Legal Insights
Irrevocable trusts are a common instrument used to reduce estate taxes, shield assets from creditors or lawsuits, or bypass probate. The creator of a trust (the “Settlor”) transfers their ownership interest in an asset to the trust, ceding their ownership as well as the ability to freely change or revoke the trust. At face value, irrevocable trusts sound permanent and unchangeable, but the reality is that there are a few limited avenues that make irrevocable trusts malleable.
Decanting an Irrevocable Trust
The plain definition of “decant” is “to pour (a liquid, such as wine) from one vessel into another.”[1] Legally speaking, decanting a trust is no different—the assets from an irrevocable trust may be “poured” into another trust with modified terms. These “modified terms” in the new trust may be administrative changes (such as changing the number of trustees) or changes to how the trust assets are distributed. Rhode Island and New York, along with 35 other states, have enacted decanting statutes. While decanting is a powerful tool, it is also a delicate one that should be done with the assistance of counsel.
New York: The New York Estate, Powers, and Trusts Law (EPT) provides a comprehensive statute to handle the decanting process, which can be achieved in two ways depending on the language in the original trust.[2]
The first way in which a New York trust can be decanted is by explicit authority; this occurs where the language in the trust allows the trustee to exercise unlimited discretion[3] to make payments to the beneficiary of the trust and “invade” the trust’s principal.[4] If the language in the original trust authorizes the trustee to do so, then the trustee may move the assets into a second irrevocable trust. While this requires no court intervention, the trustee must keep at least one of the current beneficiaries as a beneficiary in the new trust. The trustee may, however, remove current, successor, or remainder beneficiaries. This option for decanting offers the most flexibility to those decanting to make administrative changes.
The second option offers less flexibility, and occurs when the trustee has not been granted unlimited discretion to make payments to beneficiaries from the income of the trust and invade the trust’s principal.[5] In this scenario, the trustee may still move the assets into another irrevocable trust, but the new trust must have the same current, successor, and remainder beneficiaries as the original trust. Additionally, the new trust must not change how the original trust authorized the trustee to distribute income or invade the principal. The new trust can extend the term of the original trust, and during that extension the distribution provisions of the original trust may be changed. This method of decanting offers the chance to extend the length of the original trust and change how the trust income and principal are distributed during that time but is not as flexible as the first option because it requires that all the beneficiaries of the original trust remain the same in the new trust.
Rhode Island: The Rhode Island General Laws only allow for a trust to be decanted when the trustee has the authority to invade the principal of the original trust to make distributions to a beneficiary.[6] Rhode Island’s method largely mirrors New York’s first method of decanting a trust, but with some key differences. In Rhode Island, the original trust must not be a “Special Needs Trust” or a “Supplemental Needs Trust,”[7] may only include beneficiaries of the original trust, and is not permitted to reduce any fixed income or annuity interests in the assets of the original trust.
Additionally, before a trustee transfers the assets of the original trust into the new one, they must notify all “qualified beneficiaries” (those who are living and are/would be a distributee or permissible distributee of trust income or principal) in writing at least sixty (60) days prior to decanting. While the statute allows a distributee to object to the decanting, the caselaw is unclear on what judicial recourse they might have if the decanting continues. It is important to discuss decanting with counsel before taking steps to do so to avoid any potential action against the authorizing trustee.
Assigning a Trust Protector
Another way that a Settlor of a trust leaves the door open for modification later is to decant into a trust with a trust protector. The trust protector is a third party (usually an attorney or someone knowledgeable in tax and trust issues) that exists outside the traditional parties to a trust (settlor, trustee, and beneficiary) who is granted administrative powers through the language of the trust. The trust protector is generally given the ability to change governing provisions, modify beneficiaries of the trust, or remove or replace a derelict trustee, modifications that are usually difficult if the trustee of an irrevocable trust attempted them. Additionally, trust protectors typically may resign voluntarily but otherwise may only be removed by a court order. There are a variety of ways in which states address the use of trust protectors in trusts.
A common difference across all jurisdictions is their determination of whether trust protectors are fiduciaries of the trust or something else entirely. Several states have adopted Section 808 of the Uniform Trust Code, which classifies trust protectors as fiduciaries since they have the power to direct the modification of the trust.[8] Other states have adopted parts of Section 808, while the remaining states (such as New York and Rhode Island) have not adopted any portion of Section 808.
Since New York does not provide statutory guidance to trust protectors, their duties are unclear if not expressly outlined in the language of the trust. However, if the trust protector acts in opposition to any fiduciary duties outlined in the language of the trust to which they are not expressly bound, they may still be exposing themselves to liability. Because new caselaw continues to alter the role and duties of trust protectors, it is important to discuss adding a trust protector with knowledgeable counsel.
Rhode Island General Laws § 18-9.2-2 combines trust advisors and trust protectors into one definition but still limits authority of the trust advisor/protector to the language of the trust.[9] Likewise, whether a trust advisor/protector in Rhode Island owes fiduciary duties to the trustees and beneficiaries is also left to the language of the trust. It is paramount that an attorney is consulted on the addition of a trust advisor/protector to make sure that both all parties to the trust and the trust itself are adequately protected.
Conclusion
While irrevocable trusts sound permanent, there are ways to either leave the door open for change or alter the trust after it has been formed. The landscape around trusts is an ever-changing one, so it is important to discuss your options with a knowledgeable attorney.
[1] DECANT Definition & Meaning – Merriam-Webster
[2] NYS Open Legislation | NYSenate.gov
[3] EPT 10-6.6(s)(9) “The term “unlimited discretion” means the unlimited right to distribute principal that is not modified in any manner. A power to pay principal that includes words such as best interests, welfare, comfort, or happiness shall not be considered a limitation or modification of the right to distribute principal.” “Discretion” in trust law is split into ascertainable (objective criteria, such as health, education, maintenance, and support) and non-ascertainable standards (subjective criteria, such as best interests, welfare, comfort, or happiness mentioned in the statute).
[4] NY EPT § 10-6.6(b)
[5] NY EPT § 10-6.6(c)(1)-(4)
[6] RIGL § 18-4-31
[7] 42 U.S.C.A. § 1396p(d)(4)(A)
[9] Several states (including Alaska, Delaware, and Nevada) make trust advisors and trust protectors distinguishable from one another.
——————————————————————–
This DarrowEverett Insight should not be construed as legal advice or a legal opinion. This Insight is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. Please reach out to us if you need help addressing any of the issues discussed in this Insight, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.
This Insight does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.
