July 26, 2017

Irrevocable trusts that were set up a few years ago (as well as many trusts that are still being set up today) which have provisions that are “etched in stone,” may later, due to changing laws or family circumstances, operate in a way that was completely unexpected.

These trusts, although originally designed to carry out the intended laudable goals of the settlor (creator of the trust), may now bring about unintended consequences.

Just to name a few examples, the existing trust may (1) require distributions to be made to someone at the wrong time (such as during a divorce, in the midst of careless spending sprees, or as a creditor threat is brewing), (2) cause taxable income that would be better taxed at a beneficiary’s 15% tax bracket instead of at the trust’s 43.4% tax bracket, or (3) expose low tax-basis assets to a large capital gains tax that could otherwise attain a tax-free step-up in basis to eliminate the capital gains.

If the same existing trust has no provision to allow the trust to be modified or moved to another trust that better addresses (prevents) such catastrophes, there is good news. Numerous states now allow these existing trusts to “decant” (pour assets from one trust to another trust) to an improved trust design that better accomplishes asset protection, tax advantages or other goals.

If the existing trust is being administered in a state that does not allow for this decanting, the existing trust can most likely have the state in which it is being administered changed to a state with favorable decanting laws. The trust can then engage in the desired decanting process. South Dakota, for example, has very flexible decanting laws that can in many cases allow any of the catastrophes mentioned above to be totally averted.

By Edward D. Brown Esq., LLM. CPA