Private Client Services Update – Decanting: Not Just for Wine Anymore – Virginia’s Adoption of the Uniform Trust Decanting Act
A trustee has always had some flexibility and ability to modify an irrevocable trust in Virginia, whether pursuant to the terms of the trust agreement, through judicial modification, or through non-judicial settlement agreement, a mechanism that was incorporated into Virginia law as part of the Uniform Trust Code. Virginia fiduciaries have also had the ability to decant trusts since 2012 but with little statutory guidance on the details of decanting.1 To address this uncertainty and provide a full statutory framework for trustees to decant, Virginia recently adopted the Uniform Trust Decanting Act (the “UTDA”), which became effective on July 1, 2017. The Uniform Law Commission recommended the complete UTDA in 2015, and since then Colorado, New Mexico, North Carolina, Virginia, and Washington have enacted the UTDA, and Illinois and Nevada have pending legislation to adopt the UTDA as well.2
In its introduction to the Uniform Act, the Uniform Law Commission describes decanting’s purpose as, “not to disregard the settlor’s intent but to modify the trust to better effectuate the settlor’s broader purposes or the settlor’s probable intent if the settlor had anticipated the circumstances at the time of decanting.”3 Just as was envisioned by the Uniform Law Commission, Virginia’s incorporation of the expanded UTDA should provide trustees with the flexibility to carry out a settlor’s intent through the cost-effective modification of a trust to match the trust’s current circumstances, which may differ vastly from what was envisioned by the settlor at the time the trust agreement was drafted.
Options for Decanting
The UTDA divides trustees that are authorized to decant into two categories: (1) trustees with expanded distributive discretion; and (2) trustees with limited distributive discretion. If a trustee has the discretion to distribute all or part of the income or principal of a trust to one or more of the current beneficiaries (not limited by any standard), then the trustee has “expanded distributive discretion,” and if a trustee’s discretion to distribute income or principal is limited by the ascertainable standard or other reasonably definite standard, then the trustee has “limited distributive discretion.”4 Virginia’s enactment of the UTDA expands upon the UTDA as written by the Uniform Law Commission. Under the uniform act, only trustees with the power to distribute principal can decant a trust, and a trustee who only has the power to distribute the income of a trust does not have the authority to decant the trust.5 Virginia’s UTDA specifically allows a trustee with the discretion to distribute income or principal to decant.6
A trustee with expanded distributive discretion can modify a trust through decanting in the following ways:
- Eliminate (but not add) current beneficiaries
- Make a current beneficiary a remainder or successor beneficiary
- Eliminate (but not add) remainder and successor beneficiaries
- Make a remainder beneficiary a successor beneficiary or vice versa
- Alter or eliminate rights that are not vested interests
- Change distribution standards
- Add or eliminate spendthrift provisions
- Extend the duration of the trust
- Change jurisdiction and state law governing the trust
- Change trustee or trustee succession provisions
- Change powers of the trustee
- Change administrative provisions
- Add investment advisors, trust protectors, or other fiduciaries such as distribution advisors
- Divide and merge trusts
- Retain, take away, or create powers of appointment in one or more current beneficiaries, including adding non-beneficiaries of the first trust as permissible appointees of a newly created power of appointment in the second trust7
A trustee with limited distributive discretion cannot materially change the dispositive provisions of the trust, and the beneficial provisions of the second trust must be “substantially the same as in thefirst trust.”8 The Uniform Law Commission gives the example that a trustee with limited distributive discretion cannot change ages for outright distributions or standards for distributions but can help to define terms contained in the trust agreement.9 A trustee may decant to specifically define “health care to include “assisted living” or “education” to include preschool or graduate school to the extent it is not defined in the first trust instrument.10 A trustee with limited distributive discretion can modify a trust through decanting in the following ways:
- Modify administrative provisions
- Modify trustee succession provisions
- Modify investment powers
- Modify jurisdiction and state law governing the trust11
Under the UTDA, a trustee (whether or not it has limited or expanded distributive discretion) cannot: (1) add current, remainder, or successor beneficiaries; (2) reduce or eliminate a vested interest; or (3) accelerate an interest so that a remainder beneficiary becomes a current beneficiary.12 If a trustee has expanded distributive discretion over part but not all of the income or principal of a first trust, then the trustee may exercise the expanded distributive decanting powers only over that part of the income or principal over which the trustee has expanded distributive discretion.13 Similarly, if a trustee has limited distributive discretion over part but not all of the income or principal of a first trust, then the trustee may exercise the specifically enumerated limited decanting powers only over that part of the income or principal over which the trustee has limited distributive discretion.14
The UTDA applies to any Virginia trust created before, on, or after its effective date of July 1, 2017.15 The UTDA speaks in terms that are already familiar to Virginia fiduciaries and shares definitions with the Uniform Trust Code and newly enacted Uniform Powers of Appointment Act.16 The UTDA speaks in terms of the “first trust” and the “second trust” throughout the Act.The “first trust” is the trust over which a trustee has the power to decant and is governed by the trust agreement’s pre-decanting terms, and the “second trust” is the first trust after modification or restatement and is governed by the decanted trust’s terms.17
Although the term “decanting” evokes the image of pouring the existing trust assets into a newly written trust agreement that is entirely separate from the first trust agreement, that is not the only kind of decanting permitted by the UTDA. The UTDA specifically contemplates and allows for a fiduciary to decant by modifying specific provisions in the first trust agreement and leaving the remainder of the first trust agreement in placemuch like an amendment to a revocable trust agreement.18 Trust decanting under the UTDA is a three step process: (1) notice; (2) lapse of the notice period; and (3) signed record by the fiduciary.
After having made the decision to decant, a trustee first must send notice of the proposed decanting to the following individuals: the settlor of the trust (if alive), the qualified beneficiaries of the trust (as defined in Virginia Code section 64.2-701), any holders of presently exercisable powers of appointment over the trust, any person who has the right to remove or replace any fiduciary, any co-fiduciaries, any newly appointed fiduciaries of the second trust, any advisor or trust protector of the trust, and any person holding an adverse interest who has the power to consent to the revocation of the trust.19 In the case of a charitable interest, the trustee must also send a copy of the notice to the Attorney General, as the Attorney General is treated as a qualified beneficiary of a trust with a charitable interest.20 The notice must contain details about the proposed decanting, the effective date of decanting, a copy of the first trust agreement, and a copy of the second trust agreement (or modifications to the first trust agreement).21
The UTDA’s notice requirements comport with the Uniform Trust Code’s mandate thatthe trustee has a duty to keep qualified beneficiaries “reasonably informed about the administration of the trust and of the material facts necessary for them to protect their interests.”22 Unlike the trustee’s formal duty to inform and report, which can be waived under the terms of a trust agreement,23 the notice that must be provided under the UTDA cannot be waived in the trust agreement and always must be given to the required parties.24
After giving notice to the appropriate parties, the trustee may proceed with decanting fifty-nine (59) days after the day notice is given.25 In the case of an agreed-upon trust decanting, the notice recipients may waive the notice period in a signed record, and the trustee has the ability to decant before the expiration of the formal notice period.26
The trustee is not required to obtain consent from any of the parties entitled to receive notice under the UTDA, nor is the trustee required to stop the decanting process if it receives any objection to the proposed decanting.27 The UTDA does provide, however, that the receipt of notice, the waiver of the notice period, or the expiration of the notice period does not preclude any interested party’s right to file an action with the court asserting that the decanting was an abuse of the trustee’s discretion or a breach of fiduciary duty.28
Signed Record of Decanting
After the expiration of the notice period (or after the complete waiver of such a period), the trustee must make a signed record of the decanting, which identifies the first and second trusts and the corresponding trust agreements, identifies the property being transferred to the second trust, and states whether any property remains in the first trust.29 In the case of a decanting that modified the first trust rather than drafting a new trust agreement, the signed record may be the first trust instrument incorporating the modified terms of the decanting.30
A trustee is not required to obtain court approval for decanting, but the trustee or any party who is required to receive notice under the UTDA can petition the court to provide any “relief to carry out the purposes” of the UTDA.31Specifically, the UTDA provides that a court can determine whether a proposed decanting is permitted under the UTDA and is consistent with the fiduciary duties of the trustee; can approve an exercise of the decanting power; or determine that an exercise of the decanting power is ineffective because it does not comply with the UTDA or is an abuse of the fiduciary’s discretion or a breach of fiduciary duty.32
Statutory and common law fiduciary duties like the duties of loyalty and impartiality still govern how a trustee can decant a trust. For instance, the Uniform Law Commission gives the example that a trustee could not decant to permit self-dealing with the second trust as that self-dealing would inherently be a breach of the trustee’s fiduciary duties to the trust and its beneficiaries.33 Additionally, a trusteeis not authorized to decant with the purpose of inserting provisions in the second trust indemnifying or exculpating any of the trustee’s actions under the first trust instrument.34 The UTDAspecifically provides that decanting does not relieve the trust property from any liability that otherwise attaches to the trust property prior to decanting.35
Virginia law does not impose upon a trustee the affirmative duty to exercise the decanting power, but if a trustee does exercise its discretion to decant a trust, then the decanting must be exercised in accordance with the trustees fiduciary duties.36 There is an argument under common law that if the trustee was aware of circumstances affecting the trust that could be modified through decanting to better serve the trust and/or its beneficiaries, then it could be a breach of fiduciary duty to not decant the trust when made aware of these circumstances.37
The UTDA contains a specific provision that disallows decanting in a way that would disqualify the second trust for certain tax benefits or tax treatment afforded to the first trust.38 For example, a trustee cannot decant a trust in a way that would jeopardize the marital deduction or charitable deduction of the trust.
In I.R.S. Notice 2011-101, the Service requested comments from practitioners regarding the tax consequences of decanting, and so presumably regulations and IRS guidance will follow.39In Revenue Procedure 2017-3, the Service reiterated that it will not issue any private letter rulings with respect to decanting and specifically on the following three topics: (1) the fiduciary income tax consequences of a change in beneficial interest; (2) whether a change in beneficial interests is treated as a taxable gift; and (3) whether property from a generation-skipping transfer (“GST”) exempt trust that changes beneficial interests results in the loss of GST exempt status or constitutes a taxable termination or distribution under I.R.C. section 2612.40
Without any relevant statutes, regulations, or other guidance from the Service on the tax implications of decanting, practitioners and scholars suggest that “making analogies to other transfers about which the law is more developed may be an appropriate substitute.”41
On a practical level, there seems to be some disagreement among practitioners about whether a trust needs to obtain a new EIN after decanting. In the case of a modification of the first trust, it seems logical that because the newly decanted trust is a continuation of the original trust with slightly modified terms that the trust does not need to obtain a new EIN after the decanting. Similarly, it would follow that none of the trust assets need to be re-titled to fully effect the decanting. However, there seems to be some disagreement as to whether the second trust, if fully re-written and not simply modified, would need to obtain a new EIN after decanting.42 Obviously this would cause the decanting to be a longer and more expensive process with re-titling of all of the trust assets, opening and closing of bank accounts, etc.
Generally decanting is a nonrecognition event for income tax purposes, and trust beneficiaries should not recognize any gain or loss upon the decanting.43 Practitioners generally agree that all tax attributes of the first trust, such as basis, unused net operating losses,and carry-over losses, are maintained in the second trust, and “if the entire trust property is decanted into another trust, the new trust is the same trust for income tax purposes as the one from which the payment was made.”44
Estate and Gift Tax
If the decanting of a trust does not affect the settlor’s powers or interests in the trust, then there should be no adverse estate tax consequences. However, it is possible to create unintended or adverse estate tax consequences for the beneficiaries of a trust that is being decanted. For example, if a trustee were to grant a beneficiary a general power of appointment in the second trust, the decanting may cause inclusion of trust assets in that beneficiary’s estate that would not have been included but for the decanting.45
There should be no gift tax consequences to decanting unless the trustee exercising the decanting power is also a beneficiary of the trust or if the decanting modifies a beneficiary’s presently exercisable power or withdrawal or presently exercisable general power of appointment.46 Before the adoption of the UTDA, there had been some concern that if a beneficiary had a right to object to the decanting and failed to do so, then the relinquishment of the right to property from the trust for less than full and adequate consideration would be considered a taxable gift.47The UTDA addressed this issue directly by not requiring a beneficiarys consent or acquiescence to effect the decanting; because the beneficiary does not possess an enforceable right to receive the trust property, then there is no taxable gift (even if the beneficiary actually does consent or approve the decanting).48
Generation-Skipping Transfer Tax
Because decanting is often used to modernize or update old and stale trusts, presumably many of the trusts ripe for decanting will be exempt from GST tax because they were created prior to the adoption of the GST tax in 1986. One major concern, therefore, is whether decanting will cause a GST exempt trust (either because the trust was created prior to 1986 and is “grandfathered” or whether it is exempt because GST exemption has been allocated to it), to lose its GST exempt status or cause a taxable termination or distribution under the GST rules.
In late 2000, the Service issued Treasury Regulations that contained four “safe harbors” for changes that could be made to a GST exempt trust without causing the trust to lose its GST exempt status: (1) discretionary distributions safe harbor; (2) court-approved settlement safe harbor; (3) judicial construction safe harbor; and (4) trust modification safe harbor.49 In addition to the regulatory safe harbors, the Service, through a series of pre-2000 private letter rulings, suggested that GST exempt status is only lost by modifying a trust if the modification to the trust “changes the quality, value or timing of any powers, beneficial interests, rights or expectancies originally provided for under the terms of the trust.”50The 2000 Treasury Regulations did not refer to this so-called “no change” rule, which leaves open the question of whether a trust modification that fails to qualify for one of the safe harbors may still retain its exempt status based on the no change test, but it seems to be a reasonable position for a trustee to take with the Service.51
Because the loss ofGST exempt status could be extremely costly to high net worth families with dynasty trusts spanning generations, it is difficult to say whether trustees should rely on the safe harbors or the no change test when deciding to decant a GST exempt trust or whether such a trustee should wait, if possible, until the Service does issue guidance on the issue. There is an argument that decanting without any binding authority on the tax implications could be considered a breach of fiduciary duty if the decanting caused the trust to lose its GST exempt status and resulted in a taxable termination or distribution at the then applicable GST tax rate, which is currently forty percent (40%).
Drafting for Decanting
As stated earlier, the UTDA will apply to any trust now in existence or drafted in the future, regardless of whether the trust instrument makes specific reference to the trustee’s power to decant. A spendthrift clause or a statement saying the trust is irrevocable will not be enough to disqualify the trust from decanting under the UTDA, and the trust instrument’s allowance for the modification of the trust agreement through some other mechanism (such as a trust protector) does not preclude the trust from also being able to be decanted under the UTDA.52 If a settlor desires to limit a trustee’s ability to decant in some way, then a settlor can specifically providein a trust instrument that the fiduciary cannot decant (or make specific modifications) by a specific reference to the UTDA.53 The settlor could also impose a requirement in the trust instrument that decanting requires court approval prior to the trustee exercising the discretion to decant, and that provision will be honored and carried over into the second (or modified) trust.54
Despite its somewhat uncertain tax consequences, the UTDA is the way of the future for trust modification. It will take trustees and practitioners some time to get acclimated to decanting as a viable option for non-judicial modification and also to tackle some of the risks that trustees take by pursing decanting, but the UTDAs flexibility and solid statutory framework combined with the larger context of the Uniform Trust Code will support and propel trust administration and modification into the future.
- Va. Code Ann. 64.2-778.1 (1950) (now repealed).
- Uniform Law Commission, Legislative Fact SheetTrust Decanting, http://uniformlaws.org/LegislativeFactSheet.aspx?title=Trust%20Decanting (last visited Aug. 10, 2017).
- Unif. Trust Decanting Act, Prefatory Note (Unif. Law Commn 2016).
- Va. Code Ann. 64.2-701.
- Unif. Trust Decanting Act, Section 2.
- Va. Code Ann. 64.2-701.
- Va. Code Ann. 64.2-779.8; Unif. Trust Decanting Act, to Section 11 cmt.
- Unif. Trust Decanting Act, Section 12 cmt.
- Va. Code Ann. 64.2-779.9; Unif. Trust Decanting Act, to Section 12 cmt.
- This particular prohibition on accelerating any remainder interest is presumably to avoid any argument from the IRS that accelerating a remainder interest is an I.R.C. 674 grantor trust power that would cause the trust to be treated as a grantor trust as to the trustee. See Jonathan G. Blattmachr, Jerold I. Horn, & Diana S.C. Zeydel, An Analysis of Tax Effects of Decanting, 47 Real Property, Trust, and Estate Law Journal 141, 159 (Spring 2012).
- Va. Code Ann. 64.2-779.8.
- Id. 64.2-779.3.
- Va. Code Ann. 64.2-700 et seq.; Va. Code Ann. 64.2-2700 et seq.
- Id. 64.2-701.
- Unif. Trust Decanting Act, Prefatory Note.
- Va. Code Ann. 64.2-779.5.
- Id. 64.2-779.11.
- Id. 64.2-779.5.
- Id. 64.2-775(A).
- Id. 64.2-775(D).
- Va. Code Ann. 64.2-779.5.
- Id. 64.2-779.5.
- Id. 64.2-779.5.
- Unif. Trust Decanting Act, Section 7 cmt.
- Va. Code Ann. 64.2-779.5
- Id. 64.2-779.7.
- Unif. Trust Decanting Act, to Section 10 cmt.
- Va. Code Ann. 64.2-779.6(A).
- Unif. Trust Decanting Act, to Section 4 cmt.
- Va. Code Ann. 64.2-779.24.
- Id. 64.2-779.2.
- The Restatement (Third) of Trusts could be read to a create fiduciary duty to modify or decant the trust if the trustee knows or should know of circumstances that justify judicial action in administrative provisions. Unif. Trust Decanting Act, to Section 4 cmt. (citing Restatements (Third) of Trusts 66(2)).
- Va. Code Ann. 64.2-779.16.
- I.R.S. Notice 2011-101, 2011-52 I.R.B. 932 (Dec. 27, 2011).
- Rev. Proc. 2017-3, 2017-1 I.R.B. 130 (Jan. 3, 2017).
- Blattmachr, supra, at 150.
- Unif. Trust Decanting Act, Prefatory note (Subject to future tax guidance, if the second trust is a continuation of the first trust, there may be no need to treat the first trust as having terminated for income tax purposes and no need to obtain a new tax identification number.); William R. Culp, Jr. & Briani Bennett Mellen, 871 T.M., Trust Decanting, at IV.D(5)(c) (If decanting results in all of the assets of one trust being transferred to a second trust, then the second trust should be entitled to use the first trust’s tax identification number. Alternatively, the second trust should have an election to receive a new tax identification number (citing Cf.PLR 200607015)); Brandon A.S. Ross, Practical Considerations of Decanting, 30(2) Probate & Property Magazine 36 (Mar-Apr 2016) (After creating the Second Trust, one should obtain a new employer identification number (EIN) for the Second Trust).
- Blattmachr, supra, at 158.
- Id. at 154 (citing PLR 200736002).
- 871 T.M., Trust Decanting at IV.B.
- Id. at IV.C.
- Id. at IV.C.
- Id. at IV.C.4(a)(1).
- Treas. Reg. 26.2601-1(b)(4)(i)(A)(D).
- 871T.M.,Trust Decanting at 871.IV.A(1)(a) (citinge.g.,PLR 200052007,PLR 9732034,PLR 9318019,see alsoPLR 8851017.).
- Id. at .IV.A(1)(b).
- Va. Code Ann. 64.2-779.12 (1950); Unif. Trust Decanting Act, Section 15 cmt.
- Va. Code Ann. 64.2-779.12 (1950).
- Unif. Trust Decanting Act, Section 15 cmt.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.