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Flexibility Is Key to Dynasty Trust Survival

Diana Zeydel offers some advice on the “care and feeding” of dynasty trusts at Heckerling 2018.

The big questions that are on everyone’s minds are, will grantor trusts be less popular because of income tax considerations? Should you create one anyway because of state income taxes? And, how do you make the decision between grantor and non-grantor trusts?

The answer, according to Diana S.C. Zeydel, global chair of the Private Wealth Services Practice at GreenbergTraurig in Miami and a member of Trusts & Estates’ Estate Planning & Taxation Committee, is “flexibility.”

During her presentation at the 52nd Annual Heckerling Estate Planning Institute on Estate Planning, Zeydel pondered, “Do you abandon dynasty trusts? No matter how forward looking a dynasty trust is, there’s always a need to update it.” Even for many clients, for whom there’s effectively no estate tax, we shouldn’t abandon trusts, because they’re the most flexible estate planning tools. A trust gives a client the ability to change the disposition after the transfer: a change to the who, what, when—that’s the beauty of the trust.

Tools to Use

In some cases, less is more, and “skinny” will work. Put less in the trust, and you get more flexibility. In other cases, it’s better to “pump up” the trust. Regardless, there are many possibilities for trust planning.

The key is to draft a dynasty trust for flexibility. Decanting, merger, amendment and non-judicial settlements are all possibilities to consider. In fact, noted Zeydel, these choices are somewhat regional. She’s found that her colleagues on the East Coast like decanting, while her West Coast colleagues lean more toward amendments. 

There’s also a tension between the discretionary distributions power versus ascertainable standards. A trust that permits a trustee to make distributions for beneficiaries in the trustee’s absolute discretion allows for more flexibility than a trust that permits distributions according to an ascertainable standard. Zeydel prefers to “trust the trustee.” She noted that this approach—to give the trustee the ability to make distributions, rather than use ascertainable standards in specific amounts or for specific purposes—is often the better approach to give more flexibility.

Flexibility vs. Fiduciary Duty

How “low” can you go with the fiduciary liability you impose on a trustee? In states that have adopted the Uniform Trust Code, the terms of a trust instrument can’t exculpate a trustee for bad faith or for reckless indifference with respect to the purposes of the trust or the interests of its beneficiaries. However, you can reduce trustee liability to a low standard. In fact, said Zeydel, a low standard may actually make the trust function better. That is, there’s a corporate fiduciary sitting at the table, which may be better for the administration of the trust than having “Uncle Bob” serve as the trustee.

Changing Property Interests

What if you need to make changes to a trust that has no flexibility? To determine whether a modification, reformation, termination or decanting of an interest in a trust estate may incur transfer tax, you’ll need to figure out the nature of the property interests held and determine whether those interests are susceptible to gratuitous transfer. State law determines the property interest; federal law determines the tax. Zeydel gave a refresher on property interests, noting that an interest in trust may be a present interest or a future interest. Under common law, transferees may hold three types of future interests: a vested remainder, a contingent remainder and an executory interest.

Vested interests are transferable, not subject to the Rule Against Perpetuities and subject to tax. For a remainder interest to vest, the transfer must give the interest to a presently ascertainable person, and the interest may not be subject to a condition precedent.

“What does the document say?” should be the starting point of any analysis, said Zeydel.

Changing Existing Trusts

Rescission, reformation, modification and termination are avenues to consider to change an existing trust. In the United States, a beneficiary’s application to modify or terminate a trust prior to the time required by the trust instrument will be disallowed.This American concept came out of Claflin v. Claflin, in which the court held that termination or modification of an irrevocable trust isn’t permitted if it’s contrary to a material purpose of the settlor.

The more modern U.S. view, however, is reflected in the UTC, which has six separate provisions dealing with the reformation, modification or termination of a trust.

Tax Concerns

What can you unwind? If the tax event has already taken place, an attempt to undo the action giving rise to tax consequences may fail. However, the modern interpretation of the completed transaction doctrine allows alteration, without adverse tax consequences, of a transaction that otherwise appears complete if the taxpayer demonstrates that due to a mistake of fact or law, the transaction has an effect the transferor didn’t intend at the time of the transfer.

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