Decanting allows trustees to change some provisions of an irrevocable trust by 'pouring' the assets into a new trust with modified terms. Decanting may be authorized by the express terms of the trust instrument, by common law, or by state statute. Decanting
can be used to make administrative changes like a change of trust
situs, changes to the number and powers of trustees, or to consolidate
trusts, to list a few. Decanting also can be used to make certain
changes to how the trust assets are distributed, like enhanced
spendthrift provisions, enhanced asset protection, or to qualify a
special needs beneficiary for needs-based benefits, among other
dispositive changes.
Some state statutes authorize decanting in a restatement of the original trust, eliminating the tedious task of re-titling assets to the new trust. Presently, 12 states have adopted the Uniform Trust Decanting Act (UTDA), being: AL, CO, IL, ME, MA, MT, NE, NM, NC, VA, WA and WV. 24 other states have not adopted the UTDA but have their own specific decanting statutes, being: AL, AZ, CA, DE, FL, GA, IN, IA, KY, MI, MN, MO, NV, NH, NY, ND, OH, RI, SC, SD, TN, TX, WI and WY. Decanting by restatement is a preferred method for most practitioners. If the original trust is sitused in a state that does not allow decanting via a restatement, then the practitioner could consider changing its situs to a friendlier state. The following should be avoided when decanting a trust:
1. Don’t add new beneficiaries. Trustees
do not have the discretion to distribute trust property to
non-beneficiaries. So, decanting should not attempt to add beneficiaries
who were not contemplated in the original trust instrument. If
decanting intends and has the authority to add new beneficiaries, only a
non-beneficiary trustee may exercise its decanting powers. If the
trustee is also a beneficiary, consider whether the trust protector can
remove the beneficiary as trustee or appoint a special trustee to
perform the decanting. To avoid creating a taxable gift event, consider
granting a special power of appointment over trust property in the
decanted trust to the beneficiary of the original trust.
2. Don’t modify a grandfathered trust. GST
tax applies to transfers made after October 22, 1986, and thus some
trusts enjoy a “grandfather” status. If a grandfathered trust is
decanted and assets are directly or indirectly added, then the
grandfathered status is lost, exposing the trust to GST tax. While
exercising a special power of appointment is not considered adding
assets to the trust, different rules apply when there is a distribution
from, or a modification to, a grandfathered trust. In these situations,
the IRS does not treat decanting as exercising a special power of
appointment for GST tax purposes. Therefore, where there is a change in
beneficial interest, decanting arising from the trustee’s powers to
distribute trust property or to modify the original trust could be
considered “adding assets to the trust”—even if done under the special
power of appointment.
3. Don’t grant new general powers of appointment. Estate tax issues can arise when the decanted trust grants the settlor a power not present under the original trust. As to trust beneficiaries, estate tax inclusion can arise where:
The decanted trust grants a beneficiary a general power of appointment not provided in the original trust, causing inclusion in the beneficiary’s estate under IRC §2041;
The property included in the beneficiary’s estate is treated as a gift by the beneficiary as a result of the decanting;
The power to decant is itself deemed a general power of appointment under IRC §2041; or
The decanting causes an incomplete gift to become complete on the beneficiary’s death.