Posts Tagged ‘trust reformation’

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.

Powers of Appointment and Trust Reformation

JULY 1, 2013 VOLUME 20 NUMBER 24
Sometimes things just don’t work out the way you intend. That is hardly a novel observation, but it can have a big effect on the work you hire a lawyer to do for you.

Let’s try an example. Suppose that you want to give some money to your grandchildren. You have four grandchildren, aged 10 through 17. You are planning on setting aside some money for education and to get them a start in life. You have done well in life, and are ready to put money aside right now.

Though your grandchildren are uncommonly smart (aren’t all our grandchildren above average?), they are pretty young. You agree with your lawyer that their money should be put in trust. You want to get the gifts completely out of your estate, however, so you decide to create irrevocable trusts — one for each grandchild. You ask your lawyer to draft the trusts, and you and your spouse intend to put $28,000 per year into each trust, at least as long as you are able to afford making the gifts.

The trusts are drafted; they name each grandchild’s parent (your daughter as to two of the grandchildren, your son as to the other two) as trustee. The documents are pretty much identical, and each is about twenty pages long. You have read them, but they are pretty hard to follow — though your lawyer has given you good advice about what they say. Did we mention that your lawyer is your son-in-law, the father of two of your grandchildren? He is very smart, and you know that he has thought through the provisions of the trust. You and your spouse sign, and you write the first of several annual checks to the respective trusts.

Four years go by. You by now have made $100,000 gifts to each of the grandchildren’s trusts. That is when you learn that your daughter and son-in-law are getting divorced. It’s unfortunate, but you are glad that you had the foresight to name your daughter as sole trustee rather than making her husband a co-trustee for their grandchildren.

Five years later, you have been making regular contributions to the trusts and they have grown significantly. Your grandchildren got scholarships for college and stayed close to home, so most of the money is still sitting there. Your family situation has gotten a little more complicated, though: your former son-in-law has remarried and had two more kids, and he  (and they) is pretty much out of your daughter’s life. Your son has also gotten divorced, but neither he nor his ex-wife has remarried.

Before the next installment, we feel constrained to remind you that this is your imaginary life. Your oldest grandson, now age 27, married, and making his way in the world, dies in a terrible auto accident. His trust had grown to over $200,000; what is to become of that money?

Look at the trust document. It says that your grandson had something called a “power of appointment.” That means he could have written a will designating who would receive the trust’s assets, but of course he did not make any will at all. What happens if he dies without a will? The trust says his money goes to his children, if he has any (he did not). It says nothing about his wife. The remaining money, it turns out, goes to his siblings.

But that means that two-thirds of the money you gave to your grandson would go to your former son-in-law’s children by his second wife. Surely that can not be what you intended. It hardly even seems likely that your former son-in-law had any such idea in mind when he wrote the trusts a decade ago. Is there any way to prevent the money from going to these children you don’t even know, and are not related to?

That story is a slimmed-down and somewhat sanitized version of a recent North Dakota Supreme Court case. It gives us a chance to write about not only the job of being a lawyer, but also the concept of court reformation of trusts.

One of the odd things about being a lawyer is the need to think through the many various ways that bad things could happen to our clients, whom we usually like very much. That’s also the reason legal language often seems so stilted and awkward; we are trying to clearly convey meaning in an uncertain future world. One convenient way to provide for future changes is to give trust beneficiaries (in appropriate cases, of course) the power to designate to whom trust monies will be given upon their own death. That power to appoint the trust to another person is a “power of appointment.” It can be general, or it can be limited (as in a power to appoint only to the beneficiary’s spouse, issue, parents or siblings, or only to charitable organizations, or only to beneficiaries named Dave, or whatever).

Effective use of a power of appointment, of course, requires the holder of the power to do something. That also explains why, when you make an appointment to talk about estate planning with a lawyer, she wants to know if you are a beneficiary of any other trusts, and to see the trust document(s); she is looking for powers of appointment that need to be exercised.

But back to our scenario: is it possible to convince a judge that you never intended family money to go to non-relatives? That you simply could not have imagined the sequence of events that played out back when you first signed those trust documents? Yes, as it turns out. Though the probate judge in the North Dakota case refused to allow reformation of the trust, the state Supreme Court reversed that holding and authorized a change to name only the deceased grandson’s siblings who were also descendants of the original trust creators. In Re Matthew Larson Trust Agreement, May 28, 2013.

Wise legal commentator Yogi Berra is often quoted for the legal maxim that describes how complicated a lawyer’s imagination must be. Turns out it wasn’t him, but probably was physicist Niels Bohr, who said “prediction is very difficult, especially about the future.” Bohr certainly was the source for this appropriate observation about the art of physics and lawyering: “an expert is a person who has found out by his own painful experience all the mistakes that one can make in a very narrow field.”

Court Avoids Deciding Fate of Unnecessary Special Needs Trust

MAY 13, 2013 VOLUME 20 NUMBER 19
We read an interesting appellate court case this week involving an Indiana special needs trust. The court’s resolution of the case was actually not all that interesting — it was dismissed on technical grounds. But the story was an interesting one, and involved a problem that we see from time to time. It also gives a chance to suggest some solutions to that problem (in addition to the one that the trial court judge actually implemented in the case).

Eileen Rogers (not her real name) owned a family farm in Indiana, and she had three adult children. One of them, daughter Jewel, was disabled: she had been diagnosed as suffering from bipolar disorder, and she received Social Security Disability payments. Because of her SSDI benefits Jewel was also covered by Medicare.

Ms. Rogers and her late husband had created a trust before his death. It provided that on the second spouse’s death the combined estate would be divided into three equal shares, with one to go to each child. In 2006 Ms. Rogers amended the trust to set up a special needs trust for Jewel’s one-third share. That special needs trust included a sort of a “poison pill” provision: if any government agency ever decided to treat the money as available to Jewel and thereby sought to  reduce her public benefits, her trust would terminate and be distributed to the other two children, as if Jewel had died.

In 2010 Ms. Rogers died. A dispute developed between her other two children (Jewel’s brother and sister) about what to do with the trust for her benefit. The basic problem: Jewel didn’t need a special needs trust to qualify for benefits. Astute readers will have seen this coming: Jewel’s Social Security Disability and Medicare benefits would not be affected by an outright inheritance, since they are not sensitive to assets or the income earned on those assets.

What should be done? Jewel’s brother thought that the trust should continue anyway, with him as trustee. Since the principal asset in Ms. Rogers’ estate was the family farm, that would allow the farm to stay largely intact and continue under his management. Jewel’s sister, however, agreed with Jewel herself: the farm should be divided, and Jewel’s one-third share should be distributed to her outright. The trust had been set up by mistake, they reasoned, and it should be terminated.

The local trial court agreed with the two sisters. He ruled that there was no reason to keep the trust and it should be dissolved. Jewel’s brother sought to intervene and to argue that the trust’s terms should be followed; the judge denied his request and maintained the dissolution of the trust.

Jewel’s brother appealed. Tragically, he died before the appeal was decided — but it was continued on his estate’s behalf by his wife. As noted earlier, the Indiana Court of Appeals dismissed the appeal based on technical grounds: the order denying Jewel’s brother’s request did not contain the language necessary to make it an appealable order. Raper v. Haber, May 6, 2013.

Even though the dispute over Ms. Roger’s trust does not establish any precedent, and wasn’t even decided on the merits of the trial court’s ruling, it does give us a chance to reflect on the problem of unnecessary special needs trusts. We see this issue from time to time: with all the public discussion about special needs trusts, parents and other family members often think they must establish such a trust for any person with any disability regardless of other circumstances. But, in fact, many people with disabilities receive all their benefits from Social Security Disability and Medicare, and such individuals will not usually be affected by inheritances they might receive outright.

The issue is actually more complicated than that. Some individuals receive both Social Security Disability AND Supplemental Security Income (SSI) payments, often because they are covered under their retired parents’ accounts. If they inherit money outright, they might lose the SSI portion of that income, and perhaps have their Medicaid benefits reduced or eliminated. But sometimes such individuals will receive an increase in their Social Security (not SSI) payments upon the death of their parents — and so it can often be difficult to determine in advance whether a special needs trust is really necessary.

Does that mean that no special needs trust should be considered for someone who is already receiving Social Security rather than SSI? Not necessarily. Sometimes a special needs trust (or at least an irrevocable trust) is appropriate for one or the other — or both — of two reasons:

  1. Even though the individual is not receiving SSI payments, he or she might be receiving Medicaid benefits — and sometimes without really even realizing it. Medicaid might, for instance, be paying for their Medicare Part D (prescription drug coverage) premiums and co-payments.
  2. Even though a “special needs” trust might not be necessary, a person with disabilities might be unable to reliably handle their own money. In such a case, an irrevocable trust — which might even look much like a special needs trust — might be appropriate.

Another issue comes to mind in reviewing the appellate court decision involving Ms. Rogers’ trust: might there have been other alternatives available? Of course, we do not know the details of her family situation, or her daughter Jewel’s level of ability and sophistication, so we are not really proposing alternate resolutions for her case. But in other circumstances, it might be possible to modify the unneeded special needs trust to make it more appropriate (rather than terminating it altogether). There are several ways such a thing might be accomplished, and solving problems like that are what good lawyers do best.

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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