Revocable trusts may always be revoked, amended, or terminated while the person who created the trust (grantor) is alive and wishes to do so. However, many irrevocable trusts were created for a specific purpose, which is no longer being served by the trust instrument.
Why might trust modification or termination be necessary or desirable?
An irrevocable trust becomes fixed in time as of the date of its creation. However, with time, family circumstances and laws change. For instance, most Bypass Trusts were designed to use the deceased spouse’s federal estate and gift tax exemption to protect Bypass Trust beneficiaries from a second tax upon the death of the surviving spouse. Assets in those Bypass Trusts pass to the beneficiaries free of federal estate tax, but assets in those Bypass Trusts do not receive a step up income-tax basis. A surviving spouse might seek to administer or modify the trust in such a way to obtain a second step-up in income-tax basis for the couple’s beneficiaries.
These are some of the ways that we can help to optimize the trust to both achieve its original intent and serve its beneficiaries:
- Improve trust administration or management
- Correct drafting errors
- Obtain a step-up in income-tax basis
- Minimize income taxes of estate taxes
- Qualify a beneficiary for government benefits
- Move the trust to another state (change governing law)
- Combine trusts
- Divide trusts
- Address changed family circumstances
- Address changes to the law
- Change trustee succession provisions
- Change trustee powers
- High tax rates on capital gains or undistributed income
- Remove or add limits on the kinds of assets in which the trustee may invest
- Adjust or remove a power of appointment
- Add or remove a trust protector or advisor
How can a trust be modified?
Modification in accordance with the trust instrument.
Sometimes the terms of the trust itself allow for modification. For instance, the trust might give a trust protector or trust advisor the power to amend the administrative provisions of the trust. Or the trust instrument may give the trustee or beneficiary a power that they can exercise to their benefit.
Modification by agreement of the beneficiaries, trustees, and/or grantors
When the trust instrument itself does not allow for modification, the California Probate Code allows trustees and beneficiaries to modify the trust. In most instances such modification requires the approval of the probate court.
Decanting is a process of taking the assets from an existing trust and distributing them into a new trust with more favorable terms. In this process a trust is “decanted” in much the same way a bottle of wine would be decanted. The decanting process has existed in other states for more than a quarter of a century. California enacted the Uniform Trust Decanting Act in September 2018.
Modifying trusts can have tax consequences for the trust itself, the beneficiaries, and the grantor. We help our clients review their trusts to determine if a trust modification or termination may be desirable, what the tax consequences might be to all parties, and how the modification may be accomplished.