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Recent Developments in Estate and Trust Administration

11.18.2009

 

A. Introduction

This outline is a survey of recent developments in estate and trust administration, including changes in a number of North Carolina statutes that directly affect several areas of interest for the clients of both accountants and attorneys. Many of the techniques and changes outlined herein now provide valuable estate and tax planning opportunities previously unavailable in North Carolina.

B. Trust Decanting 

1. What is Decanting?

Decanting is the term primarily used to describe the act of paying trust property from one trust to another under the trustee’s discretionary power to make distributions to or for the benefit of one or more beneficiaries. Often this power to distribute trust corpus is called the power to invade a trust. With decanting, instead of exercising an invasion power by making payment directly to or for a beneficiary, a trustee can now pay the assets over to a new trust for the beneficiary. This power enables a trustee to address a variety of potential issues including favorable tax planning, changes to trust management, or state law issues. Finally, the most valuable benefit of trust decanting is its ability to make corrections or adjustments in an irrevocable trust setting.

2. History of Decanting

Although a relatively new technique in most parts of the country, decanting originated in Florida in 1940 with the case of Phipps v. Palm Beach Trust Co., 196 So. 199 (Fl. 1940). From this case sprung a series of cases across many states which formed the basis of the body of law on modern day decanting. In many states, a form of decanting now exists under the state’s common law. In addition, several states have codified the use of decanting with state specific decanting statutes. New York was the first to enact such a statute and currently eight other states have enacted decanting statutes including Alaska, Arizona, Delaware, Florida, Nevada, New Hampshire, North Carolina, South Dakota and Tennessee. There is no “Uniform Decanting Act” and each of these state statutes is different with regard to the powers and flexibility afforded the trustee.

3. Why use Decanting?

Trust decanting can be used to address several issues that may present themselves during the life of a trust instrument. In addition, trust decanting is a process that, in many situations, may not require a judicial hearing or court approval, meaning less hassle and expense for the trust. The list below is a small sample of the many benefits and situations where trust decanting can prove valuable.

a. Modernize or improve outdated trust provisions. Trust decanting allows a trustee to incorporate recent changes in the law by adding new Trustee authority or powers not previously available.

b. Address Changed Circumstances. Quite often a client’s view of the future never materializes as envisioned or an unanticipated series of events creates a situation much different from the client’s original intention. In addition, many of these changes occur after a trust has become irrevocable and the client no longer has the ability to unilaterally amend the instrument. Trust decanting provides a valuable way to account for the unforeseen without the need for court approval. Some examples of unforeseen circumstances are:

i. Disabled Beneficiaries. A beneficiary becomes disabled or has special needs. The Trustee could decant that specific beneficiary’s portion into a supplemental needs trust to enable the beneficiary to avoid disqualification for federal or state government benefits.

ii. Distributive Provisions. A Grantor may have set up a trust that is to distribute all trust corpus to a beneficiary at a set age or event, or perhaps in tiers at two or three different ages. If events later present themselves where that beneficiary, for whatever reason, shouldn’t receive a large lump sum of assets upon such age or event, then the Trustee could decant such assets into another trust for the benefit of the same beneficiary, but with a later age distribution or even continuation for the lifetime of the beneficiary.

iii. Creditor or Marital issues. Decanting allows a Trustee to make adjustments for unforeseen creditor or marital problems that could otherwise adversely affect the Grantor’s intended use of the trust assets. The decanting power could also include the addition of spendthrift language in the trust.

iv. Uneven wealth accumulation. Should one or more beneficiaries have accumulated assets to the point that they really don’t ‘need’ the assistance the trust provides, the Trustee could use decanting to place the trust assets into another trust to provide greater benefit to those beneficiaries more in need.

c. Change trust situs. If a trust presently does not allow a change in situs or place of administration, decanting can allow a Trustee to move a trust to another jurisdiction for administration. This might provide tax benefits if the new jurisdiction has more favorable tax laws.

d. Tax issues. A Trustee may need to correct a Crummey power of withdrawal to qualify for the gift tax annual exclusion. A Trustee may need to make a trust a grantor trust for income tax purposes which would allow for the sale of appreciated assets by the Trust to the Grantor without the recognition of income. As noted above, another state’s tax laws may be more beneficial and the Trustee would like to change trust situs to avail itself of these tax benefits. Finally, a Trustee can use decanting to fully maximize the GST exemptions of either the Grantor or a beneficiary.

Planning Pointer: Be careful when using decanting to extend the term of GST exempt trusts. For “Grandfathered” (Pre 9/25/1985) GST trusts certain safe harbors must be met in order not to lose Grandfathered status. In addition, there are no current regulations that speak to the consequences of the extension of GST exempt trusts beyond the trust’s original termination date.

e. Correct Drafting Errors. Whether substantive or clerical in nature, a variety of drafting errors or omissions may not be discovered until after the trust is irrevocable. Trust decanting can correct these errors.

f. Trustee or administrative changes. Trust decanting can allow for later alteration to Trustee administration provisions including the number of votes required to act among co-trustees or the order of successor trustees.

4. Decanting in North Carolina.

The North Carolina Decanting Statute (An Act To Allow A Trustee To Appoint Trust Property To Another Trust For The Same Beneficiary) was signed into law by the Governor on July 17, 2009 and became effective on October 1, 2009. The North Carolina Decanting Statute can be found in N.C.G.S. §36C-8-816.1. At its core, the statute provides:

A trustee of an original trust may, without authorization by the court, exercise the discretionary power to distribute principal or income to or for the benefit of one or more current beneficiaries of the original trust by appointing all or part of the principal or income of the original trust subject to the power in favor of a trustee of a second trust.  The trustee of the original trust may exercise this power whether or not there is a current need to distribute principal or income under any standard provided in the terms of the original trust.  The trustee's special power to appoint trust principal or income in further trust under this section includes the power to create the second trust.

Key elements of the statute include:

a. Discretion to invade. The Trustee must have the discretionary power to distribute assets to or for the benefit of one or more beneficiaries of the original trust. If so, the statute allows the special power to appoint trust principal or income to include creation and funding of a second trust.

b. Same standards. If an ascertainable standard limited the Trustee’s distributions from the initial trust, the same standards must also govern the second trust. Likewise a future beneficial interest in the original trust cannot be accelerated in the second trust.

c. Like beneficiaries. The beneficiaries of the second trust must include only one or more of the beneficiaries of the original trust. No new beneficiaries are allowed in the second trust.

d. Procedural elements

i. Execute a Decanting Document
ii. File the Decanting Document with original trust
iii. Give notice to the Qualified Beneficiaries
1. Beneficiaries can waive notice
2. Beneficiaries can also petition the court for approval

5. Tax implications of Decanting

a. Gift Tax. A Trustee’s use of decanting should not cause gift tax concerns unless the Trustee is a beneficiary or beneficiary consent is required to exercise the trustee’s power to decant.

Planning Pointer: The biggest trap for an unintended gift tax consequence is the situation where the Trustee is also a beneficiary of the trust. Be mindful to use caution in such a situation. It is generally recommended that a Trustee who is also a beneficiary not participate in the decanting. In fact, the North Carolina decanting statute specifically does not allow a Trustee to exercise the decanting power if the Trustee is a beneficiary of the original trust.

b. Estate Tax. Most cases of decanting should not have adverse estate tax consequences unless:

i. The second trust provides the beneficiary with a general power of appointment causing the property to become subject to I.R.C. §2041.

ii. There is an incomplete gift completed only upon the beneficiary’s death.

iii. The original Grantor is deemed to have too much involvement or implied control, thereby causing inclusion under I.R.C. §2038.

c. Income Tax. In most cases a decanting of property from one trust to another will not raise income tax issues. In limited cases if the decanting results in a sale or exchange of property or if the sale or exchange results in materially different property held in the new trust, then income tax issues may arise.

C. Repeal of North Carolina Rule Against Perpetuities

1. What is the Rule Against Perpetuities?

The beginnings of the rule against perpetuities date back to historical England. Stripped to its most basic definition, the classical statement on the rule came from John Chipman Gray of Harvard Law School who stated: “No interest is good unless it must vest, if at all, not later than twenty-one years after some life in being at the creation of the interest.”

2. Purpose of the Rule

The rule has long been in place with the intent of limiting the power of an individual to control the disposition of one’s assets long after the person’s death.

3. Practical Application

In practice, the rule has been one of the most complex, unintelligible and misunderstood rules in the law. In an effort to help ease the harsh results of the rule and to facilitate the creation of long-term trusts, North Carolina adopted the Uniform Statutory Rule Against Perpetuities (USRAP) in 1995 which provided for a 90-year wait-and-see look back period. However, despite the passage of USRAP, the push for a complete repeal of the rule in North Carolina remained in order to stay competitive with a number of other states which have completely repealed the rule.

4. Repeal of the Rule Against Perpetuities

a. Law. On August 19, 2007, Governor Michael F. Easley signed into law House Bill 1384, Session Law 2007-390 which repealed both the original rule against perpetuities and the USRAP as they apply to North Carolina trusts. This law is now N.C. General Statute §41-23.

b. Uncertainty. Despite its passage, many practitioners as well as trust companies were still hesitant to be involved with dynastic trusts due to the new N.C.G.S. §41-23 being in potential violation of the N.C. Constitutional Prohibition Against Perpetuities and Monopolies as found in Article 1, Section 34 of the North Carolina Constitution.

c. Brown Brothers Harriman Trust Co. v. Benson 09 CVS 13456. The Brown Brothers case ultimately tackled the issues of potential conflict between North Carolina’s repeal of the rule against perpetuities and the NC Constitution. On February 26, 2009 the North Carolina Business Court held that:

i. N.C.G.S. §41-23 was a valid exercise of the General Assembly’s power to repeal the rule against perpetuities.

ii. The prohibitions in Article I, Section 34 of the NC Constitution only apply to unreasonable restraints on the alienation of property and not the vesting of remote interests.

iii. The dynastic trust at issue did not violate the North Carolina Constitution.

6. Present Situation. The Brown Brothers case is awaiting appellate review. If not overturned on appeal, North Carolina practitioners will be able to implement North Carolina dynastic or perpetual trusts if the client’s needs and desires so demand. Of course, other states may have more favorable trust income tax rules and clients may still forum shop the state best suited to locate such a trust.

Planning Pointer: Although dynasty trusts now appear to be allowed in North Carolina, the rules of the generation skipping transfer (GST) tax still apply and will limit the initial size of any such trust. In fact, many legal scholars believe that it was the introduction of the GST tax in 1986 that stopped many of the previous estate tax avoidance loopholes and began the initial push for repeal of the rule against perpetuities.

D. Alternatives to Formal Estate Administration

1. Summary Administration. Summary administration is available when a decedent dies either testate or intestate leaving a surviving spouse as the sole devisee or heir (N.C.G.S. § 28A-28-1). The surviving spouse may file a petition for summary administration and upon the signing of the order of summary administration by the Clerk of Court, the estate administration process is over. A certified copy of the order provides the authority for the surviving spouse to administer and transfer assets to her.

Planning Pointer: With summary administration there is no publication of notice to creditors and the surviving spouse becomes 100% liable for any debts of the deceased spouse to the extent of the value of property received. Because of this assumption of liability, many Clerks require a surviving spouse to use an attorney before approving a summary administration. If a surviving spouse has any doubt as to potential creditors or claims outstanding, a formal administration is recommended. Likewise if the surviving spouse plans to sell any real property in the decedent’s sole name within two years of the date of death, summary administration should be avoided and a full estate administration with formal notice to creditors should be done instead.

2. Notice to Creditors Without A Formal Estate Administration. Previously, only a formal administration allowed for the publication of notice to creditors in order to bar all unknown creditor claims. Recent changes to the North Carolina Statutes now provide for a procedure to provide notice to creditors without a formal estate administration when a decedent dies without leaving probate assets. These new rules can be found in the North Carolina General Statutes, Chapter 28A, Article 29.

Planning Pointer: This recent development provides a valuable resource for those clients wishing to cut off unknown creditors of a decedent, but whose assets are held entirely in trust or pass entirely outside of probate by right of survivorship or beneficiary designation.

3. Small Estates Increase. House Bill 203, Session Law 2009-175 has recently amended N.C.G.S. §28A-25-1 to increase the size of estates that can be administered as a ‘small estate’ from $10,000 to $20,000. Under this statute a party (the “collector”) will file an affidavit of collection (AOC–E–203) with the clerk of court and upon transfer of all estate assets to the beneficiaries will then file a final affidavit of collection, disbursement and distribution (AOC-E-204).

a. Differences between administration by affidavit (small estate) and formal administration:

i. Collector by affidavit is not required to be bonded;
ii. Collector by affidavit is not a Personal Representative;
iii. No inventory is required; and
iv. Notice to creditors is not required.

4. Increased Spousal Allowance. Recent changes to N.C.G.S. § 30-15 have increased the spousal allowance from $10,000 to $20,000. The spousal allowance is an amount of assets a surviving spouse can receive from an estate which is exempt from any judgments, liens or creditors of the decedent. The amount is intended to provide support for a surviving spouse for the year following a decedent’s death. The right to a spousal allowance is available whether the estate is administered through a formal administration process or one of the other less formal alternatives.

Planning Pointer: The Small Estate value may be determined after the removal of assets to satisfy the spousal allowance. With the recent increase, a decedent leaving a surviving spouse and probate assets of no more than $40,000 could benefit from the combination of these two recent increases without the need for a full estate administration.

Planning Pointer: The spousal allowance can be funded with any personal property. In many instances the spousal allowance is an effective way to quickly and efficiently transfer full title in a vehicle, or like asset, to the surviving spouse.

Planning Pointer: Don’t forget the children. All minor children, including full time students under age 22, and disabled or incompetent children under age 21, are entitled to $2,000 as a yearly allowance in addition to the spousal allowance.

E. North Carolina’s New Elective Share Statute

1. What is an elective share?

As a general rule, an individual is free to dispose of or bequeath one’s assets as they so choose including the disinheritance of family members at will. However, absent a pre or post marital agreement to the contrary, one cannot fully disinherit a surviving spouse. First effective on January 1, 2001, the new North Carolina Elective Share statute now governs the procedure for a disinherited spouse to properly claim a share of their deceased spouse’s estate in the event the decedent did not sufficiently provide for his surviving spouse at death.

2. General disposition. In summary, the North Carolina elective share statute provides a surviving spouse with:

a. one-half of the deceased’s total net assets if the decedent is not survived by any lineal descendants;

b. one-half of the deceased’s total net assets if the decedent is survived by one child or issue of one predeceased child; or

c. one-third of the deceased’s total net assets if the decedent is survived by two or more children or the issue of two or more predeceased children.

d. In the event of a second or later marriage, the above fractions are reduced by one-half if the deceased has surviving issues from a previous marriage and there are no issue from the current marriage.

3. Confusion. Although well intended in its protection of surviving spouses, the North Carolina Elective Share statute adopted in 2001 was at times cumbersome to interpret in complex situations. In particular, the term ‘total net assets’, which defined the assets subject to the elective share claim, was difficult to determine.

4. In re Estate of Pope 666 S.E.2d 140 (2008). The term ‘total net assets’ in calculating a surviving spouse’s elective share under the statutes was at issue in the recent Pope case. In Pope the surviving spouse had petitioned for an elective share and wanted to include in ‘total net assets’ assets that were held in an irrevocable trust during the decedent’s lifetime and which passed to a charitable foundation upon the decedent’s death. Upon review, the North Carolina Court of Appeals affirmed the lower court’s denial of the surviving spouse’s right to claim an elective share of the assets in the decedent’s irrevocable trust. The court held that although the decedent held equitable title to the assets as a result of being a lifetime beneficiary of the trust, the legal title was actually in the name of the trustees. Likewise, the court noted that the assets couldn’t be subject to an elective share claim as assets ‘includable in the decedent’s taxable estate’ because the taxable estate was zero since the assets transferred to the family’s charitable foundation and qualified for the estate tax charitable deduction.

5. New Elective Share Statute. In response to the statute’s confusion as highlighted in the Pope case, the North Carolina elective share statute was recently rewritten and now applies to decedents dying on or after October 1, 2009. The new statute is substantively the same as the old one, but more clearly clarifies and defines ‘total assets’ and other terms defined in the statute. Key points to still remember in connection with an elective share claim:

a. An elective share petition must be filed within six (6) months after the issuance of the Estate’s letters testamentary.

b. The elective share hearing shall be held within two to six months after the filing of the petition claiming an elective share

c. The same fractional rights in interest are present (1/2, 1/3 or less depending on number of descendants, second marriage, etc…) as were in the original statute.

6. The Elective Life Estate. In lieu of taking an outright intestate share, the surviving spouse of an intestate, or a surviving spouse who has petitioned for an elective share, can elect the following as their intestate or elective share:

a. A life estate in one-third (1/3) of all the real estate of which the deceased spouse was seized and possessed of an estate of inheritance at any time during coverture.

b. This one-third (1/3) life estate shall also include a full life estate in the usual dwelling house occupied by the surviving spouse including fee simple ownership of all household furnishings therein.

i. Except for a few mortgage related exceptions, neither the household furnishings in the dwelling house nor the life estate taken under this election shall be subject to the payment of debts due from the estate of the deceased spouse

Planning Pointer. Although the elective life estate is not commonly used by surviving spouses, it is important to remember and may be crucial in certain situations. For example, in extremely debt ridden estates the elective life estate can potentially leave the surviving spouse with at least somewhere to live free from the debts of the deceased spouse. It is because of this life estate election right that lenders and buyers require both husband and wife to sign real estate deeds and deeds of trust, even if only one spouse is on the title, in order to fully release all spousal rights associated with the real property.

F. North Carolina’s Uniform Trust Code – Modification and Termination of Irrevocable Trusts

Article 4 of the North Carolina’s Uniform Trust Code ( N.C.G.S. §36C-4-411 through §36C-4-416) contains statutes that allow a grantor, beneficiary or trustee to alter or terminate an irrevocable trust.

a. 36C-4-411(a) - Consent of the Settler and all beneficiaries. An irrevocable trust can be modified or terminated if the settlor and all the beneficiaries consent. This type of modification is the only statutory provision under the UTC which does not require a court order to amend an irrevocable trust.

i. Although not required, a party may file an action in superior court to approve such a modification or termination.

ii. An incapacitated settlor’s attorney in fact or guardian can still exercise this power for the incapacitated settlor, if authorized under the power of attorney document or guardianship.

iii. This type modification or termination is available even if the modification or termination is inconsistent with the original purpose of the trust.

Planning Pointer. The statutory definition of Settlor includes the person who created the trust as well as anyone who later transfers assets to the trust. If multiple parties have participated in funding a trust, all will need to be alive and participate in the agreement to modify or terminate under this statutory method.

b. 36C-4-411(b) (c) and (d) - Compelled modification or modification with Consent of the beneficiaries.

i. Under subsection (b) and (c) of N.C.G.S. Section 36C-4-411, the court may terminate or modify an irrevocable trust, upon consent by all beneficiaries, if it is determined that the continuation of the trust is not necessary to achieve its original purpose, or the modification is necessary to maintain the trust’s original purpose. In addition, the court can also order the modification or termination if the reason for such modification or termination substantially outweighs the interest in accomplishing the material purpose of the trust.

ii. If one or more beneficiaries do not agree with the proposed modification or termination, the court may still terminate or modify the trust under part (d) if the trust would have been modified should all beneficiaries have consented and the modification will adequately protect the non-consenting beneficiary.

Planning Pointer. These modification methods are most typically used because the settlor is no longer living and able to consent. However, part (d) can be used when the settlor is still living and one or more beneficiaries will not consent to a modification or termination.

Planning Pointer. Some commentators worry that the ability of the settlor to participate in the modification or termination of an irrevocable trust raises potential inclusion issues under §2036 or §2038. However, the official comment to N.C.G.S. §36C-4-411 states, “the settlor’s right to join the beneficiaries in terminating or modifying a trust under this section does not rise to the level of a taxable power.” If there is serious concern that the settlor’s consent may cause inclusion under I.R.C. Sections 2036 or 2038, a court action can be initiated by the beneficiaries, and if all the beneficiaries are in accord, a consent order con be obtained relatively easily.

c. 36C-4-412 - Unanticipated circumstances. An irrevocable trust can be modified or terminated if the court finds that such modification or termination will further the original purposes of the trust. In addition, a trust may be modified if its existing terms cause unnecessary waste or strain on the trust’s administration.

d. 36C-4-413 - Cy Pres. In addition to the other modification remedies available, a charitable trust may be terminated or modified if the court finds the purpose of the charitable trust has become unlawful, impractical, impossible to achieve, or wasteful.

e. 36C-4-414 - Uneconomic Trust. A trust may be terminated if it is determined that it be uneconomical to continue the administration of the trust.

i. If the trust corpus falls below $50,000.00 the Trustee can, without the need for prior court approval, terminate the trust under the statute.

ii. If the trust corpus is over $50,000.00, the superior court must be petitioned and find in favor of the petitioning party as to the uneconomical operation of the trust before granting termination.

f. 36C-4-415 - Drafting mistake or scrivener error. A trust may be modified to conform with the settlor’s original intention if the court finds that the terms of the trust were affected by a mistake of a fact or law or by a drafting error.

g. 36C-4-416. - Tax Objectives. The court may allow the modification of the terms of a trust to help achieve a settlor’s intended tax objectives. Such modification can also be applied retroactively if so ordered by the court.

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