Is There Really “Can” In “Decant”?
Tax Concerns And Breach Of Fiduciary Duty
Donald P. DiCarlo and Edward F. Krzanowski
A.Trust Decanting: What, Why, Where, And How It Is
Done?
1.
What is decanting?
Donald P. DiCarlo
is director of wealth planning for Wilmington
Trust, N.A. He has written and spoken extensively
on trust and estate issues. He can be reached at
[email protected].
Edward F. Krzanowski
is partner in the Individual Clients Department of
Day Pitney in West Hartford, Connecticut. He advises clients on all aspects of estate planning as
well as estate and trust administration, with particular emphasis on sophisticated wealth preservation techniques, charitable giving, retirement
benefits, executive compensation, and complex
taxation. He can be reached at efkrzanowski@
daypitney.com.
Fundamentally, the process of “trust decanting” refers
to the utilization of a state statutory power authorizing
the trustee of an irrevocable trust, which meets certain
criteria, to appoint all or a portion of the trust principal
in further continuing trust under new terms established
by the trustee. The keys to understanding the opportunity and risks associated with trust decanting are twofold: first, that the power of appointment belongs to the
trustee and not to any beneficiary; and, second, that
the terms of the new trust are established by the trustee
without the express approval of any beneficiary (or the
Settlor in most circumstances). This is what has made
decanting a novel concept in professional trust administration over the last decade. One that has proven to be
both helpful and challenging to professional and individual trustees alike.
Many trustees, whether they realize it or not, are
already empowered by other state common or statutory
law (e.g., the Uniform Trust Code) or by the terms of
the governing instrument to potentially amend or even
revoke an irrevocable trust or to make distributions for
the benefit of a beneficiary. While such powers are often similar in effect and can be used to resolve similar
problems, they are distinct legal concepts from statutory trust decanting, which is the focus of this outline.
Most commentators agree that the legal end result of
a statutory decanting process is the termination of one
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trust relationship (referred to as the Distributing Trust) and the creation of a new one (referred to as
the Receiving Trust).
2.
Why is it done?
Simply put, decanting is done so as to make some improvement to the terms of the Distributing Trust.
The question of whether something is actually improved, of course, is relative. Whether a trust is improved will depend on the perspective of the interested party. What is better from a trustee’s perspective may certainly be worse from a beneficiary’s perspective and vice versa. The Settlor’s perspective
or presumed intention must be respected as a threshold matter and will most often be inferred from
the document and circumstances. Many potential issues obviously go away when all of the interested
parties to the Distributing Trust share the perspective that the proposed improvement is beneficial.
There are many reasons to decant a trust, but generally the objectives can be divided into two
broad categories:
a.Changes to administrative provisions: Common goals in this category include clarifying or altering
the administrative (non-dispositive) provisions of a trust to improve its operation, efficiency (either
cost or tax), or governance. Under the Delaware decanting statute (12 Del. Code Ann tit. 12 section
3528), for example, trust decanting can be used to: (i) add a direction or consent to an investment
or distribution adviser to invest or participate in the investment of some or all of the trust assets or
direct or participate in distribution decisions; (ii) modernize antiquated provisions; (iii) incorporate
modern or more flexible investment authority; (iv) enumerate express powers useful or perhaps essential to the trustee; (v) add other advisers; (vi) add trust protectors or similar fiduciaries having special roles or powers such as the ability to oversee or remove trustees or other fiduciaries; (vii) revise
provisions that otherwise might cause potential tax problems; and (viii) revise standards of care or
liability as appropriate to increase trust flexibility.
b.Changes to beneficial interests. Many decanting processes are initially contemplated in order to
change or alter the beneficial interests of an existing trust. Many never go forward because the
proposed change may be broader than the state decanting statute provides. Professional trustees
are generally not willing to decant to a trust that results in substantial modifications to trust provisions, especially dispositive provisions, without full consent and judicial approval. With that said,
however, state decanting statutes are often used by trustees to change the timing and manner in
which a beneficiary realizes his or her interests. Moreover, some states, such as Delaware, allow the
trustee to grant a new power of appointment to a beneficiary, which could conceivably have the
effect of creating beneficial interests not contemplated by the Settlor under the terms of the Distributing Trust. The decision to use decanting to alter the beneficial interest should clearly cause
the most concern for professional trustees. Such changes are ripe for disagreement among classes
of beneficiaries, will often cause resentment on the part of one or more beneficiaries, and may have
negative tax implications.
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One of the more routine objectives of decanting is to simply extend the duration of the trust relationship itself. Reasons for extending the term may include a desire to protect a beneficiary from
his or her own misfeasance (e.g., addiction, gambling, etc) or from the potential malfeasance of
another (e.g., predators and creditors). Extending the duration of a trust may also be beneficial
from a state income tax perspective (the scope of which is beyond this presentation). Great caution
must be exercised when limiting or extending the term or duration of any trust to avoid negative
gift, estate, and generation skipping transfer tax implications (discussed more fully below).
There is also a category of changes that can be seen as a hybrid between procedural and dispositive such as the addition of a spendthrift provision or the limitation on a beneficiary’s entitlement
to receive information about the trust. In Delaware, for example, it’s seemingly possible to limit the
duty of a trustee to notify the beneficiaries about the nature and extent of their beneficial interests.
3. Where can it be done?
At least 13 states (Alaska, Arizona, Delaware, Florida, Indiana, Missouri, Nevada, New Hampshire,
New York, North Caroina, Ohio, South Dakota, and Tennessee) have adopted some version of a
decanting statute. It has been rumored that as many as a dozen other states are currently reviewing
legislative proposals.
While the general objective is the same, i.e., empowering the trustee to appoint trust principal in
further trust without court approval, there are notable differences between and among the various state
statutes. As an example, Delaware, Alaska, and Tennessee arguably allow a trustee to decant even if
the trustee’s discretion over principal is limited to an ascertainable standard (note: the standard itself
could not be expanded or reduced in the Receiving Trust). Other states such as New York and Florida
require full discretion over principal as initial criteria to decant even if the standard would not be
changed.
Most state statutes do not require beneficiary or court approval, although several states (Arizona,
Nevada, New York, and North Carolina) reportedly grant the beneficiary the option of seeking court
review. There are also varying restrictions placed upon decanting among the states to protect such
things as fixed income interests and to preserve marital gift and estate deduction qualification. These
are usually boot-strap provisions designed to help the trustee avoid unintended consequences.
4.
How is it done?
Because state decanting statutes are designed to authorize a private transaction (no court approval
required), there are few formalities and the actual decanting transaction is surprisingly simple. The
Delaware statute for example provides that the decanting transaction is effectuated when a written
instrument is signed and acknowledged by the trustee and filed with the records of the Distributing
Trust. Acknowledgment is generally taken to mean it is signed before a notary public. Beyond these few
formalities, the trustee has much discretion on how to document and finalize the transaction. When
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the trustee of the Distributing Trust is to be replaced or when the trustee of the Receiving Trust is appointed trustee of the Distributing Trust for the sole purpose of making decanting decision, issues of
release and indemnity become important and often result in additional documentation.
B. Managing Fiduciary Risk
Since there has not yet been any reported case holding that a trustee had an affirmative duty to decant a
trust, decanting is mostly done upon the request of a beneficiary or other interested party and only when
the trustee feels ‘adequately protected’ in doing so. As a threshold matter, in the view of the authors, being
adequately protected means that each and every potential beneficiary has either affirmatively consented,
deemed to have consented, or clearly would not benefit from objecting to the decanting transaction. In addition, the potential tax consequences, if any, are opined upon and acknowledged so that no state or federal
surprise would be forthcoming.
Consent, approval, and release agreements therefore become critically important in mitigating fiduciary risk. Under Delaware law, adult trust beneficiaries may release a trustee from liability for engaging in
a decanting transaction. 12 Del. Code Ann. tit. 12 §3588. Furthermore, through the principal of virtual
representation, the releases of the trust’s adult beneficiaries and presumptive remaindermen generally will
bind the trust’s minor and unborn beneficiaries and contingent remaindermen. 12 Del. Code Ann. tit. 12
§3547.
Even if consent is to be obtained, a trustee who contemplates effectuating a trust decanting transaction ought to document that a reasonable process was undertaken to ensure that the decision to decant was
prudent. That review process may include some or all of the following analysis:
1.
ho is the “moving party” to the proposed decanting transaction and what is their motivation? Is it
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in the best interest of the beneficiaries?
2.
hy are other alternatives such as judicial or non-judicial trust modification, severance, reformation,
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or interpretation inadequate?
3.Does the trustee have the threshold power to decant (i.e., to appoint assets from the Distributing Trust)
in document or under governing law?
a.Proper situs and jurisdiction (questions of validity and construction vs. questions of administration)?
b. Terms of instrument silent, prohibitive, or permissive?
c. Standard of distribution limited?