Surprise! Modifying an Irrevocable Trust is Possible by Sarah Gaymon, CPA
Posted on December 04, 2024
by
Sarah Gaymon
As its name implies, the terms of an irrevocable trust are generally intended to be set in stone and, therefore, unchangeable without a costly legal battle. However, as time passes, individuals’ lives and circumstances evolve along with the passage of new laws, making decisions from long ago seem outdated, unsuitable and often contrary to grantors and trust beneficiaries’ planned needs and goals. Fortunately, half of U.S. states currently have laws that allow modifications to irrevocable trust through “decanting.”
What is Decanting?
Much like decanting a bottle of wine, decanting a trust enables a trustee to “pour” or transfer the assets from an original irrevocable trust (the distributing trust) into a new one (the receiving trust) with different terms and provisions that are often better suited to beneficiaries’ current circumstances. Although this process preserves the trust’s existing tax benefits and creditor protections, it neither changes the grantor’s objectives nor may it be used to meet beneficiaries’ frivolous wants and desires.
Why Consider Decanting a Trust?
A grantor who established an irrevocable trust several years or decades ago probably did not anticipate the full range of potential scenarios and issues that could occur in the future. For example, as tax laws change, the state where the grantor originally established the trust may no longer provide the same levels of asset protection as it had previously. As a result, trustees may be able to decant the trust and move it to a jurisdiction that offers greater tax benefits, such as a state that does not have income taxes. However, in these situations, trustees must be careful of long-arm statutes in some states that will continue to tax the trust even after a change in jurisdiction or residency rules that govern taxes based on the grantor’s state of residence.
Additionally, consider when a beneficiary is embroiled in a contentious divorce proceeding or at risk of compromising their use of the trust assets. Under these circumstances, the trustee may decide it is in the best interest of the trust and its beneficiaries to modify the timing of distributions. The same can be true when there is a significant distribution planned for a minor child. Decanting the original trust allows for more flexibility in the receiving trust and makes it easier to accommodate beneficiaries’ changing circumstances without negating the grantor’s original intentions.
Other reasons for decanting an irrevocable trust include extending the trust’s termination date, creating a dynasty trust for future generations, terminating trustees, reducing administrative costs or dividing trust property to create separate trusts.
When Decanting a Trust May Not Make Sense
While the reasons for decanting are numerous, there are situations when doing so is beneficial. For example, some trusts include specific language that prevents the decanting of assets or precludes trustees from having the power to distribute principal from the trusts. Additionally, trustees and beneficiaries must assess the decanting’s legal, tax and reporting consequences, including whether it results in a taxable gain and whether tax attributes (such as net operating loss carryovers) transfer with trust assets.
No one can predict how an irrevocable trust will impact its beneficiaries in the future. Grantors can merely assess the situation based on the circumstances and laws applicable at the time of settlement and create trusts they hope will benefit their beneficiaries in the manner they desire. It behooves grantors, trustees and beneficiaries to proceed carefully under the guidance of experienced financial and legal professionals before taking action.
About the Author: Sarah Gaymon, CPA, is a director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she works with entrepreneurs and high-net-worth families to plan for tax-efficient wealth preservation and multi-generational wealth transfers. She can be reached at the CPA firm’s West Palm Beach, Fla., office at (561) 361-2050 or info@bpbcpa.com.
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