notice as
evidenced by the certified mail
return receipt and waive the notice
period by a signed written
instrument delivered to the trustee,
the trustee’s power to appoint
principal or income shall be
exercisable after notice is waived by
all such beneficiaries, notwithstanding the effective date of the
exercise of the power;
Read literally, (7)(c) would not allow the
trustee of the first trust to solicit and
receive written waivers by sending the
proposed record of exercise and notice
to each beneficiary by e-mail or by
overnight courier delivery.
Two classes of beneficiaries can block
proposed decanting (unless a District
Court approves it) by commencing a
proceeding to object:
(d) A current beneficiary or a
beneficiary who is not a current
beneficiary but is a member of the
oldest generation of the remainder
beneficiaries of the original trust
may, no later than thirty (30) days
from the date of receiving notice
under paragraph (b) of this
subsection, commence a judicial
proceeding
in
District
Court
pursuant to KRS 386.675 to object to
the proposed exercise of the power
under subsection (2) of this section.
In such case the proposed exercise of
the power shall require consent of
the District Court as defined by KRS
386.450(3). Any determination of the
District Court shall be subject to KRS
386.454(5);
and

Any “current beneficiary” of the
original trust, as defined in
subsection (1)(a)

Any remainder beneficiary who is a
member of the oldest generation of
remainder beneficiaries named or
defined in the original trust
The objecting beneficiary must file the
“objection proceeding” within 30 days
after receipt of the statutory notice
under (7)(b).
If the trustee or a beneficiary party
disagrees with the District Court’s
decision to approve or disapprove the
decanting distribution after a timely
objection, the aggrieved party can file an
adversary proceeding in Circuit Court
(cross-reference to KRS 386.454(5),
which in turn refers to KRS
§ 24A.120(2)).
20
Text of KRS § 386.175
Comments
Subsection (7)(b) and (e) make the notice
process unwieldy if any beneficiary
refuses to accept certified mail service or
cannot be served by mail, even if there is
no objection by any of the beneficiaries
who have received sufficient service by
certified mail.
(e) In the event that a
beneficiary did not receive the notice
as evidenced by the certified mail
return receipt, and no other
beneficiary has commenced a
proceeding under paragraph (d) of
this subsection, the trustee may seek
the approval of the District Court to
exercise the power.
(8) is a broad statement of legislative
intent. The first sentence protects the
trustee of the original trust from a
breach-of-trust claim if any beneficiary
is displeased with the trustee’s decision
to refrain from exercising the decanting
power.
(8)
Nothing in this section shall
be construed to create or imply a duty
of the trustee to exercise the power to
distribute principal or income, and no
inference of impropriety shall be made
as a result of a trustee not exercising the
power to appoint principal or income
conferred under subsection (2) of this
section. Nothing in this section shall be
construed to abridge the right of any
trustee who has the power to appoint
property in further trust that arises
under the terms of the original trust or
under any provision of law or under
common
law.
The second sentence in (8) means that
explicit, “customized” decanting powers
can be included in new irrevocable trust
instruments. Trustees who rely on such
explicit decanting provisions or on other
applicable law (instead of relying on the
Kentucky statute) may make decanting
distributions that would not be
permitted under the Kentucky statute.
Whether such decanting distributions
would cause adverse tax consequences
or other problems is a separate issue.
For obvious reasons, decanting from a
CRAT or CRUT is not permitted under
this statute Early terminations and
severances of CRATs and CRUTs are
still possible with court approval.
(9)
This section shall not apply to
any charitable remainder trust as
defined in 26 U.S.C. sec. 664(d).
21
Text of KRS § 386.175
Comments
Read literally, subsection (10) would:
(10) A trustee or beneficiary may
commence a judicial proceeding in the
District Court pursuant to KRS 386.675
to approve or disapprove of a proposed
exercise of the trustee’s special power to
appoint to a second trust pursuant to
subsection (2) of this section. In such
case approval by the District Court shall
have the same meaning as provided in
KRS 386.450(3) and the approval shall
be subject to KRS 386.454(5).

Allow any beneficiary to proactively
petition and “lobby” for or against a
decanting distribution that is
permitted under this statute, before a
statutory notice is issued under
subsection (7)(b); or

Allow the trustee of the original trust
to petition for instructions or
approval with respect to a possible
decanting distribution, under KRS
§ 386.675.
Kentucky’s decanting statute will allow decanting to occur in more situations
compared to the trust decanting statutes in some other states (such as Ohio and
Indiana), because the original trust instrument need only give the trustee some
discretion to distribute income or principal. That discretion need not be worded as
“absolute” or “unlimited” and need not be broad. Although Kentucky’s statute restricts
the nature and the scope of changes that can be made in the second trust, the presence
of HEMS-type ascertainable standard wording in an original trust instrument will not,
by itself, prevent decanting distributions from that trust. In this respect, the Kentucky
statute is similar to the New York statute as amended in 2011 and to the Delaware
statute.
As explained above, the Kentucky decanting statute allows the second trust to
eliminate or to change the beneficial interest of one or more beneficiaries of the original
trust, so long as —

The beneficiary whose interest is being eliminated or restricted does not have a
fixed income interest, unitrust interest, or annuity interest in the original trust;

The second trust’s terms do not adversely affect a beneficial interest in the
original trust that qualified for the charitable or marital deductions;

A currently-exercisable withdrawal power held by a beneficiary is either
preserved or protected; and

Any “remainder” interest held by a beneficiary will not have its vesting delayed
under the second trust, if that beneficiary’s interest in the first trust was funded
with annual exclusion gifts under Code sections 2503(b) or 2503(c).
Is there a way to circumvent the Kentucky statute’s prohibition of adding
beneficiaries in the second trust that receives a decanting distribution? On the face of
22
the statute, the only available work-around is indirect: The trustee can rely on KRS
§ 386.175(4)(i) and can structure the second trust so that one of the current beneficiaries
of the original trust has a special power of appointment over some portion of the second
trust’s assets. The permissible appointees can “include persons who are not
beneficiaries of the original or second trust.”
Like several other state decanting statutes, Kentucky’s statute does not specify, in
significant detail, what content the “written instrument” required by KRS 386.175(7)(a)
should have. A suggested sample “Record of Exercise” appears at the beginning of
Appendix 4, starting on Page 51. It is sensible to assume that a written record of
exercise should include all of the following information:

A description of the property or the amount of money that is being decanted
from the original trust to the second trust

Quotation of (or at least citation to) the provision in the original trust instrument
that is the source of the trustee’s decanting power (i.e., discretionary power to
distribute principal and/or income from the original trust)

An effective date for the decanting distribution (see below)

The name and address of the trustee of the second trust receiving the distribution

The date of the trust instrument for the second trust and other information
identifying the trust by name or account number

A recitation that a complete copy of the trust instrument for the second trust is
attached as
If the trust instrument for the second trust is not available at the time that the trustee
wishes to sign and acknowledge the written instrument evidencing the exercise of the
decanting power, and if the trustee cannot or will not postpone signing until after the
full trust instrument is available, the written “instrument of exercise” arguably should
list all of the “current beneficiaries” and oldest-generation remainder beneficiaries of
the second trust and should accurately summarize the interest that each such
beneficiary has in the second trust.
V.
What are the Potential Tax Consequences if Decanting Occurs?
(A) For Now, Nobody Knows (Most Trust Decanting is a Non-Ruling Area).
For about two and half years, the tax consequences of trust decanting has been a
“no ruling” area for the IRS. This began with Rev. Proc. 2011-3, 2011-1 IRB 111, issued
on January 3, 2011. In Rev. Proc. 2011-3, the IRS included an income tax issue, a gift tax
issue, and a GST tax issue among the “areas under study” in which the IRS would not
issue rulings or determination letters until after Service publishes regulations or other
guidance.
23
Substantially the same “no rulings” text appeared in Rev. Proc. 2012-3, 2012-1
IRB 113 (January 3, 2012) and in Rev. Proc. 2013-3, 2013-1 IRB 113 (January 2, 2013).
The relevant text from Rev. Proc. 2013-3 reads as follows (The wording in the 2011 and
2013 Rev Procs. is identical or nearly so):
SECTION 5. AREAS UNDER STUDY IN WHICH RULINGS OR
DETERMINATION LETTERS WILL NOT BE ISSUED UNTIL THE
SERVICE RESOLVES THE ISSUE THROUGH PUBLICATION OF A
REVENUE RULING, A REVENUE PROCEDURE, REGULATIONS OR
OTHERWISE
0.1
Specific Questions and Problems.
....
(16) Sections 661 and 662.—Deduction for Estates and Trusts
Accumulating Income or Distributing Corpus; Inclusion of Amounts in Gross
Income of Beneficiaries of Estates and Trusts Accumulating Income or
Distributing Corpus.—Whether the distribution of property by a trustee
from an irrevocable trust to another irrevocable trust (sometimes referred
to as a “decanting”) resulting in a change in beneficial interests is a
distribution for which a deduction is allowable under § 661 or which
requires an amount to be included in the gross income of any person
under § 662.
....
(23) Section 2501.—Imposition of Tax.—Whether the distribution of
property by a trustee from an irrevocable trust to another irrevocable trust
(sometimes referred to as a “decanting”) resulting in a change in beneficial
interests is a gift under § 2501.
(24) Sections 2601 and 2663.—Tax Imposed; Regulations.—Whether the
distribution of property by a trustee from an irrevocable generationskipping transfer tax (GST) exempt trust to another irrevocable trust
(sometimes referred to as a “decanting”) resulting in a change in beneficial
interests is the loss of GST exempt status or constitutes a taxable
termination or taxable distribution under § 2612.
Do these three Revenue Procedures prohibit all rulings regarding decanting in all fact
patterns? Not necessarily. The IRS will not issue rulings with respect to the federal tax
consequences where the decanting results in a “change in beneficial interests.” If a
particular decanting were to leave all beneficial interests in the original (first) trust
intact and were to change only administrative provisions, the IRS arguably would not
be able to rely on Rev. Proc. 2013-3 to decline to issue a letter ruling (Of course, if
decanting effected only administrative changes, the trustee would have little or no
incentive to seek a letter ruling).
24
(A)
Private Letter Ruling 201134017
One notable ruling that “squeaked through,” despite the “no ruling” policy
announced in January 2011, is PLR 201134017, 2011 WL 3781554, dated May 26, 2011.
This letter ruling does not use the words “decant” or “decanting.”
According to the recited facts, the original or source trust became irrevocable
after September 25, 1985 (and therefore was not “grandfathered” for GST tax purposes)
but had a zero inclusion ratio. The irrevocable trust instrument for the original trust
explicitly gave a special trustee the power to direct the main trustee to distribute
principal or income or both from the main trust to or for the benefit of the settlors’
living descendants or to other trusts for their benefit. The special trustee proposed to
exercise this power of direction in order to cause the distribution of all of the assets of
the original trust into a new trust, under which the beneficiaries’ respective interests
would remain essentially the same, but with more flexible administrative provisions,
including the ability of the beneficiaries to remove and replace the special trustee with
an independent person satisfying the requirements in Code § 672(c). The new trust was
carefully designed so that neither the special trustee nor any beneficiary would have a
general power of appointment, and so that no beneficiary could exercise his or her
special power of appointment in a way that would create a new interest whose vesting
or power of alienation would be postponed beyond the termination date of the new
trust.
In PLR 201134017, the IRS issued all five of the requested rulings. For income tax
purposes, the decanting distribution did not amount to a taxable sale or exchange of
trust assets by any beneficiaries or by the original trust, because beneficiary consent was
not required under the terms of the trust instrument. Further, the IRS determined that
new trust received the assets of the original trust with the same basis (under Code
§ 1015(a)) and the same holding period (under Code § 1223(2)).8
On the GST tax issue, the IRS ruled that the new or receiving trust would
continue to have a zero inclusion ratio, because the new trust’s terms would not allow
any beneficiary to exercise his or her special power of appointment in a way that would
postpone the vesting of any beneficial interest beyond a life-in-being-plus-21-years
When the trustee of an original trust makes a decanting distribution of 100 percent of
its assets to a new, second trust, the simplest and most straightforward conclusion is
that for fiduciary income tax purposes, no new trust has been created, and the second
trust simply takes over the tax attributes (including the basis and holding period for
each asset) that the original trust had. Although the IRS may ultimately announce some
other position, a decanting distribution from the original trust should be treated for
income tax purposes as a distribution(s) to the beneficiaries of the original trust who
are also beneficiaries of the second trust, and should carry out DNI accordingly. The
fiduciary analysis becomes more complicated if the original trust retains any assets after
decanting, or if the decanting is from a grantor trust to a non-grantor trust or vice versa.
8
25
period staring when the original or source trust became irrevocable. See the further
discussion of “zero inclusion ratio” (ZIR) generation-skipping trust below, in Part (D) of
this paper.
On the gift and estate tax issues, the IRS ruled in PLR 201134017 that the
beneficiaries’ power to remove and replace the special trustee were not general powers
of appointment, and that the [decanting] distribution from the original trust to the new
trust would not constitute a taxable gift transfer by any beneficiary, because [in the
IRS’s words]
. . . all beneficial interests in trust assets will be the same before and after
the proposed transfer to [the new] Receiving Trust. The proposed transfer
of [original] Trust 1 assets to Receiving Trust, as described above, will not
result in any change in the beneficial interests of any of the trusts’
beneficiaries.
In PLR 201134017, the fact situation was ideal for favorable rulings, because under both
the original trust and the second (new or receiving) trust, all the beneficiaries’ interests
were flexibly designed and defined as wholly discretionary. Until the IRS issues
guidance, no one can say how much a beneficiary’s interest in a second or new trust
could be modified (Adding a spendthrift restriction or “incentive trust” provisions?
Narrowing the class of permissible appointees under a beneficiary’s existing nongeneral power of appointment?) without causing a “change in beneficial interests” that
shifts value, and which therefore would be a taxable transfer for gift tax purposes.
(B) IRS Notice 2011-101 and General Questions About Tax Consequences.
On December 27, 2011, the IRS released Notice 2011-101, 2011-52 IRB 932, to
announce that the Service and Treasury are studying the tax implications of decanting
“when there is a change in the beneficial interests in the trust,” and that they are
“considering approaches to addressing some or all of the relevant tax issues in
published guidance.” Although this Notice was not a promise to issue proposed
regulations, the Service did solicit comments by April 25, 2012.
Appendix 2 is a complete copy of Notice 2011-101.
Before the IRS issued Notice 2011-101, members of two ACTEC committees
(including Diana S. C. Zeydel, Mary Ann Mancini Ron Aucutt, and Louis Mezzullo)
were working on a detailed commentary letter to the Service about the federal tax issues
presented by trust decanting. The ACTEC committee eventually completed a 32-page
commentary letter, including a seven page suggested revenue ruling.
http://www.actec.org/Documents/misc/Mezzullo_Comments_04_02_12.pdf is the
link to the final pdf version of the ACTEC commentary letter, dated April 2, 2012.
Other interested groups sent later comments to the IRS, but the ACTEC letter is the
longest and most detailed. Appendix 3 comprises this writer’s summary of ACTEC’s
position on most of the federal tax issues addressed in its April 2, 2012 commentary
letter to the IRS.
26
In January 2013, the National Conference of Commissioners on Uniform State
Laws announced that a drafting committee has been formed to draft a new uniform act
on trust decanting (either as a stand-alone act or an addition to the Uniform Trust
Code). This committee is also supposed to “monitor the effort of the Internal Revenue
Service and the Department of the Treasury to draft and promulgate guidance on the
tax
treatment
of
trust
decanting.”
See
http://www.uniformlaws.org/NewsDetail.aspx?title=New%20Study%20and%20Drafting%20
Committees%20to%20be%20Appointed.
In October 2012, ACTEC formed a study committee regarding trust decanting;
the committee is chaired by ACTEC Fellow Stanley Kent of Colorado Springs.
Reportedly, there will be no ACTEC drafting committee on trust decanting until after
the IRS issues guidance.
(C) Can the Tax Risk Be Minimized While We Wait for IRS Guidance?
Until the IRS actually issues a Revenue Ruling, TAM, proposed regulation, or
other guidance, it is impossible to identify all of the risks of adverse tax consequences
from decanting, or to reliably forecast the likelihood of an unpleasant IRS response.
However, we can glean some clues from Notice 2011-101. Risk-averse trustees and their
advisors might be well-served by avoiding the following “patterns” for trust decanting
until after the IRS has published actual or proposed guidance:

Avoid decanting when the trustee of the original trust is also a beneficiary and
when the decanting would cause any change at all in the trustee-beneficiary’s
individual interest in the assets of the second trust.

Avoid decanting to a second trust under which the interests of one or more
beneficiaries of the original trust are eliminated or subjected to additional
restrictions, while the interests of one or more other beneficiaries are enhanced.

Avoid decanting from an original trust in which skip persons have beneficial
interests other than contingent remainder interests.

Avoid decanting to a second trust under which an individual who is a skip
person (with respect to the original trust’s settlor) has a larger or enhanced
beneficial interest, or a beneficial interest that becomes alienable at a time earlier
than would have been possible under the original trust.

Avoid decanting to a second trust that accelerates the time at which any
beneficiary becomes entitled to absolute control of part or all of his or her interest
in the decanted assets.

Avoid decanting to a second trust under which a beneficiary receives a more
definite or less restricted beneficial interest, compared to a more restricted or
discretionary interest under the original trust’s terms.
27

Among the terms of the second trust, do not give any beneficiary a limited power
to appoint trust assets to any person who is not already a beneficiary of the
original trust.
The remaining material in this Part V discusses potential tax consequences in the
“vacuum” created by the IRS’s current “no rulings” stance and Notice 2011-101.
(D) Loss of Grandfathered GST Exempt Status or Loss of Zero Inclusion Ratio.
Much of the energy spent on the drafting and enactment of state decanting
statutes has been “generated” by practitioners who have attempted to use common law
decanting powers in order to modify generation-skipping trusts, especially in order to
react to changes in circumstances, or, occasionally, to attempt to postpone the ultimate
termination date for some GST trusts.
Although the number of generation-skipping trusts that may be affected by
decanting is probably small in absolute terms, the stakes are potentially high in terms of
adverse GST tax consequences (i.e., the cost in additional GST tax). There are three
general areas of concern:

Avoiding any action (including decanting) that could cause the “original trust”
to lose its “grandfathered” GST-exempt status, if the original trust became
irrevocable on or before September 25, 1985 and has not been modified since
then.

Avoiding any action (including decanting) that could cause the “original trust”
to have an inclusion ratio other than zero (under Code § 2642(a)) if the original
trust is a post-September 1985 trust and is exempt from the GST tax only because
it has a zero inclusion ratio.

Avoiding any action (including the creation of new beneficial interests through
decanting, or the modification of existing beneficial interests in the second trust)
that could be treated as a new taxable “transfer” to a skip person for GST tax
purposes.
Grandfathered Trusts. A generation-skipping trust that became irrevocable not
later than September 25 1985 (a “grandfathered trust”) is exempt from the federal GST
tax under section 1433(b) of the Tax Reform Act of 1986, as later amended.
There are two regulatory safe harbors, either of which can be used to prevent a
loss of GST-exempt status for a grandfathered trust.
First, under Treasury Regulations, it is clear that a decanting distribution from a
grandfathered trust to a new trust will not cause a loss of “grandfathered exempt”
status if both of the following conditions are satisfied:
o At the time the trust became irrevocable, the terms of the trust or applicable state
law allowed the decanting distribution to be made to a second trust without
28
the consent or approval of any beneficiary and without the approval of a
court; AND
o Compared to the terms of the first trust, the terms of the second trust will not
extend the time for vesting of any beneficiary’s interest beyond any life in
being at the time the original trust became irrevocable plus 21 years or
beyond a date that is 90 years after the date of creation of the original trust.
See Reg. § 26.2601-1(b)(4)(i)(A) and Reg. § 26.2601-1(b)(1)(v)(D).
The two time periods specified in the second bullet point above are often referred to as
the “Federal Perpetuities Period” or the “Regulatory RAP [Rule Against Perpetuities].”
Most commentators agree that the 90-year period and the life-in-being-plus-21-years
period are not alternatives, where it is sufficient to satisfy either one. Both rules must be
satisfied at the time the distribution or decanting power is exercised.
Because no state had a decanting statute on September 25, 1985, it’s necessary to
rely on the common law (as the Florida court did in the 1940 Phipps case), or the terms
of the original trust, or both, in order to satisfy the first condition, in the first bullet
point above. The second condition can be satisfied by carefully designing the terms of
the second trust that receives the decanting distribution from the original trust, or by
relying on a protective provision in the state decanting statute (See KRS § 386.175(4)(i)). 9
In a number of Private Letter Rulings (see PLRs 9737024, 9804046, 9438023, and
200227020), the IRS ruled that various modifications to existing grandfathered trusts did
not result in a loss of GST-exempt status where the timing, vesting, quality or value of
beneficiaries’ interests did not change and where the required termination date for the
second trust was not beyond the end of the any-life-in-being-plus 21 years period. By
analogy, the IRS’s reasoning in the Regulations and in these letter rulings could be
applied to situations in which a decanting power is exercised to make distributions to a
second trust, where the end result is the same as a modification of the first (original)
trust.
If the trustee of a grandfathered GST-exempt “original trust” is concerned about
the possible loss of exempt status as a result of decanting, and if the trustee is not
willing to rely on the common law to satisfy the first condition stated above, Reg.
§ 26.2601-1(b)(4)(i)(D)(1) provides a second safe harbor, a second pair of conditions,
Kentucky’s statutory Rule Against Perpetuities (RAP), KRS § 381.225(1)(a), sets a
“permissible period” of 21 years after the death of an individual alive (at the time of
creation of the future interest in an irrevocable trust). Kentucky’s statute therefore
complies with “half” of the IRS’s so-called “Regulatory RAP” of the IRS. Caution is
warranted, however, because a particular second trust formed and funded under
Kentucky’s decanting statute might comply with the statutory RAP of life-in-beingplus-21 years, and yet fail to comply with the other half of the IRS’s Regulatory RAP —
the 90-year requirement.
9
29
which, if satisfied, will allow the grandfathered, exempt status to carry over to the
second trust:
o The trustee distribution does not shift a beneficial interest in the trust to any
beneficiary who occupies a lower generation (see Code § 2651) than the
person(s) who held the beneficial interest before the trustee distribution, AND
o The trustee distribution does not extend the time for vesting of any beneficial
interest in the trust beyond the period provided for in the original trust.
See also Reg. § 26.2601-1(b)(4)(i)(E), Example 2. Note that this second safe harbor does
not prohibit beneficiary or court approval.
Non-Grandfathered GST Trusts With Zero Inclusion Ratios (ZIR Trusts).
What if the original trust is not a grandfathered GST trust (because it became
irrevocable after September 25, 1985 or was modified later), but the original trust is
currently exempt from the GST tax because it has an inclusion ratio of zero under Code
§ 2642(a)?
In some letter rulings and other non-binding guidance, the IRS has
simultaneously hedged its bets and suggested that if a particular change (accomplished
through trust modification or decanting) would not have affected the GST-exempt
status of a grandfathered trust irrevocable on September 25, 1985, then that same change
through decanting from a original trust with a zero inclusion ratio should not affect the
exempt status of the original trust by changing its inclusion ratio.10
The ACTEC commentary letter of April 2, 2012 cites two Private Letter Rulings
(PLRs 200551020 and 200839025) in which the IRS was asked to address the effect of
certain modifications to groups of ZIR trusts (change in trust situs; increasing the upper
limit on certain discretionary distributions; increase in the number of trustees; changes
in trustee replacement procedures). After the modifications, the beneficiaries had the
power to vote collectively to replace independent trustees with new independent
trustees, but the trusts’ terms, as modified, did not extend the trusts’ termination dates,
shift beneficial interests down to lower generations, or extend the date for vesting of
any beneficiary’s interest. The IRS issued the requested favorable rulings that the
modified trusts would not lose their inclusion ratios of zero. In PLR 201134017,
discussed above, the IRS applied the same reasoning to a proposed decanting
distribution from a non-grandfathered ZIR trust, instead of to a modification.
Keep in mind that the GST tax Regulations do not prohibit or punish the shifting
of beneficial interests “horizontally” within the same generation or “up” from the
generation of skip persons to the generation of non-skip persons.
In this writer’s opinion, and based on the definitions of “applicable fraction” and
“inclusion ratio” in Code § 2642, there is no good reason to conclude that a decanting
10
See Private Letter Ruling 200743028 (May 29, 2007).
30
distribution from a original trust with a zero inclusion ratio should result in the second
trust having an inclusion ratio that is different from zero, if no new dollar value is
transferred to the second trust. PLR 201134017 is a positive sign. However, until the IRS
issues generally-applicable guidance, absolute certainty on this issue is not possible.
One way to minimize the risk of an unwanted change in the inclusion ratio or an
unwanted, new GST transfer is to design the second trust so that (1) no new skip
person(s) receive an interest in the second trust as a result of decanting, (2) existing
estate tax exposure for skip person beneficiaries at their deaths is preserved, and (3) the
time of vesting or the time for final distributions to skip person beneficiaries is not
postponed, compared to the date(s) in the trust instrument for the original trust.
Remember that in Notice 2011-101, the IRS has suspended the issuance of further
private letter rulings regarding the tax consequences of decanting until after Treasury
has issued generally-applicable guidance. In the absence of such guidance, if a skip
person has the right under an existing trust instrument to receive “outright”
distributions at age X, could a decanting distribution be used to replace that “outright”
interest with a life income interest for that skip person under the second trust, coupled
with a testamentary general power of appointment or other provisions that would
ensure inclusion of the rest of that skip person’s share of the trust assets in his or her
gross estate? A series of letter rulings11 involving modifications of GST-exempt trusts
(grandfathered or Zero Inclusion Ratio) suggests decanting to a carefully-designed
second trust would not have an adverse GST tax result, so long as —

That skip-person beneficiary is the only person who could benefit from
distributions from the second trust during his or her lifetime, and

That skip person’s share of the remaining assets of the second trust will be
included in his or her gross estate at death for one reason or another.
(E) What is the “Delaware Tax Trap,” and Should We Worry About It?
The “Delaware Tax Trap” is an unfavorable estate or gift tax result that is
triggered when a non-fiduciary (a beneficiary or donee who is not a trustee) exercises a
limited power of appointment, where that power could be validly exercised to postpone
the vesting of an interest in the property subject to the appointment power. The
Delaware Tax Trap exists or can arise because of Code § 2514(d), which reads as follows
[italics added]:
See, e.g., Private Letter Ruling 200308045 (November 19, 2002) [replacing financially
irresponsible great-granddaughter’s outright entitlement to trust corpus with an
exclusive life income interest plus a general testamentary power of appointment]. See
also PLR 200520023 (January 28, 2005), which is one of the few letter rulings that
addressed an actual decanting to new trusts, instead of a court-approved reformation or
modification.
11
31
(d)
CREATION OF ANOTHER POWER IN CERTAIN CASES. – If a power of
appointment created after October 21, 1942 is exercised by creating
another power of appointment which, under the applicable local law, can
be validly exercised so as to postpone the vesting of any estate or interest
in the property which was subject to the first power, or suspend the
absolute ownership or power of alienation of such property, for a period
ascertainable without regard to the date of the creation of the first power,
such exercise of the first power shall, to the extent of the property subject to the
first power, be deemed a transfer of property by the individual possessing such
power.
A similar rule appears in Code § 2041(a)(3) and applies, for estate tax purposes, to the
creation of a second limited or special power of appointment. In other words, if the
beneficiary or donee who holds even a limited power of appointment can exercise the
power by creating another power of appointment that could further postpone the
vesting of some other appointee’s or beneficiary’s interest in the appointed property,
that exercise of the appointment power will be treated as a taxable gift for gift tax
purposes (inter vivos exercise) or as part of the power-holder’s gross estate for estate tax
purposes (if exercised by a testamentary-type instrument and at death).
This problem came to be called the Delaware Tax Trap because of a Delaware
statute that made the Rule Against Perpetuities period begin to run anew from the date
of exercise of a power of appointment, instead of from the date on which the power of
appointment was created.12
The Delaware Tax Trap should be irrelevant to decanting by a trustee who has
no beneficial interest in the trust. An independent trustee does not have and arguably
cannot have donative intent with respect to the assets of a trust, and conceptually, the
independent trustee cannot make a transfer of trust property (by decanting, regular
distribution, or otherwise) that is a taxable event for estate or gift tax purposes. See Reg.
§ 25.2511-1(g)(1).
Moreover, Kentucky’s decanting statute and RAP statute appear to prevent the
Delaware Tax Trap from being sprung. First, KRS § 386.175(6)(a) provides that the
exercise of the statutory decanting power “shall be considered an exercise of a [limited
or non-general] power of appointment.” Second, KRS § 386.175(6)(b) states that the
exercise of the decanting power “shall be subject to” the Kentucky RAP statutes, for the
. In July 2000, Delaware enacted an “anti-tax-trap” provision that applies to all
irrevocable trusts that are “not subject to” the GST tax or that have inclusion ratios of
zero. If such a trust is created through the exercise of a power of appointment (e.g.¸
decanting), then for the purpose of starting the RAP period, the trust is treated as being
created when the original power of appointment was created, and not at the later time
when the power is exercised. See 25 Del. Code § 503(c) [last sentence] and 504, as
amended or added by 72 Laws 2000, Chapter 397, Senate Bill No. 313.
12
32
purpose of determining when the “permissible period” begins for suspension of a
beneficiary’s power of alienation. Finally, KRS § 381.225(1)(c) states that the permissible
period (the life of an individual who is alive plus 21 years after his or her death) begins
at the time that the power (the non-general power of appointment, or decanting power)
is created, and not at a later time when that power is exercised:
(c) If a future property interest or trust is created by exercise of a power of
appointment, the permissible period is computed from the time the power
is exercised if the power is a general power exercisable in favor of the
donee, the donee’s estate, the donee’s creditors, or the creditors of the
donee’s estate, whether or not it is exercisable in favor of others, and even
if the general power is exercisable only by will; in the case of other
powers, the permissible period is computed from the time the power is
created but facts at the time the power is exercised are considered in
determining whether the power of alienation is suspended beyond the
death of an individual or individuals alive at the time of creation of the
power plus twenty-one (21) years.
[underscored emphasis added.] In this writer’s opinion, the last four lines of section
381.225(c) do not create substantial uncertainty about when the permissible period
begins if a decanting distribution will further postpone the vesting or free
transferability of some beneficiary’s interest, compared to the terms of the original trust.
In most cases, the period should begin on the date that the original trust was created,
and the Delaware Tax Trap should not be sprung.
If a trustee will be relying on a decanting power specifically stated in the trust
instrument instead of on a state statute, the decanting provision should contain a
similar rule if the settlor and the trustee want to be extremely proactive in ruling out
future problems with the Rule Against Perpetuities.
VI.
What Other Issues Should a Trustee Worry About, in Deciding Whether or
Not to Decant?
(A) Excessive Involvement by the Settlor of the Original Trust.
If the settlor of the original trust (as the source of a proposed decanting
distribution) is living, then after decanting is initially brought up, the trustee should
discourage the settlor from involving himself or herself in the decision process about
whether to decant, how much to decant, the “design” of the second trust, etc. Or, at any
rate, the settlor and the settlor’s preferences and suggestions should be absent from the
paper trail of written discussions. If the settlor’s involvement is significant and easy to
prove, the IRS could later argue that the assets of the original trust are included in the
settlor’s gross estate for estate tax purposes under Code sections 2036 or 2038, because
he or she retained, in fact or in substance, the power to control the administration of the
nominally irrevocable original trust.
33
(B) Frustrating the Settlor’s Intent (Being Too Eager to Please Some Beneficiaries).
A trustee may find it difficult to determine whether or not to make a decanting
distribution —

If the settlor’s original intent regarding the original trust’s structure and purposes
is fairly well known, AND

If intervening events (such as the circumstances and life events of one or more
beneficiaries) have made the trust’s structure seem inflexible or inconsistent with
the aggregate best interests of all beneficiaries, AND

If a decanting distribution to a new trust could solve the “problem,” BUT

The trustee is uncertain whether the settlor would approve the change if the
settlor were alive and knew the situation.
Is it appropriate, or even possible, for the trustee to make an educated guess about what
the settlor’s current intentions and desires would be, if he or she could see the
beneficiaries’ current situations and circumstances? And in deciding to decant or not, in
the best interests of the beneficiaries, should the trustee be guided by the settlor’s
original intent or by guesses about what the settlor would want to do now? There are
no obvious and clear answers. In such situations, the most prudent strategy is to
petition a court for instructions about whether or not to decant, and with what changed
provisions in the second trust.
(C) An Attempted Change of Situs or Governing Law for the Second Trust May
Not Work.
The living settlor of an irrevocable trust, or some faction of the beneficiaries, or
some external professional advisor, may “lobby” the trustee to make decanting
distributions for the principal purpose of changing the trust’s situs or the governing law
or both. If the original trust instrument contains an explicit governing law clause but not
a provision specifically allowing a change in the governing law clause, decanting may
seem to be a good method for changing the governing law. However, depending on the
nature and location of the trust assets, the residences of the beneficiaries, the trust’s
purposes, other facts and circumstances, and public policy considerations, a court may
apply general conflict-of-laws rules and conclude that some other jurisdiction’s laws
(such as the law of the jurisdiction where the original trust was formed) should apply to
the second trust, instead of the “chosen” new governing law specified in the trust
instrument for the second trust.
Similarly, decanting may not be effective to change the legal situs of the second
trust. KRS § 386.725 states that trust provisions regarding a trust’s principal place of
administration, or changes in that place of administration, will control unless
compliance with such a provision “would be contrary to efficient administration or the
purposes of the trust.” If the trustee decants assets from an original Kentucky-based
trust into a second trust whose trust instrument makes some other state the new situs,
34
that change of situs may not be effective if that other state’s trust laws allow public policy
considerations to influence a determination of where the second trust’s “principal place
of administration” should be. For example, section 108(b) of the Uniform Trust Code
requires the trustee to administer a trust “at a place appropriate to its purposes, its
administration, and the interests of the beneficiaries.” [Emphasis added] Thus, KRS
§ 386.725 mentions “efficient administration” and “the purposes of the trust” as the
criteria, but UTC § 108 adds “the interests of the beneficiaries.”
If the trustee of the second trust is an individual, does not reside in the new
jurisdiction, and does not carry out significant administrative tasks within that new
jurisdiction, the attempted change of situs may fail if it is challenged under a state law
similar to UTC § 108. A trustee who is thinking of decanting as a means of changing
situs should review the laws in the original trust’s current situs and the laws of the
“target state” for the second trust, in order to determine the likelihood that a change of
situs through decanting would be challenged by a beneficiary or reversed by a court.
(D) The Risk of Beneficiary Objections to Decanting AND from Soliciting Releases
or Consents from Beneficiaries.
Among professional trustees (and smarter, worldly-wise layperson trustees), it’s
common — and normally laudable — to prefer to obtain written consents or releases
from all potentially affected beneficiaries whenever the trustee is thinking of taking an
action that may be controversial.13 And if obtaining beneficiary consent is good, then
obtaining court approval for the potentially-controversial action is even better.
However, when the potential action is a proposed decanting distribution to
another trust, seeking and obtaining beneficiary consent isn’t an absolute, unalloyed
good, with no disadvantages.
First, Kentucky’s decanting statute, like most of the other state statutes, does not
require beneficiary consent in order for decanting to be valid. And second, there is some
risk that a release or a consent from a beneficiary of the original trust could be treated,
for federal tax purposes, as a receipt of trust assets by that beneficiary, followed by a
contribution by that beneficiary of those assets to a new trust, where that contribution
is a new, taxable gift by that beneficiary.14 If the beneficiary who gives a consent or
A consent, acquiescence, release, or ratification from a beneficiary who is under an
incapacity or legal disability, or who does not receive all material facts or know his or
her rights, may be worthless. With respect to an incapacitated, minor, or unknown
beneficiary in some situations, having a court appoint a representative or guardian ad
litem may be the only way to ensure that a release or consent will bind that beneficiary.
13
See Sexton v. U.S., 300 F.2d 490 (7th Cir. 1962) [When a trust beneficiary joined others
in consenting to an extension of the trust’s termination date, she continued to receive a
share of net income for her life effectively relinquished an interest in trust corpus, and
14
35
release is treated as having received the decanted assets from the original trust and as
having contributed those assets to the second trust, does this mean that the second trust
is now a “self-settled” trust, so that any spendthrift protection from the beneficiary’s
creditors would be lost under KRS § 381.180?
In this writer’s opinion, the following principles should guide the trustee’s
decision about whether to seek or to insist upon receiving releases or written consents
from the beneficiaries of the original trust with respect to a proposed decanting.

Don’t use decanting to make extensive, controversial changes. If the trustee is
thinking of exercising (or is being asked to exercise) a decanting power in order
to effect a significant change in the design or structure of a trust, such as the
complete elimination of the interests of one or more beneficiaries, and if it’s
plausible to conclude that this change would draw objections — or would fail to
receive consents — from one or more beneficiaries, then the trustee should rethink the objective and the proposed strategy. Scale back the change that the
second trust will be making, compared to the terms of the original trust, give the
statutory notice to the qualified beneficiaries under KRS § 386.175(7)(b), and
hope that no beneficiary files an objection proceeding within the 30-day period.

If feasible, use a “severance power” to “divide and conquer” and to limit the
number of potential objectors. If the proposal or decision to make a decanting
distribution is being “driven” by concern regarding the diminished capacity,
behavioral problems, creditor problems, or other quirks of a single beneficiary of a
multiple-beneficiary trust, and if the trust instrument for the original trust or
applicable law gives the trustee a power to sever the original trust into separate
trusts, the trustee should consider a two-step approach: First, exercise the
severance power, after giving any required notice to the beneficiaries, so that the
“problem beneficiary” is isolated as the sole current beneficiary of one trust after
the severance. And second, exercise the decanting power only with respect to the
assets in that problem beneficiary’s separate trust. Ideally, this two-step strategy
should result in only one current beneficiary having standing to object, and only
one current beneficiary from whom a release would need to be obtained, if the
trustee insists on getting a release.

Use a limited power of appointment to “compensate” a beneficiary for the
loss of an outright distribution right or for the deletion of a remainder
beneficiary. Suppose that one of the objectives for decanting is to replace a
beneficiary’s right to receive an outright distribution at age X or time Z with a
continuing right to receive or benefit from discretionary distributions for that
therefore made a transfer taxable under Code §2036(a)(1)]. See also Rev. Rul. 86-39,
1986-1 C.B. 301 [A trust beneficiary acquiesced in a recapitalization of closely held stock
in the trust, which resulted in a decrease in the value of the trust assets subject to the
beneficiary’s general power of appointment, and that decrease in value was a taxable
gift to the remainder beneficiaries].
36
beneficiary’s lifetime, or to eliminate a remainder interest for a “problem
grandchild” who is a remainder beneficiary in the original trust after the death of
the current beneficiary. The current beneficiary who is losing an outright
distribution right or the remainder beneficiary (or his or her representative) may
be induced to not object to the decanting if the second trust gives the current
beneficiary a limited testamentary power of appointment with respect to the
assets remaining in the current beneficiary’s separate (second) trust at the time of
his or her death.

Do not seek beneficiary consent or court approval if the original trust is a preSeptember 1985 “grandfathered trust” and if the first safe harbor (starting on
the bottom of Page 28 above) is the only way to maintain GST-exempt status
for the second trust. This problem is relevant for either grandfathered trusts or
Zero Inclusion Ratio exempt trusts if the second safe harbor in Reg. § 26.26011(b)(4)(i)(D)(1) cannot be relied upon because the terms of the second trust shift a
beneficial interest to a lower generation or postpone the vesting of a beneficial
interest beyond the time provided for in the first trust.
In this writer’s opinion, it is a good general practice to include, in any irrevocable
trust instrument, a general provision that confirms the significance of committing any
decision or determination to the “sole discretion” of a trustee or of another actor (such
as a trust protector, trust supervisor, or trust advisor) who has fiduciary powers and
duties with respect to the trust:
Section ____.
“Sole Discretion.”
Whenever this Trust
Agreement states that a particular power may be exercised or a
determination may be made by the Trustee [or by the Trust Supervisor] in
his, her or its “sole discretion,” no beneficiary or other person will have
any claim against the Trustee [or Trust Supervisor] as a result of the
Trustee’s [or Trust Supervisor’s] determination or his or her exercise or
non-exercise of such a discretionary power. This Section does not protect
the Trustee [or Trust Supervisor] from liability for (a) acts of self-dealing,
(b) acts amounting to fraud, or [optional] (c) other wrongful acts or
omissions that are committed in bad faith or that are more than merely
negligent (that is, reckless or intentional).
When such a provision is present in the trust instruments for both the original trust and
the second trust, and when the original trust’s terms explicitly permit the trustee to
make a decanting distribution “in the trustee’s sole discretion,” the trustee
automatically has significant protection from liability to or objections by any beneficiary
of the original trust. It may be possible to add such a provision to the trust instrument
to the original trust by means of a court-approved modification. However, the presence
of a “sole discretion” provision in the original trust instrument probably does not give
the trustee additional protection from liability if the trustee must rely on a state statute
as the source of authority for decanting.
37
(E) What If a Trustee is Also a Beneficiary of the Original Trust?
If the original trust has a trustee who is also a beneficiary, the safest course of
action is to completely exclude that trustee-beneficiary from the entire discussion-anddecision process regarding a proposed decanting distribution and the design of the
terms of the second trust. If this is not possible, and if the trustee-beneficiary’s
individual interest in the original trust would be improved or enhanced by the
proposed decanting, OR if the second trust would impose a lower standard of care or
liability exposure on the trustee-beneficiary as a fiduciary, then the trustee-beneficiary
should petition for court approval of the decanting under KRS §§ 386.175(10) and
386.675(1)(c). Without court approval, the trustee-beneficiary would be exposed to
claims for self-dealing or conflict of interest.
If the trustee of the original trust is also a beneficiary of that trust, can his or her
exercise of the decanting power be a taxable gift for gift tax purposes? Quite possibly,
depending on the wording of the original trust instrument and the constraints, if any,
placed on the trustee-beneficiary’s power to make distributions for his or her own
benefit. Reg. § 25.2511-1(g)(2) is not particularly helpful. It says that if the trustee has a
beneficial interest in the trust, the trustee’s transfer of trust property will not be a
taxable transfer —
if it is made pursuant to a fiduciary power the exercise or non-exercise of
which is limited by a reasonably fixed or ascertainable standard which is
set forth in the trust instrument.
Finally, check the administrative terms in the trust instrument and confirm
whether or not any beneficiaries can independently exercise the power to remove and
replace the trustee with a non-independent trustee. If the beneficiaries do have this
power, and if decanting from the original trust is determined to be the best way to
accomplish the ultimate objective, it may be advisable to do a narrow, court-approved
modification of the trustee replacement provisions, so that no beneficiary has the power
to appoint himself or herself (or another non-independent person) as a successor
trustee. Making this change should reduce the likelihood of an IRS argument that one
or more beneficiaries possess the powers of the trustee as a result of their ability to
appoint a non-independent successor trustee. See Rev. Rul. 95-58, 1995-2 C.B. 191.
(F)
Dealing With Later-Arising Liabilities or Problems of the First (Original)
Trust.
What if a decanting distribution is made from the original trust to the second
trust, and if some unpaid tax liability, beneficiary claim or objection, or other thirdparty claim is asserted against the original trust or its trustee?
It is prudent for the trustee of the original trust to obtain a written
indemnification agreement from the trustee of the second trust at the time that the
decanting distribution is made. The obligation to indemnify (see the sample provision at
38
the end of Appendix 4) can be defined and limited according to the value of the assets
received from the original trust.
Even if the same corporate fiduciary or individual is serving as the trustee of
both the original trust and second trust, an indemnification agreement still has value, by
confirming which trust should be the source for paying a claim or liability that is
ultimately determined to be due and payable.
It may be important to determine the appropriate source(s) for payment of the
professional fees and other expenses associated with (a) the “design” and drafting of
the second trust that will receive the decanting distribution from the original trust,
(b) the procurement of any necessary tax advice, (c) notice to all of the pertinent
beneficiaries under the Kentucky statute, (d) any resulting court proceedings if there are
beneficiary objections or if the trustee decides to seek court approval, and (e) the
logistics for actually making the decanting distribution. When the ultimate goal of trust
modification is accomplished through severance or merger of trusts, disclaimer
planning, adjudicated compromises, or court-approved modifications or deviations,
there is generally only one trust from which these expenses can be paid, and one set of
beneficiaries who can object after the next periodic accounting is rendered by the
trustee. But when decanting is the tool used, there will be at least two trusts whose
assets could be used to pay the expenses. If both the original (source) trust and the
second (receiving) trust have the same single current beneficiary and substantially the
same group of remainder or successor beneficiaries, which trust’s assets are used to pay
the expenses may not matter to the stakeholders. If the original trust will not terminate
altogether and is “losing” a troublesome beneficiary who will become the sole or
primary beneficiary of the second (receiving) trust, the source for payment of the
expenses may matter a great deal.
This writer sees no obvious “right” way to determine how much (if any) of the
expenses should be paid from the assets of the original trust before the decanting
distribution is made. If there is an obvious or reflexive “default setting” on the issue of
which trust’s assets should be used to pay the decanting-related expenses, it may be
that the second trust’s assets should be used exclusively.
Especially if the trustee of the original trust will not be the trustee of the second
trust, there may be no good reason for the original trust to continue in existence. For
example, if the original trust has three beneficiaries that historically and customarily
have received equal discretionary distributions, and if the decision to decant is being
driven by the problems (substance abuse, marital difficulties, financial irresponsibility,
potential creditor claims) of one beneficiary, the original trust can be terminated as to
that beneficiary alone if the trustee first does a severance of the original trust into three
trusts, and then proceeds to make a decanting distribution of 100 percent of the assets of
the “problem beneficiary’s” trust to the new, second trust. The post-severance
“original” trusts of the other two beneficiaries can continue to be administered, but the
post-severance trust of the problem beneficiary can and should be terminated. In this
39
scenario, the expenses of decanting could be paid from the original trust of the
“problem beneficiary,” or from the second trust for that beneficiary.
VII.
Final Comments
The power to decant presents a fairly long list of currently-uncertain tax issues
and many, many opportunities to make up for the lack of flexibility in existing
irrevocable trusts. Although decanting can (and generally should) be done without trust
beneficiaries’ consent and without court approval, decanting is not the only tool, or
even the best tool, in many situations. The more extensive the substantive changes that
are desired or proposed, the more likely it is that using decanting may create
unfavorable tax consequences or other problems.
It should be obvious that the best way to avoid potential problems with
decanting, and perhaps also to avoid the need for decanting, is to advise and assist
clients to build flexibility into their trust instruments during the design-and-drafting
stages, before those trusts become irrevocable.
40
Appendix 1: the Kentucky Trust Decanting Statute
KRS § 386.175
(effective July 12, 2012)
Trustee’s power to appoint principal or income in favor of trustee of second trust;
terms of second trust; special fiduciary; notice; judicial proceedings
(1)
For the purposes of this section, the following definitions apply:
(a) “Current beneficiary” means a person who is a permissible distributee
of trust income or principal;
(b) “Original trust” means a trust established under an irrevocable trust
instrument pursuant to the terms of which a trustee has discretionary power to
distribute principal or income of the trust to or for the benefit of one (1) or more
current beneficiaries of the trust; and
(c) “Second trust” means a trust established under an irrevocable trust
instrument, the current beneficiaries of which are one (1) or more of the current
beneficiaries of the original trust. The second trust may be a trust created under
the same trust instrument as the original trust or under a different trust
instrument.
(2) A trustee of an original trust may, without authorization by the court, exercise
the discretionary power to distribute principal or income to or for the benefit of one
(1) or more current beneficiaries of the original trust by appointing all or part of the
principal or income of the original trust subject to the power in favor of the trustee of a
second trust. The trustee of the original trust may exercise this power whether or not
there is a current need to distribute principal or income under any standard provided in
the terms of the original trust. The trustee’s special power to appoint trust principal or
income in further trust under this section includes the power to create the second trust.
(3) The second trust may be a trust created or administered under the laws of any
jurisdiction, within or without the United States.
(4)
The terms of the second trust shall be subject to all of the following:
(a) The beneficiaries of the second trust may include only beneficiaries of
the original trust;
(b) A beneficiary who has only a future beneficial interest, vested or
contingent, in the original trust cannot have the future beneficial interest
accelerated to a present interest in the second trust;
Appendix 1 — Kentucky Statute – 41
(c) The terms of the second trust may not reduce any fixed income,
annuity, or unitrust interest of a beneficiary in the assets of the original trust,
including an interest which is to take effect in the future;
(d) If any contribution to the original trust qualified for a marital or
charitable deduction for federal income, gift, or estate tax purposes under the
Internal Revenue Code, then the second trust shall not contain any provision
that, if included in the original trust, would have prevented the original trust
from qualifying for the deduction or that would have reduced the amount of
the deduction;
(e) If contributions to the original trust have been excluded from the gift
tax by the application of Sections 2503(b) and 2503(c) of the Internal Revenue
Code,1 then the second trust shall provide that the beneficiary’s remainder
interest in the contributions shall vest and become distributable no later than
the date upon which the interest would have vested and become distributable
under the terms of the original trust;
(f) If any beneficiary of the original trust has a currently exercisable
power of withdrawal over trust property, then either:
a. The terms of the second trust shall provide a power of withdrawal
in the second trust identical to the power of withdrawal in the original
trust; or
b. Sufficient trust property shall remain in the original trust to satisfy
the currently exercisable power of withdrawal;
(g) If the original trust holds stock of an S corporation, the terms of the
second trust shall not prevent or eliminate an election to be a qualified
subchapter S trust or an electing small business trust or result in the
termination of the S election of such corporation;
(h) If the power to distribute principal or income in the original trust is
subject to an ascertainable standard, then the power to distribute income or
principal in the second trust shall be subject to the same or a more restrictive
ascertainable standard as in the original trust when the trustee exercising the
power described in subsection (2) of this section is a possible beneficiary under
the standard; and
(i) The second trust may confer a power of appointment upon a
beneficiary of the original trust to whom or for the benefit of whom the trustee
has the power to distribute principal or income of the original trust. The
Appendix 1 — Kentucky Statute — 42
permissible appointees of the power of appointment conferred upon a
beneficiary may include persons who are not beneficiaries of the original or
second trust. The power of appointment conferred upon a beneficiary shall be
subject to KRS 381.224, 381.225, and 381.226 covering the time at which the
permissible period of the rule against perpetuities and suspension of power of
alienation begins and the law that determines the permissible period of the rule
against perpetuities and suspension of power of alienation of the original trust.
(5) The court may appoint a special fiduciary with the authority to exercise the
power to appoint principal or income under subsection (2) of this section.
(6) The exercise of the power to appoint principal or income under subsection (2) of
this section:
(a) Shall be considered an exercise of a power of appointment, other than
a power to appoint to the trustee, the trustee’s creditors, the trustee’s estate, or
the creditors of the trustee’s estate;
(b) Shall be subject to KRS 381.224, 381.225, and 381.226 covering the time
at which the permissible period of the rule against perpetuities and suspension
of power of alienation begins and the law that determines the permissible
period of the rule against perpetuities and suspension of power of alienation of
the original trust; and
(c) Is not prohibited by a spendthrift provision or by a provision in the
original trust instrument that prohibits amendment or revocation of the trust.
(7)
To effect the exercise of the power to appoint principal or income under
subsection (2) of this section, all of the following shall apply:
(a) The exercise of the power to appoint shall be made by an instrument in
writing, signed and acknowledged by the trustee, setting forth the manner of
the exercise of the power, including the terms of the second trust and the
effective date of the exercise of the power. The instrument shall be filed with
the records of the original trust;
(b)
The trustee shall give written notice of the trustee’s intention to exercise the
power to all current beneficiaries of the original trust and all beneficiaries of the oldest
generation of remainder beneficiaries of the first trust, by certified mail with restricted
delivery and return receipt, at least sixty (60) days prior to the effective date of the
exercise of the power to appoint. The notice shall include a copy of the instrument
described in paragraph (a) of this subsection;
Appendix 1 — Kentucky Statute — 43
(c)
If all beneficiaries entitled to notice have received the notice as evidenced by
the certified mail return receipt and waive the notice period by a signed written
instrument delivered to the trustee, the trustee’s power to appoint principal or income
shall be exercisable after notice is waived by all such beneficiaries, notwithstanding the
effective date of the exercise of the power;
(d)
A current beneficiary or a beneficiary who is not a current beneficiary but is a
member of the oldest generation of the remainder beneficiaries of the original trust
may, no later than thirty (30) days from the date of receiving notice under paragraph (b)
of this subsection, commence a judicial proceeding in District Court pursuant to KRS
386.675 to object to the proposed exercise of the power under subsection (2) of this
section. In such case the proposed exercise of the power shall require consent of the
District Court as defined by KRS 386.450(3). Any determination of the District Court
shall be subject to KRS 386.454(5); and
(e)
In the event that a beneficiary did not receive the notice as evidenced by the
certified mail return receipt, and no other beneficiary has commenced a proceeding
under paragraph (d) of this subsection, the trustee may seek the approval of the District
Court to exercise the power.
(8)
Nothing in this section shall be construed to create or imply a duty of the
trustee to exercise the power to distribute principal or income, and no inference of
impropriety shall be made as a result of a trustee not exercising the power to appoint
principal or income conferred under subsection (2) of this section. Nothing in this
section shall be construed to abridge the right of any trustee who has the power to
appoint property in further trust that arises under the terms of the original trust or
under any provision of law or under common law.
(9)
This section shall not apply to any charitable remainder trust as defined in 26
U.S.C. sec. 664(d).
(10) A trustee or beneficiary may commence a judicial proceeding in the District
Court pursuant to KRS 386.675 to approve or disapprove of a proposed exercise of the
trustee’s special power to appoint to a second trust pursuant to subsection (2) of this
section. In such case approval by the District Court shall have the same meaning as
provided in KRS 386.450(3) and the approval shall be subject to KRS 386.454(5).
Appendix 1 — Kentucky Statute — 44
Appendix 2: IRS Notice 2011-101, 2011-52 IRB 932
http://www.irs.gov/irb/2011-52_IRB/ar14.html
PDF copy available at http://www.irs.gov/pub/irs-irbs/irb11-52.pdf (p. 33 of pdf)
December 27, 2011
Notice 2011-101
Transfers by a Trustee From an Irrevocable Trust to Another Irrevocable Trust
(Sometimes called “Decanting”); Requests for Comments
-------------------------------------------------------------------------------Table of Contents
PURPOSE
BACKGROUND
REQUEST FOR COMMENTS
DRAFTING INFORMATION
PURPOSE
This notice requests comments regarding when (and under what circumstances)
transfers by a trustee of all or a portion of the principal of an irrevocable trust
(Distributing Trust) to another irrevocable trust (Receiving Trust), sometimes called
“decanting,” that result in a change in the beneficial interests in the trust are not subject
to income, gift, estate, and/or generation-skipping transfer (GST) taxes. In these
transfers, the interests of one or more of the beneficiaries may be changed and, in some
cases, the interest of a beneficiary may be terminated and/or another beneficiary who
did not have an interest in Distributing Trust may receive an interest in Receiving Trust.
BACKGROUND
The Treasury Department and the Internal Revenue Service (IRS) are studying the tax
implications of such transfers when there is a change in the beneficial interests in the
trust and are considering approaches to addressing some or all of the relevant tax issues
in published guidance. While these issues are under study, the IRS will not issue private
letter rulings (PLRs) with respect to such transfers that result in a change in beneficial
interests. See Sections 5.09, 5.16, and 5.17 of Rev. Proc. 2011-3, 2011-1 I.R.B. 111. The IRS
generally will continue to issue PLRs with respect to such transfers that do not result in
a change to any beneficial interests and do not result in a change in the applicable rule
against perpetuities period.
REQUEST FOR COMMENTS
The Treasury Department and the IRS invite comments from the public regarding the
income, gift, estate and GST tax issues and consequences arising from transfers by a
trustee of all or a portion of the principal of a Distributing Trust to a Receiving Trust
that change beneficial interests. The Treasury Department and IRS also invite comments
Appendix 2 (IRS Notice 2011-101) — 45
as to the relevance and effect of the various facts and circumstances listed below and the
identification of other factors that may affect the tax consequences. The facts and
circumstances that the Treasury Department and the IRS have identified as potentially
affecting one or more tax consequences include the following:
1.
A beneficiary’s right to or interest in trust principal or income is changed
(including the right or interest of a charitable beneficiary);
2.
Trust principal and/or income may be used to benefit new (additional)
beneficiaries;
3.
A beneficial interest (including any power to appoint income or corpus,
whether general or limited, or other power) is added, deleted, or changed;
4.
The transfer takes place from a trust treated as partially or wholly
owned by a person under §§ 671 through 678 of the Internal Revenue Code (a
“grantor trust”) to one which is not a grantor trust, or vice versa;
5.
The situs or governing law of the Receiving Trust differs from that of the
Distributing Trust, resulting in a termination date of the Receiving Trust that is
subsequent to the termination date of the Distributing Trust;
6.
A court order and/or approval of the state Attorney General is required
for the transfer by the terms of the Distributing Trust and/or applicable law;
7.
The beneficiaries are required to consent to the transfer by the terms of
the Distributing Trust and/or applicable local law;
8.
The beneficiaries are not required to consent to the transfer by the terms
of the Distributing Trust and/or applicable local law;
9.
Consent of the beneficiaries and/or a court order (or approval of the
state Attorney General) is not required but is obtained;
10. The effect of state law or the silence of state law on any of the above
scenarios;
11. A change in the identity of a donor or transferor for gift and/or GST tax
purposes;
12. The Distributing Trust is exempt from GST tax under § 26.2601-1, has an
inclusion ratio of zero under § 2632, or is exempt from GST under § 2663; and
13. None of the changes described above are made, but a future power to
make any such changes is created.
The Treasury Department and the IRS encourage the public to suggest a definition for
the type of transfer (“decanting”) this guidance is intended to address. Additionally, the
public is encouraged to comment on the tax consequences of such transfers in the
context of domestic trusts, the domestication of foreign trusts, transfers to foreign trusts,
and on any other relevant facts or combination of facts not included in the above list.
Appendix 2 (IRS Notice 2011-101) — 46
Written comments are encouraged to be submitted by April 25, 2012. All comments will
be available for public inspection and copying and should include a reference to this
Notice 2011-101. Comments may be submitted in one of three ways:
(1) By mail to CC:PA:LPD:PR (Notice 2011-101), Room 5203, Internal
Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044.
(2) Electronically to [email protected]. Please include
“Notice 2011-101” in the subject line of any electronic communications.
(3) By hand-delivery Monday through Friday between the hours of 8 a.m.
and 4 p.m. to CC:PA:LPD:PR (Notice 2011-101), Courier’s Desk, Internal Revenue
Service, 1111 Constitution Ave., NW, Washington, DC 20224.
DRAFTING INFORMATION
The principal author of this notice is Juli Ro Kim of the Office of Associate Chief
Counsel (Passthroughs & Special Industries). For further information regarding this
notice, contact Juli Ro Kim at (202) 622-3090 (not a toll-free call).
Appendix 2 (IRS Notice 2011-101) — 47
Appendix 3: ACTEC’s Proposed Answers to Rhetorical Questions
About Tax Consequences of Decanting
http://www.actec.org/public/Governmental_Relations/Mezzullo_Comments_04_02_
12.asp
32-pp. pdf document:
http://www.actec.org/Documents/misc/Mezzullo_Comments_04_02_12.pdf
Tax Issue
ACTEC’s
Proposed Answer
Income tax: If state law permits a non-grantor trust
to decant to a grantor trust, does the first
(source) trust become a grantor trust?
No
Income tax: If a grantor trust makes a decanting
distribution to a non-grantor trust, does an
income tax realization event occur?
No
Income tax: Is a decanting distribution a
“distribution” for purposes of Form 1041
reporting and taxation under Code §§ 661 and
662?
No, but treat second trust as a
continuation of first trust if it
received all assets
Income tax: If a decanting distribution contains
appreciated assets, does the first (source) trust
recognize gain under Code § 1001?
No gain to trust unless § 643(e)
election is made
Do any of the first trust’s beneficiaries recognize
gain?
Negative basis assets (Crane v.
U.S.) and gain to beneficiaries
(Cottage Savings) are more
difficult issues
Income tax: If the second trust receives all of the
assets of the first trust, does the second trust also
receive the tax attributes (capital loss and NOL
carryovers, etc.) of the first trust?
Yes under Code § 642(h) as to
some tax attributes
Income tax: After a decanting, does the grantor of
the first (source) trust continue to be the grantor
of the second (receiving) trust for subchapter E
purposes?
Probably yes, under Reg.
§ 1.671-2(e)(5)
Income tax: If a qualified subchapter S trust (QSST)
has a decanting power, is QSST status lost?
Should depend on how the
second trust is structured
As to the rest, recommend
treating second trust as a
continuation of the first trust
Appendix 3 (Tax Consequences?) — 48
Tax Issue
ACTEC’s
Proposed Answer
Gift tax: If a decanting distribution diminishes the
interests of a beneficiary of the first trust, is he or
she treated as making a taxable gift?
No, unless trustee is also a
beneficiary and Reg. § 25.25111(g)(2) does not help
Estate tax: If a decanting distribution diminishes the
interests of a beneficiary who retains a life
income interest, is he or she treated as having
made a transfer under Code §§ 2036 or 2038,
causing inclusion of trust assets in that
beneficiary’s gross estate at death?
Generally no
Estate or gift tax: If a trust must contain certain
provisions in order to qualify for the marital
deduction or for an annual gift exclusion under
Code § 2503(c), does the existence of a decanting
power cause the trust to cease to qualify?
Depends on restrictions in the
trust instrument(s) and in
applicable state law, including
the decanting statute, if any
Estate or gift tax: Does a donor to the first (source)
trust continue to be a donor with respect to the
second (receiving) trust after a decanting?
Yes, unless the exercise of
decanting power is treated as
the exercise of a general power
of appointment under Code
§§ 2041 or 2514
Estate or gift tax Are the gift tax consequences for a
trust beneficiary different, based on whether or
not beneficiary consent, court approval, or State
Attorney General approval is required before a
particular exercise of a decanting power?
Should not make a difference
once a state court order is
binding on the parties
GST tax: If the first (source) trust is exempt from the
GST tax as a result of grandfathering under
Code § 2601 or as a result of having a zero
inclusion ratio, does the second trust that
receives a decanting distribution continue to
have GST-exempt status?
No, unless neither of the safe
harbors under the §2601
regulations is satisfied (see the
discussion in Part V(D)
starting on Page 28
GST tax: If property that has an inclusion ratio >
zero but < one is decanted, will that property
continue to have the same inclusion ratio in the
“hands” of the receiving trust?
Yes, if the decanting is treated
as making a non-qualified
severance under Reg.
§ 26.2642-6(h)
Appendix 3 (Tax Consequences?) — 49
Tax Issue
ACTEC’s
Proposed Answer
GST tax: If a foreign trust is exempt from Chapter
12 of the Code under § 2663 and makes a
decanting distribution, is that trust property still
exempt from the GST tax?
Yes, it should be
GST tax: If the first trust decants property to a
second trust, does the second trust have the
same “transferor” (Code §§ 2652 and 2653) as
the first trust for Chapter 13 purposes?
Depends on whether a
beneficiary or the trustee is
treated as having made a
taxable gift or a §§2036 or 2038
transfer
GST tax: If the first trust is not exempt from the
GST tax, can decanting be accomplished so that
GST exemption is allocated to only a part of the
first trust?
This should be permitted
Appendix 3 (Tax Consequences?) — 50
Appendix 4: Sample Documents and Clauses for Decanting
A. Sample “Record of Exercise” of Decanting Power under KRS 386.175(7)(a)
RECORD OF EXERCISE OF DECANTING POWER
UNDER KRS 386.175(2) AND (7)(a)
Name of Trustee Acting:
_________________________________
Name and Date of
“Original Trust”:
_________________________________
Name and Creation Date of
“Second Trust” Receiving
Distribution:
_________________________________
Name and Address of
Trustee of “Second Trust”:
_________________________________
Source of Decanting Power
in “Original Trust”:
Effective Date of Exercise
of Decanting Power:
_________________________________
[cite section or ¶ number and heading or
title of provision]
____________________, 20____
1.
As of 12:01 A.M. on the Effective Date stated above, the
undersigned Trustee, acting in h__ / its fiduciary capacity as the Trustee
of the Original Trust described above, hereby distributes the following
money or property (the “Decanted Assets”) from the above-described
Original Trust to the above-named Trustee of the Second Trust described
above:
[describe assets] _________________________________________________
The Decanted Assets are distributed to the Trustee of the Second Trust in
h__ / its fiduciary capacity, on the express condition that the Trustee of
the Second Trust receive, hold and administer the Decanted Assets in a
manner consistent with all the terms of the Second Trust.
2.
A true copy of the trust instrument for the Second Trust is
attached to this Record as Exhibit A and is incorporated by reference.
3.
The undersigned Trustee’s distribution of the Decanted Assets
to the Trustee of the Second Trust is authorized by the above-cited Section
____ of the Original Trust, which provides that ______________________
________________________ [insert verbatim quotation or paraphrased
Appendix 4 (Sample Provisions) — 51
summary of source of decanting power, that is, the undersigned Trustee’s
discretion to make income or principal distributions from the Original Trust].
4.
The validity and effectiveness of this distribution of the
Decanted Assets to the Second Trust is conditioned on —
(a)
the undersigned Trustee’s compliance with the written notice
requirements in KRS § 386.175(7)(b), and
(b)
either (i) the failure of any qualified beneficiary to file a timely
objection after receiving notice, or (ii) an order of a District Court
having jurisdiction of the Original Trust, entered under subsections
7(d) or 7(e) of KRS 386.175, permitting the distribution of the
Decanted Assets to be made to the Second Trust.
If any beneficiary timely objects to this distribution of the Decanted Assets
to the Second Trust, or if a District Court is asked to make a decision, the
effectiveness of the distribution may be delayed until after the Effective
Date stated above.
5.
The undersigned Trustee reserves the right to set an earlier
Effective Date for the distribution of the Decanted Assets if all
beneficiaries who are entitled to notice receive notice and sign waivers
approving the distribution under KRS 386.175(c).
SIGNED by the undersigned Trustee on this ______ day of ______,
20____.
_______________________________
_____________, Trustee of the
___________________ Trust
STATE OF ____________ )
)
COUNTY OF __________ )
SS:
The foregoing Record of Exercise of Decanting Power was
acknowledged before me on this _____ day of _____________, 20___, by
___________________, Trustee of the _____________________ Trust, who,
being by me duly sworn, certified that all statements made therein are
true.
[Signature and title, etc. of Notary or
other officer taking acknowledgement]
Appendix 4 (Sample Provisions) — 52
B. Sample Decanting Power for a Non-GST Trust for a Child Beneficiary
NOTE: In any given real-world trust instrument, a custom-tailored decanting
provision should list fewer than all of the possible changes listed in (a) through
(k), based on what kinds of changes the settlor wants to make possible through
decanting, in light of the trust’s purposes and the likely future needs and
circumstances of the beneficiaries.
Section ___.
Power to Make Decanting Distributions. This
Section does not apply to a Trustee who also has a beneficial interest in a
Trust created or funded under this Trust Agreement. From time to time
and in the Trustee’s sole discretion, the Trustee may make one or more
decanting distributions of Trust principal or undistributed income or both
from any Child’s separate Trust under this Agreement (“original separate
Trust”) to another newly-created or existing trust (the “Receiving Trust”),
where each decanting distribution and the terms of the Receiving Trust
are consistent with all of the following criteria:
(a)
The Child who is the sole beneficiary of his or her original
separate Trust during his or her lifetime must be the sole
beneficiary of the Receiving Trust who is eligible to receive
or to benefit from distributions during that Child’s lifetime.
(b)
The Receiving Trust may postpone, accelerate, add, or
eliminate a right of that Child, under his or her original
separate Trust, to withdraw or to demand and receive one or
more outright distributions of trust assets at specified times
or intervals.
(c)
Subject to subsection (j) below, the Receiving Trust may
replace a mandatory life income interest for that Child with
a discretionary interest in the Receiving Trust’s net income
or principal or both.
(d)
The Receiving Trust may add, modify, or delete
“spendthrift” protections such as those in Section ____
below.
(e)
Subject to subsection (j) below, the Receiving Trust may
specify an overall mandatory termination date that is earlier
or later than the mandatory termination date for the Child’s
original separate Trust under Section ___ below.
(f)
After the death of the Child who is the initial beneficiary, the
Receiving Trust may replace the right of a remainder
beneficiary to receive an outright distributive share of trust
principal with a discretionary interest in the Receiving
Appendix 4 (Sample Provisions) — 53
Trust’s net income or principal or both following the death
of the Child who is the initial beneficiary.
(g)
The Receiving Trust may provide a limited power of
appointment (either lifetime or testamentary or both) to the
Child who is the sole initial beneficiary or to any remainder
beneficiary.
(h)
The Receiving Trust may eliminate the remainder or
successor interest of any person who has a remainder or
successor interest (either vested, contingent, or remote) in
the Child’s original separate Trust.
(i)
The Receiving Trust may not add as a beneficiary any
person(s) who does not have a beneficial interest in the
Child’s original separate Trust.
(j)
If the Child’s original separate Trust has received gifts or
other asset transfers that qualified as annual exclusion gifts
under Code § 2503(c) or as “non-taxable gifts” under Code
§ 2642(c) with respect to that Child as a beneficiary, the
terms of the Receiving Trust may not modify that Child’s
beneficial interest in a manner that would cause the
Receiving Trust to cease to qualify under those applicable
Code sections.
(k)
The Receiving Trust may include administrative terms
(relating to trustee replacement, accounting, trustee powers
and duties, etc.) that are different from Sections ___ and ___
of this Trust Agreement.
(l)
Subject to Section ___ [indemnification and expense payment
provision] below, the Trustee may engage the services of
attorneys, accountants, tax advisors, appraisers, and other
professionals with respect to a proposed or completed
decanting distribution, and may use assets of the original
separate Trust to pay reasonable compensation for those
services and disbursements that generally promote or
protect the best interests of the beneficiaries of one or more
trusts created and funded under this Trust Agreement.
(m)
The Trustee must obtain a signed, written indemnification
agreement from the trustee of the Receiving Trust, consistent
with Section ___ below.
The Trustee has the sole discretion and authority to approve the terms of
the Receiving Trust and the amount and timing of each decanting
distribution, within the latitude afforded by the above subsections.
Appendix 4 (Sample Provisions) — 54
Promptly after each decanting distribution made under this Section, the
Trustee must provide notice to the Child and each other qualified
beneficiary of the separate Trust from which the decanting distribution is
made. The Trustee may (but is not required to) provide notice to qualified
beneficiaries before a decanting distribution and may (but is not required
to) seek approval or instructions from the Court before making a
decanting distribution. To the extent that the decanting power granted to
the Trustee under this Section may conflict with KRS 386.175 or any other
provision of applicable law, the Settlor intends that the Trustee have the
broader power.
C. Indemnification of Original (First) Trust
Section ___.
Indemnification from Trustee of Trust Receiving
Decanting Distribution. Consistent with subsection ____(m) above, a
Trustee who makes a decanting distribution must obtain a signed
indemnification agreement from the trustee of the Receiving Trust, under
which the trustee of the Receiving Trust:
(a)
Agrees to use the assets of the Receiving Trust (including the
decanting distribution) to pay all of the reasonable expenses
of the creation or amendment of the Receiving Trust and of
making the decanting distribution, to the extent that the
services generating those expenses have benefitted or will
benefit the beneficiary or beneficiaries of the Receiving
Trust, and not the beneficiary or beneficiaries of the Trust
under this Trust Agreement from which the decanting
distribution is made; and
(b)
Subject to the limitation in the last sentence of this Section,
agrees to hold harmless and indemnify the trustee and
beneficiaries of the Trust from which the decanting
distribution is made with respect to all Claims described in
the next sentence immediately below
For purposes of this Section, “Claims” means all creditor claims, damages,
unpaid tax liabilities, suits, losses, beneficiary objections, causes of action,
and expenses (including reasonable attorney fees and other litigation
expenses) that are asserted against or incurred by the Trustee or the trust
estate of a Trust from which a decanting distribution is made under
Section ___ or applicable state law, where such Claims either (i) result
from or arise out of that decanting distribution or (ii) arise or are asserted
after the date of that decanting distribution, whether or not such Claims
have a causal connection to that decanting distribution. The
indemnification obligation of the trustee of the Receiving Trust under this
Appendix 4 (Sample Provisions) — 55
Section and under the required indemnification agreement is not a
personal liability of that trustee in his, her or its individual capacity. With
respect to any particular group of Claims that follow or are causally
connected to a particular decanting distribution, the total amount of
indemnification that the trustee of the Receiving Trust is obligated to pay
is limited to the fair market value, as of the date of that decanting
distribution, of the assets received by the Receiving Trust.
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Appendix 4 (Sample Provisions) — 56