Posts Tagged ‘trust modification’

Trust Decanting Used to Implement Special Needs Provisions

OCTOBER 10, 2016 VOLUME 23 NUMBER 38
Let’s say that your mother wants to leave an inheritance for your son (let’s call him Daniel), but that Daniel is a minor. How can she arrange his inheritance? By putting it in trust, of course. Pretty commonly, Daniel’s trust might continue until he is 21, or 25, or some other age that your mother might choose. After that, the money can go to him outright. In the meantime, you, or your mother’s accountant or lawyer, or a family member with good financial skills, can manage Daniel’s money for him.

There’s nothing very remarkable about that setup, but one common development can change the story dramatically. What if, before he reaches the age for distribution from the trust, Daniel becomes disabled — or receives a diagnosis that you just didn’t expect when you wrote the trust?

If your mother is still living, of course, she can change the trust provisions to create a “special needs” trust for Daniel. But if she were to die before the family learned that Daniel needed a different type of trust, things could get much more complicated.

If no steps are taken before Daniel turns 25 (or whatever age the trust set), then the trustee will have no choice to turn the money over to him. That will almost certainly mean that he loses some or all of public benefits he receives because of his disability — and he may not be able to manage the money anyway. That could be a bad result.

One response might be for you, as Daniel’s parent and/or guardian, to create a new special needs trust for him after he turns 25. That might require court action, and will result in a pretty tightly-controlled trust document (because the rules are fairly restrictive). This kind of trust is usually called a “self-settled” special needs trust, even though Daniel might not actually be involved in its creation at all. This kind of trust also has to provide that, when Daniel dies later, the state’s Medicaid program will be entitled to make a claim against the trust’s remaining assets — before they pass to Daniel’s other family members.

Another excellent choice in Arizona might be for Daniel’s trustee to “decant” his trust. This notion borrows its name from decanting of wine — the trustee would simply pour (as it were) the trust’s assets from the existing trust container into a new, more appropriate (and special needs) container. But there is some uncertainty about whether that new trust container would have to be a “self-settled” trust — and include the restrictive provisions and payback clause.

It was not in Arizona and does not apply Arizona law, but a recent New York appellate court decision addressed this very question. Daniel’s trustee asked the New York courts for permission to decant his trust to a new special needs trust — but without the payback provision. The trustees gave notice to the state Medicaid agency, and its representatives appeared and objected. Because Daniel would be absolutely entitled to receive the trust balance when he reached the age in the original trust document, they reasoned, the money was really his, and the trust would need to be of the self-settled variety.

Not so, argued the trustee. The money would not be Daniel’s until he reached the age set out in the trust — and in the meantime, state law permitted the trustee’s to move the trust into a new trust, governed by a new document. That meant that no payback provision was required.

The New York Surrogate’s Court (what we would call the probate court in Arizona) agreed with the trustees and allowed creation of a new trust with no payback provision. The Medicaid agency appealed, but unsuccessfully. According to the appellate court, Daniel’s trustee was correct — the new, decanted trust was not a self-settled special needs trust, since Daniel did not have the right to receive the property at the time the new trust was created. Matter of Kroll v. New York State Department of Health, October 5, 2016.

This may seem like a small thing, but the ramifications are actually quite large. If the New York precedent holds up in other states, it will open a terrific opportunity for management of trusts when circumstances have changed (as they so often do). It might be applicable not only when beneficiaries like Daniel reach the age of distribution; it might also apply when a trust contains unfortunate language, or management considerations change.

Will this be the law in Arizona? It is hard to be certain, but each case (and this one is the first) reaching a similar conclusion will add impetus to what we can hope will be a developing trend.

The Developing Law of Trust Decanting

NOVEMBER 3, 2014 VOLUME 21 NUMBER 40

We first wrote about trust “decanting” in this space three years ago. Since then we’ve had occasion to revisit the topic a handful of times — most recently about six weeks ago when we wrote about modifying trusts that no longer seemed to make as much sense, since the estate tax exemption numbers have increased so dramatically in the last fifteen years.

Since the idea first gained currency a few years ago, it has developed quickly. More than half the states in the U.S. have now adopted some form of trust decanting law (including Arizona, which was one of the early states but hardly the first). The state laws vary widely — from very restrictive (permitting trust decanting only in narrow circumstances) to very generous (Arizona, for instance, places very few limits on the kinds of trusts which can be decanted, and almost no limits on the kinds of changes that can be included — our entire statute is only about a dozen sentences long).

But what is “decanting,” and why is it called that? The idea evokes a fine wine metaphor: some wines improve when you simply pour them from the bottle to a carafe before serving. Wine lovers often insist that the wine “opens up” with aeration, and that the decanting gives them the chance to get a little air. There is no doubt that decanting helps reduce the sediment in the wine, if it has any (and the existence of sediment is likely an indicator that the wine was well-made and well-aged). It is not irrelevant that the new container is likely to be a beautiful crystal carafe (rather than a dusty old bottle with weathered label), which will add to the entire sensory experience.

Sometimes decanting (as applied to wine — we’re still developing the metaphor here) can be from one old bottle to another, newer bottle. The wine might then be recorked and returned to the wine cellar for additional aging. This can have the beneficial effect of allowing the sediment to be discarded, and improve the clarity and aging of the wine itself.

The metaphor actually holds up pretty well. Decanting a trust involves pouring (if you will) the trust assets from the older container (the original trust document) into a new, often more attractive, more suitable vessel (the new trust document). This can give new life to a trust of a certain age — whether it will continue for years or shortly be ready for consumption.

Why do we want to talk about decanting just now? Because I have just returned from a Chicago meeting of the Uniform Law Commission, a national group that tries to develop statutes that can be promoted in all U.S. jurisdictions. The notion is that if the law is the same — or at least similar — in all states and territories, then it will be much easier for people to figure out what works and much harder to game the legal system by constantly moving from the law of one state to the law of another.

The Uniform Law Commission committee meeting dealt with a new Uniform Trust Decanting Act, which is being prepared for adoption and distribution in the next year. A lot of progress was made — and the committee participants (formal members and a handful of observers) were dedicated, hard-working and thoughtful about the new proposed law.

A couple of things stood out (to me, anyway) about the project:

  • The uniform law will almost certainly divide irrevocable trusts into two categories before providing for decanting opportunities and limitations: those in which the trustee has broad discretion about distributing trust principal to the lifetime beneficiary, and those in which the trustee’s discretion is limited to a “recognizable standard” (like “for the health, education, support and maintenance of the beneficiary”).
  • Decanting will probably be permissible without court involvement in most cases — the trustee may simply decide that trust beneficiaries are better off with a new trust structure and make the change.
  • Before making some kinds of changes, though, the trustee will need to give notice to all current trust beneficiaries and those who would receive benefits upon the death of the current beneficiary (and sometimes notice will be required to more people).
  • The trust that comes from the decanting process will usually need to have about the same beneficial interests — if the original trust says that trust principal can be distributed to Diane but on her death everything goes to Tom and Dick, the trustee probably won’t be able to expand the list to include Harry. But if Tom is on public benefits, or is in prison, or has an expensive (and dangerous) drug habit, the trustee probably will have authority to modify the terms of the distribution to him.
  • Decanting is not the same thing as modifying or reforming a trust. Each has its place, and in a given case one may clearly be a better choice than the others. But one collective point about decanting, modification and reformation of trusts: today it is a lot easier than it once was to make much-needed changes to existing trusts, and this new statute will accelerate that change in Arizona and elsewhere.

Will Arizona adopt the new Uniform Trust Decanting Act once it is finalized? It’s simply too early to tell, but Arizona has been a relatively quick adopter of other uniform laws. The existing Arizona law would not need to be overwritten — or even modified — so it is likely that Arizona will at least consider the option. Meanwhile, other states with decanting statutes will face the same considerations, and those without existing decanting statutes will have an easy template for adoption.

How Increased Estate Tax Exemptions Affect Existing Trusts

SEPTEMBER 29, 2014 VOLUME 21 NUMBER 35

A lot has changed in American estate planning in the last decade (as you may have already heard). Estate tax thresholds have increased to (as of 2014) $5.34 million. On top of that figure, there is a relatively new concept of “portability” of the estate tax exemption, so that married couples can (more or less) double that exemption amount in most cases. Meanwhile, Arizona has eliminated its estate and gift tax regimens altogether.

It goes without saying, but we can’t avoid saying it: if you haven’t updated your estate plan in the past decade, you should contact your attorney right away about getting that process started. You probably can get by with a simpler estate plan than you needed before, and you can probably make most or all of your decisions on the basis of what you’d like to do with your money, rather than the tax consequences.

Meanwhile, we see a lot of estate plans that have not been updated. Some of those belong to people who have died with their aging wills and trusts in place. We also see a fair number of trusts for people who died years ago, and for whom estate tax liabilities turned out to be unimportant. Is there anything that can be shed to fix tax-driven complications that are no longer needed?

Yes, as it turns out. We do have a couple caveats that need to be mentioned as we open this discussion, though:

  1. We are writing about Arizona tax and estate law, not other states’. If you live in another state, or if your trust is set up in another state, you probably ought to speak with someone familiar with that state’s laws. Keep in mind, though, that the governing law might not be obvious; if your mother wrote a trust in, say, Florida, and died in Tennessee naming a California daughter as trustee, do you know which state’s law applies? Neither do we — the answer is going to be very fact-driven, and so the first question you might want to address with a lawyer is whether you’re even talking to a lawyer in the right state.
  2. Even if Arizona law applies, or the principles we describe here are the same for the state governing the trust, be very careful about generalizing the points we raise here. Discuss them with an attorney, and be alert for the possibility that seemingly small changes in facts can yield entirely different answers.

Disclaimers in mind, we can proceed to discuss what has to be done, and what can be done, with tax-driven estate plans that have not been updated to modern tax concerns. Here are a few examples of what we see:

  • Mr. and Mrs. Johnson created a joint revocable trust in 1995. It provided that on the first spouse’s death, the trust would be divided into two separate trusts. One is called the “decedent’s” trust, and it consists of the separate property of the first spouse to die, plus that spouse’s one-half interest in community property. Since Mr. and Mrs. Johnson are only worth about $1 million, they probably didn’t need such a two-trust arrangement at all — but Mr. Johnson has now died. Mrs. Johnson doesn’t want to go through the bother of dividing assets and, knowing that the estate tax exemption is now several times their combined net worth, she wonders if she can just skip the two-trust part.
  • Mr. and Mrs. Gonzales had a very similar trust. Mrs. Gonzales died in 1999, and Mr. Gonzales actually made the division into two trusts. The “decedent’s” trust is now worth about $1 million, and Mr. Gonzales is tired of paying the annual cost of preparing income tax reports for the trust and providing accounting information to his children (they say they don’t want him to have to do that, anyway). Can he just terminate the decedent’s trust?
  • Mr. and Mrs. Lee have a very similar trust. Mr. Lee is very ill, and Mrs. Lee has been handling their trust for the past several years. The Lees are worth about $6 million. Is there anything Mrs. Lee should be doing with their trust? Assuming Mr. Lee dies before Mrs. Lee, is there anything she should watch out for?
  • Mr. and Mrs. Jorgensen also created their two-trust arrangement in the late 1990s. A very large part of their estate is in Mr. Jorgensen’s 401(k), which names the trust as beneficiary. Is there anything they ought to be thinking about?

Of course the Johnsons, Gonzales’, and Lees could have made changes to their estate plans if both spouses were alive and able to understand and sign changes in each case. But since that didn’t happen, they may be stuck with their estate plans — unless either there is language in the trust or something in Arizona law allowing changes. The Jorgensens are in a little bit different situation, as the decision to name the trust as beneficiary of Mr. Jorgensen’s 401(k) was probably driven by tax considerations that no longer apply.

Let’s deal with the authority to make changes first. We have a couple suggestions for Mrs. Lee, Mr. Gonzales and Mrs. Johnson:

  1. Read the trust. Read it again. It may be hard to parse all the rules, but it will be a productive session. Look for things like the discretion to make distributions of principal, the authority to amend the trust, and any authority the trustee (or the surviving spouse) might have to modify the trust’s terms. Nothing there? Don’t panic. But you can’t just choose to ignore the parts you don’t like.
  2. Talk to a lawyer about Arizona’s law on modification of trusts. Ask specifically about three words: modification, reformation and decanting. Arizona law now makes it easy to change trust provisions in some circumstances — but note that you may well have an obligation not to hurt the interests of the remainder beneficiaries (children, step-children or whoever receives property on the death of the surviving spouse). Know that Arizona’s trust law has changed dramatically in the past few years, and so even if you got advice that nothing could be changed a decade ago, the answer today might be different.
  3. Check with the remainder beneficiaries. They might even agree with you that modification or termination of the trust might be a good idea. Just to be safe, though, talk with your lawyer first; she (or he) might give you a specific idea to discuss with them, or might want to initiate the discussion herself.

Mr. Jorgensen: get in to your lawyer’s office and discuss beneficiary designations. While naming a trust as beneficiary of a retirement account is not necessarily bad, it is usually dangerous and should only be done when you understand exactly what you are trying to accomplish.

Our takeaway: get good legal advice before you just decide to make changes. But don’t despair, as it might be possible to modify old estate plans, even after death.

Arkansas Court Refuses to Allow Trust Modification

JUNE 25, 2012 VOLUME 19 NUMBER 24
A recent Arkansas Court of Appeals case reminds us (yet again) how important it can be to plan for the possibility of a future disability in your family. Here’s the background (with names changed to help protect internet privacy): Ruth Olsen, like thousands of other seniors, created a revocable living trust. She provided for gifts for nine grandchildren, including her granddaughter Christie.

When the trust was signed (in 2009), Christie was in her early 20s and living in another state. A year later she was diagnosed as suffering from schizophrenia and a guardian was appointed. Just one month after the guardianship Ruth Olsen died.

Christie was receiving Medicaid benefits from the state where she lived. Her grandmother’s trust did include language indicating that the trustee should have discretion about whether or not to distribute either income or principal of her trust share to her or for her benefit, but it did not include specific language making clear that Ms. Olsen intended the trust to be a special needs trust.

The trustee of the trust is a bank headquartered in Arkansas, where Ms. Olsen lived and died. The trustee asked the local courts to allow the trust for Christie to be modified — just to make clear that it should be a special needs trust, and that the trustee should be required to try to protect Christie’s eligibility for Medicaid in her state.

The trial judge in Arkansas refused. He pointed out that — in Arkansas, at least — the Medicaid program was intended to be available only for people who had not other access to resources. According to the trial judge, it would violate the public policy of the State of Arkansas to allow court modification of a trust to prevent it being counted as a resource for Medicaid eligibility purposes.

The Arkansas Court of Appeals agreed (more accurately, it did not disagree — but the effect is the same). The appellate court declined to follow the lead of the Washington State Court of Appeals — the Washington court had allowed just such a modification, and in very similar circumstances.

The Court of Appeals cited a number of Arkansas cases in which courts refused to allow transfer of an individual’s assets into a self-settled special needs trust — thereby preventing eligibility for Arkansas Medicaid. Ruth Olsen’s trustee argued that (a) this trust was not a self-settled trust but a third-party trust, and the request was for clarification of the trust’s terms, not creation of a trust, and (b) the law and public policy in question should be those of the state where Christie lived, not Arkansas. Those arguments did not prevail. The appellate court declined to reverse the trial judge’s finding. Matter of Owen Trust, June 13, 2012.

We do not practice law in Arkansas (for which, incidentally, we are thankful), but there are a number of important points we take away from the Arkansas court decisions:

  • Courts often have a very hard time clearly separating “self-settled” special needs trusts from “third-party” special needs trusts. That should not be surprising — trust settlors, trustees and lawyers often have the same problem. It is confusing. But one key element should be kept in mind: if you are setting up a trust with your money for the benefit of someone who has (or might have) a disability, you are permitted to impose appropriate restrictions to make sure the money is not treated as an available resource for public benefits calculations.
  • Even if a formal finding of disability has not been made, it is prudent to include strong “special needs” trust language in your estate plan (your will or trust). That way you protect the availability of the money you leave to a child or grandchild and their eligibility for public benefits.
  • State laws vary. Some states (like Arkansas) take a dim view of transfers into special needs trusts — or, apparently, of efforts to ensure that even a third-party trust has appropriate provisions. Other states (like Washington) would more likely permit a clarification such as the one Ruth Olsen’s trustee proposed. Where is Arizona in this continuum of state approaches? Much closer to Washington than to Arkansas. In general, states which have adopted the Uniform Trust Code (about half of the states have) are more likely to allow modifications like the one proposed here — but not always (Arkansas has adopted the Uniform Trust Code, but it didn’t help Christie).
  • Just to keep things confusing, it is not even clear that the proposed modification is necessary. The state Medicaid rules in Christie’s new state are more important in analyzing her grandmother’s trust than are the state laws in Arkansas. And Christie might well move to yet another state before she actually makes a Medicaid application. Her grandmother’s trust — even though not perfectly written — might well be treated as a third-party special needs trust, depending on the state (and, candidly, on the eligibility worker, the law at the time of her Medicaid application and perhaps a handful of other factors).

What is the ultimate take-away message? Plan carefully. Talk with a qualified lawyer — one who knows something about disability, public benefits and the surprises that can be in store. Make sure you fully share information about your family, your concerns, and your wishes. Learn local laws and practices. Having a disability — or having a family member with a disability — can make planning much more difficult and complicated, and the results much more uncertain.

Challenge to Three-Year-Old Trust Reformation is Dismissed

JANUARY 9, 2012 VOLUME 19 NUMBER 2
With the increased emphasis on (and use of) living trusts for estate planning, we lawyers are seeing more and more cases in which an old trust needs modification. Perhaps the tax laws have changed since a parent or grandparent died. Maybe what once made sense is less defensible in light of modern investment thinking, or the cost of living has caught up with what once seemed like a generous bequest. Family dynamics, always fluid, can change the reasonableness of a decades-old estate plan. Everyone knows someone whose family was once considered wealthy, and now is considerably less so. Any of those scenarios — and dozens of others — can be the basis of a desire to change something that seemed set in stone when the plan was adopted.

That’s when lawyers begin talking about trust reformation or modification. In recent years we have begun talking about decanting — pouring the contents of an older trust into the vessel of a new trust document. Not every state permits decanting, though, and state laws vary in how they approach modification of trusts. That can lead to uncertainty, family friction and even litigation.

Take, for instance, the recent Indiana case involving the trust — and the family — of John and Ruth Rhinehart. In 1997 Mr. and Mrs. Rhinehart established an irrevocable trust for the benefit of their daughter, Julie R. Waterfield. They placed $4 million in the trust, and provided that at least $100,000 per year would be paid to their daughter. When she dies her trust will divide into three new trusts — one for each of her children. Each of those trusts will pay $25,000 per year to the grandchild for whom it is set up.

That was certainly a generous gift, and should help provide for the welfare of the Rhinehart’s daughter and grandchildren for decades. In fact, the trust has grown — as of 2009 it was worth about $22 million. What could possibly be wrong with the Rhineharts’ largesse?

Sometime shortly after the trust was created, Julie Waterfield made a pledge to Indiana University – Purdue University Fort Wayne (IPFW). She promised the University $1.5 million so that a new recital hall could be built in the campus’s new music building — a building, incidentally, named after her parents.

There was only one problem with her pledge. By late in 2002, stock holdings she had expected to use for the donation had become worthless. It appeared that the only way for her to meet her pledge would be to increase the annual payments from the trust established by her parents. She would need not $100,000 per year, but more like $275,000.

She and her lawyer approached the trustees about how to reform the trust to permit the larger distributions. Everyone agreed that if she could get the approval of all of the future beneficiaries, the trust could be modified. The trustees engaged Ms. Waterfield’s lawyer to complete the process, and he filed a court proceeding seeking an increase in the distribution. The Indiana court approved the increase, conditional on getting all eighteen potential beneficiaries — current, future and contingent — to sign consents.

At a family meeting in December, 2002, all three of Ms. Waterfield’s children signed the agreement to reform the trust. One of them requested a copy of the full agreement, and the trust’s lawyer sent him a copy a few days later. Ms. Waterfield’s distributions were increased and, presumably, her pledge fulfilled.

Three years later, two of Ms. Waterfield’s children expressed concern about the increase in their mother’s distributions. They argued that their signatures on the agreement to reform the trust had been obtained by fraud, and they brought suit against their mother and the corporate co-trustee of the trust. Ms. Waterfield and the trustee argued that it was too late — that the statute of limitations on such an action ran out two years after the change was approved. In any case, they insisted, there was no injury to Ms. Waterfield’s children: there would be plenty of money available to fund their annual $25,000 distributions. The trial judge agreed and dismissed the lawsuit.

The Indiana Court of Appeals agreed. The appellate judges noted that both sons’ signatures were on the agreement, that they acknowledged they had gotten a letter from the lawyer which claimed it enclosed a copy of the agreement, and that it strained credulity to think that they would have failed to ask for the referenced enclosure if it had not in fact been in the envelope with the letter. In other words, their cause of action — if they had one — was known to them at least by the date of that letter. In Indiana, the statute of limitations on such an allegation of breach of fiduciary duty is two years — the Waterfield children waited more than a year too long before filing their lawsuit.

Furthermore, according to the appellate judges, the growth of the trust to $22 million — despite several years of increased distributions to Ms. Waterfield — adequately protected her sons’ interest so that they were not injured by the trust reformation. The Court of Appeals rejected their argument that the trust itself was injured by what they insisted was fraudulent behavior. The beneficiaries do not have the authority to bring their action on the basis of injury to the trust, but must show injury to themselves, according to the Court. Matter of Waterfield v. Trust Co., December 30, 2011.

Would the answer have been different in Arizona? Possibly. But it is more likely that the process itself would have been different in Arizona. With adoption of the Arizona Trust Code (a version of the Uniform Trust Code) it has become easier to modify or reform a trust. Some modifications can be done without the court’s involvement at all. Perhaps more importantly, it has become somewhat easier to clearly begin the running of the statute of limitations on claims against trustees under Arizona’s new law.

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