When making distributions from one trust to another—commonly referred to as “decanting”—practitioners face two key questions. Do the trustees have the power to decant? And, if so, how should the decanting be structured? Frequently, the state decanting statute will provide the answers. But, what if there’s no applicable statute?
Morse v. Kraft
A recent Massachusetts case may help practitioners in all jurisdictions determine whether it’s possible to decant a trust under common law. In Morse v. Kraft,1 the Supreme Judicial Court of Massachusetts held that the trustees of an irrevocable Massachusetts trust had the power to distribute the trust assets to a new trust for the benefit of the same beneficiaries. Even though the trust instrument in Kraft didn’t expressly grant the trustees the power to decant, it authorized distributions “for the benefit of” the beneficiaries. Relying on this language, the court concluded that the settlor had intended to authorize distributions in further trust.
In 1982, Bob Kraft (owner of the New England Patriots) established an irrevocable trust for the benefit of his four sons. The trust instrument created a separate share for each son held for the son’s sole benefit during his life.
The 1982 instrument gave the trustees broad discretion to make distributions of income and principal. Importantly, the trustees were authorized to apply the trust assets “for the benefit of” each son, instead of making a distribution directly to him.
A key feature of the 1982 instrument—and the main reason for decanting the trust—was that only a disinterested trustee could make distribution decisions. According to the trustee’s petition, this limitation was intentional: When the trust was created, Bob didn’t know whether his young children would one day be capable of managing their respective trusts.
Thirty years later, the sons had proven to be responsible adults, and the disinterested trustee was nearing retirement. The children wanted to get more involved in administering their trusts and be able to make distributions to themselves. Because the 1982 trust instrument couldn’t be amended to remove the restriction on distributions, the disinterested trustee proposed transferring the assets to a new 2012 trust that would permit the sons to make distributions to themselves, subject to an ascertainable standard.
But for the imposition of an ascertainable standard (which was necessary to avoid subjecting the trust property to tax in the sons’ estates), the other substantive terms of the 2012 instrument were identical to the terms of the 1982 trust. Many of the administrative provisions were also modernized in the new instrument.
In his court petition, the disinterested trustee argued that he had the power to decant the trust because the instrument authorized him to make distributions “for the benefit of” a beneficiary. Even though the instrument didn’t contain an express power to make distributions in further trust, the trustee argued that the settlor had intended to give the trustees that power. To support this argument, Bob (the settlor), the lawyer who drafted the 1982 trust and the trustee himself all submitted affidavits stating that Bob understood and intended for the instrument to permit distributions in further trust.
Finally, the disinterested trustee argued that the decanting distribution was in the best interests of the beneficiaries of the 1982 trust, for three reasons. First, the sons, acting as full trustees with distributive powers, would be better able to respond to the needs of the income and remainder beneficiaries—themselves and their family members. Second, appointing the sons as trustees would allow for an orderly transition of the management of the trust to the next generation of the Kraft family. Third, decanting would allow the trustees to make use of the 2012 trust’s updated administrative provisions.
Generation-Skipping Transfer Issues
Although the disinterested trustee believed that the settlor had intended to give the trustees the power to decant the trust, he, nevertheless, sought a court ruling to ensure that the proposed decanting wouldn’t subject the trust property to the generation-skipping transfer (GST) tax.
The 1982 trust was created prior to the effective date of the GST tax regime. Thus, the proposed decanting had to fit within the safe harbor rules of the GST effective date regulations to maintain the trust’s grandfathered status. One of those safe harbors applies when a decanting is authorized by the terms of the existing trust instrument without the consent or approval of any beneficiary or court.2 The trustee asked the court to confirm that the decanting was authorized by the 1982 trust instrument and didn’t require either beneficiary or court approval.
A few aspects of the trustee’s litigation strategy are worth noting. First, all of the beneficiaries of the 1982 trust were named as defendants, and all of the adult beneficiaries (Bob’s sons) assented to the relief sought by the trustee. This suggests that the trustee’s tax advisors concluded that a voluntary assent by the beneficiaries wasn’t equivalent to a power to veto the decanting, which would have disqualified the transaction from the GST safe harbor described above. This is a helpful distinction: Trustees following Kraft may wish to seek assents from their trust beneficiaries for liability reasons, without implying that the beneficiaries’ assents are a required element of the decanting for GST safe harbor purposes.
Second, the trustee chose not to pursue an alternate GST safe harbor, which is available if a decanting doesn’t meet the requirements of the safe harbor described above, provided that the decanting doesn’t shift a beneficial interest in the trust to any beneficiary in a lower generation.3 The trustee’s advisors may have been concerned that the imposition in the 2012 trust of an ascertainable standard limiting distributions to the sons could increase the amount ultimately passing to the remainder beneficiaries in a lower generation, taking the trust outside of this alternate safe harbor.
Note that the safe harbor relied on in Kraft will almost always be the better choice. Under the Kraft safe harbor, the only additional requirement imposed by the GST regulations is that the new trust must terminate within the perpetuities period applicable to the existing trust. By contrast, if a trustee relies on the alternate safe harbor, then to preserve the GST tax-exempt status of the new trust, the new trust can’t shift beneficial interests to a lower generation. This standard may be much harder to meet.
The Court’s Analysis
The court began its analysis with a discussion of three seminal decanting cases: Phipps (Florida), Spencer (Iowa) and Wiedenmayer (New Jersey).4 Those cases held that a trustee’s power to distribute property in fee (outright) also included the power to distribute property in less than fee (in further trust), unless the settlor clearly exhibited a contrary intent.
While Massachusetts courts hadn’t previously considered a fiduciary power to distribute assets in further trust, the Kraft court cited a well-known Massachusetts case from 1976 that held that a trust beneficiary may exercise a nonfiduciary special power of appointment (POA) in further trust, unless the settlor clearly exhibited a contrary intent.5 The court also cited the Restatement (Third) of Property (Restatement Third), which likens decanting to the exercise of a special POA.6
Based on these authorities, the court held that decanting was possible without the consent or approval of any beneficiary or the court. The court emphasized, however, that the extent of a trustee’s decanting power turns on the facts of the case and the terms of the trust instrument. In particular, the key question is whether the settlor intended to grant the trustees the power to make distributions in further trust.
The court pointed out that the language of the 1982 instrument gave the trustees almost unlimited discretion to distribute property directly to the beneficiaries or apply it for their benefit. The court interpreted this broad grant of authority as evidence of the settlor’s intent to permit distributions in further trust for the beneficiaries. The court reasoned that the settlor and drafter of the 1982 trust must have known about the decanting case law that existed at the time the trust was created and intended for the instrument to be construed accordingly.
In addition, the court relied on the affidavits submitted by the parties as additional evidence of the settlor’s intent. The court adopted the position of the Restatement Third that extrinsic evidence may be used to ascertain the settlor’s purpose, even if the evidence isn’t contemporaneous with the execution of the trust.7
Common Law Decanting Power
Kraft presents significant opportunities for estate-planning practitioners. For the first time, trusts governed by Massachusetts law can be decanted directly, without the additional step of transferring the trust to another jurisdiction with a more favorable decanting regime. Likewise, practitioners in other states may be able to rely on the analysis of Kraft in the absence of specific authority on point in their jurisdiction.
From a practical perspective, Kraft emphasizes the importance of documenting a settlor’s intent. Intent may be inferred from the terms of the trust instrument if there’s language granting the trustees broad discretion to make distributions “for the benefit of” the beneficiaries. Extrinsic evidence of the donor’s intent may also be helpful, such as affidavits from living donors or the drafting attorney, although the absence of extrinsic evidence shouldn’t be fatal if the discretionary distribution language in the instrument itself is sufficiently broad.
Furthermore, the trustees must weigh the settlor’s intent to permit decanting against the settlor’s intent regarding other substantive provisions of the trust. This issue was present in Kraft, although the court didn’t comment on it because in that case, the decanting was used to remove a restriction on distributive powers (requiring a disinterested trustee) that was very important to the settlor at the time that he created the 1982 trust. Despite this tension, the Kraft trustee believed that the decanting, which had the effect of substituting beneficiary-trustees for the disinterested trustee, was consistent with his fiduciary duties. The Kraft decision suggests that changed circumstances may justify similar changes in other trusts.
While extremely useful in the right circumstances, Kraft has important limitations. First, the court expressly declined to recognize an inherent, ever-present fiduciary power to make distributions in further trust, regardless of the language of the governing instrument.
Second, Kraft provides very limited guidance for decanting trusts that don’t expressly authorize distributions “for the benefit” of the beneficiaries. Although the Kraft court placed considerable weight on the language of the trust, if a trust instrument lacks broad discretionary distribution provisions “for the benefit of” the beneficiaries, consider relying solely on other extrinsic evidence of the settlor’s intent (such as an affidavit), consistent with the position of the Restatement Third.
Structuring the Decanting
If the trustees have the power to decant the trust, how should they structure and implement the decanting transaction? Although the Kraft court declined to express an opinion on the 2012 trust terms or whether the proposed decanting was in the best interests of the beneficiaries, the facts indicate that several categories of trust modifications should be permissible.
First, using common law decanting to update the administrative provisions of an existing trust should be possible. In Kraft, one of the stated reasons for the decanting was to take advantage of the expanded administrative provisions of the 2012 trust, including a more specific enumeration of the trustees’ powers to manage the trust’s investments and an express permission to decant the trust further.
Second, it should be permissible to use common law decanting to modify trustee provisions. In Kraft, the main reason for the decanting was to give the sons the power to make distributions to themselves, which indicates that other trustee changes should likewise be possible.
Third, decanting a trust to impose a stricter standard on distributions to the beneficiaries should be possible. In Kraft, the 2012 trust contained an ascertainable standard that applied to any distributions made by the sons. By analogy, it should be possible to impose other substantive limitations on distributions (for example, requiring the beneficiaries to enter into a prenuptial agreement as a condition of receiving distributions).
Because the holding of Kraft is limited to its facts, however, it’s unclear whether other substantive modifications could be permissible.
For example, a client might wish to decant a trust to remove a beneficiary. In Kraft, the 2012 trust was carefully drafted to follow the same dispositive provisions as the 1982 one, and the court noted with approval that the beneficiaries of both trusts were the same. Nevertheless, under the reasoning of the Phipps, Spencer and Wiedenmayer cases, decanting a trust in this manner should be permissible if the trustees’ power to make distributions directly to the beneficiaries can be exercised in favor of some, but not all, of the members of the beneficial class.
Adding beneficiaries is a different matter. We’re not aware of any jurisdiction’s statutes or common law that would permit a trustee to decant a trust to add new beneficiaries, and for good reason: It would be difficult to argue that adding new beneficiaries is consistent with a trustee’s fiduciary duties to the existing beneficiaries.
There’s another way to arrive at a similar result, however. Several state statutes expressly allow decanting to grant the beneficiaries POAs, which may, in turn, be exercised to add beneficiaries. Because the beneficiary must affirmatively exercise the POA, this approach doesn’t risk violating the trustee’s fiduciary duties.
Finally, a client may wish to decant a trust to eliminate a mandatory distribution or right of withdrawal at a certain age. Usually, in that situation, the trustees will have compelling reasons to retain the assets in trust (for example, to protect the trust property from the beneficiaries’ creditors or to shield assets from estate tax). In Kraft, the new trust contained more restrictive distribution provisions, suggesting that this type of decanting (to prevent distributions at certain ages) may also be possible.
While several courts have recognized the power to decant under general principles of property law, the unmistakable trend is toward decanting legislation. Over 20 jurisdictions have already enacted decanting statutes, and the Uniform Law Commission’s Committee on Trust Decanting is working on a model act, which should be ready for adoption in the next several years.8
Until more jurisdictions enact decanting statutes, however, the common law decanting power acknowledged by the court in Kraft can be an important and useful option for practitioners.
1. Morse v. Kraft, 992 N.E.2d 1021 (July 2013).
2. Treasury Regulations Section 26.2601-1(b)(4)(i)(A).
3. Treas. Regs. Section 26.2601-1(b)(4)(i)(D).
4. Phipps v. Palm Beach Trust Co., 196 So. 299 (Fla. 1940); In re Estate of Spencer, 232 N.W.2d 491 (Iowa 1975); Wiedenmayer v. Johnson, 254 A.2d 534 (N.J. Super. 1969).
5. Loring v. Karri-Davies, 357 N.E.2d 11 (Mass. 1976).
6. Restatement (Third) of Property: Wills and Other Donative Transfers Section 17.1 Cmt g.
7. Ibid., Section 10.2 Cmt g.
8. A preliminary working draft is available at www.uniformlaws.org/Committee.aspx?title=Trust%20Decanting.