SJC takes up ‘pouring’ issue in Kraft family trust
The following article appeared in the March 2014 edition of the Massachusetts Lawyer’s Journal. By Debra Rahmin Silberstein and Christopher G.R. Davies
To a wine enthusiast, decanting serves a dual purpose: to provide aeration and to separate the wine from any sediment that developed during the aging process. To decant, simply pour the contents of the wine bottle into a separate container (the decanter), leaving undesirable sediment behind. To the trust and estate attorney, decanting generally means “pouring” the assets of an existing trust into a new trust (the decanter), and the sediment are the provisions of the old trust left behind.
It might sound fairly simple, but the power to decant can have serious implications by changing a grantor’s intent, omitting or restricting beneficiaries, and causing unintended tax consequences. Policy in Massachusetts, by its relative silence on the subject, appears to recognize this. In fact, during the recent enactment of the Massachusetts Uniform Trust Code in 2012, and a full review of trust law during the process, Massachusetts chose not to adopt a decanting statute.
Despite the legislative silence, the Supreme Judicial Court (SJC) recently took up the decanting issue in Morse v. Kraft, 466 Mass. 92 (2013). Richard Morse, sole trustee of the Kraft Family Irrevocable Trust (the trust), sought the SJC’s approval to decant the trust’s assets. Created by Robert K. Kraft (the donor) in 1982, the Kraft Family Irrevocable Trust was designed for the benefit of the “children of the marriage of the donor and Myra H. Kraft,” a class that consisted of four sons when it closed at the death of Myra H. Kraft in 2011. Each son was an income beneficiary of his own subtrust, and a potential object of powers of appointment held by the other sons.
The trust, however, allowed only “disinterested trustees” to participate in distribution decisions. At the time the trust was created, the sons were minors, so “it was impossible to know whether they would develop the skills and judgment necessary to make distribution decisions concerning their respective subtrusts.” Id.
Morse, however, wanted to delegate his trustee powers to the Kraft sons, who were now adults and able to manage their own financial affairs. Desirous of removing this restriction, and with the knowledge that the SJC’s imprimatur would be necessary to qualify the new trust as “grandfathered” under IRS Generation-Skipping Tax Regulations, Morse filed a petition asking the court to interpret the trust’s language as authorizing decanting without court approval.
Starting with Florida in 1940, the common laws of a number of states have also authorized decanting in some form, with varying restrictions. See Phipps v. Palm Beach Trust Co., 142 Fla. 782, 786 (1940); See also Florida Statute §736.04117 (enacted in 2007 and authorizing decanting by statute); In re Estate of Spencer, 232 N.W. 2d 491 (Iowa 1975); Wiedenmeyer v. Johnson, 55 N.J. 81 (1969). These courts have generally taken the position that a trustee who has the absolute discretionary power to create in a beneficiary an estate in fee simple, as a consequence of that power, has the authority to create in that beneficiary an estate in less than fee simple. See Phipps, 142 Fla. at 786. In other words, if the trustee can distribute to the beneficiary outright, then, absent further restrictions, the trustee may distribute to that beneficiary in further trust. Adopting this same position, the SJC recognized that the almost unlimited discretion granted to Morse as trustee of the 1982 trust, to make outright distributions to or for the beneficiaries, inherently included the power to distribute in further trust. See Morse, 466 Mass. at 95.
Preferring to leave the issue to the legislature, however the SJC did little to clarify the metes and bounds of the decanting power in Massachusetts. While the court recognized the existence of the common law power, it stressed that whether a trustee has the power to decant depends on the facts and circumstances of each individual case, and placed great significance on the donor’s intent. See Morse, supra, at 97 (“in interpreting a trust, the intent of the settlor is paramount”). The specific Morse facts strongly supported the SJC’s decision, as there was testimony from the donor and the original drafting attorney regarding their intent to allow decanting, even though the trust was silent. The SJC also explicitly declined to adopt the Boston Bar Association’s recommendation of a broad decanting power, irrespective of the language of the trust. Id. at 99. Further, the SJC put drafting attorneys on notice that, given the prevalence of express decanting provisions in modern trust instruments, it would be unwise to rely on the common law power in the future. Id. at 100 (“We will then consider whether the failure to expressly grant [the] power suggests an intent to preclude decanting”).
The SJC also recognized that the power to decant is potentially the power to amend an unamendable trust. (See Morse, 466 Mass. at 93). With that comes potential for abuse that future legislation in the commonwealth will need to address. Twenty-one states have adopted some form of decanting legislation and a handful more are actively considering it. (See M. Patricia Culler, American College of Trust and Estate Counsel, List of States with Decanting Statutes, Passed or Proposed, Nov. 15, 2013.) These states, in developing their legislation have developed a myriad of restrictions and conditions on the exercise of decanting powers to guard against such abuse.
First, restricting the class of beneficiaries of the new trust to those identified by the original trust is a common restriction (both by case law and statute) and was supported by dicta in Morse. See Id at 94. This limitation was adopted by the Florida Supreme Court in Phipps, supra, at 786-787, and in varying forms by all states to pass decanting legislation. See Wareh & Dorsch, Decanting: A Statutory Cornucopia, Trusts & Estates, March 2012, 24 (“no state permits the direct addition of a new beneficiary”). Restricting the class of beneficiaries becomes more complicated, however, when decanting less than the entire trust to a subset of beneficiaries, when a future interest is accelerated, or when a distribution standard is altered. States address these situations in varying ways, with a minority explicitly allowing the acceleration of a future or contingent interest,1 and others vaguely stating that the new trust may be for “one or more” of the current beneficiaries.
Second, explicit limitations on changes to distribution standards are less common, but should be considered. The majority of states are currently silent on whether a distribution standard may be changed through decanting. See Wareh & Dorsch, supra, at 26. It is unclear whether these states permit a change in distribution standard. Alaska, Delaware, New York, North Carolina and Ohio explicitly restrict the trustee’s power to change distribution standards.
Third, decanting powers may also cause adverse tax consequences. The Internal Revenue Service has yet to issue a final decision on the estate and generation skipping transfer tax consequences of decanting.2 For estate tax purposes, if a beneficiary is trustee (and can change the distribution standard or distribute outright), or if the beneficiary has the power to replace the trustee, the unbridled power to decant may result in trust principal being included in the beneficiary’s estate. Recognizing the potential for adverse tax consequences, states have taken steps to prevent this outcome. Alaska, for example, expressly requires that the new trust adhere to the same standard for invading principal as is contained in the original trust.3
The Uniform Law Commission (ULC) has formed a drafting committee to explore model decanting legislation, either in the form of a standalone statute or an amendment to the Uniform Trust Code. The Decanting Ad Hoc Committee of the Massachusetts Bar Association’s Probate Section Council, rather than submit its own legislative proposal, chose to wait for the ULC’s recommendation.
The status quo in Massachusetts remains ambiguous. Without clear evidence of the donor’s intent to grant the decanting power, is there a power at all? And if the decanting power does exist, then what limitations apply to its exercise? Absent further case law, these questions will likely be answered, in time, by the legislature. In the interim, decanting powers should be used and exercised carefully. Given the highly fact-sensitive nature of the Morse opinion, trust documents should clearly address the donor’s intent. Court approval should be sought to determine the nature and extent of the power in any particular case where donor’s intent is ambiguous or the power is not specified. Attorneys drafting new trusts should discuss the pros and cons of adding explicit decanting provisions with their clients.
1. Missouri (R.S. Mo. § 456.4-419); South Dakota (S.D.C.L. §§ 55-2-15 – 55-2-21)
2. See IRS Notice 2011-101, Transfers from an Irrevocable Trust to another Irrevocable Trust (sometimes called “decanting”); Requests for Comments, available at: www.irs.gov/pub/irs-drop/n-11-101.pdf
3. Alaska Stat. § 13.36.157.