There are 22 states that have statutes allowing the distribution trustee of an irrevocable trust to decant the trust. The trustee decants the trust by distributing the trust assets into a different trust with different terms for one or more of the same beneficiaries of the original trust. In most cases, this second trust is a brand new trust. Essentially, this gives the trustee a “do-over” to make changes to the trust terms that traditionally would not have been permitted prior to the ability to decant without a judicial modification.
Some of the states with decanting statutes allow for greater flexibility than others. Nevada has traditionally been one of the most innovate states when it comes to decanting. As a result of the passage of SB484 in the 2015 Nevada legislative session, there will be even more opportunities to change the situs of a trust to Nevada in order to take advantage of the new legislation that is effective for any trusts decanted on or after October 1, 2015.
Ability to Remove Certain Mandatory Income Interests
Prior to SB484, a trustee would not have been permitted to decant a Nevada trust into a second trust if the result of appointing the property from the original trust would be to reduce a current fixed income interest, annuity interest or unitrust interest of a beneficiary. For example, if a trust was established by a parent for a child and provided that the child was to receive all income, the trustee of the original trust would be permitted to decant the property into a second trust that modified the terms as it relates to the principal, but the second trust would still have to require that all of the income be payable to the child.
SB484 modifies this restriction. Under the new Nevada law, a trustee is permitted to decant a Nevada trust into a second trust that removes the fixed income interest, so long as the original trust from which the trustee is decanting did not qualify for a marital deduction or charitable deduction, and was not one that paid a qualified interest pursuant to IRC § 2702. If the original trust that is being decanted did qualify for a marital or charitable deduction or is one that pays a qualified interest under IRC § 2702, the same limitation prior to the modification applies and the trust may be decanted, so long as the second trust does not reduce the income interest of an income beneficiary of the original trust.
Most notably, the ability to decant an irrevocable trust to remove a mandatory income distribution affects two important areas: (1) creditor protection, and (2) federal and state income tax bracket shifting opportunities.
Creditor Protection Advantages: Unless there is a compelling reason to design a trust to force all income to be distributed out to a beneficiary, from a creditor protection standpoint this gives that beneficiary a property right over all of the income, and having that property right can open the income stream up to a creditor or a divorcing spouse. It is likely that most of our clients, if they could go back in time, would prefer to have used a trust that did not force the income out, especially since so many of the beneficiaries may go through a divorce. The new Nevada statutory changes enable to the advisor to help the client enhance the creditor and divorce protection of a trust by decanting it to remove the mandatory income distributions.
Income Tax Advantages: Nobody can accurately predict future irrevocable trust federal and state income tax brackets, individual federal income tax brackets or where the beneficiaries will be domiciled for state income tax purposes, and their state income tax brackets. If the trust is drafted to force all of the income out to one particular beneficiary, there is no ability to shift income to the lower federal and state income tax brackets of other trust beneficiaries, nor is there the ability to retain income in the trust if the beneficiary is in the same federal bracket as the trust, but where the trust is designed to avoid state income taxes that the beneficiary must pay if receiving the distribution. The flexibility of a discretionary trust that doesn’t force out all of the income to one particular beneficiary provides these potential advantages which is yet another reason to decant the trust to remove the mandatory income interest.
Ability to Accelerate a Beneficiary’s Interest in the Trust
As is the case with all 22 state decanting statutes, a trustee may not effectively add a beneficiary to a trust by appointing property from the original trust to a second trust that includes a beneficiary that was not a beneficiary of the original trust. SB484 gives greater flexibility to a trustee to modify the timing of a beneficiary’s interest in the trust. Under the revised statute, the second trust may have as beneficiaries any current beneficiaries of the original trust, or any future beneficiaries of the original trust.
This opens up additional income shifting opportunities along the same lines as is discussed above. The difference here is that there is also an ability to move future beneficiaries up to being present beneficiaries in order to have more potential low income tax brackets to use to reduce the family’s overall income tax liability.
Nevada continues as a leading innovator in the field of trusts. These new decanting opportunities should create a massive amount of new decanting business for the State of Nevada. Advisors should review all existing irrevocable trusts that force out the income in order to determine whether the trust agreement allows them to change the situs to Nevada, whether there is a local decanting statute that can be used to change the situs to Nevada or whether they can use a nonjudicial settlement agreement or any other means to move the trust situs to Nevada in order to gain these advantages.
ABOUT THE AUTHOR
Steven J. Oshins, Esq., AEP (Distinguished) is an attorney at the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada, with clients throughout the United States. He is listed in The Best Lawyers in America®. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011 and was named one of the 24 Elite Estate Planning Attorneys in America by the Trust Advisor. He has authored many of the most valuable estate planning and asset protection laws that have been enacted in Nevada. He can be reached at 702-341-6000, ext. 2, at [email protected] or at his firm’s website, www.oshins.com.
OTHER ARTICLES IN THIS ISSUE
- PRACTICE BUILDING: “Open Another Office!” by Philip J. Kavesh, J.D., LL.M. (Taxation), CFP®, ChFC, California State Bar Certified Specialist in Estate Planning, Trust & Probate Law
- SUPPORT & ADMINISTRATIVE STAFF: “5 Reasons Why You Should Have an Office Manager” by Kristina Schneider, Executive Assistant
- ESTATE PLANNING TAX: “Traps of Swap Powers” by Martin Shenkman, CPA, MBA, PFS, AEP, JD