Take-Away: Gift tax traps lurk when trust instruments are modified, or trust assets are decanted, and the beneficiary’s waiver and/or consent is solicited to the proposed trust modification or administrative act. There could be occasions when the trustee should not ask for the beneficiary’s formal consent to a proposed modification or decanting.

Background: A trust beneficiary can be treated as making a taxable gift when the non-beneficiary trustee exercises a power that increases or creates a new interest in a trust if the beneficiary fails to object to the trustee’s exercise of discretion or power. The trust beneficiary will more likely be viewed as making a taxable gift if that beneficiary affirmatively consents to the trustee’s proposed exercise of power, especially when the beneficiary’s objection would have prevented or reversed the created interest. [Treas. Reg. 25-2512-8.] This gift tax treatment can arise even when the donees of the deemed transfer have not yet been born. Nor will it matter that the deemed transfer (by the trust beneficiary) is difficult to value. [Treas.Reg. 25.2511-1(e).] Accordingly, as we move into an era when trust modifications and trust asset decantings become more commonplace, it is a good practice to think twice before the trustee asks a trust beneficiary to formally consent to the proposed trust modification or asset decanting.

Michigan Decanting Statute: This implied gift treatment is probably one of the reasons why Michigan’s trust decanting statute only requires that the trustee provide notice of the proposed trust decanting after a 63-day notice to the trust beneficiary, and it does not require the need for waivers and consents signed by each trust beneficiary to the trustee’s proposed asset decanting.

Examples: Situations can arise when a deemed gratuitous (possibly taxable) transfer arises by an individual, either by ‘sitting on their rights’ or if he/she cooperates in a proposed transaction where their existing property rights or interests are in some manner curtailed. Some examples follow:

  • Decanting: The trustee sought court approval to decant trust assets to a new trust. The state’s statute with regard to trust asset decantings only authorized a decanting if the trustee possessed the absolute discretion to make principal distributions. The trust instrument in question authorized distributions of principal only for the beneficiary’s health, education, maintenance and support (HEMS.)  The court held that the beneficiary’s consent to the proposed unauthorized trustee decanting of the trust assets did not make the decanting valid. Moreover, the trust beneficiary’s consent to the unauthorized decanting of the trust’s assets was treated as a gratuitous (taxable) transfer by the trust beneficiary who provided the consent to the unauthorized decanting. Estate of Mayer, 672 N.Y.S. 2d 998 (N.Y. Sur. Ct. 1998)
  • Trust Termination: A trust beneficiary’s written consent to a trustee’s discretionary decision to make a distribution to other non-consenting beneficiaries upon the trust’s termination resulted in a taxable gift by the trust beneficiary. Private Letter Ruling 200917004 (April 4, 2009).
  • Trust Situs Change: A trust beneficiary’s consent to a change of the trust’s situs and governing law to a jurisdiction that altered the legal definition of descendants to include adopted children, when adopted children were not originally included as descendants in the trust instrument, was a deemed taxable transfer by the consenting trust beneficiary. Private Letter Ruling 9308032 (Nov. 30, 1992)
  • Failure to Timely Exercise Rights: The failure of the holder of a promissory note to demand payment on the loan after the statute of limitations had expired is deemed a taxable gift because the lender relinquished any control over the ability to enforce the promissory note. Revenue Ruling 81-264.
  • Failure to Object to Fiduciary Accounting: The failure of a beneficiary to object to a fiduciary accounting that demonstrated an underfunding by a personal representative of a testamentary trust was held to be a taxable gift by the non-objecting beneficiary to whom the accounting was given. Revenue Ruling 84-105.
  • Donees Not Identifiable: An individual was treated as having made a taxable gift, even when it was of no ascertainable value, to then non-existent grandchildren. Robinette v. Helvering, 318 U.S. 184 (1943.)
  • Gifts of Contingent Rights: Gift tax implications can even arise with regard to a property interest that is merely a concept or contingent right. Smith v. Shaughnessy, 318 U.S. 180 (1943).

When Asking for a Consent is Problematic: In this era of non-judicial settlement agreements, trust modifications, trust terminations, and trust asset decantings, all of which are designed to make the trust more responsive to law changes and the needs of the trust beneficiaries, there may be situations when it might not be a good idea for the trustee to solicit the beneficiary’s formal waiver and consent to a proposed trust modification, or other course of conduct or transaction that would impact the beneficiary’s rights under the trust.

  • Medicaid eligibility: If a trustee wants to convert a conventional HEMS distribution trust to a wholly discretionary supplemental needs trust for its beneficiary, the trustee should NOT ask the beneficiary to consent to that conversion. If the beneficiary were to formally consent to the trustee’s actions, that consent could be construed as the transfer by the trust beneficiary of an available resource under Medicaid regulations.
  • Court restaining orders: If a trustee decides to decant the trust assets to a new trust which results in the elimination of the beneficiary’s withdrawal rights because the trust beneficiary is going through a divorce, the trustee should NOT solicit the beneficiary’s consent, in order to avoid triggering the divorce court’s equitable powers or create a situation where it appears that the trust beneficiary is intentionally violating a court restraining order entered as part of the divorce litigation. See Ferri v. Powell-Ferri, 72 N.E.3d 541, 544 (Mass. 2017).
  • Incarcerated trust beneficiaries: The trust beneficiary is incarcerated. The trustee wants to modify the trust instrument and it would like all trust beneficiaries to consent to the proposed trust modification. Most states, and the federal government, have statutes that force inmates to contribute their own resources towards their confinement expenses. Sending the proposed consent to the prisoner-beneficiary, care of the penitentiary’s warden, would result in a disclosure of the existence of the beneficiary’s interest in the trust and invite litigation to access the trust’s assets. For an analogy, see Wright v. Michigan Department of Treasury, (In re Donald Wright Trust Agreement) Nos 319832, 319834 2015 Mich App LEXIS 543 (March 17, 2015).
  • Creating beneficiary disharmony: A trust beneficiary requests that the trustee loan trust assets to that trust beneficiary. The trust instrument is not clear that a loan to a trust beneficiary is authorized or permissible. Before making any loan the trustee would like the ‘cover’ of consents from all trust beneficiaries. The trustee’s request for consents from all trust beneficiaries to the proposed loan transaction to one trust beneficiary could create considerable family disharmony among all the trust beneficiaries, especially if a ‘pot trust’ is used to make distributions to or among all of the trust beneficiaries.

Conclusion: Trustees often seek the protection provided by waivers and consents from trust beneficiaries before transactions are entered or decisions are made with regard to the administration of a trust. However, before a trust beneficiary is asked to sign a waiver or consent, first consider any implied gift tax implications if the requested consent be given to the resultant impact on the value of the beneficiary’s interest in the trust. In addition, consider the practical and financial implications that might result from making others aware of the existing beneficiary’s rights or interests in the trust, or disclosing the reasons why the trustee from the trust beneficiary solicits the consent.