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George F. Bearup, J.D. Senior Legal Trust Advisor

6-Jun-19

Consolidating and Dividing Trusts

Take-Away: Often trust instruments have as part of their ‘boilerplate’ provisions the trustee’s power to divide or consolidate trusts. Those provisions are usually included in anticipation that the trust has a generation skipping transfer tax implications which need to be navigated and assets segregated in order to preserve and best utilize the settlor’s generation skipping transfer tax (GST) exemption. Even if the trust instrument does not expressly give the trustee the power to divide (or to consolidate) trusts, these powers are available to the trustee as part of the Michigan Trust Code.

Background: One of the ‘default’ powers held by a trustee under the Michigan Trust Code is the power to divide or consolidate trusts. [MCL 700.7417.] The trust settlor is free to depart from the following rules, or expressly opt-out from their application in his or her trust instrument.

  • Trust Division: If the trustee believes that an existing trust needs to be divided, the trustee can give notice to qualified trust beneficiaries and holders of powers of appointment of the trustee’s intent to divide the trust into 2 or more separate portions or trusts and allocate property between the separate trusts. However, the trustee’s ability to divide a single trust into different portions or separate trusts requires that the ‘divided’ trusts have substantially identical terms and conditions, and the result of the division into separate trusts or portions does not impair rights of any beneficiary or adversely affect “achievement” of the trust (achievement is term which I interpret to mean the trust’s material purposes, although I have no idea why the term achievement was selected). [MCL 700.7417(1).]
  • Trust Consolidation: The same rules apply as to notices and conditions, if the trustee wants to consolidate two trusts into a single trust. However, with the consolidation of two (or more) trusts, if these trusts have different applicable rules against perpetuities periods, the property held in the consolidated trust must be maintained in separate accounts by the trustee in order to recognize and give effect to the different rules against perpetuities which limit a trust’s maximum duration. [MCL 700.7417(2).]
  • Notice: The required notice to be given by the trustee to qualified trust beneficiaries [a term of art that is defined at MCL 700.7103] is intended to give the beneficiaries an opportunity to object and seek a court determination of the trustee’s proposed division of the single trust or the consolidation of two or more trusts.

Comment: Unlike the notice that is required to be given by the trustee when the trustee proposes to exercise its power to decant the trust’s assets to a new trust, where the trustee is required to give at least 63 days advance notice to qualified trust beneficiaries before decanting the trust assets [MCL 700.7820a (7)], no time duration is imposed on the trustee’s notice of intent to consolidate or to divide the trust before that power can be exercised. By not attaching an express duration to the trustee’s obligation to give notice seems to make the purpose of giving the trust beneficiaries the opportunity to object illusory, since the division or consolidation proposed by the trustee could be in place a long in before a probate court is in a position to second-guess the trustee’s division or consolidation decision.

Comment: Like the trustee’s exercise of its decanting power under the Michigan Trust Code, the qualified trust beneficiary’s consent is not required for the trustee to be able to exercise its power to divide or consolidate the trust. In contrast, Ohio’s trust consolidation statute requires each beneficiary’s consent to the proposed trust consolidation. [Ohio Rev. Code, 13339.67.]

When the Division Power Might be Exercised:  There could be tax reasons why the trustee decides to divide a trust into two or more portions or trust shares.  Often the decision is pursued to obtain maximum advantage of GST exemptions applied to the trust, so long as the terms of the trusts are identical, which permits different investment objections to be pursued and to allow for discretionary distributions to be made from one trust and not the other. In fact, claims have been filed against trustees that fail to pursue a division of the trust to achieve or maximize GST tax savings. See Marquis v. Marquis, 437 Mass. 1010, 771 N.E. 133 (2002) in which the court granted to the trustee authority to divide a trust corpus in order to save GST taxes.

When The Consolidation Power Might be Exercised: A consolidation of two or more trusts might be a solution to a small, i.e. uneconomic, if for some reason  the value of the trust not small enough to permit its termination by the trustee [MCL 700.7414]. Even if the value of the trust corpus is small enough to permit the trust’s termination by the trustee, the unique circumstances of the trust beneficiary might justify continuing to hold the assets in the consolidated trust to be administered for the beneficiary’s welfare. Other trust consolidations are often justified by the administration of closely held business or other common investments in each trust, or the perceived simplification in trust administration and presumed cost savings associated with reporting and accounting for one trust as opposed to multiple trusts.

Drawbacks to Trust Consolidations: Even after two or more trusts are consolidated the trustee must maintain records that clearly indicate the respective interests prior to the consolidation. [MCL 700.810(d).] In addition, while a trustee may want to consolidate trusts for investment purposes, if the trustee is given the power under one of the two trusts to invade trust principal, the trustee needs to have a strong operations department to keep track of the implications of a discretionary principal distribution. Each time a principal distribution is made to one beneficiary out of the common trust fund but not to the beneficiary under the other trust, it becomes that much more difficult for the trustee to keep track of a separate trust’s allocable share of principal and the income that it generates. Moreover, if the trustee misdelivers an asset from the consolidated trust, that is a clear breach of fiduciary duty. Consequently, the benefits of aggregating two trusts into a single trust need to be weighed against its risk, particularly the risk of the trustee improperly accounting for income and principal.

Conclusion: In the absence of an express prohibition contained in a trust instrument, a trustee possesses the default power under the Michigan Trust Code to divide a trust into separate trusts, or to consolidate two or more trusts into a single trust. Usually tax reasons warrant a division of a trust into separate trust shares. Alternatively, administrative convenience and economies of scale usually are the reasons why two or more trusts are consolidated into a single trust. In a trust consolidation situation, the trustee must have operational support to ensure that its accounting responsibilities are capable of monitoring and reporting each separate trust corpus.