Practitioners Beware: Modifying or Decanting a GST Grandfathered Trust can cause the Loss of GST Exemption

danger thin iceCare must be taken when decanting or modifying older trusts.  This is especially true if the goal is to extend the term of the trust.  In truth, it should generally be avoided.

Modifying or decanting an irrevocable trust can cause a trust that is exempt from the GST because it was irrevocable prior to the effective date for the GST in 1986 (known as a “Grandfathered Trust”) to lose its exempt status.

Administrative modifications such as changing trustees is generally OK.  What should generally be avoided is shifting benefits to a lower generation.  You should carefully review Treasury Regulation section 26.2601-1 before making any changes whatsoever.

Such trusts may nevertheless be decanted or modified for purposes of extending the term of the trust.  However, the longest time that such a trust may be extended is the latter of:

    1. 90 years from the date the trust became irrevocable; and
    2. 21 years after the expiration of the rule against perpetuities applicable to the trust.

see Treas. Reg. §26.2601-1(b)(4)(i)(A)(2).

For instance, it should generally be acceptable to extend a trust that is about to terminate and distribute outright to a beneficiary at a certain age to a later age for divorce or creditor protection purposes.  What cannot be done is to shift the time for the vesting of a beneficial interest or to shift benefits to a lower generation.

Another requirement is that modification or decanting must have been authorized by state law at the time the trust was established.  However, no such authorizing statute (in any state) existed at the time the GST was enacted, so we must rely on common law. See BNA portfolio #871 IV.A.1.f.(2)(page A-18).

Your author is not aware of any cases that have specifically authorized decanting under the common law—at least not in Tennessee.  Neither Arkansas nor Mississippi has specifically authorized decanting by statute.  Does your state have a decanting statute?

Obviously, the existence or non-existence of a decanting statute does not preclude the existence of the power to decant at common law.  However, where there is such a statute, an argument can be made that such a statute was an enactment of the existing common law.   (Too bad I have nothing to support that!)

Conclusion.  The most conservative approach would be to simply avoid making any such changes to a Grandfathered Trust.  However, seeing as there were no specific statutes on point at the time the GST tax was enacted, it seems reasonably certain that if you stay within the safe harbor time periods mentioned above, you should not lose the Grandfathered status so long as you do not shift a beneficial interest downward or change the timing of vesting for a beneficial interest.

Sample Savings Provision.

Notwithstanding anything in this instrument to the contrary, this Trust will terminate upon the latter of ninety (90) years from the date the original trust became irrevocable and twenty-one (21) years beyond any life in being at the date the original trust became irrevocable plus a period of 21 years, plus if necessary, a reasonable period of gestation.

Stay Tuned.

Rob Malin

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