Michigan Trust Decantings Redux

Take-Away: Michigan has two trust decanting statutes where trustees can transfer assets to a ‘new’ trust created by the trustee. One statute deals with changes to a trust’s administrative provisions. Another statute deals with changes to a trust’s dispositive provisions. As more clients use irrevocable dynasty-type trusts or spousal lifetime access trusts [SLATs] to exploit their recent windfall with an additional $5 million transfer tax exemption (which then disappears in 2026), there will be a need to periodically change those long-term irrevocable trust instruments to adapt their terms to future changes in the law or beneficiary needs. Thus it is important to become familiar with a trustee’s power to decant a trust’s assets to a ‘new’ trust created by the trustee.

Background: A trustee which possesses a presently exercisable discretionary power to make distributions holds a power of appointment. It is that power of appointment that confers on the trustee the ability to decant, or transfer, assets from one trust to a ‘new’ trust created by the trustee. The power to decant is presumed to exist at common law, but only recently have states decided to codify that common law power that emanates from a trustee’s discretion.

Administrative Decanting: This type of decanting under the Michigan Trust Code usually deals with administrative provisions of a trust, such as those that deal with successor trustees, the power to remove trustees, a change in trust situs, or the alteration of a trustee’s method of compensation. [MCL 700.7820a.] This decanting power cannot, however, reduce a trustee’s standard of care, expand a trustee’s exoneration from liability, or diminish or eliminate a power held by another to direct the trustee. Key is that only an administrative decanting can be accomplished if the trustee’s discretion is limited by an ascertainable standard, e.g. health, education, maintenance and support.
Dispositive Decanting: This type of decanting under the Michigan Powers of Appointment Act is used to make major changes to a trust instrument, i.e. what the beneficiaries receive. This decanting is used to remove a beneficiary, convert a mandatory distribution provision to a discretionary distribution provision, extend a trust’s duration, and possibly convert a discretionary trust to a supplemental needs trust for a disabled beneficiary who receives governmental benefits. A dispositive decanting can occur when there is no ascertainable standard that limits the trustee’s discretion, e.g. when comfort, welfare, best interests or happiness are used to guide the trustee in the exercise of its discretion. A dispositive decanting can usually only alter or modify the interests of beneficiaries who are currently eligible to receive distributions; the interests of future beneficiaries, or remainder beneficiaries of the trust normally cannot be altered by a decanting. In short, a beneficiary can be removed, but not added, to the trust with an administrative decanting. However, a general power of appointment could be given to an existing trust beneficiary using a dispositive decanting, so that through an indirect exercise of that general power of appointment, third parties could ultimately benefit from the trust even when not named as a remainder beneficiary. Note that a presently exercisable withdrawal power held by a trust beneficiary, e.g. a crummey withdrawal right, cannot be eliminated with an administrative decanting.
Tax Consequences: Unfortunately the tax consequences of a trustee exercising a decanting power are not clear. The IRS has refused to provide guidance on the tax consequences of a decanting. [IRS Notice 2011-101.] One notable concern that might arise with a decanting is the possible loss of a generation skipping grandfathered exempt trust. This might be the case if the ‘new’ decanting trust causes a present beneficiary to lose a general power of appointment, which might be treated as a release by that beneficiary. In that situation, the would be treated as a constructive addition to the grandfathered trust, causing it to lose its grandfathered GST status. Or, if the loss of the power of withdrawal or a general power of appointment held by a trust beneficiary occurs as a result of the trustee’s decanting, that loss might be construed by the IRS as a gift by the trust beneficiary to other trust beneficiaries. There just is not much guidance as to the tax consequences of a trust decanting; consequently, it is important to think through the possible consequences if a dispositive decanting results in a loss of rights by a trust beneficiary.

Decanting Statutes: 31 states have decanting statutes. There is a variety in their terms, many states ‘borrowing’ provisions from other states, and some having provisions unique to that state. In the 2018 ‘rankings’ by Steve Oshins, Michigan’s decanting statutes were ranked 21^st (in a tie with 5 other states.) For comparison purposes, Delaware’s decanting statute was ranked 5^th. Some of the distinguishing features between the Delaware decanting statute and Michigan’s statutes, which arguably explains the lower Michigan ranking, follow:

Can the Trustee Decant When the Trust Uses An Ascertainable Standard that Limits the Trustee’s Discretion:

Delaware: Yes
Michigan: No

Does the Decanting Statute Require the Trustee to Give Notice to the Trust Beneficiaries of the Intent to Decant?:

Delaware: No
Michigan: Yes (63 days)

Can the Trustee Decant the Trust with an Ascertainable Standard into a Discretionary Trust?:

Delaware: No
Michigan: No

Can the Trustee Remove a Beneficiary’s Mandatory Income Interest through a Decanting?:

Delaware: Yes
Michigan: No

Does the Decanting Statute Allow for a Power of Appointment in the Second Trust to Non-Beneficiaries:

Delaware: Yes
Michigan: Yes

Can a Decanting Accelerate a Remainder Beneficiary’s Interest in the Trust?:

Delaware: No
Michigan: Silent (presumed ‘no’)

Does the state have an effective dynasty trust statute or favorable set of rules with regard to the duration of a trust, e.g. rule against perpetuities?:

Delaware: Yes, it’s statutes are ranked 8^th on the Oshin’s state rankings
Michigan: Michigan is unranked, or considered to have laws that are not favorable to establishing dynasty trusts in the same Oshin rankings

Does the state have an effective asset protection trust statute or set of rules, e.g. self-settled asset protection trusts

Delaware: Yes, its statute is ranked 7^th on the Oshin’s state rankings
Michigan: This ranking indicated that Michigan ‘does not have’ an asset protection trust but Michigan adopted its Qualified Dispositions in Trust Act a year ago; this suggests that Michigan’s low rank may be erroneous.

Recent Decanting Notoriety: A trustee’s power to decant got a lot of attention in 2017 in a somewhat infamous case reported in Connecticut, which I previously covered in an earlier missive. In Ferri vs Nancy Powell Ferri, 326 Conn 438 (2017) Mr. Ferri’s father created an irrevocable trust for his son’s benefit, holding several millions of dollars in assets. Mr. Ferri was given the right to withdraw assets (a power of appointment) when he reached specified ages; once he attained age 40 he held the right to withdraw all assets from the trust that his father had established for his benefit. The trustees regularly made distributions to Mr. Ferri to support his lifestyle while he was married. Mr. and Mrs. Ferri resided in Connecticut, which does not distinguish between marital assets and separate property in a divorce. Mrs. Ferri filed for divorce. Upon learning that Mrs. Ferri filed for divorce, and knowing that Mr. Ferri had attained an age when he was eligible to withdraw 75% of the trust assets, the co-trustees of the trust, without telling Mr. Ferri of their decision, decanted the existing trust assets into a new trust where Mr. Ferri had no withdrawal rights. It comes as no surprise that Mrs. Ferri cried foul. The Connecticut court certified the question to the Massachusetts Supreme Court, since the original trust was governed by Massachusetts law. Massachusetts has no decanting statute, but the Massachusetts Court found that the trustee had a common law power to decant, arising from the discretionary power given to the trustee under the trust instrument to make distributions to or for the benefit of the trust beneficiary. What was surprising [leading to the label notorious] was that the Court also held that the trustees could decant the trust and cut off ‘vested’ withdrawal rights held by Mr. Ferri at the time of the decanting. Consequently, several millions of dollars that Mr. Ferri could have withdrawn from the trust when his wife filed for divorce, which would have been included in the marital estate for divorce division purposes in Connecticut, escaped that exposure in the divorce. What I found lacking in credibility was the Court’s finding that Mr. Ferri was unaware that his co-trustee’s decanted the trust established for his sole benefit [and in the process the co-trustees eliminated vested withdrawal power] when you consider that the two co-trustees who did the decanting was his father’s attorney and Mr. Ferri’s own brother. I also find it hard to believe that co-trustees would decant a trust and remove several millions of dollars of assets from the sole beneficiary’s withdrawal right without advising him of that intent or the repercussions from that decision. The Ferri case has made its way onto at least half dozen ‘top ten estate planning cases for 2017’ lists that I have read in the last couple of weeks.

Conclusion: A trustee’s power to decant a trust is a powerful tool, to help shape a trust to meet the needs of trust beneficiaries. By the same token, it is questionable if clients who adopt irrevocable trusts are aware of Michigan’s decanting statutes that are available to trustees to, in a sense, ‘re-write’ the settlor’s trust. Some clients may actually want to prohibit their trustee’s power to decant at all times. Some clients may want to give their trustees full authority to decant, without being constricted by the two Michigan statutes that impose conditions and limitations on the trustee’s power to decant. Whatever the situation, it is probably a good idea to have at least some discussion with a client contemplating an irrevocable trust if they are comfortable with the trustee holding decanting powers