Irrevocable trusts restrict a beneficiary’s access to assets. Generally, trusts are designed to provide trustees with sufficient flexibility to achieve the settlor’s goals. However, until Doc Brown perfects the Flux Capacitor, the unforeseeable will occur and trusts, which were thought to be perfect in every regard at inception, will fail to achieve the settlors’ goals.
Recently, decanting has come into vogue as a means to cure a trust's failings. What is decanting? Decanting is the term used to describe a trustee distributing assets from one trust to a new trust, with different terms and conditions. The rationale is simple, a trustee that has the power to distribute property to or for the benefit of a trust beneficiary should also have the power to distribute such property to the beneficiary in trust and stipulate the terms and conditions of that trust.
Decanting can be incredibly powerful—a beneficiary’s rights can be drastically curtailed. For example, consider a hypothetical trust that will terminate upon its beneficiary’s 25th birthday and distribute all of its assets outright to that beneficiary. Through decanting a trustee could extend the duration of the trust so that it would last for the beneficiary’s lifetime.
While the flexibility can be helpful, such as stretching out a trust if a beneficiary is struggling with addiction, or in qualifying a trust as a Qualified Subchapter S Trust (QSST), decanting is fraught with traps for the unwary, such as whether the decanting results in distributable net income under I.R.C. § 662(a) or whether the decanting will result in a taxable termination under the Generation-Skipping Transfer Tax. Consequently, it is imperative that trustees consult an attorney with a strong tax background when considering decanting to “fix” a broken trust.