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The Uniform Trust Decanting Act: Significant Changes in the California Trust Landscape

What is the Uniform Trust Decanting Act?

To decant wine is to pour it from one container into another, leaving behind unwanted sediment and bringing the wine in contact with oxygen, enhancing its flavor.  In trust law, decanting is an opportunity to change the terms of a trust by “pouring” the trust assets from the original trust into a new one, leaving behind unwanted restrictions and outdated provisions.  The net result is a new trust that is similar to the original but one that can be significantly different in key areas.  This ability to change an irrevocable trust is important; circumstances change, often necessitating the modification of a trust if the grantor’s original intent is to be carried out.

The Uniform Trust Decanting Act was adopted by California in late 2018 and took effect on January 1st, 2019.  With trust law changing rapidly as a growing number of states seek to create more flexibility in managing trusts, the Uniform Trust Decanting Act was written to bring clarity and uniformity to the legal field of trust law.

Prior to the adoption of the Uniform Trust Decanting Act, or UTDA, California trustees could in some cases decant a trust under Common Law, but specific state guidance was either vague or lacking altogether.  Further complicating the process, decanting under the Common Law required either court approval or the consent of all of the beneficiaries.  Given these hurdles and the legal uncertainty regarding decanting, in many cases a California trustee wishing to decant would first move the trust into a more trust-friendly state, and then decant it there.

Changes Under the Uniform Trust Decanting Act

Adoption of the UTDA has changed the California trust landscape in some significant ways.  Trustees now have significant latitude to change a trust without court involvement or beneficiary consent.  The UTDA gives trustees expansive discretion to create and manage special needs trusts, and includes significant protections for the rights of disabled beneficiaries.

Tax benefits are protected under the UTDA, which permits bypass trusts to be decanted, thereby eliminating capital gains tax from many estates that would otherwise be heavily taxed.  Decanting under the UTDA can also be used to fix drafting errors and modernize trust provisions to better comply with the grantor’s original intent, where circumstances may have significantly changed.

Bypass Trusts Can be Decanted to Avoid Capital Gains Tax

For many years, a relatively low federal estate tax threshold required couples to create complex trusts in order to avoid paying estate taxes.  These trusts avoided estate taxes, but at the expense of creating the possibility for significant capital gains tax.  At the surviving spouse’s death, property in a bypass trust is valued for tax purposes and passed to the final beneficiaries.  Any increase in value between the date of the first spouse’s death and the date of the second spouse’s death is subject to capital gains tax.  Where the second spouse survives the first by many years, the increase – and subsequent tax bill – can be very large.

In recent years, the federal estate tax threshold has risen precipitously; currently fewer than one percent of estates are subject to federal estate taxes.  California has no state estate tax, so for the vast majority of California tax payers, estate tax is a non-issue.  While there are a few reasons why an A/B trust may still be a wise choice for couples, very few people are wealthy enough to need to take advantage of its tax shelter protections.  The problem is that for assets currently in bypass trusts, those trusts may now cost more money than they save.

The UTDA has a solution to this problem.  Where one spouse has already died and an A/B trust has become irrevocable, the trust can be decanted into a new trust in such a way as to bring the trust property into the estate of the surviving spouse.  This can be done by giving the surviving spouse a power of appointment over the trust property.  Bringing the trust property into the estate of the surviving spouse causes the value of the property to be “stepped up” to the value at the time of the surviving spouse’s death.

The marital deduction allows for unlimited tax-free gifts of money and property between spouses.  By taking advantage of the marital deduction and a decanted trust to move assets from the original trust into the surviving spouse’s estate, both estate tax and income tax penalties can be successfully avoided.

Expanded Protection for Special Needs Trusts

The UTDA gives trustees significant liberty to decant into special needs trusts.  Even trustees with only limited distributive discretion are allowed to decant trust assets into a special needs trust.  This is indicative of two of the priorities of the UTDA regarding special needs trusts: to authorize expansive trustee discretion to provide for a disabled beneficiary without being forced to make mandated distributions, and to protect the beneficiary’s access to government benefits by keeping trust assets out of the disabled beneficiary’s estate.

There are three types of special needs trusts.  Of those, two are required to include a Medi-Cal payback provision, under which at the death of the beneficiary any excess funds in the trust are used to repay Medi-Cal expenses incurred on behalf of the disabled person during their lifetime.  The UTDA does not require decanting into a special needs trust with a payback provision.

These three protections – wide trustee liberty to decant, safeguarding a right to government benefits, and no payback provision – constitute a significant defense of the rights of disabled beneficiaries.  Under the UTDA, decanting part or all of a trust into a special needs trust can now be done simply and easily, with the preservation of benefits both during the life and at the death of the beneficiary.

Power to Modify Irrevocable Trusts

Irrevocable trusts are intentionally designed to be difficult to change.  This is in contrast to revocable trusts, which are typically used where the grantor wants to retain the ability to move assets out of the trust or otherwise change the terms of the trust.  The benefits of irrevocable trusts are founded in this unchangeability and are principally related to the fact that assets in irrevocable trusts are normally not considered part of the grantor’s estate.

Irrevocable trusts can be used to protect assets from creditors, avoid taxes, and decrease the value of the grantor’s estate, enabling him or her to qualify for government or other benefits that would not be available were the property in a revocable trust.  These benefits are primarily a result of the grantor giving up the ownership of and significant control over the trust assets.

The UTDA allows irrevocable trusts to be significantly changed.  This freedom can be used to correct errors in the original trust, modify provisions that have become outdated, or change the trust to more accurately reflect the original purpose of the grantor.  Circumstances change, and the UTDA allows irrevocable trusts to be changed with them.  Given the usual difficulty in modifying irrevocable trusts, this freedom is powerful.

Protecting Assets from Creditors

The greater the access a beneficiary has to trust assets, the greater the danger that a creditor can also access that same trust property.  To protect trust assets from creditors, the property must be sufficiently unreachable by the beneficiary as to be considered outside of his or her estate.  Where a beneficiary has the power to compel distributions from the trust, the creditors can in some cases reach the same assets.

By changing a mandatory distribution to a fully discretionary distribution, assets can be protected from creditors.  Under the UTDA, this can be done; however, the trustee must have expanded distributive discretion in order to make that dispositive change.  Trustees with only limited dispositive discretion can only change administrative provisions.

Under the UTDA, a beneficiary’s right to distributions according to a standard – such as for support, best interests, and health care – is not considered a mandatory distribution.  This is important, as many trusts involve making distributions to a beneficiary for a specific purpose such as support, health care, or education.  This option can be used to provide additional protection for assets where there is a high risk of a creditor seeking the assets.

Does My Trust Meet California’s New Decanting Standards?

The UTDA has modernized California trust decanting law, providing significant benefits and protections for trust holders and beneficiaries.  If you have a trust and want to know if it is affected by this Act, please contact our office to schedule an appointment with one of our attorneys.