Trust Decanting: Flexibility and Danger Achieving Tax Benefits, - - PowerPoint PPT Presentation

The audio portion of the conference may be accessed via the telephone or by using your computer's

• speakers. Please refer to the instructions emailed to registrants for additional information. If you

have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no longer permitted.

Trust Decanting: Flexibility and Danger

Achieving Tax Benefits, Revising Fiduciary Powers, and Mitigating Trustee Liability

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific TUESDAY, MAY 10, 2016

Presenting a live 90-minute webinar with interactive Q&A Meryl G. Finkelstein, Partner, Brick & Patel, New York Todd A. Flubacher , Partner, Morris Nichols Arsht & Tunnell, Wilmington, Del.

Tips for Optimal Quality

Sound Quality If you are listening via your computer speakers, please note that the quality

• f your sound will vary depending on the speed and quality of your internet connection.

If the sound quality is not satisfactory, you may listen via the phone: dial

1-866-961-9091 and enter your PIN when prompted. Otherwise, please

send us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. NOTE: If you are seeking CPE credit, you must listen via your computer — phone listening is no longer permitted. Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

FOR LIVE EVENT ONLY

Continuing Education Credits

In order for us to process your continuing education credit, you must confirm your participation in this webinar by completing and submitting the Attendance Affirmation/Evaluation after the webinar. A link to the Attendance Affirmation/Evaluation will be in the thank you email that you will receive immediately following the program. For CPE credits, attendees must participate until the end of the Q&A session and respond to five prompts during the program plus a single verification code. In addition, you must confirm your participation by completing and submitting an Attendance Affirmation/Evaluation after the webinar and include the final verification code on the Affirmation of Attendance portion of the form. For additional information about continuing education, call us at 1-800-926-7926 ext. 35.

FOR LIVE EVENT ONLY

Program Materials

If you have not printed the conference materials for this program, please complete the following steps:

• Click on the ^ symbol next to “Conference Materials” in the middle of the left-

hand column on your screen.

• Click on the tab labeled “Handouts” that appears, and there you will see a

PDF of the slides for today's program.

• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.

FOR LIVE EVENT ONLY

TRUST DECANTING: Fiduciary Powers and Trustee Liability

Meryl G. Finkelstein Partner Brick & Patel LLP mfinkelstein@brickpatel.com May 10, 2016

INTRODUCTION

A decanting statute permits a trustee who has the discretion or authority to invade the principal of a trust (and in some cases trust income) for the benefit of one or more trust beneficiaries to exercise that authority by transferring some or all of the assets of the trust in further trust. The rationale underlying a trust decanting is that a trustee who has the discretion to make an outright distribution of trust property to or for the benefit of one or more current beneficiaries of the trust has a special power of appointment over the trust property that allows the trustee to distribute the property to another trust for the benefit of

• ne or more beneficiaries of the trust.

6

INTRODUCTION (Cont’d)

Twenty-three states have enacted specific decanting legislation. As a general rule, a state decanting statute should apply to a trust unless the terms of the instrument creating the trust specifically state to the contrary. Only three statutes (Indiana, Minnesota and New Hampshire) actually use the word “decanting” in their titles. Most refer to the trustee’s invasion or distribution power or the trustee’s power to appoint to another trust.

7

CURRENT STATUTES

States with Existing Decanting Statutes:

– New York (1992, amended August 2011 and subsequently) – Alaska (1998, reenacted 9/19/13) – Delaware (2003) (as amended)) – Tennessee (2004) (as amended) – Florida (2007) – South Dakota (2007) (as amended) – New Hampshire (2008) – Nevada (2009) (as amended) – Arizona (2009) (as amended) – North Carolina (2009) (as amended) – Indiana (2010) – Missouri (2011) – Ohio (2012) – Kentucky (2012) – Virginia (2012) – Illinois (2013) – Rhode Island (2012) (as amended) – Michigan (2012) – Texas (2013) – Wisconsin (2014) – Wyoming (2013) – South Carolina (2014) – Minnesota (2016)

8

DECANTING UNDER COMMON LAW

What if you practice in a state that does not have a decanting statute and the trust instrument does not contain a decanting provision? A decanting may be possible under common law. A common law basis for decanting is recognized under court decisions in Florida, New Jersey, Iowa and Massachusetts, and is also supported under both the Second and Third Restatements of Property. A. CASES 1.

Phipps v. Palm Beach Trust Co. (Florida Supreme Court) (1940): Phipps is the first American case recognizing the ability of a trustee authorized to make discretionary trust distributions to exercise that power to distribute trust assets to a second trust for the benefit of the beneficiaries of the first trust. – Facts – Wife (“W”) created a discretionary trust for her children and descendants and named Husband (“H”) and Trust Co. as trustees, giving H the absolute discretion to distribute trust assets among the beneficiaries. H distributed the assets of the first trust to a second trust for the benefit of the same persons. However, the second trust granted one of W’s children a testamentary power of appointment exercisable in favor of his wife, who was not a beneficiary under the first trust. – Issue – The corporate trustee brought a construction proceeding to determine whether H’s actions were within the scope of his powers as trustee. – Holding – The Florida Supreme Court upheld H’s actions. First, it determined that H’s distribution power was a special power of appointment, which included not only the ability to appoint the trust property outright to a beneficiary, but also to create a lesser interest, such as an interest in further

• trust. Second, the Court noted that the class of beneficiaries under the second trust was identical to

those under the first trust. – Commentary –Phipps is often cited as common law authority for a trustee’s ability to appoint trust property in further trust, However, H’s distribution power was more like a beneficiary power of appointment and less like the type of discretionary distribution power that a trustee normally has.

9

DECANTING UNDER COMMON LAW (Cont‘d)

A. CASES 2.

Wiedenmayer v. Johnson (N.J. Superior Court) (1969)

– Facts – Wiedenmayer involved a trust held for the benefit of an heir to the Johnson & Johnson family fortune. The trust gave the trustees absolute discretion to distribute trust principal to the beneficiary at any time they deemed it to be for his best interests. The trustees distributed the trust assets to another trust for the benefit of the

• beneficiary. The beneficiary had been married and divorced and the trustees

determined that the distribution in further trust was for the financial benefit of the beneficiary in that it would protect the trust assets from the claims of another spouse. – Issue – The guardian ad litem for the beneficiary’s minor children opposed the distribution to the second trust, claiming that it would defeat the children’s contingent remainder interest under the first trust. – Holding – The court held for the trustees, finding that the appointment in further trust was consistent with the settlor’s intent since it was in the best interest of the beneficiary to protect the trust assets from future creditor claims. It also reasoned that an outright distribution of trust assets to the beneficiary, which was within the scope of the trustees’ powers, would similarly defeat the interests of the trust’s remainder beneficiaries. – Note -- The trustees’ willingness to make distributions from the trust to the grantor’s son was expressly conditioned on the son agreeing to establish a second trust to receive those distributions.

10

DECANTING UNDER COMMON LAW (Cont‘d)

A. CASES 3.

In Re: Estate of Spencer (Iowa Supreme Court) (1975)

– Facts – Wife (“W”) created a testamentary trust for her children and gave Husband (“H”), who was a trustee, a testamentary power to grant life estates to the children, with the remainder to pass to W’s grandchildren. H exercised his power of appointment by creating a trust for his children, to last for the maximum period allowed by the Rule Against Perpetuities. – Issue – The court examined whether H had the right to appoint the trust property in further trust for his children, as opposed to granting them life estates. – Holding – The court determined that H’s appointment in further trust for the children during their lives was consistent with W’s intention that the trust assets remain within her family line and that they pass as a single unit. However, the court also determined that the assets could not be held in further trust beyond the lives of W’s children as it was clear that W intended that the assets pass outright to her grandchildren upon the death of her children. – Note – The power held by H was exercisable in his individual capacity, not in his capacity as a trustee of the trust. Thus, the court did not analyze the exercise of the power from a fiduciary standpoint.

11

DECANTING UNDER COMMON LAW (Cont‘d)

A. CASES 4.

Morse v. Kraft (Mass. Supreme Judicial Court ) (2013)

– Facts – Morse involved an inter vivos trust created for the benefit of the grantor’s sons and their issue. The trust consisted of four subtrusts, each of which gave the trustees full discretion to distribute trust income and principal “for the benefit of” the grantor’s sons. When the trust was created, the sons were all minors, and under the terms of the trust instrument, were ineligible to serve as trustees of the sub-trusts after attaining the age of

• majority. Morse, the independent trustee, brought an action for declaratory relief to clarify

that the terms of the trust authorized him to transfer all of the assets of the subtrusts to new subtrusts (created under a new master trust) for the benefit of the same beneficiaries without beneficiary consent or court approval. The new trust would have broader administrative powers that authorized the grantor’s sons to serve as co-trustees of their

• subtrusts. Since the trust did not specifically allow an appointment of trust assets in

further trust (and Massachusetts does not have a decanting statute), the ruling was necessary in order to avoid losing the GST grandfathered status of the trust. – Issue – Whether the distribution language of the trust, which authorized the trustee to distribute trust principal “for the benefit of” each child, authorized a distribution in further trust. – Holding – Relying primarily on Wiedenmayer and Phipps, the court held that the trustee could transfer the assets of the subtrusts to new subtrusts without beneficiary consent or court approval. In finding that the trustees held a decanting power, the court relied on the specific language of the trust instrument, which gave the trustees the power to distribute

12

DECANTING UNDER COMMON LAW (Cont‘d)

Holding (Cont’d) – trust principal “for the benefit of” the beneficiary. According to the court, the language used in the trust created a “broad grant of almost unlimited discretion” which the court found was “evidence of the settlor’s intent that the disinterested trustee have the authority to distribute assets in further trust for the beneficiaries’ benefit.” Note – The language in the trust instrument that the Morse court relied on is important because the court did not recognize an inherent power of the trustees of all discretionary trusts to exercise their distribution authority to distribute assets in further trust. The Boston Bar Association, in its amicus brief, had requested that the court recognize a decanting power in any discretionary trust where the trustee has the power to distribute trust assets “to” the

• beneficiary. The court declined to adopt this request and limited its finding of an inherent

decanting power only to trusts where the trustee has the power to distribute “for the benefit

• f” the beneficiaries.

13

DECANTING UNDER COMMON LAW (Cont‘d)

• B. RESTATEMENTS OF PROPERTY – Under the majority of decanting statutes, a

trustee’s exercise of the power to distribute trust property from a first trust to a second trust is expressly analogous to the exercise of a special power of appointment. Second Restatement of Property (“Second Restatement”)

• 1. Under the Second Restatement, a trustee’s discretionary power to distribute trust

assets gives the trustee the power to designate beneficial interests in the trust property and is considered a power of appointment as defined in the Second Restatement.

• 2. The power to appoint the trust property allows the trustee to vest interests in the

property in the appointees of the property and to divest the interests of the persons who would otherwise receive the property in default of the exercise of the power.

• 3. Under the Second Restatement, unless the donor has manifested a contrary

intention, the holder of a special power of appointment has the same rights to dispose of the property among the objects of the power that he would have had he

• wned the property directly – i.e., by making either an outright disposition of the

property or disposing of it in further trust.

• 4. Thus, unless a trust instrument specifically limits the trustee’s distribution power to

making outright distributions, the trustee’s distribution power includes the power to appoint the trust property in further trust for the beneficiaries.

14

DECANTING UNDER COMMON LAW (Cont‘d)

Third Restatement of Property (“Third Restatement”)

• 1. The Third Restatement takes a different approach by distinguishing between

beneficiary powers of appointment and fiduciary distributive powers.

• 2. Under the Third Restatement, fiduciary distributive powers include a trustee’s power

to distribute trust income and principal to one or more designated trust beneficiaries.

• 3. A fiduciary distributive power is not considered a discretionary power of appointment

under the Third Restatement because the exercise of the power is subject to the trustee’s fiduciary obligations.

• 4. The Third Restatement provides that subject to fiduciary standards and the terms of

the power as set forth in the trust instrument, a trustee can exercise a fiduciary distributive power such as a power of invasion to create another trust.

• 5. In addition, under the Third Restatement, a trustee exercising a distribution power in

further trust is expressly subject to the same rules that apply to the exercise of a beneficiary power of appointment, including the persons for whose benefit the power can be exercised, under the same rules that apply where a trust is created by a beneficiary’s exercise of a special power of appointment.

15

TRUST DECANTINGS -- THRESHOLD CONSIDERATIONS FOR THE TRUSTEE

• Is the proposed decanting consistent with the trustee’s fiduciary

duties, including the duties of loyalty and impartiality?

• Before decanting a trust, the trustee must thoroughly review the

governing instrument. All of the decanting statutes should apply unless the trust agreement provides to the contrary or the relevant statute (if being used) excludes the type of trust that is the subject

• f the proposed decanting.

– If the trust instrument prohibits the trustee from decanting the trust, the trustee cannot act absent court authorization. – If the trust instrument gives the trustee specific power to decant the trust, the trustee should confirm that the proposed decanting is consistent with what the trust instrument allows. – Alternatively, the decanting power under the trust instrument may make it clear that it is not intended to preempt the trustee’s power under state law, in which case the state decanting statute would also apply.

16

TRUST DECANTINGS -- THRESHOLD CONSIDERATIONS FOR THE TRUSTEE (Cont’d)

• If the trust instrument creating the first trust is silent, the trustee

must confirm whether he has the requisite power under the applicable state decanting statute.

• If the decanting will be effectuated under the applicable state

decanting statute, the trustee must confirm that the exercise of the decanting power complies with all statutory requirements and does not violate any limitations under the statute.

• In addition, issues may arise in determining which state’s law

applies to the first trust, particularly if the situs or governing law of the trust was changed prior to the proposed decanting.

17

STATUTORY DIFFERENCES

All of the state decanting statutes are intended to allow the trustee to appoint the assets of an existing trust to a second trust – but the operative provisions of the statutes can differ in a variety of ways, including:

• The level of discretion that the trustee must have with respect to

the power to invade the first trust (i.e., trusts where the trustee has absolute or unlimited discretion to make distributions versus trusts with distribution standards).

• Whether a decanting may be based solely on a power to invade

trust income.

• The persons for whose benefit the power to invade the first trust

may be exercised and the persons who are permissible beneficiaries under the second trust.

• Whether powers of appointment not granted under the first trust

may be granted to a beneficiary under the second trust.

18

STATUTORY DIFFERENCES (Cont’d)

• Limitations on the trustee’s exercise of the decanting power that

are intended to preserve tax benefits of the first trust such as marital and charitable deductions, gift tax annual exclusions, sub- S elections and allocations of GST exemption.

• Restrictions on the ability of a beneficiary-trustee to participate in

a decanting.

• The procedural aspects of the trustee’s exercise of the decanting

power, including:

– Method of exercise; – Notice to beneficiaries, contents of the notice, waivers of notice and waiver or acceleration of the notice period; – Beneficiary consent; and – Court approval and/or court filing requirements.

19

SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW

• Only Florida’s decanting statute requires that the trustee have the

absolute discretion or power to distribute trust principal in order to decant an existing trust.

• What constitutes absolute discretion or power under the Florida statute?

– Absolute discretion or power is one that is not limited to specific or ascertainable purposes such as HEMS. However, a power to invade for the best interests, welfare, comfort or happiness of a beneficiary does not constitute a standard.

• All of the other state decanting statutes permit a decanting where the

trustee’s distribution or invasion power under the existing trust is limited by a standard, but a distribution standard often limits the scope of the changes that the decanting can effectuate (i.e., changes in beneficial interests versus administrative changes).

20

SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW (Cont’d)

• If the trustee’s discretion under the first trust is limited by a

standard, the decanting statute must be reviewed to determine if the same standard must be included in the second trust.

– The Alaska, Illinois, Minnesota, Missouri, New York, North Carolina, South Carolina and Texas statutes all require that the same standard be included in the second trust and most also require that it be exercisable in favor of the same beneficiaries as provided under the first trust. – The Alaska, Minnesota and New York statutes also provide that if the term of the first trust is extended in the second trust, then during the entire extended term of the second trust, the second trust must retain the original standard set forth in the first trust, but the second trust may additionally provide for unlimited discretion once the initial term under the first trust has expired. – Where the trustee does not have unlimited discretion, the Alaska statute permits the original standard set forth in the first trust to be changed where the assets are appointed to a supplemental or special needs trust. – The Arizona and Kentucky statutes require that the same or a more restrictive standard be included in the second trust where the trustee exercising the distribution power is a possible beneficiary under the standard.

21

SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW (Cont’d)

– Under the Ohio statute, if the trustee’s discretionary distribution power is limited by a standard, the trustee’s exercise of its distribution power will only be valid if the second trust does not materially change the interests of the beneficiaries of the first trust (which means that a decanting can only be undertaken to make administrative changes to the first trust). But if the trustee’s power is unlimited, then beneficial interests under the first trust can be materially changed under the second trust. – Under the Michigan statute, unless the trustee has a “presently exercisable discretionary power” to make distributions under the first trust, the second trust cannot materially change the beneficial interests of the beneficiaries of the first trust (including persons who hold non-fiduciary powers of appointment). – Under the Virginia statute, where the first trust contains an ascertainable standard for distributions, the second trust must include the same standard unless a court approves a change in or elimination of the standard and the standard must be exercised in favor of the same current beneficiaries as set forth in the first trust.

22

SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW (Cont’d)

– Under the Wisconsin statute, where the first trust contains a specific or ascertainable standard, the second trust does not need to have the exact same standard, but it may not have a broader standard (but this provision does not apply where the second trust is for an individual with a disability). – Under the Delaware statute, the trustee’s exercise of the invasion power must comply with any standard that limits the trustee’s authority to make distributions from the first trust (example – if the first trust has a 5% annual distribution limit, then only 5% of the assets can be decanted annually).

23

SCOPE OF THE TRUSTEE’S INVASION POWER UNDER STATE LAW (Cont’d)

In a number of states, a decanting may be based on a trustee’s discretionary power to distribute trust income, not just principal.

• The Delaware, Kentucky, Michigan, Missouri, Nevada, North

Carolina, South Carolina, South Dakota, Virginia and Wyoming statutes all apply to a trustee’s power to distribute trust income or principal.

• The Arizona and New Hampshire statutes refer to the power to

make distributions, which includes both principal and income.

• Under the Texas and Wisconsin statutes, where the trustee has

the discretion to distribute principal of the first trust, that power may be exercised in favor of beneficiaries of the first trust who are eligible to receive income or principal from the first trust (and in Wisconsin also annuity or unitrust payments).

24

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST

One of most difficult issues arising with respect to trust decantings is determining the identity of the permissible beneficiaries of the second trust and to what extent the beneficiary provisions of the first trust may be varied in the second trust. Questions that typically arise in this context are:

• Can current beneficiaries of the first trust be eliminated in the second

trust:

– Under all of the statutes, the answer appears to be yes where the trustee has an unlimited distribution power or absolute discretion. – Note that in several states, including Alaska, Illinois, Minnesota, New York, North Carolina, Ohio and Virginia, if the trustee does not have absolute or unlimited discretion, then the interests of current beneficiaries of the first trust may not be eliminated in the second trust. – In Michigan, the trustee of the first trust must have a presently exercisable discretionary distribution power in order to eliminate current beneficiaries of the first trust. – Under the Texas and Wisconsin statutes, if the trustee does not have full discretion, then the current, successor and presumptive remainder beneficiaries of the second trust must be the same as the current, successor and presumptive remainder beneficiaries of the first trust.

25

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST (Cont’d)

• Can remainder beneficiaries of the first trust be eliminated in

the second trust:

– This is not explicitly addressed under most of the statutes, but many commentators take the position that if the interest of a current beneficiary can be eliminated under the statute, the interest of a future or remainder beneficiary also can be eliminated. – The Alaska, Illinois, Minnesota, New York, Ohio, Texas and Wisconsin statutes all specifically provide that remainder interests (and in some cases successor interests) can be eliminated only where the trustee of the first trust has absolute

• r unlimited discretion. If the trustee of the first trust does not have absolute or

unlimited discretion, then the interests of remainder beneficiaries of the first trust may not be eliminated in the second trust. – In Michigan, if the trustee of the first trust does not have a presently exercisable discretionary power to make distributions, interests of remainder beneficiaries

• f the first trust cannot be eliminated.

– In Delaware, the interests of remainder beneficiaries under the first cannot be eliminated in the second trust (regardless of the level of the trustee’s discretion to make distributions).

26

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST (Cont’d)

• Can the interests of remainder beneficiaries of the first trust

be accelerated to present interests in the second trust:

– The Missouri and South Dakota statutes specifically permit the acceleration of remainder interests. – Although most of the statutes are silent, if the power to invade the principal of the first trust must be exercised in favor of one or more current beneficiaries of first trust, it follows that the acceleration of remainder interests should not be permitted. – The Kentucky, North Carolina, South Carolina and Virginia statutes all specifically prohibit the acceleration of remainder interests. This is also implied under other statutes (such as Delaware).

27

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST (Cont’d)

• Can the second trust add as beneficiaries persons who are

not beneficiaries under the first trust.

– None of the statutes permit the addition of beneficiaries in the second trust and the majority specifically state that the beneficiaries of the second trust may include only persons who are beneficiaries of the first trust. – The New Hampshire statute specifically provides that the second trust may not include a beneficiary who is not a beneficiary of the first trust. – Matter of Johnson (2015 NY Slip Op 30018(U) (Surrogate’s Court, New York County, 1/13/15) In matter of Johnson, the New York County Surrogate’s Court

invalidated the July 25, 2011 decanting of 2 trusts created for the benefit of the beneficiary and directed the return of the decanted assets to the trustees of the invaded

• trust. The decanting was effectuated under EPTL §10-6.6 as it existed prior to the August

17, 2011 amendment of the statute. The appointed trust extended the term of the invaded trusts for the life of the beneficiary. However, the appointed trust also purported to change the ultimate remainder beneficiaries of the invaded trusts by adding persons who were not beneficiaries under the invaded trust. The Court noted that as a “universal rule” none of the 22 then-existing decanting statutes permit the appointed trust to include any beneficiaries who aren’t beneficiaries of the invaded trust.

28

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST (Cont’d)

Some statutes allow the second trust to grant a power of appointment not provided for under the first trust, effectively allowing the “back- door” addition of beneficiaries through the exercise of the power of appointment.

– The Alaska, Delaware, Illinois, Kentucky, Michigan, Minnesota, Nevada, New York, North Carolina, Ohio, South Carolina, South Dakota, Tennessee, Texas, Virginia and Wisconsin statutes all permit the second trust to grant a power of appointment (usually including a general power of appointment) not provided for in the first trust to a beneficiary of the second trust. Under these statutes, the potential appointees under the power of appointment do not have to be beneficiaries of either the first trust or the second trust, thus providing a method for adding beneficiaries.

Under some statutes limitations apply:

– Under the Illinois, Minnesota, Ohio, Texas and Wisconsin statutes, the trustee must have absolute discretion to distribute trust principal in order to add a power

• f appointment under the second trust.

– The Alaska, Illinois, Minnesota and Texas statutes also require that the beneficiary who is given the power of appointment be a beneficiary who could have received an outright distribution of property of the first trust.

29

PERMISSIBLE BENEFICIARIES OF THE SECOND TRUST (Cont’d)

– New York allows a current beneficiary under the first trust to be granted a power of appointment in the second trust that is not in the first trust where the trustee has absolute discretion and the beneficiary could have received the entire principal of the first trust outright. – Under the New York statute, however, the potential donees of the power must be unlimited (i.e., the power must be exercisable in favor of anyone in the world except where the beneficiary, the grantor or grantor’s spouse would have a general power of appointment). – Under the Michigan statute, the trustee must have a presently exercisable discretionary power to make distributions in order to grant a general or special power of appointment to a beneficiary of the first trust under the second trust. – The Alaska, Minnesota, New York and Texas statutes specifically provide that where the trustee’s discretion is not absolute or unlimited and the first trust grants a power of appointment to a beneficiary, the second trust must also grant this power of appointment and the class of permissible appointees must be the same as in the first trust. This is implied under the Michigan statute where the first trust includes a discretionary trust provision.

30

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER

The decanting statutes generally preserve certain provisions contained in the first trust, particularly as they relate to maintaining the tax benefits of the first trust and/or protecting certain fixed or mandatory interests of the beneficiaries of the first trust such as income interests and rights of withdrawal.

• All of the state decanting statutes prohibit the reduction (or

elimination) of fixed or mandatory income interests under the first trust, but in some cases the scope of the prohibition is limited:

– In Delaware and South Dakota, this restriction applies only where the first trust is a marital trust. – In Michigan, where the trustee of the first trust has a presently exercisable discretionary power to make distributions, this restriction applies in the case of trusts that were intended to qualify for a marital or charitable deduction, regardless of whether any such deduction was actually taken. – In Alaska, Illinois, Minnesota, Nevada, New Hampshire, New York, Ohio and Texas, only current income interests, not future income interests, are specifically protected. This is implied under the Missouri statute.

31

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER (Cont’d) – The Kentucky statute protects both current and future fixed income interests.

– The Alaska, Arizona, Florida, Indiana, Illinois, Michigan, Minnesota, Nevada, Kentucky, New Hampshire, New York, North Carolina, Ohio, Rhode Island, South Carolina, Texas, Virginia and Wisconsin statutes also prohibit the reduction or elimination of annuity and/or unitrust interests, but note: – In Delaware, this limitation applies only if the first trust is a marital trust. – In Michigan, this limitation apples to marital and charitable trusts where the trustee of the first trust has a presently exercisable discretionary power. – In Missouri, income and unitrust/annuity interests cannot be reduced in marital trusts, CRTs, GRATs and trusts holding sub-S stock. – In South Dakota this limitation applies to CRTs and GRATs. – In Alaska, these interests can be reduced, limited or modified if the second trust is a supplemental or special needs trust.

• Many statutes contain provisions preserving specific tax benefits of the first trust:

– Marital and charitable deductions are specifically protected under the Alaska, Florida, Indiana, Illinois, Kentucky, Minnesota, Nevada, New Hampshire, New York, North Carolina, Ohio, Rhode Island, Tennessee, Texas, Virginia and Wisconsin statutes. In most

• f these states, the second trust cannot include any provision which, if included in the first

trust, would have prevented it from qualifying for such deduction. Under the Ohio statutes, the second trust also cannot omit any such provision.

32

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER (Cont’d) – Contributions qualifying for the gift tax annual exclusion are specifically protected under

the Alaska, Illinois, Nevada, New Hampshire, Tennessee, New York, Texas and Wisconsin statutes. – Under the Delaware, Illinois, Kentucky, Michigan (where the trustee of the first trust has a presently exercisable discretionary power), Missouri, Nevada, North Carolina, Ohio, South Carolina, South Dakota, Virginia and Wisconsin statutes, if contributions qualified for the gift tax annual exclusion under IRC 2503(b) based on the first trust’s qualification as a 2503(c) trust, the second trust cannot extend the age for vesting and distribution of the beneficiary’s interest beyond the age set forth in the first trust. – Under the Arizona and South Carolina statutes, the proposed decanting cannot adversely affect the tax treatment of the first trust, the trustee, the settlor or the beneficiaries. The Alaska, Illinois, New York and Texas statutes similarly prohibit a decanting where it would jeopardize any tax benefit of the first trust. – The Alaska, Illinois, Kentucky, Ohio, Tennessee and Texas statutes also specifically protect trusts for which sub-S elections have been made. – Under the Minnesota statute, the qualification of a transfer as a direct skip transfer cannot be jeopardized. – Under the New York, Illinois, Michigan and Texas statutes, grantor trust status is not a tax benefit and a decanting can be undertaken to change a trust from a grantor trust to a non-grantor trust and vice versa.

33

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER (Cont’d)

In Michigan, where the trustee of the first trust does not have a presently exercisable discretionary power to make distributions, the governing instrument for the second trust cannot include or eliminate provisions which would cause the second trust to fail to qualify for any tax benefit (i.e., deduction, exemption, exclusion or other tax attribute) the first trust was intended to qualify for (but grantor trust status is not considered a tax benefit).

• Many statutes also protect property subject to presently

exercisable rights or powers of withdrawal.

– Under the New Hampshire statute, the decanting power does not apply to such property. – Under the Missouri, Nevada and South Dakota statutes, the decanting power does not apply unless the beneficiary’s power of withdrawal under the first trust is unchanged in the second trust. – Under the Delaware statute, the decanting power does not apply to a presently exercisable right of withdrawal held by a person who is the only beneficiary to or for whose benefit distributions may be made under the first trust. – Under the Kentucky, North Carolina, South Carolina and Virginia statutes, the second trust must provide an identical power of withdrawal or sufficient assets to satisfy the right

• f withdrawal must remain in the first trust.

34

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER (Cont’d)

– The Alaska, Illinois, Minnesota, New York, Ohio and Texas statutes also prohibit the elimination of the current right to withdraw a specified dollar amount or percentage of trust principal. – The Alaska, Illinois, Minnesota, New York, Ohio and Texas statutes also protect a beneficiary’s right to receive mandatory principal distributions under the first trust. – The Alaska statute permits current mandatory rights to be reduced, modified or limited during the extended term of a trust or where the second trust is a supplemental or special needs trust (the latter also applies under the Minnesota statute). – Under the Michigan statutes (i) where the first trust contains a discretionary trust provision, any mandatory distribution right cannot be eliminated and (ii) where the trustee

• f the first trust has a presently exercisable discretionary power, the second trust cannot

reduce a presently exercisable general power to withdraw a specified percentage or amount of trust property in a beneficiary who is the only trust beneficiary to or for the benefit of whom the trustee has the power to make discretionary distributions.

35

STATUTORY LIMITATIONS ON EXERCISE OF TRUSTEE’S INVASION POWER (Cont’d)

• Many of the statutes also contain provisions prohibiting the

extension of the permissible period of the rule against perpetuities applicable to the first trust.

– Attempts to extend the duration of a trust can have varying consequences depending on whether the trust is grandfathered from the GST tax, exempt from the GST tax or non-exempt. – Care should be taken when a trust is decanted from a state that has a rule against perpetuities to a state that has repealed the rule against perpetuities or has a longer rule than the rule applicable to the first trust.

– Note that in Delaware, a trustee may decant from a first trust of limited duration to a second trust of longer duration, including to a perpetual trust. – In Michigan, where the trust has a discretionary distribution provision, the statute provides that an increase in the maximum period during which the vesting of future interests may be suspended or postponed under applicable law is not a material change in beneficial interests. This may allow the Michigan statute to be used to increase the duration of a trust having a zero inclusion ratio for GST tax purposes (because of an allocation of GST exemption), without regard to the Rule Against Perpetuities provided in the GST effective date regulations.

36

ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS

Some of the decanting statutes also explicitly limit the ability of a beneficiary-trustee to decant. Concerns here include the potential for a taxable gift being made by the beneficiary-trustee or the beneficiary-trustee being deemed to hold a general power of appointment.

• In Alaska, Minnesota, New York, North Carolina, South Carolina and

Virginia, a beneficiary-trustee simply is not authorized to act. North Carolina, South Carolina, and Virginia also specifically permit the court to appoint a special fiduciary to exercise the power if all trustees are beneficiaries of the first trust.

• In Arizona, the beneficiary-trustee cannot act if it would have an adverse

tax impact on the beneficiary-trustee.

• Where absolute discretion is required and the action of a beneficiary-

trustee would be tantamount to the exercise of a general power of appointment, the beneficiary-trustee arguably cannot act.

37

ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS (Cont’d)

• Under the Wisconsin statute, a trustee with a beneficial interest in the

first trust cannot decant the first trust unless the second trust is for an individual with a disability, the trustee’s only beneficial interest in the trust is as a reminder beneficiary and the second trust does not increase the trustee’s beneficial interest.

• Under the Nevada and New Hampshire statutes, a beneficiary-trustee

cannot act : (a) if under the trust instrument or applicable law, the beneficiary-trustee cannot make or participate in discretionary distributions to himself, or is limited by an ascertainable standard, or (b) the beneficiary-trustee’s power to distribute to himself requires the consent of a co-trustee or other person holding an adverse interest and the second trust does not limit distributions to the beneficiary- trustee to an ascertainable standard and is exercisable without consent of a co-trustee or other person holding an adverse interest.

38

ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS (Cont'd)

• Under the South Dakota statute, a restricted trustee cannot act if

doing so could have the effect of (i) benefitting the restricted trustee as a beneficiary unless the exercise is limited to a HEMS standard, (ii) removing restrictions on distributions to a beneficiary

• f the first trust unless distributions under the second trust are

limited to a HEMS standard, or (iii) increasing the distributions that can be made from the second trust to the restricted trustee or to beneficiaries who can remove and replace trustees with related or subordinate parties to the beneficiaries unless the exercise of such authority is limited by a HEMS standard.

39

ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS (Cont'd)

• In Missouri, unless the trustee’s distribution power is limited by a

HEMS standard, the trustee cannot decant the assets of the first trust if (a) the trustee is a beneficiary of the first trust, or (b) any beneficiary of the first trust can remove and replace the trustee of the first trust with a related or subordinate party to such beneficiary.

• The provisions of the Michigan decanting statute are subject to the

provisions of §7815(3) of the MTC, which provides that unless the trust instrument expressly indicates that §7815(3) does not apply, (a) a trustee-beneficiary who has the power to make discretionary distributions to or for the trustee’s benefit may only make distributions subject to an ascertainable standard and (b) a trustee may not make a discretionary trust distribution to discharge the trustee’s legal support obligation.

40

ADDITIONAL LIMITATIONS WHERE TRUSTEE IS A BENEFICIARY OR WHERE BENEFICIARIES POSSESS CERTAIN POWERS (Cont'd)

• Also be aware of restrictions on decanting where beneficiaries of

the second trust have the right to remove and replace trustees. For example, the Missouri, Nevada, New Hampshire and South Dakota statutes require that the second trust contain an ascertainable standard for distributions where the beneficiaries have the right to remove and replace trustees with a related or non-subordinate party to the beneficiary.

• In Nevada and New Hampshire, a beneficiary-trustee cannot

decant if the first trust prohibits a trustee’s use of trust assets to discharge his support obligation unless the second trust also contains such a prohibition.

41

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST

• Does the statute specify a manner of exercise:

– Most of the statutes, including Alaska, Delaware, Florida, Illinois, Indiana, Kentucky, Minnesota, New York, North Carolina, Ohio, Rhode Island, South Carolina, South Dakota, Texas, Virginia and Wisconsin require a written instrument that is signed and acknowledged by the trustee and filed with the records of the first trust (and the second trust in Illinois, Texas and Wisconsin). – Where the trustee of the first trust does not have a presently exercisable discretionary power, the Michigan statute requires a written instrument exercising the trustee’s distribution power under the first trust. – The Arizona, Missouri, New Hampshire and Wisconsin statutes are all silent.

• Can the second trust be established under the first trust or is

a new trust required?

– The Alaska, South Dakota and Wisconsin statutes specifically require that a new governing instrument be created. – The Arizona, Delaware, Florida, Indiana, Michigan, Missouri, North Carolina, Ohio, South Carolina and Tennessee statutes all specifically authorize the trustee to establish the second trust under the first trust (or a new governing instrument can be created).

42

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST (Cont’d)

• Is advance notice of the decanting required?

– The Florida, Indiana, Minnesota, North Carolina, Rhode Island and Virginia statutes all require 60 days advance notice to the beneficiaries of the first trust. – The Ohio statute requires 30 days advance notice to all beneficiaries of the first trust. – The South Dakota statute requires 20 days advance notice to all beneficiaries

• f the first trust.

– The Illinois statute requires that 60 days advance notice be given to all legally competent current beneficiaries and presumptive remainder beneficiaries of the first trust (all as determined on the date the notice is sent). If the trust has a current charitable beneficiary or presumptive remainder beneficiary, notice must also be sent to the Attorney General. – The Kentucky statute requires 60 days advance notice to current beneficiaries

• f the first trust and to all beneficiaries in the oldest generation of remainder

beneficiaries of the first trust. – The Texas statute requires at least 30 days advanced notice to all current beneficiaries and presumptive remainder beneficiaries of the first trust.

43

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST (Cont’d)

– The South Carolina statute requires at least 90 days advanced notice to all qualified beneficiaries of the first trust. – The Missouri statute requires 60 days advance notice to all permissible distributees and qualified beneficiaries of the second trust. – In Alaska and New York, notice must be served on the beneficiaries of the first trust (interested persons) and also the trust creator, if living, and all persons with the right to remove or replace the trustee exercising the decanting power. – Michigan requires at least 63 days advance notice to the settlor (if living) and all qualified trust beneficiaries if the trustee does not have a presently exercisable discretionary power. – Wisconsin requires at least 30 days advance notice to all qualified beneficiaries

• f the first trust, each trust protector and directing party under the first trust and

the settlor of the first trust. – New Hampshire, Illinois and Texas require notice to the Director of Charitable Trusts/AG where the first trust has a current or future charitable beneficiary. – The Nevada statute authorizes but does not require notice and the Delaware statute does not require any notice.

44

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST (Cont’d)

• What constitutes notice? In Alaska, Minnesota, New York and Wisconsin,

notice requires serving a copy of the decanting instrument plus both trust

• instruments. In Florida, Indiana, Kentucky, Michigan, North Carolina and Rhode

Island, serving a copy of the proposed instrument exercising the decanting power is sufficient. In South Dakota, serving a copy of the decanting instrument and the second trust constitutes notice. In Texas, the trustee must serve a written notice regarding the terms of the proposal decanting and copies of the first and second trusts.

• Can beneficiaries waive notice?

– The Florida, Indiana, Kentucky, Michigan, Minnesota, Nevada, North Carolina, Ohio, Rhode Island, South Carolina, South Dakota and Wisconsin statutes all allow a beneficiary to specifically waive the notice period, in which case the decanting will be effective prior to the expiration of the notice period. Alaska and New York allow the beneficiaries to accelerate the effective date of the decanting, which is 30 days from the date that the serving of notice is complete. In Illinois, the decanting will be effective 60 days after notice is sent. – The Missouri, Texas and Virginia statutes allow trust beneficiaries to waive notice itself.

45

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST (Cont’d)

• Is beneficiary consent required?

– Beneficiary consent generally is not required in any state and there are both gift and GST tax reasons for this. The exceptions are (i) Nevada where property specifically allocated to a beneficiary of the first trust will no longer be allocated for the beneficiary under either the first or the second trust and (ii) Michigan and Ohio, where consent of the beneficiaries of the second trust or court approval is required when the second trust increases or changes the method for computing compensation of the trustee, and also in Michigan where the trustee is to receive a fee for the decanting. – Note that in Michigan, the consent requirements apply only where the decanting trustee does not have a presently exercisable discretionary power to make distributions. – Also, some statutes, such as Alaska, Florida, Indiana, North Carolina, Nevada, New York, Ohio, Rhode Island, Texas, Virginia and Wisconsin make it clear that a trustee’s giving notice and/or a beneficiary’s waiver of the notice period do not limit a beneficiary’s right to object. – The South Carolina statute makes it clear that a trust instrument can waive the notice provision for a decanting effected thereunder.

46

MECHANICS OF THE TRUSTEE’S EXERCISE OF THE POWER TO APPOINT IN FURTHER TRUST (Cont’d)

• Is court approval required or are there court filing

requirements?

– Only Ohio requires court approval and only in cases where the first trust is a testamentary trust created by an Ohio domiciliary. – New York has a court filing requirement for testamentary trusts and inter vivos trusts that were the subject of prior court proceeding (but court approval is not required). – Some statutes, such as those in Alaska, Arizona, Illinois, Kentucky, Minnesota, Nevada, New York, North Carolina, Texas and Wisconsin, make it clear that the trustee can petition for court approval. – The Alaska, Michigan and Minnesota statutes specifically provide that the trustee can act without court approval and without the consent of the settlor or any person interested in the first trust.

47

ADDITIONAL STATUTORY PROVISIONS

• In Delaware, Nevada and Ohio, the second trust can provide that it will be

administered on terms substantially identical to the terms of the first trust after the passage of time or the occurrence of an event specified in the second trust. This also applies in Michigan where the trustee of the first trust has a presently exercisable discretionary power.

• Alaska, New York, Illinois, Minnesota and Wisconsin specifically permit the term
• f the first trust to be extended in the second trust. This is implied under the

Michigan and Ohio statutes.

• In Alaska, Illinois, Minnesota, New York, Ohio and Texas, the decanting cannot

change the commissions of the trustee under the second trust and the Illinois, Minnesota, New York and Ohio statutes also prohibit a trustee from decanting a trust in order to reduce the trustee’s standard of care or to exonerate or indemnify the trustee from liability under the second trust. The Texas statute prohibits a trustee from decanting in order to decrease or indemnify against a trustee's liability or exonerate a trustee from liability for failure to exercise reasonable care, diligence, and prudence.

• The Michigan statute permits the decanting to change the method or the rate of

the trustee’s compensation, but the beneficiaries must receive notice of such change if the decanting trustee has a presently exercisable power to make

• distributions. If the first trust includes a discretionary trust provision, then the

beneficiaries must consent to a change in the trustee’s compensation. The same rules hold true for provisions indemnifying the trustee.

48

ADDITIONAL STATUTORY PROVISIONS (Cont’d)

• Virtually all of the statutes provide that spendthrift clauses and provisions

prohibiting amendment or revocation of the first trust do not bar a decanting (See Alaska, Florida, Indiana, Illinois, Kentucky, Michigan, Minnesota, Missouri, Nevada, New Hampshire, New York, North Carolina, Ohio, Rhode Island, South Carolina, South Dakota, Texas, Virginia and Wisconsin).

• The more modern statutes also provide that a trustee does not have a

duty to decant and many provide that the trustee’s failure to decant does not give rise to an inference of impropriety (See Alaska, Delaware, Florida, Indiana, Illinois, Kentucky, Michigan, Minnesota, Missouri, Nevada, New Hampshire, New York, North Carolina, Ohio, Rhode Island, South Carolina, Texas, Virginia and Wisconsin).

• Many statutes also provide that the statute does not abridge other rights
• f the trustee to appoint trust assets, whether under the trust instrument

itself, or under state law or common law (See Alaska, Delaware, Florida, Illinois, Indiana, Kentucky, Michigan, Nevada, New York, North Carolina, Ohio, Rhode Island, South Carolina, Texas and Virginia).

49

ADDITIONAL STATUTORY PROVISIONS (Cont’d)

• Some statutes, such as Delaware, Missouri, New Hampshire, New York, Ohio,

South Dakota and Virginia, contain statements that a decanting is subject to all of the trustee’s fiduciary duties and standards as they would apply in making a discretionary outright distribution and some statutes set forth guidelines that the trustee must consider before exercising a decanting power (such as the purposes

• f the trust as intended by the grantor, whether the decanting is in the best

interests of all trust beneficiaries, whether the distribution is being made in good faith and the potential tax consequences of the decanting).

• Under the Minnesota statute, the trustee has a fiduciary duty to exercise the

power in the best interests of one or more proper objects of the exercise of the power and as a prudent person would exercise the power under the prevailing circumstances.

• Under the Texas statute, the trustee must exercise a decanting power in good

faith, in accordance with the terms and purposes of the trust and in the interests

• f the beneficiaries.
• The Wisconsin statute also imposes a good faith requirement if there is any loss

related to the appointment.

• All of the statutes apply to both testamentary and irrevocable inter vivos trusts

that are governed by the laws of that state and many statutes also make it clear that the statute applies to a trust whose jurisdiction has been transferred to that state.

50

ADDITIONAL STATUTORY PROVISIONS (Cont’d)

• Some of the statutes, such as Delaware, Ohio and Tennessee

specifically apply to trusts administered under the laws of that state, even if the trust is governed by the law of another state.

• Under the Alaska and New York statutes, if the trust has a resident

trustee and the other trustees elect to have the primary administration of the trust located in that state, their decanting statutes will apply (even if the trust is not governed by that state’s law).

• The Alaska, Minnesota, New York, Illinois and Wisconsin statutes make it

clear that a distribution of all of the assets of the first trust includes subsequently discovered assets of the first trust, whereas if only a part of the assets of the first trust are distributed, then subsequently discovered assets will continue to belong to the first trust.

• Under the Michigan and Texas statutes, the trustee of the second trust

has the option of designating whether after-discovered assets of the first trust should remain as assets of the first trust if it continues.

• The Alaska, Illinois, Minnesota, New York and Virginia statutes

specifically allow the trustee of the first trust to decant to a second trust that is a supplemental needs or special needs trust.

51

ADDITIONAL STATUTORY PROVISIONS (Cont’d)

• Some of the statutes do not apply to specific types of trusts.

Examples:

– The Rhode Island statute does not apply to supplemental needs or special needs trusts. – The Kentucky statute does not apply to charitable remainder trusts.

52

UNIFORM TRUST DECANTING ACT

In 2015, the Uniform Trust Decanting Act was approved and recommended for enactment by the National Conference of Commissioners on Uniform State Laws. The Act was promulgated in order to provide a uniform framework for decanting trusts in order to eliminate conflicts between the different state decanting statutes. The Act incorporates the best provisions from existing state decanting statutes and also includes some novel and very helpful concepts not seen in the existing statutes. The Act distinguishes the power to decant from the power to distribute. By doing so, the decanting power can be used to modify the first trust without creating a new trust that is separate and distinct from the first trust. Thus, it is possible to modify

• nly specific provisions in the first trust, and treat the second “modified” trust as a

continuation of the first trust. This avoids having to re-title trust assets, or treat the first trust as having terminated for income tax purposes. A summary of the relevant provisions of the Act follows.

53

Uniform Trust Decanting Act

Section 2 -- Definitions The Act sets forth a number of definitions, including authorized fiduciary, beneficiary, charitable interest, expanded distributive discretion, first trust, second trust, and reasonably definite standard. Section 3 -- Application The Act applies to irrevocable, express trusts where the trust grants a trustee

• r other fiduciary the discretionary power to distribute trust principal. It also

applies to a revocable trust where the settlor can only revoke with the consent

• f the trustee or an adverse party.

A fiduciary without discretionary distribution power can petition the court for the appointment of a special fiduciary authorized to exercise the decanting power. A fiduciary without a discretionary distribution power over principal can also create a supplemental needs trust if the decanting will further the purposes of the first trust. The Act does not apply to wholly charitable trusts.

54

Uniform Trust Decanting Act

Section 4 -- Fiduciary Duty An authorized fiduciary who exercises a decanting power must do so in accordance with the fiduciary duties of the authorized fiduciary, which include administering the trust in good faith, in accordance with its terms and purposes, and in the interests of the beneficiaries. However, the Act does not impose a duty to decant or to inform the beneficiaries of the applicability of the Act. Generally, the authorized fiduciary will be the trustee unless the trust has divided trusteeship that gives another fiduciary such as a distribution director or advisor the right to make or direct principal distributions. The settlor cannot be an authorized fiduciary. Section 5 -- Application; Governing Law The Act applies to trusts that have their principal place of administration in the adopting state, trusts that are governed by the laws of that state for administration and trusts that are governed by the laws of that state for purposes of construction

• r determining meaning and effect.

55

Uniform Trust Decanting Act

Section 6 -- Reasonable Reliance A trustee or other person may reasonably rely on the validity of a prior decanting, whether it was performed under the Act or under

• ther law of the state (such as common law if applicable) or another
• jurisdiction. Although the trustee is still charged with reviewing the

facts of the prior decanting, he will not be liable if his reliance on the validity of the prior decanting is reasonable. Thus, if the second trust contained terms that are clearly prohibited by the applicable decanting law, the trustee’s reliance on the validity of the prior decanting would not be reasonable.

56

Uniform Trust Decanting Act

Section 7 -- Notice; Exercise of Decanting Power Consent and court approval are not required, but notice of the intended exercise of the decanting power must be given not later than 60 days before the exercise to: each settlor of the first trust (if living), each qualified beneficiary of the first trust, each holder of a presently exercisable power of appointment over any part or all of the first trust, each person who has the right to remove or replace the authorized fiduciary, each other fiduciary of the first trust, each fiduciary of the second trust, and the Attorney General if Section 14 of the Act applies (i.e., if the trust has a determinable charitable interest). Notice must specify the manner in which the authorized fiduciary intends to exercise the decanting power, the proposed effective date and include copies of the first and second trust instruments. Notice may not be waived but the notice period may be waived in writing. The receipt of notice, and waiver and/or expiration of the notice period do not affect a person’s right to object. If the authorized fiduciary acts with reasonable care to provide notice and fails, it does not render the exercise of the decanting power ineffective.

57

Uniform Trust Decanting Act

Section 8 -- Representation If the first trust instrument authorizes certain persons to receive notice on behalf of trust beneficiaries or other persons, the representative can receive notice of the proposed

• decanting. A person with authority to represent and bind a person under the first trust

instrument can also consent or a give a binding waiver on behalf of such person, unless such person objects. A settlor cannot represent or bind a beneficiary. Section 9 -- Court Involvement An authorized fiduciary, beneficiary, person entitled to notice or the Attorney General (with respect to a charitable interest) may petition the court to provide instructions to the authorized fiduciary with respect to whether a proposed decanting is permitted, to appoint a special fiduciary to exercise the decanting power, to approve the exercise of a decanting power, or determine that a proposed or attempted decanting is ineffective. The court may also approve an increase in a fiduciary’s compensation or modify a provision granting a person the right to remove or replace a fiduciary. Section 10 -- Formalities The exercise of the decanting power must be made in a writing signed by the authorized fiduciary that identifies the first trust and the second trust(s) and states what property of the first trust is being distributed to each second trust and any property that remains in the first trust. 58

Uniform Trust Decanting Act

Section 11 -- Decanting Power Under Expanded Distributive Discretion The Act distinguishes between fiduciaries with “limited distribution discretion” and “expanded distributive discretion.” Where the fiduciary’s distribution discretion is expanded under the first trust, so that it is not limited to an ascertainable standard, the fiduciary may decant the trust in order to modify beneficial interests, subject to the Act’s specific limitations. Where the authorized fiduciary has “expanded distributive discretion” the second trust may make a variety of changes, including: eliminating (but not adding) one or more current beneficiaries; making a current beneficiary a presumptive remainder or successor beneficiary; eliminating (but not adding) one or more presumptive remainder or successor beneficiaries; making a presumptive remainder beneficiary a successor beneficiary and vice versa; altering or eliminating rights that are not vested interests; changing the standard for distributions; adding or eliminating a spendthrift provision;

59

Uniform Trust Decanting Act

Section 11 -- Decanting Power Under Expanded Distributive Discretion (cont’d)

extending the duration of a trust subject to Section 20 of the Act; eliminating, modifying or adding powers of appointment; changing the fiduciaries appointed under the trust; changing administrative provisions of the trust. However: Remainder interests cannot accelerated to present interests. Vested interests cannot be eliminated, including the right to a receive a mandatory distribution of income, a specified dollar amount or a percentage of the value of the trust property; the right to withdraw income, a specified dollar amount or percentage of the trust property; a presently exercisable general power of appointment.

60

Uniform Trust Decanting Act

Section 12 -- Decanting Power Under Limited Distributive Discretion Where the fiduciary’s distribution discretion is limited under the first trust, so that it is subject to an ascertainable standard (HEMS) or reasonably definite standard, the interests of each beneficiary in the second trust must be substantially similar to such beneficiary’s interests in the first trust. Substantially similar means that there is no material change in a beneficiary’s interests. Thus, extending the duration of a trust that would

• therwise terminate at a specific age is not permitted. In such a case, the

changes that can be made to the trust will be administrative in nature.

61

Uniform Trust Decanting Act

Section 13 -- Trust for Beneficiary with Disability This section allows a decanting to a supplemental needs trust for a disabled beneficiary where the “special-needs fiduciary” believes the beneficiary may qualify for governmental benefits (even if the beneficiary does not currently receive benefits and has not been adjudicated incompetent). Most importantly, this section allows a decanting to a special needs trust even if the authorized fiduciary has no discretion to make distributions or only discretion over income and not principal where it will be in furtherance of the purposes of the first trust. This section uses the term “special-needs fiduciary” and not “authorized fiduciary” because an authorized fiduciary must have the power to distribute principal. If the first trust has multiple beneficiaries, the interests of the beneficiaries

• ther than the disabled beneficiary must be substantially similar to their

interests in the first trust.

62

Uniform Trust Decanting Act

Section 14 -- Protection of Charitable Interest The Act does not apply to wholly charitable trusts. If the first trust has a determinable charitable interest but is not a wholly charitable trust, the second trust cannot diminish the charitable interest, change an identified charitable organization or change the charitable purpose. Note, however, that the Act would likely not apply to a charitable split interest trust since the trustee generally does not have a principal distribution power. The Attorney General must receive notice of any decanting of a trust with a charitable interest. A determinable charitable interest is a charitable interest that is not subject to fiduciary discretion or any significant contingencies.

63

Uniform Trust Decanting Act

Section 15 -- Trust Limitation on Decanting A trust instrument may expressly prohibit the decanting of the trust under the Act or any other applicable statute. A statement in a trust that it is irrevocable or unamendable, or spendthrift, does not prevent a decanting. If the first trust instrument contains any express limitations on the trustee’s exercise of a decanting power, those restrictions will be honored. In addition, if the trust instrument contains provisions for modifying the trust (such as permitting a trust protector to modify the trust), that does not prevent the modification of the trust pursuant to a decanting unless the trust instruments expressly prohibits decanting. Section 16 -- Change in Compensation If the first trust instrument specifically sets forth the authorized fiduciary’s compensation, the stated compensation cannot be increased under the second trust unless all qualified beneficiaries consent in writing or the increase is approved by the court. If the first trust instrument does not specify the authorized fiduciary’s compensation, the decanting may not increase the compensation in the second trust above the compensation permitted under state law unless all qualified beneficiaries consent in writing or the increase is approved by the court. Incidental changes in the authorized fiduciary’s compensation that arise because of the decanting are not treated as an increase in the fiduciary’s compensation. Thus, if the duration of a trust is extended, the fact that the fiduciary will receive compensation for a longer period is deemed to be incidental.

64

Uniform Trust Decanting Act

Section 17 -- Relief from Liability and Indemnification An authorized fiduciary cannot decant the first trust in order to insert in the second trust a provision that relieves the authorized fiduciary from liability or indemnifies the authorized fiduciary to a greater extent than what was provided under the first

• trust. However, this may arise indirectly if the authorized fiduciary decants to

another state whose laws provide additional protection from liability. An authorized fiduciary of the first trust may be indemnified for any claims or liability that may become payable from the first trust after its assets are distributed to the second trust. The Act makes it clear that a trust can be decanted to a jurisdiction where fiduciary responsibility can be divided, but the decanting cannot eliminate the fiduciary duties that accompany each fiduciary position under the second trust. For example, a trustee who does not have investment responsibility under the second trust can be relieved of fiduciary liability for investment decisions so long as the investment advisor under the second trust acts in a fiduciary capacity and has fiduciary liability for its investment decisions.

65

Uniform Trust Decanting Act

Section 18 -- Removal or Replacement of Authorized Fiduciary An authorized fiduciary may not decant in order to modify a provision in the first trust instrument that grants another person the right to remove or replace the fiduciary absent court approval or the consent of the person currently holding the removal and replacement right. In addition, unless the qualified beneficiaries also consent, the person holding the removal and replacement power can only consent to a modification with respect to herself or himself, and cannot consent to a modification of the right of any person who will subsequently hold the removal and replacement power. Even with court approval or the consent of the qualified beneficiaries, however, the modification must grant a substantially similar power to another person.

66

Uniform Trust Decanting Act

Section 19 -- Tax Related Limitations This section limits the ability of an authorized fiduciary to decant and in doing so, jeopardize the tax benefits of the first trust. Consequently, the authorized fiduciary cannot decant a trust in a manner that would jeopardize a marital deduction or charitable deduction of the first trust (either by including or omitted provisions which, if included in or omitted from the first trust would have caused the first trust not to qualify for the deduction). The Act also protects gifts that qualified for the gift tax annual exclusion (i.e., by prohibiting the premature termination of existing Crummey rights) and also 2503(c) trust so that their duration cannot be extended prior to the time the beneficiary attains age 21. If a trust that is eligible to hold sub-chapter S stock is decanted, the second trust must also be eligible to hold sub-chapter S stock. For example, if an ESBT is decanted, the second trust may be either an ESBT, a QSST or a grantor trust. If the first trust is a QSST, the second trust must also be a QSST (i.e., it is not sufficient that the second trust be an authorized S-corp stockholder).

67

Uniform Trust Decanting Act

Section 19 -- Tax Related Limitations (cont’d) If the first trust has a zero inclusion ratio because it is eligible to receive GST annual exclusion gifts under IRC Section 2642(c), the second trust may not include

• r omit a term that would prevent the second trust from also having a zero inclusion

ratio. If the first trust is directly or indirectly the beneficiary of an IRA or other qualified retirement benefit, and if the life expectancy of the beneficiary can be used to determine minimum distributions from the first trust, the trust cannot be decanted to a second trust that includes or omits a term that would have increased the required minimum distributions. If the first trust qualifies as a foreign grantor trust under IRC Section 672(f)(2)(A) it cannot be decanted to a second trust that does not meet the requirements of that section. The Act also provides a “catch-all” provision intended to preserve any other tax benefits not specifically listed in Section 19 for which the first trust qualified if the first trust instrument either expressly indicates an intent to qualify for the benefit or is clearly designed to so qualify.

68

Uniform Trust Decanting Act

Section 19 -- Tax Related Limitations (cont’d) Under the Act, grantor trust status (other than for a foreign grantor trust) is not a tax benefit and the Act expressly permits the exercise of a decanting power in order to change grantor trust status. However, because the conversion of a non-grantor trust to a grantor trust could impose significant tax liability on the settlor, the settlor can object to the proposed conversion within the notice period unless the settlor has the power to cause the second trust to cease to be a grantor trust. Similarly, where the first trust is a grantor trust and the settlor or someone else has the power to terminate grantor trust status, the second trust, if it is also a grantor trust, must contain the same provision allowing grantor trust status to be terminated.

69

Uniform Trust Decanting Act

Section 20 -- Duration of Second Trust The second trust can have a duration that is the same or different from the duration of the first trust; provided, however, that to the extent the property of the second trust is attributable to property of the first trust, the property of the second trust will be subject to any perpetuity, accumulation, or suspension-of-the-power-of-alienation period applicable to the first trust. Thus, if a New York trust (where the maximum term of the trust was determined with reference to lives in being when the trust became irrevocable) is decanted to Delaware (which allows perpetual trusts) the perpetuities period applicable to the first trust cannot be eliminated in the second trust. If, however, the duration of the first trust is limited to lives in being, the class of measuring lives under the second trust can be expanded as long as members of the expanded class were in being on the date the first trust became irrevocable. Thus, if the first trust is to terminate with reference to issue of the settlor who were alive when the trust became irrevocable, the second trust can terminate with reference to issue of the settlor’s grandparents who were alive when the trust became irrevocable. The second trust can also terminate earlier than the trust duration rule applicable to the first trust, so that an irrevocable trust that was created in 2010 can be decanted into a trust that became irrevocable on an earlier date.

70

Uniform Trust Decanting Act

Section 21 -- Need to Distribute Not Required An authorized fiduciary may exercise the decanting power even if the authorized fiduciary would not have made a principal distribution to a beneficiary under the distribution standard of the first trust. Thus, if distributions can be made subject to a HEMS standard, taking into account the beneficiary’s other resources, the authorized fiduciary can decant the trust even if the beneficiary has sufficient other resources so that he would not have received any distribution from the first trust. However, the authorized fiduciary must still have a current right (and not a future right) to distribute trust principal to the beneficiary. Section 22 -- Savings Provision The Act provides a remedy for a decanting that does not comply with the Act’s

• requirements. In such a case, any impermissible provisions included in the second trust

are read out and any required provision from the first trust is read into the second trust. This avoids having the decanting invalidated completely. To the extent the terms of the second trust are revised as a result of the savings clause, the authorized fiduciary has a duty to inform the qualified beneficiaries of the change (since the copy of the second trust instrument that they received as a part of the notice requirement would not accurately reflect the terms of the second trust).

71

Uniform Trust Decanting Act

Section 23 – Trust for Care of Animal This section applies to trusts created to provide for the care of one or more animals. Since the term “person” does not include a nonhuman animal, an animal trust technically does not have a beneficiary for the purposes of state law decanting statutes. Whether an animal trust can be decanted will depend upon the level of discretion the authorized fiduciary has to make distributions for the animal or any other person. Since animal trusts generally have a human who is designated to enforce the trust on behalf of the animal, that person is entitled to receive notice of the decanting. If such a person does not exist, then the trustee can request the court to appoint such a person. If an animal trust is decanted, the funds must continue to be used for their intended purpose during the period they are intended to benefit the animal, and trust assets cannot be diverted to other beneficiaries of the trust.

72

Uniform Trust Decanting Act

Section 24 – Terms of Second Trust This section provides that a reference in an adopting state’s trust code to a trust instrument or terms of the trust includes a second trust instrument and the terms of the second trust. Section 25 -- Settlor The settlor of the first trust will be considered to be the settlor of the second trust with respect to the portion of the principal of the first trust that is subject to the exercise of the decanting power. Thus, if the first trust is decanted to a new trust with assets contributed by a settlor other than the settlor of the first trust, the settlor of the first trust will be considered the settlor of only that portion of the second trust that is funded with assets contributed from the first trust. In such a case, if issues regarding the second trust arise and if the intent of the settlor would be relevant to resolving those issues, the intent of the settlors of the first trust and the second trust, as well as the authorized fiduciary, may be considered.

73

Uniform Trust Decanting Act

Section 26 – Later-Discovered Property If the authorized fiduciary intended to distribute all of the property of the first trust to the second trust, all later-discovered property and property paid to or acquired by the first trust after the exercise of the decanting power is part of the estate of the second trust. If the authorized fiduciary intended to distribute only part of the property of the first trust to the second trust, all later-discovered property and property paid to or acquired by the first trust after the exercise of the decanting power is part of the estate of the first trust. Notwithstanding the foregoing rules, the authorized fiduciary may specify a contrary result in the instrument exercising the decanting power. Section 27 – Obligations If property of the first trust is subject to an enforceable debt, liability or other obligation, the trustee cannot evade those liabilities by decanting to a new trust. The debt, liability or other

• bligation will be enforceable against the property of the second trust to the same extent as

under the first trust. Only obligations that are enforceable at the time of the decanting are

• protected. However, this Section does not prevent an authorized fiduciary from exercising the

decanting power to protect trust property to a greater extent under the second trust than it was protected under the first trust (i.e., the trustee can decant to add a spendthrift provision to a trust).

74

Presenter

Meryl G. Finkelstein

Partner Brick & Patel LLP mfinkelstein@brickpatel.com (212) 554-5230

Meryl is a partner at Brick & Patel LLP in New York, where she focuses on trusts and estates matters, with an emphasis on estate and wealth planning for individuals and their families. Her clients include a wide variety of business professionals, owners of closely-held businesses and private investors. She has over two decades of experience in the development and implementation of sophisticated estate and wealth transfer plans. Her expertise extends not only to advising U.S. citizens, but also includes advising resident and non- resident aliens.

75

Disclaimer

The purpose of this communication is to provide general information of a legal nature. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Brick & Patel LLP.

76

Decanting: Flexibility & Danger

Strafford Publications Webinar on Trust Decanting Presented by Todd A. Flubacher, Partner | Morris, Nichols, Arsht & Tunnell LLP

May 10, 2016

May 10, 2016 | 78 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• A decanting statute permits a trustee who has the authority to invade the principal
• f a trust (and in some cases trust income) for the benefit of one or more trust

beneficiaries to exercise that authority by transferring some or all of the assets of the trust in further trust.

• The rationale underlying decanting is that a trustee who has the discretion to make

an outright distribution of trust property to or for the benefit of one or more current beneficiaries of the trust has a special power of appointment over the trust property that allows the trustee to distribute the property to another trust for the benefit of

• ne or more beneficiaries of the trust.

Introduction to Decanting

May 10, 2016 | 79 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

Real Examples:

• Convert to a “directed trust”
• Migrate situs or governing law of a trust
• Grant a beneficiary a power of appointment
• Eliminate a beneficiary from a class of discretionary beneficiaries
• Eliminate an income interest
• Postpone a withdrawal or distribution right
• Divide a pot trust
• Eliminate a trustee duty to notify or report to beneficiaries
• Alter administrative provisions

How Is Decanting Used?

May 10, 2016 | 80 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

You may want to first consider whether decanting is the best option. Have you considered:

• Administrative power to amend.
• Judicial modification.
• Non-Judicial Settlement Agreement.
• Merger.

Consider Other Alternatives

May 10, 2016 | 81 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• 1. Evaluate the trustee’s power to decant (Possibly change situs and

governing law).

• 2. Evaluate trustee’s duties in connection with decanting.
• 3. Evaluate trustee risk.
• 4. Assess virtual representation for consent/release.
• 5. Assess tax implications.
• 6. Draft the documents.
• 7. Obtain beneficiary consent or release with accounting.
• 8. Satisfy statutory procedures like notice or court filing.
• 9. Set up new trust accounts, get new EIN, etc.

10.Transfer assets.

Overview of Steps For Decanting

May 10, 2016 | 82 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• What state law governs the trust?
• Does the trustee have the express power to decant under the instrument?
• Does the trustee have the power to decant under a statute that does apply or could

apply?

• What is the nature of the power to distribute principal? Discretion? Ascertainable

standard?

• Does the power granted by the instrument or governing law allow you to make the

changes you want?

• Must/can the trust be moved to a new jurisdiction that permits decanting?
• How do you move the trust?
• How do you change applicable law?

Step 1: Evaluate the Trustee’s Power to Decant

May 10, 2016 | 83 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Many statutes provide that the decanting shall be viewed as an exercise of a power
• f appointment. Under Delaware law, the validity of the exercise of a power of

appointment is governed by the laws of the jurisdiction in which the trust is

• administered. The Delaware decanting statute provides that the statute shall apply

to any trust administered in Delaware.

• However, other states may have a different conflicts of laws approach to the

applicability of a decanting statute.

• The issues of situs, governing law and place of administration can become

complicated, particularly if a trust is being moved to a jurisdiction in order to utilize a decanting statute.

• If these issues are not addressed, there can be risk that the decanting was not

proper, or that the trustee cannot effectively obtain releases.

• It may be necessary to get legal counsel in one or more jurisdictions to address

these multi-jurisdictional issues.

What Law Applies?

May 10, 2016 | 84 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• When does the state’s decanting statute apply?
• Can you change the law governing administration to effectively use releases and

virtual representation under applicable law?

• How do you move the trust to a new jurisdiction and change applicable law?
• Review choice of law provision in the document.
• Review transfer of situs provision in the document.
• Review removal and appointment of trustee provision in the document.
• Analyze rules and requirements for transferring a trust under the laws of the

current jurisdiction.

• Evaluate all applicable conflicts of laws rules.

Changing Governing Law

May 10, 2016 | 85 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• The trustee generally must have the power to distribute all of the principal (or in some cases

income) to one or more beneficiaries (discretion or ascertainable standard).

• Can the trustee only distribute principal after income has been exhausted?
• Are there any procedures to be satisfied when distributing principal (e.g. does the trustee

make distributions with the direction or consent of another)?

• Compare the original instrument to the new instrument, identify the differences, and assess

whether the proposed changes are permissible under the applicable statute.

• Does the decanting statute limit the ability to reduce the standard of liability of the trustee of

the new trust?

• Administrative Changes: Typically, administrative provisions can be modified in almost

any way that is desired.

• Changing Beneficial Interests: However, if the decanting alters the beneficiaries’ interests,

then close scrutiny is necessary to ensure that the new instrument does not run afoul of the applicable statute.

• Generally, you cannot add beneficiaries or change or eliminate the interests of beneficiaries who are

not currently proper objects of an exercise of the power to distribute principal.

• Different statutes may also have other specific limitations (such as the inability to change the income

interest under a marital trust or change the vesting of an interest under a 2503(c) trust).

Evaluating the Trustee’s Power to Decant

May 10, 2016 | 86 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• The decanting must be consistent with the trustee’s applicable fiduciary duties for

making a distribution.

• When a trustee decants, it is making a distribution of the trust assets.
• In exercising its discretion, the trustee must uphold its duties of impartiality, care

and loyalty to all of the trust beneficiaries. Are the changes to be made by the decanting consistent with those duties? Does this present risk to the trustee?

• If there is a standard for making principal distributions, such as an ascertainable

standard, the decanting must comply with the standard.

• Where a trustee has the power to invade the principal of a trust for a beneficiary

that is subject to a standard, the trustee owes the other beneficiaries of the trust the duty of care to make some investigation to learn whether the condition precedent to the right to the principal exists and justifies the distribution.

• A corporate trustee will typically run the decision through its Trust Committee

responsible for discretionary distributions.

Step 2: Evaluate the Trustee’s Fiduciary Duties

May 10, 2016 | 87 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• A trustee will generally be concerned about the potential liability for breach of

fiduciary duties associated with its exercise of discretion to appoint the trust assets to the new trust, unless the reasons for the decanting are so ministerial and innocuous that it poses little or no risk to the trustee.

• The risk could be limited, or eliminated, if all of the beneficiaries consent to the

decanting and release the trustee for all liability in connection with it.

• Of course, it is not always the case that all of the beneficiaries are living adults and

there are often contingent remainder beneficiaries who might potentially complain in the future.

• Fortunately, many jurisdictions, like Delaware, have virtual representation statutes

that can effectively bind all present and future beneficiaries of the trust if all of the adult beneficiaries release the trustee, and there is no conflict of interest between those beneficiaries and the parties represented (this is more easily accomplished when the changes caused by the decanting are administrative in nature and are not changes to beneficial interests).

• HOWEVER – What law governs the releases and virtual representation?

Step 3: Evaluate Trustee Risk

May 10, 2016 | 88 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• A trustee should have two lines of defense in connection with a decanting, if the

trustee has the power to make principal distributions in its discretion.

• First, the trustee can get release and indemnification agreements from the

beneficiaries with virtual representation binding the minors and unborns.

• Second, even if there is some issue with the release and indemnification, the

trustee’s actions will be judged under the abuse of discretion standard. This provides that the trustee’s exercise of discretion will only be overturned if it’s actions were arbitrary or capricious, not merely unreasonable.

Trustee Liability Concerns Two Lines of Defense

May 10, 2016 | 89 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• If the trustee has discretion to make distributions under the original instrument,

then the decision to make the distribution would typically be reviewed by a court under an abuse of discretion standard.

• In order to demonstrate that the trustee did not abuse (or abdicate) its discretion,

the trustee should process the decision through its usual procedures for making a discretionary distribution.

• The trustee should run the decanting decision through the trustee’s normal

policies and procedures.

• The trustee should investigate the facts and circumstances.
• It may be advisable to get advice from legal counsel.
• The process should be documented.

Standard of Review for Trustee’s Exercise of Discretion

May 10, 2016 | 90 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Prepare a family tree and identify beneficiaries – adults and minors.
• Apply the virtual representation statute to the facts.
• Do the changes resulting from the decanting result in a conflict of interest between

the consenting adults and the minor, unborn and unascertainable beneficiaries being represented?

• Consider every implication of the decanting.
• Will any signors be exculpated or be given greater authority or control?
• Do the parties have different interests in the outcome, different investment
• bjectives, different interests in income or growth, etc.?

Step 4: Assess Virtual Representation

May 10, 2016 | 91 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• In Notice 2011-101 (the “Notice”) the IRS requested comments from practitioners

regarding the income, gift, estate and GST tax issues and consequences of a decanting that changes beneficial interests of the first trust.

• The Notice identifies certain facts and circumstances as potentially having tax
• consequences. These include situations where:
• A beneficiary’s right to or interest in trust property is changed;
• Trust beneficiaries are added;
• Beneficial interests are added, deleted, or changed;
• Assets are transferred from a grantor trust to a non-grantor trust or vice versa;
• Beneficiaries of the first trust are required to consent, are not required to consent or

actually do consent even though consent is not required;

• The identity of the transferor for gift and/or GST tax purposes changes; and
• The first trust is a GST grandfathered trust or is exempt from GST tax.
• While this issue is under study, the IRS has advised that it will not issue any

private letter rulings with respect to a decanting that involves a change in beneficial interests

Step 5: Assess Tax Implications

May 10, 2016 | 92 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• If the changes made by the decanting do not shift beneficial interests and are

purely administrative then there should be little risk of adverse tax consequences.

• Evaluate income, gift, estate and generation skipping transfer tax issues.

Step 5: Assess Tax Implications (cont.)

May 10, 2016 | 93 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Discretionary Distribution Safe Harbor (Treas. Reg. 26.2601-1(b)(4)(i)(A)).
• When the trust became irrevocable, either the terms of the trust instrument or local law

authorized distributions in further trust without the consent or approval of any beneficiary or court; and

• The resulting trust does not extend the time for vesting of any interest in the trust in a

manner that may postpone or suspend the vesting, absolute ownership or power of alienation of an interest in property for a period, measured from the date the original trust became irrevocable, beyond the longer of (a) lives in being plus 21 years, or (b) 90 years.

• Trust Modification Safe Harbor (Treas. Reg. 26.2601-1(b)(4)(i)(D)).
• The distribution does not cause a beneficial interest to be shifted to a beneficiary in a

lower generation, and

• The governing instrument of the resulting trust does not extend the time for the vesting
• f any beneficial interest beyond the period provided for in the original trust instrument.

Two Decanting Safeharbors for Grandfathered GST Exempt Trusts

May 10, 2016 | 94 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Simple Decanting Instrument: Depending upon the number of changes, you

might simply draft a simple decanting instrument that provides that the new trust shall be held in accordance with all of the terms and conditions of the original trust subject to some enumerated changes and additions.

• New Trust Agreement: Alternatively, you might draft an entirely new trust

agreement with a separate decanting instrument that memorializes the trustee’s exercise of its power to decant the assets of the original trust to the new trust.

• The new trust could be a declaration of trust, or have the trustee of the original

trust as the grantor, or it could have some other person as the grantor.

• Make the dispositive provisions of the new trust instrument closely resemble

the original instrument to avoid confusion about what was changed.

• Trustee Release, indemnification and approval of account.

Step 6: Draft the Documents

May 10, 2016 | 95 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Decanting as a Termination of the Old Trust
• When a trust is decanted, the assets of the first trust flow over into the second trust, and

the first trust is terminated. Not only will the trustee typically seek releases in connection with its exercise of discretion to decant, but it will likely seek releases and an accounting, and any other typical procedure that a trustee in its particular jurisdiction will seek when a trust is terminated and its service as trustee ends.

• Decanting as a Removal of the Trustee
• Since the assets have been transferred to a new trust, which may or may not have the

same trustee as the original trust, a decanting can also be viewed from the trustee’s perspective as a removal of the trustee of the first trust and an appointment of a successor trustee. Consequently, it is advisable to include an indemnification provision in the new, second trust instrument that runs to the trustee of the original trust, even if the individual or corporate identity of the trustee is the same for both trusts (such individual or entity will still be serving in two different capacities).

• Thus, the outgoing trustee knows that if claims, taxes, fees, liabilities, etc. from the
• riginal trust arise in the future, which would have been properly payable from the trust,

the trustee of the original, now defunct trust can still have some recourse against the new trust to be reimbursed.

Step 7: Obtain Consents and Releases with Accounts

May 10, 2016 | 96 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

Attachments to the Release should include:

• Full accounting
• Original trust instrument
• New Trust instrument
• Decanting instrument
• Description of changes made by the decanting

Step 7: Obtain Consents and Releases with Accounts (cont.)

May 10, 2016 | 97 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• Some statutes may permit or require the trustee to provide notice to beneficiaries
• r file a notice with the court.
• Generally, a decanting requires a written instrument, signed by the trustee and

notarized.

Step 8: Satisfy Required Procedures

May 10, 2016 | 98 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• The decanting results in a newly-created trust. The trustee of the new trust will

typically go through the procedure to set up a new trust account.

• The account set-up process may take some time and may involve compliance with

regulatory requirements for traditional trust account set-up.

• The new trust may or may not be treated as a new, separate taxpayer with a new

Tax ID Number.

Step 9: Set Up New Accounts

May 10, 2016 | 99 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• As a part of the decanting, the assets of the original trust will be distributed to a

new trust.

• This may require:
• Retitling of assets and accounts;
• Transfers of limited liability company interests through assignment and

assumption agreements;

• Retitling stock and stock certificates; and
• Retitling real estate.
• These steps must be completed properly to abide by the technical requirements of

the transaction.

Step 10: Transfer Assets

May 10, 2016 | 100 Morris, Nichols, Arsht & Tunnell LLP | Trust Decanting: Flexibility & Danger

• By far, the biggest hurdle in accomplishing a decanting is the trustee’s reluctance

to take on the risk associated with the exercise of discretion. There may be potential transfer tax issues associated with getting beneficiary consents or releases.

• When drafting new trust agreements, it is advisable to draft:
• express decanting provisions to facilitate broad decanting powers; and
• enabling provisions in the agreements which limit a trustee’s liability and

provides indemnification in connection with a decanting.

• This kind of advanced planning might provide the flexibility and protection for a

trustee to enable the trustee to perform a decanting in the future, if it is desired by the beneficiaries, without the delay and expense of releases, accountings, indemnifications, etc.

Planning Ahead for Decanting

May 10, 2016| 101

Todd A. Flubacher

PARTNER Trusts, Estates & Tax Group (302) 351-9374 T tflubacher@mnat.com

Todd works with national and local clients on the creation, migration, modification and administration of Delaware trusts. He represents Delaware trustees, beneficiaries, law firms and individuals throughout the country on all matters involving Delaware trusts and estates. His practice emphasizes the unique advantages of Delaware trust law, including directed trusts, dynasty trusts, tax planning, asset protection trusts, and all aspects

• f trust validity, construction and administration. Todd has substantial experience

with migrating trusts to Delaware and modifying trusts by decanting, merger, non- judicial settlement agreements, Delaware Court of Chancery trust petitions, administrative amendments, and addressing issues pertaining to choice of Delaware governing law. He drafts, reviews and comments on Delaware trust documents and renders Delaware trust law opinions. Todd is a Fellow of the American College of Trust and Estate Counsel (ACTEC). He is included in The Best Lawyers in America (2014-2016) and AV-rated by his peers in Martindale-Hubbell. Todd is a past-chair of both the Estates & Trusts and Tax Sections of the Delaware State Bar Association. Todd is a nationally recognized author on Delaware trust law and his articles have appeared in notable publications such as Trusts & Estates magazine and Estate Planning magazine, among others. He is a frequent presenter and panelist, appearing before professional and business audiences across the country.

Speaker