Technique of the Month: Decanting to Remove a Mandatory Income Interest
By Steven J. Oshins, Esq., AEP (Distinguished)
Trust decanting is the act of distributing assets from one trust to a new trust with different terms. Just as one can decant wine by pouring it from its original bottle into a new bottle, leaving the unwanted sediment in the original bottle, one can pour the assets from one trust into a new trust, leaving the unwanted terms in the original trust.
Which States Allow a Decanting to Removing a Mandatory Income Interest?
There are now 25 states that have decanting statutes. Of the 25 states, only six of them allow a decanting to remove a mandatory income interest. These states are Delaware, Missouri, Nevada, Ohio, South Carolina, and South Dakota.
Of these six states, Delaware, Nevada, Ohio, and South Dakota stand out as all being generally considered first-tier or second-tier trust jurisdictions, so assume that these are the four options that the reader will likely consider as the destination to take advantage of the opportunities described in this article.
The estate planner will generally take advantage of one of these four jurisdictions by (1) moving an existing trust situs to the preferred jurisdiction via a specific power provided in the trust agreement, (2) decanting from the current trust jurisdiction to the new preferred trust jurisdiction, or (3) using a non-judicial settlement agreement to change the trust situs to that of the favored trust jurisdiction.
Why Remove a Mandatory Income Interest?
There are two primary reasons to remove a mandatory income interest: (1) creditor and divorce protection, and (2) federal and state income tax savings. These are not the only reasons, but these are the two that will be highlighted herein.
Creditor and Divorce Protection – A trust with mandatory income distributions to a beneficiary gives that beneficiary a vested right to those distributions. This vested right is an asset that can be reached by the beneficiary’s creditors and is an asset that can be part of a marital estate and divisible in a divorce. If the trust is decanted and the trust assets are distributed into a new trust that doesn’t require mandatory income distributions, then the trustees have the discretion to distribute some, none or all of the income, but without the beneficiary having a vested right that can be taken by a creditor or in a divorce.
Federal and State Income Tax Savings – A trust with mandatory income distributions to a beneficiary forces the taxable income on to that beneficiary’s income tax return regardless of whether that beneficiary even needs or wants the income. Why not have the option to retain the income in the trust to exploit the situation where the beneficiary and the trust are in the same federal income tax bracket, but the beneficiary lives in a state with a state income tax? And why not give the trustees the power to sprinkle the income to multiple beneficiaries, including beneficiaries who are in a lower federal and state income tax bracket than the trust or than the so-called primary beneficiary who doesn’t want or need the income? The tax savings can be significant.
Conclusion
Delaware, Nevada, Ohio, and South Dakota are the key states of the six states that have statutes allowing a trustee to decant the trust into a new or different trust that removes a mandatory income interest. Because there are only a handful of trust jurisdictions that allow for this flexibility, this opportunity often goes unnoticed by planners.
Estate planners should look for opportunities to exploit this strategy by moving trusts domiciled in other states to one of these four states and then decanting the trust to remove the mandatory income interest for the reasons discussed in this article.
ABOUT THE AUTHOR
Steven J. Oshins, AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018, 2020, 2022, 2024 and 2026. He can be reached at 702-341-6000, ext. 2 or [email protected]. His law firm’s website is www.oshins.com.