Article on the Tax Effects of Decanting

Most states permit judicial modification of a trust, at least in certain circumstances. Yet, a judicial modification of an irrevocable trust may not be entirely satisfactory because the requirement to respect the settlor’s intent, at least to some degree, may constrain the court’s authority. In addition, a judicial modification that requires beneficiary approval may have adverse tax consequences. If, however, the trustee could pay all or part of the corpus over to a different trust, that may remove the adversity, inefficiency, or lack of benefit with the least number of adverse consequences, including adverse tax consequences or opposition by one or more of the beneficiaries. In some cases, the drafter will expressly authorize the trustee or another to make such a payment or to “decant” the trust. But many trust instruments do not expressly contain that authority, although one may contend that a power to “apply” a distribution for a beneficiary’s benefit includes a power to pay trust assets over to another trust for the beneficiary. By statute, a growing number of states expressly authorize a trustee, at least in certain circumstances, to pay the corpus–and, in some cases, the income–of one trust over to another.

By analogy to the pouring of a liquid, such as wine, from one container to another, the power of a trustee to invade the corpus of one trust in favor of another trust is commonly referred to as “decanting.” For purposes of this article, a decanting power is a power exercisable by the trustee of an irrevocable trust–under the common law, the express grant of authority of a governing instrument, or an applicable state statute, and in all cases without prior court approval or prior beneficiary consent–to invade the corpus of the original trust, in whole or in part, in favor of another trust for the benefit of one, some, or all of the beneficiaries of the original trust. This article discusses the potential tax effects of decanting.