By Carol F. Burger, Molly F. James, Melissa Roberts Tannery and Tania S. Sebastian
Effective July 1, 2012, Virginia has a new law which permits the trustee to change some provisions of an irrevocable trust by appointing or decanting income and/or principal of a trust to another trust, under certain circumstances. Unless the terms of a trust expressly prohibit decanting, this law may be applied to any trust governed under Virginia law, without further court approval or consent of the beneficiaries (although a beneficiary has a right to commence a proceeding to approve or disapprove such action by the trustee). Virginia joins at least 14 states that have already passed similar legislation authorizing decanting.
Decanting is permitted if a trustee who is not an "interested trustee" has a discretionary power to distribute principal or income of the original trust to or for the benefit of one or more current beneficiaries. The new law authorizes the trustee to exercise this discretionary power to appoint some or all of the principal and/or income in favor of a second trust, which may also be a trust created by that trustee.
If the trustee's discretionary power is limited by an ascertainable standard, the same beneficiaries who may benefit from the original trust under this standard must benefit from the second trust, under the same standard. However, only one or some of the current beneficiaries of the original trust need be included in the second trust if the trustee has an unlimited discretionary power. Significantly, whether or not the trustee's discretionary power is limited, the second trust may confer a power of appointment upon a current beneficiary of the original trust, and permissible appointees of such power of appointment need not be beneficiaries of the original trust.
Decanting can fix administrative issues for the trust as well as respond to changing circumstances of the beneficiaries by, for example, permitting the trustee to decant to a trust that has more modern administrative provisions, changing the trust situs and the governing law, or trustee provisions. Other uses for decanting include where a trust advisor, trust protector or co-trustees are desired but not permitted under the terms of the original trust.
This new law imposes particular restrictions when decanting. For example, a current beneficiary who is a trustee may not decant under this new law. Neither can a trustee who could be removed or replaced by a current beneficiary who has the power to designate a related or subordinate party as a trustee.
Other restrictions under the new law work to preserve marital and charitable deductions taken with respect to contributions to the original trust, to retain the original vesting period for contributions made to the original trust that were treated as annual exclusion gifts, and to maintain consistent treatment in the application of the permissible period of the rule against perpetuities as it related to the original trust, under Virginia's property laws, specifically Va. Code. Ann. §§ 55-12.1 through 55-13.3. Perhaps the most significant restriction is that the second trust may only include beneficiaries of the original trust.
Although this law permits the trustee to decant without the consent of the original trust's beneficiaries, absent a signed written waiver by the qualified beneficiaries of the original trust, the trustee must still provide to those beneficiaries, the grantor of the trust (if living), and any persons acting as an advisor or protector of the trust, a written notice of the trustee's intent to decant at least 60 days prior to the effective date of such action.
At present, the IRS has yet to rule on what possible (adverse) tax consequences may occur by decanting. In Rev. Proc. 2011-3, 2011-1 I.R.B. 111 (and reaffirmed in Rev. Proc. 2012-3, 2012-1 I.R.B. 113), the IRS added decanting to its "no ruling" list, prohibiting rulings and determination letters from being issued on matters pertaining to decanting, until it publishes guidance on this issue. Comments on decanting were requested in IRS Notice 2011-101, and we expect to see guidance published by the IRS very soon.
Troutman Sanders Trust and Estate Attorneys can assist trustees who wish to decant a trust by preparing the necessary documentation.
©Troutman Sanders LLP
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