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Modifying Irrevocable Trusts Using Nonjudicial Settlement Agreements

Structuring NJSA Wrappers, Relocating Trust Situs, Resolving Disputes, Remedying Trust Construction Issues

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1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific WEDNESDAY, JANUARY 4, 2017

Presenting a live 90-minute webinar with interactive Q&A Abby L.T . Feinman, Partner, Katten Muchin Rosenman, Los Angeles Diane B. Burks, Special Counsel, Katten Muchin Rosenman, Charlotte, N.C. Laura K. Zeigler, Principal, Fiduciary Counsel, Bessemer Trust, Los Angeles

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Modifyin ing Irre Irrevocable Tru rusts Usin ing Nonjudicia ial Sett ttlement Agre reements

Strafford Live CLE/CPE Webinars January 4, 2017

Abby L.T. Feinman Diane B. Burks Laura K. Zeigler Partner Special Counsel Principal, Fiduciary Counsel Katten Muchin Rosenman LLP Katten Muchin Rosenman LLP Bessemer Trust 2029 Century Park East 550 S. Tryon Street 10250 Constellation Boulevard, Suite 2600 Suite 2900 Suite 2600 Los Angeles, CA 90067 Charlotte, NC 28202 Los Angeles, CA 90067 (310) 788-4722 (704) 344-3153 (213) 892-0900 abby.feinman@kattenlaw.com diane.burks@kattenlaw.com zeigler@bessemer.com

I.

• I. A

Amendin ing an Irre Irrevocable Tru rust

Is Is the the Irrev Irrevocable le Tru rust st Irrev Irrevocable le?

• The Irrevocable Trust offers dual benefits of

potentially reducing estate taxes while currently transferring wealth.

• In exchange for these benefits, the grantor

relinquishes the ability to amend and revoke the trust.

• Although the trust is irrevocable, it is not immutable

and can be modified to adapt to changes in circumstances.

6

Why Change th the Tru rust?

Corr rrect Mist istak akes, , Add ddre ress s Ambig biguiti ties, , and and Chan ange Adm dmini inist strative Pro rovisi sions:

• Correct a scrivener’s error
• Modernize trust provisions
• Change trust situs and/or governing

law

• Change administrative terms – i.e.,

directed trust, dividing decision responsibility

• Divide or merge trusts
• Reduce administrative costs
• Convert a domestic trust to a foreign

trust or vice versa

7

Beneficiary Relat lated Reasons to Modify fy the Trust

• Grant or limit beneficiary a power of appointment
• Limit the beneficiary’s rights to receive information

(Delaware permits restricting the Trustee’s duty to provide information)

• Eliminate a beneficiary
• Move to jurisdiction that provides asset protection for

self-settled irrevocable trusts

• Change from a pot trust to separate shares
• Transfer assets to a special needs trust
• Address change in circumstances – creditor, marital or

health (substance abuse or other unproductive behavior)

8

Tax Reasons to to Modif ify th the Tru rust

• Change from a grantor trust to a non-grantor trust or

vice versa

• Minimize state income taxes
• Division of trusts for marital deduction or GST planning
• Use grantor’s or beneficiary’s GST exemption

9

How Do You Make th the Change?

Historically, because trusts were viewed as inalterable,

• ften the grantors or trustees would resort to draining

them to avoid undesirable consequences. But, there are a number of alternatives to this approach.

• Exercise of General Trust Powers
• Judicial Modification
• Decanting
• Nonjudicial Modification

10

Exercise of f General Tru rust Powers to to Alte lter Tru rust or r to to Move Assets fro from One Tru rust to to Another

• Power of substitution
• Power of revocation or

termination

• Trustee succession,

removal, appointment

• Trustee power to delay

distribution

• Conversion to unitrust
• Sale of trust assets
• Divide a trust
• Change trust situs
• Power of amendment
• Disclaimer
• Powers of appointment
• Merge similar trusts
• Change governing law
• Turn grantor trust powers
• n or off

11

Ju Judic icia ial Tru rust Modif ific ication

• Trustee or beneficiary brings action to modify the

trust.

• Useful when grantor cannot or will not consent to an

action proposed by the beneficiaries.

• Unlike consent modification, the modification or

termination cannot frustrate a material purpose of the trust, unless the need for the modification or termination substantially outweighs the material purpose of the trust.

12

Ju Judic icia ial Tru rust Modif ific ication

• Modification of charitable trusts is allowed only if

charitable purpose is frustrated, impossible, illegal

• r obsolete. State Attorney General may need to be

involved.

• Process includes the trustee, the beneficiaries and
• ther interested parties. The grantor may also be

involved.

• Court’s decision is generally respected by

government authority. IRS may require a State Supreme Court decision to be bound (Bosch case).

13

Constructi tion Pro roceedin ing

• Where trust is ambiguous or trust did not provide for

the happening of a particular event.

• Patent ambiguity
• Latent ambiguity
• IRS position - If consistent with state law, then the

change is retroactive back to the date the original trust was effective.

14

Refo formation Pro roceeding

• Proceeding where a court addresses unambiguous

language which when interpreted literally would create an unintended result.

• Scrivener’s error
• Alter trust to achieve the result intended by

the settlor

• Alter trust to achieve the result the settlor

would have wanted based on certain circumstances or changes in the law

• Correcting drafting error, a settlor’s mistake of fact or

law, or changes in law or circumstances can be cured by

• reformation. The Restatement (Third) of the Law of

Property (Wills & Other Donative Transfers) §12.1.

15

Decantin ing to to Modify ify Irre Irrevocable Tru rusts

• Ultimate amendment power
• Allows single party (the trustee) to modify

the trust without court involvement or beneficiary consent

• Decanting is the process of exercising a

fiduciary power to distribute assets from

• ne trust to another (like pouring wine from
• ne bottle to another)
• Trustee transfers existing trust assets to a

new trust with more favorable terms

• Power granted by the terms of the trust,

case law or state statute

• Whether decanting a trust will be the

ideal/preferred technique for modification depends on the motivation behind altering the trust’s terms

16

Decantin ing Auth thority Under r Common Law

• Decanting first originated at common law in Florida in

1940 with the Phipps v. Palm Beach Trust Company, 196 So. 299 (Fla. 1949).

• Decanting exists under the common law of several
• states. See also, In Re: Estate of Spencer, 232 N.W.2d

491 (Iowa 1975); Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. Ct. App. Div. 1969); Morse v. Kraft, 466 Mass. 92 (2013).

• These states permitted trustees to decant to a new

trust through the exercise of a broad discretionary distribution power.

• The theory is that decanting is embedded in the

trustee’s broad discretionary distribution power under common law.

17

Decantin ing Auth thority Under r Resta tatements

• The Restatement (Second) of Property: Donative Transfers

§§11.1, 19.4 states that unless the trust provides otherwise, the trustee’s discretionary power to distribute trust property is akin to a power of appointment which includes the power to:

• Make distributions in trust for permissible beneficiaries

and

• Create new powers of appointment over trust assets in

favor of permissible appointees of the original power.

• Restatement (Third) of Property similarly supports this

concept but does not treat the power to invade as a special power of appointment because of the fiduciary obligations of a trustee. See Restatement (Third) of Property (Wills and Other Donative Transfers) § 17.1.

18

Restate tements and UTC

• Similarly §75 of the Restatement (Third) of Trusts

provides that a Trustee with absolute discretion is still subject to standards of good faith and reasonableness where a non-fiduciary is not.

• Decanting provisions are not part of the UTC.
• The UTC contains provisions for trust

modification and trust reformation.

19

NY – Fir irst Decantin ing Statute

• In 1992, New York was the first state to enact a

decanting statute.

• Trustee with absolute discretion to invade

principal can distribute trust property further in trust.

• 25 states have enacted decanting statutes. Many

more states are considering enacting them.

20

States Wit ith Decanting Statutes –Fir irst Enacted

• New York – 1992
• Alaska – 1998
• Delaware – 2003
• Tennessee – 2004
• Florida and South Dakota – 2007
• New Hampshire – 2008
• Nevada, Arizona and North Carolina – 2009
• Indiana – 2010
• Missouri – 2011
• Ohio, Kentucky, Virginia, Michigan and Rhode Island – 2012
• Illinois, Texas and Wyoming – 2013
• South Carolina and Wisconsin– 2014
• Colorado, Minnesota, – 2016
• New Mexico - 2017

21

Pre remise Behi hind nd Decanti ting Sta tatu tute tes & Unifo iformity

• State decanting statutes vary in detail. All operate

from the same premise. Power to invade principal = power to appoint principal to a new trust for some or all of the beneficiaries.

• Uniform Powers of Appointment Act
• Contrary position ≠ Power of Appointment
• Power of appointment = non-fiduciary power
• Decanting = Power of Amendment

22

Overview of

• f Uni

nifor form Tru rust t Decant ntin ing Act

• The Uniform Law Commission formed a Trust

Decanting Committee in early 2013.

• At the core of the Uniform Act is the general scope
• f changes that may be made by decanting.
• Limited Distribution Discretion = the interest of each

beneficiary under the new trust must be substantially similar to that person’s interest in the first trust.

• Expanded Distribution Discretion = the second trust

may have different dispositive provisions, subject to some limitations.

23

What if if th the Tru rust is is Located in in a Sta tate te th that t Does Not Have a Decantin ing Statute?

Change situs to a jurisdiction with favorable decanting rules.

• Trust provides for change of situs.
• Trust provides for changing trustee – changing

trustee can invoke nexus with the state.

• State law permits changing situs.
• Petition court to change situs.

24

Threshold Considerations in in Decanting

• Consistent with fiduciary duties?
• Prohibited or permitted in the trust agreement?
• If the trust agreement is silent, does state law

provide for decanting?

• Statutory requirements satisfied?

25

Exis istence of f Decantin ing Power

• If a trust agreement does not provide for decanting

but the trust’s state governing law provides for decanting, then the state statute will apply.

• Most states provide that the state’s decanting statute

will apply to a trust that moves its situs to that state.

• Need to determine which state has best decanting

statute for you.

• Each state that has enacted a decanting statute has

defined the degree of discretionary authority over distributions that a trustee must have in order to exercise the statutory power to decant. (i.e., absolute discretion, any discretion).

• Some state statutes prohibit or limit a trustee from

having the power to decant if the trustee is also a beneficiary.

26

What Can Be Decanted?

• Trustee must have the power to make discretionary

distributions.

• All states that have enacted decanting statutes

permit the decanting of trust principal.

• Some state statutes limit decanting to trust principal

and not income.

• Many state statutes allow for the decanting of both

trust income and principal.

27

Limitations on Trustee’s Authority

• All decanting statutes require the exercise of

the decanting power in favor of one or more of the beneficiaries of the original trust.

• Trustee cannot add beneficiaries.

28

Gra rantin ing Power of f Appoin intment Over r New Tru rust

• None of the state statutes prohibit the trustee from

granting the beneficiaries a power of appointment

• ver the new trust.
• Granting a power of appointment to a beneficiary of

the original trust may allow the decanting to indirectly add beneficiaries.

29

Altering Trustee’s Discretion in New Trust

• State statutes vary on altering the trustee’s

discretion in making discretionary distributions in the new trust.

• Some states provide that the standard cannot

be less restrictive than the old trust.

• Some states provide that, if the old trust has

health, education, maintenance and support, then the new trust needs the same standard.

30

Elimination of Beneficiaries’ Rights in Trust

Some state statutes prohibit the elimination of certain beneficiaries’ rights over the trust:

• Annuity or unitrust interests
• Fixed income interests – e.g. mandatory distributions of

income

• Annual exclusion gifts
• Necessary provisions to qualify for the marital or charitable

deduction

• Withdrawal powers (i.e., Crummey withdrawal, 5x5 power)
• Extend the IRC § 2503(c) vesting period (beyond 21 years)
• Provisions to avoid estate tax inclusion (Nevada and New

Hampshire)

• Specific property allocations and values (Nevada)

31

Noti tice Requirements

• Some states require that the trustee give notice of

the decanting to the original trust’s beneficiaries.

• Must be a writing about the anticipated decanting

signed by the trustee.

• Court approval or consent not required, although

permissible.

• The omission of beneficiary consent helps avoid

potential adverse tax consequences.

• Concern – Beneficiary consent ≈ taxable gift

32

Nonjudicia ial Tru rust Modifi ification

• Modification or termination of a trust without court

approval can be accomplished under certain circumstances if all of the parties (i.e., grantor, beneficiaries) consent.

• Action can even be in opposition to trust’s purpose.
• If a beneficiary refuses to consent, modification by

consent is unavailable.

• IRS may not be bound by the agreement.

Commissioner v. Estate of Bosch, 387 U.S. 456 (1967). The IRS is not bound by a matter unless that matter has been determined by the highest state court.

33

Types of f Nonju judic icial Modifi ifications

• The Uniform Trust Code permits two types of nonjudicial

modifications:

– Nonjudicial settlement agreements (NJSA) (UTC §111) and – Nonjudicial modifications (UTC §411).

• If the settlor is alive, a non-charitable irrevocable trust

may be modified (or terminated) with the consent of the settlor and all beneficiaries, even if the modification or termination is inconsistent with a material purpose of the trust.

• If the settlor is deceased (or is alive but unwilling or

unable to consent) nonjudicial modification is not possible–the trust may be modified or terminated with the consent of all of the beneficiaries and if the modification of the trust is not inconsistent with a material purpose of trust.

34

II.

• II. Unifo

iform Tru rust Code Pro rovisions

Introduced in 2016

35

NJS JSA Under r th the Unifo iform Tru rust Code

• In the past, the main way of solving issues that arose

with irrevocable trusts was expensive and often involved going to court.

• UTC §111 now allows for NJSAs with respect to trusts.
• Comment to UTC states that resolutions by nonjudicial

means are “encouraged” – however, a nonjudicial settlement cannot be used to produce a result not authorized by law.

• These are extremely useful tools, because there is a lot
• f flexibility in changes that can be made and settlor

consent is not required.

36

NJS JSA Under r th the Unifo iform Tru rust Code

• The code makes one other important change. Due to the

very nature of a trust, there may be beneficiaries who are either not competent or not yet alive. In the past, a court would need to appoint an individual known as a guardian ad litem to represent the interests of those incompetent and potential beneficiaries. That process added even more complexity and expense.

• The code’s new provision for virtual representation,

however, allows other trust beneficiaries with substantially similar interests to represent the interests of those beneficiaries who are unable to represent themselves -- as long as no conflict of interest exists.

• For example, it may now be possible for an adult grandchild

to represent other minor grandchildren, all of whom are remainder beneficiaries in a trust.

37

II.

• II. Unifo

iform Tru rust Code Pro rovisions

UTC Se Secti ction 111 (a) For purposes of this section, “interested persons” means persons whose consent would be required in order to achieve a binding settlement were the settlement to be approved by the court. (b) Except as otherwise provided in subsection (c), interested persons may enter into a binding nonjudicial settlement agreement with respect to any matter involving a trust. (c) A nonjudicial settlement agreement is valid only to the extent it does not violate a material purpose of the trust and includes terms and conditions that could be properly approved by the court under this [Code] or other applicable law.

38

II.

• II. Unifo

iform Tru rust Code Pro rovisions

UTC Se Section 111 (d) Matters that may be resolved by a nonjudicial settlement agreement include: (1) the interpretation or construction of the terms of the trust; (2) the approval of a trustee’s report or accounting; (3) direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power; (4) the resignation or appointment of a trustee and the determination of a trustee’s compensation; (5) transfer of a trust’s principal place of administration; and (6) liability of a trustee for an action relating to the trust. (e) Any interested person may request the court to approve a nonjudicial settlement agreement, to determine whether the representation as provided in [Article] 3 was adequate, and to determine whether the agreement contains terms and conditions the court could have properly approved.

39

UTC 111 Requir irements fo for r NJS JSA

• Int

Interested per erso sons may enter into a binding NJSA with respect to any matter involving a trust.

• Valid only to the extent the agreement includes terms

and conditions that could be properly approved by a court.

40

II. II.A In Intere rested Pers rsons

• UTC §111(a): “For purposes of this section, “interested

persons” means persons whose consent would be required in

• rder to achieve a binding settlement were the settlement to

be approved by the court.”

• Comment to Section 111: “Because of the great variety of

matters to which a nonjudicial settlement may be applied, this section does not attempt to precisely define the “interested persons” whose consent is required to obtain a binding settlement as provided in subsection (a).” (emphasis added)

• However, the trustee’s consent would ordinarily be required to
• btain a binding settlement with respect to matters involving a

trustee’s administration, such as approval of a trustee’s report

• r resignation.
• The required parties to a NJSA vary by jurisdiction and it may

not always be clear from the respective state’s definition which consents are required.

42

II. II.A In Intere rested Pers rsons

• Some jurisdictions more clearly define “interested parties”

(discussed in Part III).

• In jurisdictions where “interested parties” is not defined,

look to other provisions of the jurisdiction’s trust code or case law to determine which parties may be deemed to be interested in the matter: – Example: UTC §411(b) permits the modification of a noncharitable irrevocable trust upon consent of all

• beneficiaries. Presume that all beneficiaries are

interested persons.

• Trustee’s consent (UTC Comment): The trustee’s consent

would ordinarily be required to obtain a binding settlement with respect to matters involving a trustee’s administration.

• Beneficiary consent: likely always required.

43

II. II.A In Inte tere reste ted Pers rsons: Repre resentati tion

• Representation under the UTC may be required to bind minor, unborn, or unascertainable beneficiaries.

– UTC § 302 – Representation by Holder of General Testamentary Power of Appointment

• To the extent there is no conflict of interest between the holder of a general testamentary power of

appointment and the persons represented with respect to the particular question or dispute, the holder may represent and bind persons whose interests, as permissible appointees, takers in default, or otherwise, are subject to the power. – UTC § 303 – Representation by Fiduciaries and Parents

• To the extent there is no conflict of interest between the representative and the person represented or

among those being represented with respect to a particular question or dispute: – (1) a [conservator] may represent and bind the estate that the [conservator] controls; – (2) a [guardian] may represent and bind the ward if a [conservator] of the ward’s estate has not been appointed; – (3) an agent having authority to act with respect to the particular question or dispute may represent and bind the principal; – (4) a trustee may represent and bind the beneficiaries of the trust; – (5) a personal representative of a decedent’s estate may represent and bind persons interested in the estate; and – (6) a parent may represent and bind the parent’s minor or unborn child if a [conservator] or [guardian] for the child has not been appointed. – UTC § 304 – Representation by Person having Substantially Identical Interest

• Unless otherwise represented, a minor, incapacitated, or unborn individual, or a person whose identity or

location is unknown and not reasonably ascertainable, may be represented by and bound by another having a substantially identical interest with respect to the particular question or dispute, but only to the extent there is no conflict of interest between the representative and the person represented. – UTC § 305 – Appointment of Representative (e.g., a guardian ad litem)

• (a) If the court determines that an interest is not represented under this [article], or that the otherwise

available representation might be inadequate, the court may appoint a [representative] to receive notice, give consent, and otherwise represent, bind, and act on behalf of a minor, incapacitated, or unborn individual,

• r a person whose identity or location is unknown. A [representative] may be appointed to represent

several persons or interests.

• (b) A [representative] may act on behalf of the individual represented with respect to any matter arising

under this [Code], whether or not a judicial proceeding concerning the trust is pending.

• (c) In making decisions, a [representative] may consider general benefit accruing to the living members of

the individual’s family.

44

II. II.A In Inte tere reste ted Pers rsons: Representation of f In Intere rested Pers rson

• Representation of necessary parties.

– An interested person may be represented in a NJSA – Binding on the represented party. – Trustee is not liable for giving notice, information or an accounting to a represented party.

• There are rules governing who represents minors, unborns,

incapacitated beneficiaries, beneficiaries whose identity and/or location are unknown, permissible appointees under a power of appointment, and takers in default under powers of appointment. – Actual vs. Virtual Representation.

• Actual representation: Based upon the individual’s

relationship to the represented party. – Holder of general power of appointment – Fiduciaries/agents/guardians – Parents

• Virtual representation: Based upon an individual holding

substantially identical interests in the trust as the represented beneficiary (UTC §304).

45

II. II.A In Intere rested Pers rsons: Repre resentation – Sta tatu tutory Diffe ifferences

– Many states expressly reference representation:

• North Carolina (N.C.G.S. §36C-1-111(d)): Any interested person

may request the court to approve a nonjudicial settlement agreement, to determine whether the representation as provided in Article 3 of this Chapter was adequate, and to determine whether the agreement contains terms and conditions the court could have properly approved.

• Virginia (Va. Code §64.2-709(E)): Any interested person may

petition the court to approve a nonjudicial settlement agreement, to determine whether the representation as provided in Article 3 (Va. Code § 64.2-714 et seq.) was adequate, and to determine whether the agreement contains terms and conditions the court could have properly approved. – Other states do not expressly refer to the state’s representation statute:

• Florida (Fla. Stat. §736.0111(5)): Any interested person may

request the court to approve or disapprove a nonjudicial settlement agreement.

46

II.B II.B – Prohibition Against Modifying “Material Purpose” of Trust

• UTC §111(c): A nonjudicial settlement agreement is valid
• nly to the extent it does not violate a material purpose
• f the trust and includes terms and conditions that could

be properly approved by the court under this [Code] or

• ther applicable law.
• “Material purpose” is not defined by the UTC, nor

addressed in the UTC’s commentary.

• The UTC allows any interested person to seek judicial

determination on the validity of a NJSA. Therefore, an interested person may attack a NJSA by claiming the agreement violated a material purpose.

47

II.B II.B – Prohibition Against Modifying “Material Purpose” of Trust

• Key: intent of grantor in creating the trust.

– If grantor is living, he or she may be able to provide clarity on the purpose of the trust and sign the NJSA solely for the purpose of indicating that the NJSA does not violate a material purpose of the trust. – Note for practitioners: document material purposes for trusts in files and working papers, especially if the grantor feels very strongly about the purpose and the purpose is unique.

48

II.B II.B – Prohibition Against Modifying “Material Purpose” of Trust

• Examples of material purpose:

– Spendthrift trust – Trusts established for the ongoing management or

• peration of a business

– Trusts excluding specific individuals (children, adopted children, children born out of wedlock)

• Example: Trust created for the benefit of a spendthrift
• r fiscally irresponsible adult child. Trustee and adult

child cannot defeat the material purpose of the trust to provide for a full outright distribution of assets to the child.

49

II.C II.C – What Term rms May be Modifi ified by Bin indin ing NJS JSAs

• The UTC provides a non

non-exclus usive ve list of six matters a NJSA can address

• UTC §111(d): Matters that may be resolved by a nonjudicial

settlement agreement include: (1) the interpretation or construction of the terms of the trust; (2) the approval of a trustee’s report or accounting; (3) direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power; (4) the resignation or appointment of a trustee and the determination of a trustee’s compensation; (5) transfer of a trust’s principal place of administration; and (6) liability of a trustee for an action relating to the trust.

50

II.C II.C – What Term rms May be Modifi ified by Bin indin ing NJS JSAs

• UTC §111(d)(1): the interpretation or construction of the terms of the trust;

– Example: trust is unclear whether distributions to issue are per stirpes or per capita.

• UTC §111(d)(3): direction to a trustee to refrain from performing a particular

act or the grant to a trustee of any necessary or desirable power; – Limiting trustee’s authority allows a trustee and the beneficiaries to put contractual limits on the trustee’s authority. May also allow for the creation of directed trusts of the bifurcation of trustee duties. – May permit the trustee to take certain actions which may be counter to traditional principles of fiduciary duty. For example, a trustee may typically have the duty to diversify trust assets. A NJSA could permit the trustee to invest in a single or small group of assets (such as closely-held business stock or real estate) without concern about liability. The NJSA could also permit the trustee to invest in non-traditional assets or pursue a more aggressive investment strategy.

51

II.C II.C – What Term rms May be Modifi ified by Bin indin ing NJS JSAs

• UTC §111(d)(4): the resignation or appointment of a trustee and the

determination of a trustee’s compensation; – A trustee may resign pursuant to the terms of the trust or applicable statute (i.e., UTC §705). However, a NJSA between the trustee and beneficiaries will frequently prove helpful in working out the terms of the trustee’s resignation.

• UTC §111(d)(6): liability of a trustee for an action relating to the trust.

– A NJSA can release a trustee from liability for certain actions – UTC §1009: A trustee is not liable to a beneficiary for breach of trust if the beneficiary consented to the conduct constituting the breach, released the trustee from liability for the breach, or ratified the transaction constituting the breach, unless: (1) the consent, release, or ratification of the beneficiary was induced by improper conduct of the trustee; or (2) at the time of the consent, release, or ratification, the beneficiary did not know of the beneficiary’s rights or of the material facts relating to the breach.

52

II.C II.C – What Term rms May be Modifi ified by Bin indin ing NJS JSAs

• Other matters that may be resolved:

– Revise administrative provisions to confirm with rules imposed by corporate fiduciaries – Provide for further succession of trustees – Account for unanticipated circumstances affecting a beneficiary (special needs, drug abuse, divorce, etc.)

53

• Some non-UTC states have adopted provisions

authorizing NJSAs: – Delaware – Del. Code tit. 12, §3338 – Idaho – Idaho Code §15-9-301 et. seq. (nonjudicial binding agreement) – Illinois – 760 Ill. Comp. Stat. §5/16.1(d)

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model

54

• Some non-UTC states have adopted provisions authorizing NJSAs (Cont):

– Washington – Wash. Rev. Code. §11.96A.220 (nonjudicial binding agreement).

• “RCW 11.96A.210 through 11.96A.250 shall be applicable to the resolution of

any matter, as defined by RCW 11.96A.030, other than matters subject to chapter 11.88 or 11.92 RCW, or a trust for a minor or other incapacitated person created at its inception by the judgment or decree of a court unless the judgment or decree provides that RCW 11.96A.210 through 11.96A.250 shall be

• applicable. If all parties agree to a resolution of any such matter, then the

agreement shall be evidenced by a written agreement signed by all parties. Subject to the provisions of RCW 11.96A.240, the written agreement shall be binding and conclusive on all persons interested in the estate or trust. The agreement shall identify the subject matter of the dispute and the parties...” (emphasis added)

• “If a party who virtually represents another under RCW 11.96A.120 signs the

agreement, then the party's signature constitutes the signature of all persons whom the party virtually represents, and all the virtually represented persons shall be bound by the agreement.”

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model

55

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model

• Some UTC states call a NJSA by another term:

– Ohio statute refers to “private settlement agreement” (Ohio Rev. Code §5801.10(C))

56

III.

• III. Oth

ther NJS JSA Sta tatu tutory Pro rovis isions and Vari riances fro from UTC Model: In Intere rested Pers rsons

• Many states simply use the “interested persons” language from the UTC.
• Some states more clearly define the parties who must consent to the NJSA.
• Example: Delaware (non-UTC jurisdiction):

– 12 Del. Code tit. 12, §3338(a): For purposes of this section, “interested persons’’ means persons whose consent would be required in order to achieve a binding settlement were the settlement to be approved by the Court of Chancery. With respect to any nonjudicial settlement agreement regarding a trust, the term ‘’interested persons” means all whose interest in the trust would be affected by the proposed nonjudicial settlement agreement, which may include: (1) Trustees and other fiduciaries; (2) Trust beneficiaries, who will generally be those with a present interest in the trust and those whose interest in the trust would vest, without regard to the exercise or nonexercise of any power of appointment, if the present interests in the trust terminated on the date of the nonjudicial settlement agreement; (3) The trustor of the trust, if living; and (4) All other persons having an interest in the trust according to the express terms of the governing instrument (such as, but not limited to, holders of powers and persons having other rights, held in a nonfiduciary capacity, relating to trust property).

57

III.

• III. Oth

ther NJS JSA Sta tatu tutory Pro rovis isions and Vari riances fro from UTC Model: In Intere rested Pers rsons

• Example: Delaware (non-UTC jurisdiction):

– Delaware Chancery Court Rule 101(a)(7): Consents or statements of non-objection to the relief sought in the petition from all whose interest in the trust is affected by the petition, which may include, but shall not be limited to, consents from: (i) Trustees and other fiduciaries, unless they have otherwise signified their consent or non-objection to the petition by acting as a petitioner

• r accepting a fiduciary position;

(ii) Trust beneficiaries, who will generally be those with a present interest in the trust and those whose interest in the trust would vest, without regard to the exercise or non-exercise of a power of appointment, if the present interest in the trust terminated on the date the petition is filed; (iii) The trustor of the trust, if living; and (iv) All other persons having an interest in the trust according to the express terms of the trust instrument (such as, but not limited to, holders of powers and persons having other rights, held in a nonfiduciary capacity, relating to trust property).

58

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model: In Inte tere rested Pers rsons

• Arizona statute provides a list of “interested persons”, but the list

includes those with a very tenuous relationship to trust (e.g., spouse

• r creditor).

– Ariz. Rev. Stat. §14-10111(f) - for the purposes of this section, “interested person” has the same meaning prescribed in section 14-1201. – Ariz. Rev. Stat. §14-1201(28) – “Interested person" includes any trustee, heir, devisee, child, spouse, creditor, beneficiary, person holding a power of appointment and other person who has a property right in or claim against a trust estate or the estate of a decedent, ward or protected person. Interested person also includes a person who has priority for appointment as personal representative and other fiduciaries representing interested

• persons. Interested person, as the term relates to particular

persons, may vary from time to time and must be determined according to the particular purposes of, and matter involved in, any proceeding. (emphasis added).

59

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model: In Inte tere rested Pers rsons

• Pennsylvania statute requires the consent of all

beneficiaries and trustees – 20 Pa. Cons. Stat. §7710.1(b) – “… all beneficiaries and trustees of a trust may enter into a binding nonjudicial settlement agreement with respect to any matter involving the trust.”

60

III.

• III. Oth

ther NJS JSA Sta tatu tutory Pro rovis isions and Vari riances fro from UTC Model: In Intere rested Pers rsons

• Tennessee – “qualified beneficiaries”
• Tenn. Code Ann. §35-15-111(a) – “…the trustee and the qualified beneficiaries may

enter into a binding nonjudicial settlement agreement with respect to any matter involving a trust.”

• Tenn. Code Ann. §35-15-103(24) – "Qualified beneficiary" means a beneficiary who,

assuming the nonexercise of all powers of appointment and the nonoccurrence of any event not reasonably expected to occur, on the date the beneficiary's qualification is determined: (A) Is a distributee or permissible distributee of trust income or principal; (B) Would be a distributee or permissible distributee of trust income or principal if the interests of the distributees described in subdivision (24)(A) terminated on that date; or (C) Would be a distributee or permissible distributee of trust income or principal if the trust terminated on that date; (D) Notwithstanding any other provisions of this subdivision (24), no ultimate beneficiary

• r potential ultimate beneficiary shall be a qualified beneficiary….
• Tenn. Code Ann. §35-15-110:

(a) A charitable organization expressly designated to receive distributions under the terms of a charitable trust has the rights of a qualified beneficiary under this chapter, if the charitable organization, on the date the charitable organization's qualification is being determined: (1) Is a distributee or a permissible distributee of trust income or principal; (2) Would be a distributee or a permissible distributee of trust income or principal if the interests of other distributees or permissible distributees then receiving or eligible to receive distributions terminated on that date without causing the trust to terminate; or (3) Would be a distributee or a permissible distributee of trust income or principal if the trust terminated on that date. (b) The attorney general and reporter of this state has the rights of a qualified beneficiary with respect to a charitable trust having its principal place of administration in this state.

61

III.

• III. Oth

ther NJS JSA Sta tatu tutory Pro rovis isions and Vari riances fro from UTC Model: Matters That May be Addre ressed

• Some states have adopted the UTC provision that provides a

non-exclusive list of matters that can be addressed by NJSA: – Massachusetts (Mass. Gen Laws. ch. 203E, §111(d)) – Matters that may be resolved by a non-judicial settlement agreement shall include: (1) the interpretation or construction of the terms of a trust; (2) the approval of a trustee's report or accounting; (3) direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power; (4) the resignation or appointment of a trustee and the determination of a trustee’s compensation; (5) transfer of a trust’s principal place of administration; and (6) liability of a trustee for an action relating to the trust.

62

III.

• III. Other

r NJSA Statutory Pro rovis isio ions and Vari riances fro from UTC Model: Matters rs That May be Addre ressed

North Carolina:

• N.C.G.S. §36C-1-111(b): Interested persons

may enter into a binding nonjudicial settlement agreement with respect to any of the following matters involving a trust: (1) The approval of a trustee’s report or accounting; (2) Direction to a trustee to perform or refrain from performing a particular administrative act or the grant to a trustee of any necessary

• r desirable administrative power, including a

power granted under G.S. §36C-8-816; (3) The resignation or appointment of a trustee and the determination of a trustee's compensation; (4) Transfer of a trust’s principal place of administration; and (5) Liability of a trustee for any action taken under subdivisions (1) through (4) of this subsection.

South Carolina:

• S.C. Code §62-7-111(b): Interested

persons may enter into a binding nonjudicial settlement agreement with respect to only the following trust matters: (1) the approval of a trustee’s report or accounting; (2) direction to a trustee to perform or refrain from performing a particular administrative act or the grant to a trustee of any necessary or desirable administrative power; (3) the resignation or appointment of a trustee and the determination of a trustee's compensation; (4) transfer of a trust’s principal place

• f administration; and

(5) liability of a trustee for an action relating to the trust.

63

III.

• III. Other

r NJSA Statutory Pro rovis isio ions and Vari riances fro from UTC Model: Matters rs That May be Addre ressed

• Some states do not allow a NJSA to direct or restrict the

Trustee: – Kansas (Kan. Stat. Ann. §58a-111(d)) – Matters that may be resolved by a nonjudicial settlement agreement are limited to: (1) The approval of a trustee's report or accounting; (2) the resignation or appointment of a trustee and the determination of a trustee’s compensation; (3) transfer of a trust's principal place of administration; and (4) liability of a trustee for an action relating to the trust. – KEY: no ability to direct or restrict Trustee.

• Limits the ability for a NJSA “wrapper”.

64

III.

• III. Oth

ther NJS JSA Sta tatu tutory Pro rovis isions and Vari riances fro from UTC Model: Matters That May be Addre ressed

• Some states allow a NJSA to be used to modify a trust:

– Florida (Fla. Stat. §736.0111(3)) – “A nonjudicial settlement may not be used to produce a result not authorized by other provisions of this code, including, but not limited to, terminating or modifying a trust in an impermissible manner.” – Illinois (760 Ill. Comp. Stat. §5/16.1(d)(4)(K)) – “The following matters may be resolved by a nonjudicial settlement agreement…. Modification of the terms of the trust pertaining to administration of the trust.” – New Hampshire (N.H. Rev. Stat. §564-B:1-111(d)(7)) – “Matters that may be resolved by a nonjudicial settlement agreement include without limitation…. the termination or modification of a trust.”

• Note: modification should not violate a material purpose of

the trust.

65

III.

• III. Other

r NJSA Statutory Pro rovis isio ions and Vari riances fro from UTC Model: Matters rs That May be Addre ressed

• Ohio goes one step further and expressly authorizes modifications to qualify for the

charitable deduction or estate tax marital deduction:

• Ohio Rev. Code §5801.10(C)(4)-(6): “Matters that may be resolved by a private

settlement agreement include, but are not limited to, all of the following: (4) Modifying the terms of the trust, if the modification is not inconsistent with any material purpose of the trust; (5) Modifying the terms of the trust in the manner required to qualify the gift under the terms of the trust for the charitable estate or gift tax deduction permitted by federal law, including the addition of mandatory governing instrument requirements for a charitable remainder trust as required by the Internal Revenue Code and regulations promulgated under it in any case in which the parties interested in the trust have submitted written agreements to the proposed changes or written disclaimer of interest; (6) Modifying the terms of the trust in the manner required to qualify any gift under the terms of the trust for the estate tax marital deduction available to noncitizen spouses, including the addition of mandatory governing instrument requirements for a qualified domestic trust under section 2056A of the Internal Revenue Code and regulations promulgated under it in any case in which the parties interested in the trust have submitted written agreements to the proposed changes or written disclaimer of interest;

66

III.

• III. Other NJS

JSA Statutory Pro rovis isions and Vari riances fro from UTC Model

• Take-aways:

– Confirm if state of administration is a UTC state, a non-UTC state with a NJSA statute, or otherwise. – Confirm who the “interested parties” are under the state’s statute. – Confirm if the state of administration authorizes the NJSA to address any matter or a limited list of matters. – When selecting a jurisdiction for a trust, take note of the ease of utilizing a NJSA under that state’s laws.

67

IV IV. . Usin ing a NJS JSA to to Relo locate te a Tru rust Sit itus us

• Determining Situs of the Trust:

– Look at the trust instrument to see if the governing law is addressed. – Determine whether situs has changed during the course of administration. – Why does it matter?

• Governing law and principal place of

administration—determines which laws apply.

• Principal place of administration—governs

administrative matters, including: – State taxation and reporting obligations – State court jurisdiction – State law governing administration of trust

68

Usin ing a NJS JSA to to Reloc locate a Tru rust t Sit itus us

Governing law—determines meaning and effect of the terms of a trust, including:

• Identity of beneficiaries
• Extent of beneficiaries’ interests
• Allocation of income and principal
• Creditor access
• Necessary parties
• Representation
• Effect of invalidity
• Trustee liability

69

Usin ing a NJS JSA to to Relo locate a Tru rust t Sit itus

Choi

• ice

e of

• f Law

aw – Which ich Stat State Law aw Gov

• vern

erns the the Tru rust st?

• The trust’s governing law generally applies. The

Restatement (Second) Conflicts of Laws: Trusts §§268(1), 272(a) (1971).

• The law governing construction and administration
• f a trust may be different. Construction. See

Restatement (Second) Conflicts of Laws §§268, 277. Uniform Trust Code §107 (2010 rev.).

70

Usin ing a NJS JSA to to Relo locate a Tru rust t Sit itus

Whi hich Sta State Law Governs?

• The UTC provides that the trust is governed by the law

specified in the trust instrument unless the designated governing law’s jurisdiction is overridden by another jurisdiction having the most significant contacts to the issue.

• In the states that have adopted the UTC and in the

District of Columbia, the settlor is free to designate the governing law of any state for matters of construction.

• The Restatement (Second) of Conflicts of Laws and the

UTC provide that issues related to trust administration are governed by the laws of the state where the principal place of administration takes place.

71

Usin ing a NJS JSA to to Relo locate a Tru rust t Sit itus

What if if th the e Tru rust st is is Silen Silent?

• The Restatement (Second) Conflicts of Laws:

Trusts §§268(2), 270(b), 272(b) (1971), Uniform Trust Code §107 (2010 rev.).

• Trust is silent.
• Trust administration versus dispositive matters
• Trust administration = principal place of

administration

• Dispositive matters = laws of the state that the

settlor would have desired to be applicable

72

Usin ing a NJS JSA to to Reloc locate a Tru rust t Sit itus us

• NJSAs can be used to change trust situs to a more favorable

jurisdiction.

• UTC §111 specifically lists the transfer of a trust’s principal place of

administration as a matter that can be resolved by a NJSA.

• If not prohibited by the trust instrument, in some jurisdictions,

changing situs for administrative law purposes can be accomplished by merely changing the trustee. This depends on state law.

• For example, Delaware law will govern for administrative law

purposes if a Delaware Trustee is appointed.

• In the Peierls decisions, the court concluded that Delaware law will

generally govern the administration of any trust that permits a successor trustee to be appointed unconstrained by geography. Thus, if a Delaware trustee is appointed, the trust is then administered in Delaware. In the Matter of Peierls Family Inter Vivos Trusts, No. 16812 (Del. Oct. 4. 2013).

• If the state permits NJSAs then you can move the trust by agreement.

If not, the trust may be moved by petitioning the court to allow the trust to move to the new situs. Be careful to follow the rules in severing situs. For state tax purposes, the original tax state may still have taxing authority over the trust.

73

Usin ing a NJS JSA to to Reloc locate a Tru rust t Sit itus us

• 23 UTC states and the District of Columbia have

statutes permitting the use of the NJSA for changing the situs of a trust.

• 11 non-UTC states have statutes permitting the

nonjudicial transfer of the situs of a trust.

• 16 states have no statute permitting the nonjudicial

transfer of the situs of a trust.

74

Potential Tax Is Issues Resultin ing fro from Changin ing Sit itus

Beware re of f State tate Fid iduc uciary Income Tax Issu ssues: s:

• Delaware does not impose state income taxes on an irrevocable

trust’s accumulated earnings and capital gains if there are no beneficiaries living in the state.

• Some states do not tax income or capital gains.
• However, the income tax treatment of trusts varies significantly

from state to state.

• Relevant Factors Depending on the State:

– If the trust is administered in the state. – If one or more trustees live or do business in the state. – If the trust was created by the Will of a testator who lived in the state at death. – If the trustor of an inter vivos trust lived in the state when the placed assets in the trust or when the trust became irrevocable. – If one or more noncontingent beneficiaries live in the state.

75

V. . Obta tain ining Court rt Approval of f NJS JSAs

• Interested persons may request the court to approve the

NJSA to determine if representation was adequate and to determine whether the agreement contains terms and conditions the court could have approved.

• This highlights the necessity of having consent from all

ll interested persons because essentially an interested person can turn a NJSA into a judicial settlement.

• However, court inquiry is limited to determining whether

the beneficiaries were adequately represented and whether the terms of the NJSA are terms that the court could

• therwise approve.
• Parties seeking court review beyond the limited review of

the NJSA as described above would need file for review under another code provision and not under UTC §111.

76

Sta tatu tute te of f Lim imit itations

• Beneficiary must bring a cause of action for breach of trust

within the appropriate statute of limitations period.

• States vary on statute of limitations for breach of trust
• actions. However, the statute begins to run from the date

the beneficiary or representative sent the beneficiary the statement or report that adequately disclosed the alleged breach of trust.

• Some states allow for a shorter statute of limitations for

breach of trust based on the inclusion of certain notice language on the statements provided that the disclosure was adequate. (California and Florida)

• Adequate disclosure = sufficient information to identify the

potential claim or to alert the beneficiary to inquire into its existence.

77

Tru rustee Lia iabil ilit ity

• If beneficiary consents to conduct constituting a breach of

trust, trustee is not liable to a beneficiary unless: – Induced by improper conduct of trustee – Beneficiary lacked knowledge of beneficiary’s rights or material facts relating to the breach

• Reliance on trust instrument – Trustee who acts in

reasonable reliance on the terms of the trust is not liable for a breach of trust to the extent the breach resulted from the reliance.

• Reliance may not be justified when:

– Trustee is aware that the terms of the trust have been clarified or changed by a NJSA, court order, or otherwise – Trust is ambiguous and trustee relies on one of several meanings

78

VI.

• I. Str

truc ucturin ing th the NJS JSA Wra rapper

• The NJSA wrapper carves out a certain role while releasing the

current trustee from liability for that role.

• NJSA wrapper is an alternative to decanting or merger to create

a directed trust.

• Examples – an NJSA wrapper may be used to:

– Appoint “investment trustee,” “distribution trustee” or other “special purpose trustee” with certain exclusive powers; – Create administrative nexus to a particular state (appoint “administrative trustee”); – Hold a concentrated position in a single asset; – Hold a portion of a limited liability company; – To open and fund a discretionary management account with a different investment manager; or – To overcome traditional common law rules against self- dealing.

79

Str truc uctu turing th the NJS JSA Wra rapper

• Benefits:

– May eliminate tax concerns about creating/modifying a trust – Less expensive – Faster – More predictable than a judicial modification

• The NJSA wrapper is preferred to other techniques because

no new trust is created in the process and no new tax identification number is obtained.

• A properly drafted NJSA should carve out the role or activity

and relieve the trustee of any liability for the covered act.

• Where functions are delegated to another manager, agent or

fiduciary, the NJSA should make clear that the trustee is not delegating the trustee’s duties but instead the trustee is restricted with respect to taking the actions covered in the NJSA.

80

Str truc uctu turing th the NJS JSA Wra rapper

• If desirable, the NJSA could contain provisions

restricting the trustee’s power to provide information to the trust’s beneficiaries. For example, Delaware permits quiet trusts.

• A NJSA does not require consideration to be effective.

One point of concern is whether any release of the trustee for the acts covered by the NJSA is effective without consideration. Delaware has specifically addressed this issue and provides that a release is enforceable with or without consideration. See 12 Del. Code §3588.

81

Str truc uctu turing th the NJS JSA Wra rapper

• Thus, it is important to evaluate the trustee’s potential

liability exposure. In UTC jurisdictions, the trust instrument cannot exculpate the trustee for bad faith or reckless indifference.

• Delaware permits exculpation of a trustee except for

willful misconduct.

• Concern: Absent the willful misconduct standard, a

trustee may still have a duty to monitor the NJSA covered activity to avoid liability.

82

Sam ample NJS JSA Pro rovis ision fo for r Tru rusts Cre reated in in Non-UTC Stat ates es

Samp Sample le Provis isio ion Nonjudicial icial Se Sett ttle lement t Ag Agree eements

“Except as otherwise provided in subsection , the persons whose consent would be required in order to achieve a binding settlement were the settlement to be approved by a court of competent jurisdiction, may enter into a binding nonjudicial settlement agreement with respect to any matter involving any trust created hereunder, so long as such agreement does not violate a material purpose of the trust, includes terms and conditions that could be properly approved by a court of competent jurisdiction under applicable law, or that could have been directed by an individual vested with authority to amend the trust, and so long as the agreement does not result in conferring on any beneficiary or other person a general power of appointment that would cause inclusion of trust property in such person’s state, where no such general power of appointment would have existed without such agreement. Matters that may be resolved by a nonjudicial settlement agreement include, without limitation: (1) the interpretation

• r construction of the terms of the trust; (2) the approval of a trustee’s report or accounting;

(3) direction to a trustee to refrain from performing a particular act or the grant to a trustee of any necessary or desirable power; (4) the resignation or appointment of a trustee and the determination of a trustee’s compensation; (5) transfer of a trust’s situs or principal place of administration; and (6) the liability of a trustee for an action relating to the trust. Any interested person may request a court of competent jurisdiction to approve a nonjudicial settlement agreement, to determine whether the representation as provided in [Article __] was adequate under the terms thereof, and to determine whether the agreement contains terms and conditions the court could have properly approved. The settlor’s intent is that the court approve any such agreement, irrespective of the court’s opinion of the wisdom of such an agreement, unless the court concludes that the agreement could not, under any circumstances, have been approved by the court in settlement of a judicial dispute.”

84

VII.

• II. Alte

lternativ ive to to NJS JSA - Nonjudicia ial Consent Modif ific ications

• Nonjudicial Consent Modification.

– Governed by UTC §411(a) – Modification or termination while settlor is alive – All ll beneficiaries and the settlor must t consent – Settlor consent may be given by an authorized agent – Virtual representation is available – Generally, trustee consent is not required – Basically, this section of the UTC allows a trust to be modified or terminated over a trustee’s objection – however, under UTC §410(b) the trustee would have standing to object – Beneficiaries also have standing to object under UTC §410(b)

85

Alte lternati tive to to NJS JSA - Nonjudicia ial Consent t Modif ific ications

• Nonjudicial Consent Modification.

– Broad scope – The consent modification is broader than the NJSA.

• Here, the modification or termination can be

completed even if it is inconsistent with a material purpose of the trust; theory is that the settlor is consenting.

• For these purposes, a spendthrift provision is

explicitly not considered a material purpose. – Distribution if consent to terminate – If the trust is terminated by a nonjudicial consent modification, the trustee distributes the property as agreed upon by the beneficiaries. – Lack of beneficiary consent – If not all beneficiaries consent, you will likely have to go to court.

86

Alte lternati tive to to NJS JSA - Non

• njud

udicia ial Con

• nsent

t Mod

• dif

ific ications

• Nonj

njudicial l Conse nsent Modifi dification. – Modification or termination after settlor’s death:

• Still possible even if not all beneficiaries consent
• Must not be inconsistent with a material purpose
• f the trust
• Beneficiaries who are not consenting have their

interests adequately protected

87

Alt lternative to NJS JSA - Non

• njud

udicia ial Con

• nsent

t Mod

• dif

ific ications

• Nonj

njudicial l Conse nsent Modifi dification. – Court approval – The modification or termination may be approved by the court if the court is satisfied that:

• If all of the beneficiaries had consented, the trust

could have been modified or terminated under UTC §411(a); and

• The interests of a beneficiary who does not

consent will be adequately protected.

88

Alte lternati tive to to NJS JSA - Nonjudicia ial Consent Modif ific ications

• Nonj

njudicial l Conse nsent Modifi dification. – Gift Tax Consequences.

• Generally, there is no gift by settlor or

beneficiary.

• The fact that the settlor is joining the

beneficiaries in the termination or modification does not cause this to be a gift by the settlor. Treas Reg §20.2038-1(a)(2).

• If this is a termination, as long as the

beneficiaries agree to distribute the trust property in accordance with their proportionate interests, there is no gift by a beneficiary either.

89

Alte lternati tive to to NJS JSA - Nonjudicia ial Consent t Modif ific ications

• Non
• njudicial Con
• nsent Mod
• dificati

tion. – Estate Tax Inclusion.

• There should not be estate tax inclusion.
• Some practitioners were concerned this would cause

inclusion under 2036 or 2038 (i.e., has the settlor retained the power to modify trust in conjunction with others ).

• In response, the UTC was revised to require that the settlor

cannot represent any beneficiaries.

• Some states have specifically provided that the settlor has a

mere “veto power” – thus the settlor’s power is more passive and should not cause inclusion.

• PLR 201233008 – settlor’s consent to a trust modification

pursuant to state statute did not cause the trust assets to be included in the settlor’s gross estate under IRC §§2036 or 2038.

90

VIII

• III. Oth

ther Alte lternatives to to NJS JSA

• Equ

quitable Devia iation. – Governed by UTC §412 – Modification is based on a change in circumstances to facilitate settlor’s probable intent

• Wasteful or impractical for the trust to continue
• Modification is consistent with the material purpose

if the trust – Beneficiary consent is not required

• Modification or

r Term rmination of f Uneconomic Tru rust. t. – Governed by UTC §414 – Trust can terminate if the trust falls below a value that makes administering the trust uneconomical – Distribution upon trust termination must be consistent with the purpose of the trust

91

IX IX. . Federa ral Tax Consequences of f Tru rust Modifi fication

• Commissioner v. Estate of Bosch, 387 U.S. 456

(1967) – IRS may not be bound by a state court decision unless the matter has been decided by the highest state court.

• Completed Transaction Rule – Reformation or

modification of a trust may not be effective to change the tax consequences as written under the trust instrument even if the reformation or modification is permitted by state law.

• State court decisions before the taxable event has
• ccurred are binding on the IRS even if such

decision is inconsistent with state law. Rev. Rul. 73- 142.

92

Federal Tax Concerns

• Consent may result in gift in certain circumstances.
• Self dealing concerns with changes to a charitable trust.
• Implication of a construction decree.
• Consistent with state law = respected by the IRS as if

terms had been in the original trust instrument.

• Consent or lack thereof is not an issue in this instance.
• Marital deduction cases – Court cases have construed

in favor of allowing a marital deduction even where trust instrument did not contain the appropriate

• language. Mittleman v. Comm’r, 522 F.2d 132 (D.C.
• Cir. 1975); Estate of Sawyer v. Comm’r, 73 T.C. 1

(1979) In Sawyer, the Tax Court held that “a testator’s normal interest would be to maximize deductions and minimize tax liability...”

93

Federal Tax Concerns

• Possible loss of GST exempt status if there is a

change to a beneficial interest but otherwise GST status is retained.

• Pursuant to Treas. Reg. §26.2601-1(b)(4)(i)(C), GST

exempt status of a trust should not be impacted by a judicial construction proceeding to correct a scrivener’s error or to clarify an ambiguity in the trust instrument provided that two factors are met:

• Court proceeding involved a bona fide issue and
• Construction is consistent with state law.

94

Inc Income Tax Is Issue ues

• Cottage Savings Association v. Commissioner, 499 U.S.

554 (1991)

• Test: Exchange of interests results in a disposition under

IRC § 1001 only if the interests exchanged are “materially different in kind or extent.”

• Compare the legal entitlements before and after the

modification.

• This test has been applied by the IRS in numerous PLRs

when analyzing whether a trust modification will be a taxable disposition by beneficiaries for income tax purposes.

95

Gift ift Tax Is Issues

• Gift will be deemed to be made to the extent the modification shifts

value from one beneficiary to the other.

• If a bona fide dispute/litigation exists, then a settlement resulting

from the dispute should be treated as a transfer for full and adequate consideration and, thus, not a gift for gift tax purposes.

• Intrafamily settlements will not be regarded as a bona fide

compromise unless the claims were legitimate and are satisfied, to the extent feasible, on an economically fair basis. Ahmanson Foundation v. U.S., 674 F.2d 761 (9th Cir. 1981)

• If a beneficiary consents to a shifting of his or her beneficial

interest to another person resulting in the possibility of a decease in that beneficiary’s interest, then the beneficiary may be viewed as making a gift. If there is no collusion and the agreement is in settlement of bona fide litigation or dispute, then the modification will likely not be viewed as a gift. See Comm’r v. Vease, 314 F.2d 79 (9th Cir. 1963) and Grossman v. Campbell, 368 F.2d 206 (5th

• Cir. 1966).

96

GST Tax Is Issues

• Preserve GST upon Modification – Treas. Reg. § 26.2601-

1(b)(4)(i)(D)

• Modification may not:

– Shift a beneficial interest in the trust to a lower generation than those who held interests prior to the modification.

• Shift occurs if there is either an increase in the

amount of a GST transfer or the creation of a new GST transfer

• A modification to administrative provisions that

indirectly increases a GST transfer will not be treated as a shift of a beneficial interest to a lower generation – Extend the time for vesting of any beneficial interest beyond the period provided for in the original trust

97

Bin indin ing Authorit ity fo for r Tax Purp rposes

• In the absence of an authoritative decision by the highest

state court, the IRS is not bound by the agreement.

• Court’s decision is generally respected by government
• authority. IRS may require a State Supreme Court

decision to be bound (Bosch case).

• Consider a Private Letter Ruling.

98

Care reful Tax Pla lanning is is Requir ired When Decantin ing

99

IRS’ Position on Decanting

• In Rev. Proc. 2011-3 the IRS placed decanting on its

no-ruling list.

• Section 5 of the Rev. Proc. provides a specific list of

matters that it will not rule on such as:

• Decanting giving rise to a IRC §661 deduction or

inclusion in gross income under IRC §662.

• Decanting resulting in a taxable gift.
• Decanting causing the loss of GST exempt status or

a taxable event under IRC §2612.

• Decanting was put on the IRS’ priority guidance plan

but was later omitted from the 2013-2014 plan.

• Current status: IRS is still working on these issues.

100

In Income Tax Is Issues - Decantin ing

• In general, decanting assets from one trust to

another should not result in income tax consequences to the trust or its beneficiaries.

• Key income tax issues:

– Decanting power and IRC §671 treatment – Decanting from one trust to another and DNI – Decanting and gain recognition under IRC §1001

101

Decanti ting Power and IRC §671 Treatment

Gran antor trust status IRC §674(a).

• Power to add beneficiaries.
• Is new trust a new beneficiary?
• Beneficiary = Any one or more of the old trust

beneficiaries and not the trust itself.

• Delaware statute (like others) requires that the

beneficiaries of the new trust are also beneficiaries of the old trust.

• Delaware does permit the adding of a power of

appointment to the new trust.

102

Decanti ting Power and IRC §671 Treatment

• Who is

is th the e gran rantor?

• If the new trust is a continuation of the old trust,

the original grantor remains the grantor of the new trust.

• Exception for the exercise of a power of

appointment.

• Oth

ther gran rantor tru trust issu issues.

• Transfer from one grantor trust to another grantor

trust should have no income tax effect. Rev. Rul. 85-13, 1985-1 C.B. 184.; Rev. Rul. 2007-13, 2007-11 I.R.B. 684.

• Non-grantor trust to a grantor trust should have

no income tax effect. Rev. Rul. 85-13 and 2007- 13; Chief Counsel Advice 200923024.

103

Decantin ing fro from One Tru rust to to Another and DNI

• Uncertainty over old EIN number for new trust. PLR

200607015; PLR 200736002.

• Interplay between IRC §§661 and 662.
• Trust can be a beneficiary under these sections.

Lynchburg Trust and Savings Bank v. Comm’r., 68 E.2d 356 (4th Cir. 1934); Duke v. Comm’r., 38 BTA 1265 (1938).

• Tax attributes of new trust should be the same.
• The new trust’s distributable net income (DNI) should

be shifted to the new trust, including capital gain.

• Treas. Reg. §1.643(a)-3(e).
• Unused carryovers and deductions carry over to the

new trust. IRC §642(h)(2).

104

Decanti ting and Gain in Recogniti tion Under §IRC 1001 1001

• Decanting should not result in recognition of gain or

loss in most circumstances.

• Under IRC §1001, gain is recognized when an asset is

sold or disposed of in exchange for property that is materially different. Treas. Reg. §1.1001-1(a); Cottage Savings Ass’n v. Comm’r., 499 U.S. 554 (1991).

• Trustee authority to decant = no material change.
• Decanting of all old trust assets to the new trust is a

modification and not the creation of a new entity for income tax purposes. PLR 200723014; PLR 200607015.

• Watch out for negative basis assets! See, Crane v.

Comm’r., 331 U.S. 1 (1947).

105

Decantin ing fro from Domestic ic Tru rust to to Foreign Tru rust and Vic ice Vers rsa

• Transfer of domestic trust assets to a foreign trust is a

recognition event. IRC §684.

• However, the domestic trust is entitled to a deduction

for any income generated in decanting all of its assets to a foreign trust. IRC §661(a).

• Gain is recognized once the grantor trust status of the

foreign trust terminates. Treas. Reg. §1.684-2(e).

• Decanting foreign trust assets to domestic trust.
• Foreign trust’s undistributed net income and

throwback rules under Subchapter J.

• Reporting obligation. IRC §6048.
• IRS may assert the domestic trust is a new trust if

there are substantial modifications.

106

Gift ift Tax Is Issues - Decanti ting

• Impact of beneficiary consent or acquiescence.
• Diminished beneficial interests. Gift implications and

application of IRC §§2036, 2038.

• Existence of decanting power in a marital trust (estate
• r gift) and effect on marital deduction.

107

Gift ift Tax Consequences - Decantin ing

• Transfer during lifetime for less than adequate

consideration.

• You need an act of transfer = gift.
• Trustee is causing the transfer not the beneficiary.
• Beneficiary consent or acquiesce.
• Beneficiary (acting as trustee) decanting ramifications.
• Use an independent trustee or confer a power of

appointment on the trustee/beneficiary to name new beneficiaries or change the interests under the new trust may avoid this result.

• Gift tax only applies to a transfer of a beneficial

interest in property. Treas. Reg. §25.2511-1(g)(1).

108

Dela laware Tax Tra rap

• The exercise, release or lapse of a power of

appointment is deemed a transfer of property by the powerholder.

• If a beneficiary exercises a power of appointment to

create a new trust and the termination date of the new trust can extend beyond the original trusts’ perpetuities period, then the exercise of that power by the beneficiary during his or her lifetime may result in inclusion in the estate of the powerholder. IRC §§2514(d) and 2041(a)(3).

• This

is is is no not t an an issu issue if if th the e ind indep epende dent tru trustee ex exer ercises th the e power er.

109

Esta tate Tax Consequences - Decanti ting

Decanting should not result in estate inclusion for federal estate tax purposes unless:

• Decanting results in the beneficiary making a gift.
• Beneficiary’s exercise of a power of appointment was

treated as an incomplete gift. When the beneficiary dies the gift is then complete and inclusion results. IRC §§2036

• r 2038.
• Grantor’s or beneficiary’s implied control over the trust

assets.

• Beneficiary’s power to remove and replace the trustee

does not result in estate inclusion unless they could appoint himself or herself or someone who is related or subordinate to the beneficiary.

• Beware: Moving a trust from a self settled trust state to a

non-self settled trust state. This could cause inclusion.

110

GST Tax Con

• nsequences - Decantin

ing

• Special consideration must be given to decanting

grandfathered GST trusts.

• Irrevocable trusts established on or before

September 25, 1985 are exempt from GST and are thus called “grandfathered GST trusts”.

• The Treasury Regulations distinguish between

powers of appointment and decanting.

111

GST Tax Consequences - Decantin ing

• Actual or constructive additions to the GST

grandfathered trust through the beneficiary’s release, exercise or lapse of a power of appointment can result in the appointed property being subject to GST tax.

• Numerous private letter rulings hold that if a

modification does not result in any change in the quality, value, or timing of any beneficial interest under the trust, a grandfathered GST trust will no not lose its exempt status.

• Purely administrative changes to the trust should

not result in loss of status.

112

GST Tax Consequences - Decantin ing

• The regulations focus on whether the exercise of a

power of appointment will delay the vesting of a grandfathered trust.

• Treas. Reg. §26.2601-1(b)(1)(v)(B) provides that if

the exercise of a power of appointment extends the vesting beyond the original perpetuities period, then the exercise of the power is treated as an addition to the trust which results in the loss of GST exempt status.

• This only applies to the exercise and not to a release
• r lapse of the power. Treas. Reg. §26.2601-

1(b)(1)(v)(B)(1).

• The Treasury Regulations provide two safe harbors

for decanting. Treas. Reg. §26.2601-1(b)(4)(i).

113

GST Tax Con

• nsequences – Decantin

ing Firs irst t Safe fe Harb rbor

– Treas. Reg. §26.2601-1(b)(4)(i)(A) provides that decanting a GST – grandfathered trust will not result in loss of GST exempt status if: (1) the terms of the trust agreement or local law at the time the trust became irrevocable authorized the trustee to make distributions to a new trust, wit ithout the consent

• r approval of a beneficiary or court, and

(2) the terms of the new trust do not extend the vesting

• f any beneficial interest in a way that would suspend or

delay the vesting, absolute ownership, or power of alienation beyond the longer of (i) the life of a person in being at the date the original trust became irrevocable plus a period of 21 years, or (ii) a ninety year period beginning on the date of the creating of the original trust.

114

GST Tax Con

• nsequences – Decantin

ing Second nd Safe fe Harb rbor

– For those grandfathered trusts not meeting the requirements of the first – safe harbor, the second safe harbor in Treas. Reg. §26.2601- – 1(b)(4)(i)(D) provides that a trust modification will not result in the – loss of GST exempt status if the modification: (1) is valid under state law, (2) does not shift a beneficial interest to a beneficiary who

• ccupies a generation lower than the beneficiary who held

the interest prior to the modification, and nd (3) does not extend the vesting period of the beneficial interest beyond the perpetuities period of the original trust.

115

State and Local Taxes

• When moving trusts from one jurisdiction to another, or

when changing applicable state law, certain state and local taxes may be avoided, decreased, or increased depending upon the facts of the situation.

• State income tax issues.
• Linn v. Department of Revenue, 2013 IL. App. (4th)
• 121055. This case supports changing residency of trust

for state income tax purposes.

• State statute supported position that trust should be

taxed.

• Minimum ties for constitutional due process – Illinois

failed this prong of the test.

• Be alert: More than one state may try to tax the trust.
• Property tax reassessment.

116

X. . Oth ther Pit itfa falls

• Changing the trust may trigger a no-contest clause
• Modification may be costly
• Some jurisdictions will not allow trusts to move if

there is a resident trustee or trust property located in that state

• Privacy issues (Delaware, Alaska and South Dakota
• ffer some privacy)

117

• XI. Trustee’s Fiduciary Duties When Decanting
• When decanting, the trustee must exercise its’

fiduciary duties to the beneficiaries.

• Duty of Impartiality
• Duty of Loyalty
• Acting upon the beneficiaries’ request alone may

result in an abuse of the trustee’s discretion in some circumstances.

• Exercise of discretion will be upheld, even if

unreasonable, if the trustee’s actions were not arbitrary or capricious.

118

XII.

• II. Fin

inal Accountin ing, Pre reventi ting Dis isput utes and nd Fin inal Tax Return rn

• Waiver of accounting
• Interested parties should have representation
• Receipts and releases
• Court approval to settle accounts
• Final income tax return needs to be filed when
• riginal trust terminates

119

To ensure re compl pliance wit ith re requ quire irements im impo posed by U.S. .S. Tre reasury Regulations, Bessemer Tru rust t info informs you tha that any U.S. .S. ta tax advic ice contained in in this this communication (in (including any atta ttachments) was not t inte intended or r wri ritten to to be used, , and cannot be used, , fo for r the the pu purpo rpose of f (i) (i) avoid iding pe penalties under the the In Inte ternal Revenue Code or r (ii (ii) pro romoting, mark rketing or r re recommending to to another party rty any tran transaction or r matt tter r addressed he here rein.