3 Ways to Modify Your Trust Agreement for Changing Circumstances
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When trusts are designed to last for decades or generations, many of our clients eventually feel some growing pains, telling us that the trust agreement “doesn’t fit” or feels “out of date” given their current circumstances. This disconnect can be driven by several factors – the physical movement of trustees and beneficiaries across state lines, changes in the tax laws and regulations affecting the trust and its beneficiaries, altered needs of beneficiaries (especially in later generations), etc. When trust agreements do not provide enough flexibility for a Trustee to adapt over the years, trust administration can feel burdensome and frustrating for all involved.
Assuming that the trust termination is not desired or possible, many clients have expressed a desire to modify certain terms to better fit their current needs and circumstances. As Maryland has joined several other states in adopting a version of the Uniform Trust Decanting Act, we wanted to take the opportunity to review some of the avenues that may be available to modify provisions of trust agreements when circumstances change.
1. Judicial Modification
Historically, if an interested party to an irrevocable trust (generally a beneficiary) sought to modify trust terms, he or she would have to initiate judicial modification or reformation of the trust by filing a lawsuit. Because judicial modification relies on a judge’s interpretation of the agreement – reviewing statements as to the grantor’s intentions and purposes – the scope of modifications may be limited, especially if the trust agreement is not clear. Further, due to the nature of the process, judicial modification is generally the most expensive, and least certain, method for modifying an irrevocable trust, as there are no guarantees a judge will agree to modifications sought.
Despite this uncertainty, there are instances where judicial modification may be recommended – such as when the interested parties have competing goals, or when there are certain tax attributes of the trust that need to be preserved and enforced with tax authorities. For example, where clients want to bind the IRS to accept a modification (without risking tax consequences), it may be necessary for the Supreme Court of the state to approve the modification.
2. Nonjudicial Settlement Agreement
A Nonjudicial Settlement Agreement, or NJSA, allows the interested parties of a trust – the Trustee, beneficiaries, and grantor (if still living) – to alter certain terms by mutual agreement. An NJSA is generally the simplest and least expensive option for modifying irrevocable trust provisions because the NJSA only modifies specific provisions, as a kind of amendment to the original trust agreement.
However, depending on the modifications desired, agreement by the interested parties to an NJSA could have significant risks and consequences for the grantor, beneficiaries, and/or the trust itself. For example, if the interested parties agree that the trust needs to provide more powers to a Trustee – e.g., to name successor Trustees, or to change the tax situs – an NJSA can be used to provide these powers to current and future Trustees. However, if the parties want to alter distributions to beneficiaries, agreement to an NJSA can result in certain consequences that the trust may have been created to avoid.
If the grantor of a trust is still living, his or her agreement to alter distributions could result in estate tax inclusion of trust assets in the grantor’s taxable estate, if the IRS determines that the grantor has effectively retained control over the use and enjoyment of trust assets. Similarly, if a beneficiary receiving means-tested disability benefits agrees to changes in distributions, the Social Security Administration could determine that the beneficiary exercised control over trust assets so that a noncountable resource (the trust) becomes a countable resource when determining eligibility for benefits. Further, if beneficiaries agree to an NJSA which alters their separate beneficial interests in the trust, the IRS may find that the beneficiaries have effectively made gifts between and among themselves as a result of the changes to their respective interests.
3. Trust Decanting
Trust decanting allows a Trustee with the power to distribute trust principal to “pour” trust assets from the original trust into a new trust arrangement, incorporating the desired modifications. While the common law of some states case created a decanting power in Trustees who have broad authority to make principal distributions from trust assets, most states, including Maryland, rely on the adoption of decanting statutes that empower a Trustee with discretionary authority to distribute trust principal to decant a trust if and when changes are needed.
Decanting can be a more complicated process because it requires the creation of a new instrument to govern future administration. Accordingly, the Trustee must be careful to preserve certain characteristics of the original trust agreement when creating the new agreement to avoid unintended consequences. Additionally, where the Trustee’s discretionary power to distribute principal is limited to a specific standard, the Trustee will likewise be limited as to the changes permitted under the new trust agreement.
One benefit to the decanting statutes is that the Trustee, as fiduciary, relies on the statutory framework to make needed changes to the trust without requiring the agreement of other interested parties. Instead, the Trustee provides notice of his or her intent to decant to the grantor (if still living) and the qualified beneficiaries, providing the other interested parties with copies of the original trust agreement and the proposed new agreement, and setting a timeline for the others to challenge the decanting if they disagree with the proposed changes. In this way, many of the risks associated with a grantor or beneficiary being deemed to exercise control over trust assets can be avoided.
Proceed with Caution
Modifications to trust agreements should be undertaken in a way that not only maintains the grantor’s intentions and the material purposes of the trust but also one that takes care to preserve certain protections and benefits of the trust arrangement as a whole. In order to preserve the benefits of the trust arrangement – for estate tax planning purposes and/or creditor protections – it is vital that trust modifications be made with the utmost caution. Trust modifications should only be made under the supervision of attorneys and other advisors with experience in the various laws governing and affecting trusts and their taxation, to avoid unintended consequences.
The attorneys at Sessa & Dorsey utilize their experience in all areas of trust administration and fiduciary taxation to consider and balance the varying interests when parties seek to modify an irrevocable trust. If you are a beneficiary or Trustee of a trust that is not structured to meet your needs, contact our office today to make an appointment with one of our attorneys to discuss the options that may be available to you.
At Sessa & Dorsey, we consider the bigger picture at hand and advise our clients on the best estates and trusts for their specific needs and desires. If you have questions, please contact us at (443) 589-5600.
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