Reasons to Decant or Otherwise Modify an Irrevocable Trust

While the reasons to decant or otherwise modify an irrevocable trust are as numerous as the imagination can create, here is a listing of some of the more common reasons:

  1. Correct trust drafting errors, such as scrivener’s errors or ambiguous terms. A lot of trusts were simply not drafted properly and these mistakes can be corrected.
  2. Change the Trustee. Many trusts were drafted in an inflexible manner and require burdensome and expensive court action to change a Trustee. Now, this type of change may be much easier to make for good reason or no reason at all as long as the proper procedure is followed, the proper parties are notified, and all proper parties consent.
  3. Change the trust’s distribution standard, for example (1) to change from a support trust standard (such as an ascertainable health, education, maintenance and support or AHEMS@ standard) to a full discretion distribution standard, (2) to change from required income/principal distributions to either a support or full discretion standard, or vice versa, or (3) to add incentive/disincentive trust distribution powers/limitations to provide trustee flexibility in dealing with beneficiaries needing extra care. Such added flexibility can be used for tax planning purposes, to provide significant asset protection benefits, and/or to simply enable the trustee to deal with the facts as they change and exist at any particular time.
  4. Enhance trustee’s power over classification of income and principal and related distributions to particular beneficiaries in light of significant differences in marginal income tax rates and application of the Net Investment Income Tax (NIIT).
  5. Enhance other trustee provisions to increase flexibility, for example, to broaden investment powers, or to simply update to more desirable trust administration provisions, such as changing trustee appointment process and compensation provisions.
  6. Add Trust Protector or utilize Directed Trust structure to involve more specialized fiduciaries, decision makers or those with oversight.
  7. Change governing law, be it applicable state law or a change to the laws of a foreign country for administrative convenience or to obtain access to more desirable administrative, asset protection or tax laws.
  8. Create or change powers of appointment to achieve tax and/or non-tax benefits. For example, create a testamentary general power of appointment in beneficiary to achieve estate tax inclusion at the beneficiary’s death, and the thereby obtain a step-up in income tax basis. Or, better yet, give the power to a non-beneficiary to create this general power in a beneficiary to enable a possible on-off estate tax inclusion/step-up switch. A second example enables the use of the beneficiaries’ lower tax rates while accumulating the trust’s income. This income tax flexibility can be accomplished by giving a non-beneficiary the power to create an inter-vivos (lifetime) general power of appointment in one or more beneficiaries to withdrawal all (or a portion) of the trust’s taxable income to turn an otherwise non-grantor trust into a grantor trust as to the beneficiary(ies), which power could be exercised like a switch from year to year. As a third example in an otherwise inflexible trust, provide a beneficiary with a limited power of appointment that could then be used to exercise the Delaware Tax Trap to obtain estate tax inclusion and the desired step-up in income tax basis but without the need to give the beneficiary a general power of appointment. As a fourth example, a limited power of appointment could be created or modified to indirectly enable the changing or adding of beneficiaries.
  9. Combine or separate trusts to, for example, reduce administrative costs and hassles, better reflect the needs and desires of various beneficiaries, provide enhanced investment options with one trust share that may not be desired as to all trust shares, provide ability to separate risky assets from less risky assets, and possibly achieve desired tax benefits.
  10. Change income tax status of trust, including the change from grantor trust status to non-grantor trust status, or vice versa. While almost all trusts used to be structured as grantor trusts during the creator’s life to gain various tax and flexibility advantages, non-grantor trusts can now achieve other various tax benefits, which has only been enhanced by the significant changes under the 2017 Tax Act. For example, properly structured, a non-grantor trust can achieve an unlimited ability to deduct charitable gifts against gross income, additional deductions can be achieved for otherwise limited state and local taxes (SALT deductions), possible ability to avoid state level income tax on income accumulated in the trust, and possibility to play a part in the structuring to take advantage of the 20% deduction on pass-through business income.
  11. Create specialized types of trusts, such as (i) trusts able to own S corporation stock (ii) a supplemental or special needs trust to prevent trust assets from limiting or preventing a beneficiary from qualifying for means tested government benefits, or (iii) enable trust to qualify as a designated beneficiary for purposes of the minimum distribution rules and thereby enable stretch IRA status.
  12. Add or remove spendthrift provision in order to achieve other desired results or to enter into other desired transactions.
  13. Either directly or indirectly enable changes in current/future beneficiaries, which may include not only the timing of when particular beneficiaries may benefit but also the possibility of adding other beneficiaries altogether, both individuals and charities.
  14. Potentially protect against claims of beneficiary’s creditors, by changing the trustee’s distribution standard or other provisions to prevent mandatory distributions to the beneficiary. For example, the Massachusetts Supreme Court, in Ferri v. Powell-Ferri, approved a trust decanting to remove the beneficiary’s power of withdrawal and thereby remove this portion of trust assets from becoming a part of the beneficiary’s marital estate in an active divorce situation. 476 Mass. 651 (2017).
  15. Dealing with divorcing spouses, which may include any number of desired changes.
  16. Change/extend the trust’s term, for example, to continue tax and/or non-tax benefits of the trust for a longer period of time. This is important since GA’s Rule Against Perpetuities (RAP) was extended beginning on July 1, 2018 from a safe harbor of 90 years to 360 years. The RAP is the time limit that a trust can last without distributing / vesting assets in the trust beneficiaries. Important note: the ability to extend a trust beyond its original RAP may require a change in the transferor for wealth transfer tax purposes, which means that a taxable gift (during life) or estate tax inclusion (upon death) may be required and/or any previously allocated GST tax exemption (or GST grandfathered status) may be lost. Of course, in this era of extremely high wealth transfer tax exemptions, this creation of a taxable gift, estate tax inclusion, and/or loss of previously allocated GST tax exemption (or loss of GST grandfathered status) may not be a significant issue. On the other hand, legal positions do exist to extend a trust’s term (beyond original RAP) that would avoid a wealth transfer tax event, but these positions may not be clearly supported by significant IRS authority and are therefore subject to more tax risk.
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