Take-Away: In a period where flexibility is frequently desired in the administration of an irrevocable trust, to adapt the trust to constantly changing tax and property laws, or to modify the trust to reflect changes in the circumstances of trust beneficiaries, one popular tool used to make a trust more flexible is the trustee’s ability to transfer trust assets to a new (second) trust created by the trustee. This tool is called decanting.  Michigan has two separate statutes that grant a trustee the authority to decant the assets held in an irrevocable trust. One is used to make only changes to the trust’s administrative provisions. The other may be used, with limitations, to affect the rights of trust beneficiaries. Michigan has not [yet] adopted the Uniform Trust Decanting Act.

Background: If a trustee possesses the discretion under a trust instrument to make distributions to or for the benefit of a beneficiary, then the trustee arguably possesses the authority to decant the assets held in the trust to a new (second) trust that is created by the trustee. Practically speaking, the trustee holds a general power of appointment over the trust assets, and the act of decanting the trust’s assets to the ‘new’ trust is the equivalent of the exercise of that power of appointment. The rationale behind a trust decanting by the trustee is that if a trustee possesses the ability to make discretionary distributions to or for the benefit of a beneficiary, then trustee should also be permitted to exercise that same discretion to distribute trust assets to another trust for that same beneficiary. About half of the states give trustees some type of express statutory authority to decant the assets of an irrevocable trust. Other states conclude that the power to decant exists at common law if the trustee is given discretion to make distributions from the trust.

Uniform Trust Decanting Act (the Act):  This model Act came into existence in July 2015. Since then Colorado, New Mexico, North Carolina, Virginia, Washington, Alabama and California have all adopted the model trust decanting Act. Illinois introduced the model Act in 2018 but that bill died in the legislature.

  • Scope of Discretion: Under the Act how broadly a trustee can exercise a decanting power will depend upon the breadth of the trustee’s discretionary distribution power under the trust instrument. The Act bifurcates a trustee’s discretion into two categories: limited and expansive.
  • Limited: A limited distributive discretion is subject to an ascertainable standard or a reasonably definite standard that constrains the trustee’s distribution discretion to some degree. Under the Act this standard requires the trustee to decant so that that each beneficiary’s interest is substantially similar in the second trust. As a result, when the trust contains limited distributive discretion it will allow for administrative, but not dispositive, changes in the second trust. This is about the same with Michigan’s first statutory authorization for a trustee to decant the assets under the trust to a second trust. [MCL 700.7820a.]
  • Expansive: Expansive distribution discretion under the Act provides broader rules for a trustee to decant a trust’s assets. While the trustee may not either (i) add new beneficiaries or (ii) eliminate vested interests under the trust, the trustee may grant a power of appointment to a beneficiary of the second trust that is exercisable among a class of permissible appointees that is broader than, or different from, the beneficiaries of the first trust. In addition, with expansive distribution discretion, the trustee can also remove beneficiaries, omit powers of appointment, and eliminate rights that are not already vested interests in the trust. Michigan’s fairly comparable decanting statute permits some alteration of a beneficiary’s interest under the second trust. [MCL 556.115a(1)(2)(a).] An example where the trustee’s discretion would not be restricted by an ascertainable standard would be where the trustee was authorized to make distributions, in the trustee’s discretion, for the beneficiary’s welfare, comfort, best interests, and happiness, none of which are considered to be ascertainable standards that limit the trustee’s discretion or which can be enforced by the beneficiary in the probate court, or when a purely discretionary trust is used, e.g.  where the trustee may make distributions to or for the benefit of the trust beneficiary as the trustee deems advisable.
  • Judicial Involvement: Court approval of a trust decanting exercised by the trustee is not required.
  • Beneficiary Consent: Nor is the consent of the trust beneficiaries required to the trustee’s exercise of a decanting power.
  • Notice: The Act requires only a 60-day notice to trust beneficiaries. Under Michigan’s decanting statute the notice period of the intent to decant must be given to qualified trust beneficiaries 63 days in advance. [MCL 700.7820a (7).]
  • Power of Withdrawal: The Act, like Michigan’s statutes, expressly prohibits the decanting of a trust’s assets that would reduce or eliminate a presently exercisable power of withdrawal held by a beneficiary, in order to protect the exercise of an intended crummey withdrawal right and thus preserve the federal gift tax annual exclusion if that is one of the material purposes of the trust.
  • Tax Sensitive Trusts: The Act, like Michigan’s statutes, also expressly limits the trustee’s decanting power in order to preserve other transfer tax attributes that are intended with the first trust, such as a lifetime QTIP marital deduction trust or a charitable remainder trust, which have mandatory trust provisions in order to achieve the intended transfer or income tax purposes of the first trust.

Tax Consequences of a Decanting: The Act is silent on the transfer tax consequences of a trustee’s exercise of a decanting power. Back in 2011 Treasury issued a notice in which it said that it would not provide formal guidance to a trustee on the transfer tax consequences of a decision to decant a trust’s assets to a second trust. [IRS Notice, 2011-101, 2011-52 IRB 932.] One concern is with the possible lapse or release of a general power of appointment held by a trust beneficiary, and the implications of that lapse or release on the generation skipping transfer tax (GST) and the possibility that a trust beneficiary will be treated as making a taxable gift of a beneficial interest in the first trust to a beneficiary of the second trust who receives more interests than were held in the first trust. As such, before a decanting takes place the trustee should determine if it is possible that the act of decanting will cause a gift tax or GST tax to be incurred. Another concern is if it appears that the trustee’s exercise of a decanting power is at the direction of the trust’s settlor (who changed his/her mind about the original trust) where it might be viewed by the IRS as the settlor retaining an implied understanding with the trustee, possibly resulting in the settlor’s estate inclusion under either IRC 2036 (retained control over enjoyment of trust assets or income) or IRC 2038 (retained control over who receives trust assets.)

Trust Provisions: It is common these days that in a trust instrument, especially a dynasty-type of trust, for the settlor to contemplate that the trustee will exercise a power to decant. Rather than rely on Michigan’s statute, or the Act, which are essentially default statutes to be followed when the trust instrument is silent, to instead include express provisions that confer on the trustee the power to decant the trust, specify the notice provisions, and also indicate if the decanted trust can add or remove trust beneficiaries. If a trust instrument includes its own, unique, decanting authorization it should probably also add the reasons why the settlor wishes that decanting power held by the trustee, and include a statement if the exercise of that decanting power needs to ultimately continue to treat trust beneficiaries equally in the second trust. Conversely, if the trust settlor is adamant that the terms of the trust with respect to the trust beneficiaries must always remain the same, then the settlor should include an express, formal, prohibition of the decanting of the trust’s assets to a new trust.

Conclusion: To my knowledge, no effort has been made [yet] to introduce the Uniform Trust Decanting Act in the Michigan Legislature. Arguably there is no need to do so in light of Michigan’s two separate statutes that expressly deal with the trustee’s power to decant, both of which seem to parallel (at least to some degree) the limited and expansive categories that are used in the Uniform Act. Probably more important is to keep in mind that both Michigan statutes and the Act are default laws, and a trust instrument can contain its own set of rules with regard to how the trustee may go about decanting trust assets to a second trust, or alternatively to expressly prohibit any act of decanting by the trustee.