The Internal Revenue Service (IRS) released a Private Letter Ruling (PLR 201652002) last month that ruled in favor of retroactive trust modification.
The PLR addressed a grantor’s approximately 7-year history of reforming multiple trusts for gift tax purposes. The trust grantor originally retained an attorney to prepare multiple irrevocable trusts, then subsequently learned (after hiring a different attorney to review the plan) that the original drafting attorney neglected to include language in each trust document necessary for gift tax purposes.
Upon learning this, the grantor requested a court order to modify the trusts. The order was granted, and courts ruled that the grantor’s interest in the trusts was retroactively qualified for tax purposes. The grantor’s original trust documents were created with the intent that the grantor’s retained interest would constitute a qualified interest. Since the drafting attorney’s oversight in including the appropriate trust language prevented the grantor from receiving a qualified interest, and the courts recognized retroactive modification for tax purposes; the IRS ruled the same for federal tax purposes.
A few factors to consider with this case and others involving tax benefits associated with modification of irrevocable trusts:
- Language in the trust document. In the case referenced in the PLR above, terms in the trust document provided for modification. While trusts can be modified in many ways, including provisions in the original document can provide flexibility and control should unexpected matters arise. A modern and effective means for modification and overall fluid trust administration is inclusion of trust protector provisions. A trust protector is a party granted certain powers over the trust, such as modification, whose role could help prevent delays and costs of court-ordered changes.
- State law. Every jurisdiction varies in the powers and limitations provided for trust modification procedures. The state where the trusts were administered in the PLR above was not revealed, but the letter notes that the state law allowed for modification. Review active and pending legislation pertaining to trust modification before establishing a new trust and whenever amending trust documents.
- Original intent. In this case the courts recognized the grantor’s original intent, and this intent was memorialized in the original trust document. If ambiguity is present in similar cases, the outcome of a retroactive modification could be unlikely. This PLR highlights the importance of including a statement of intent.
Methods of Trust Modification for Irrevocable Trusts
Depending on the type of trust, provisions in the trust document, and where the trust is located, various out-of-court methods for modification are available:
- Trust Protector. As noted above, trust protectors have specific powers granted to them over trust administration, including modification. The protector’s main influence is to ensure the grantor’s original intent and preserve the best interests of the beneficiaries.
- Decanting. Trust decanting allows for assets in an existing trust to pass to a new trust, and the new trust may have terms that differ from the original. Decanting is not permitted in every state. Read how state decanting laws rank.
- Non-judicial settlement agreement. This method requires unanimous agreement among all parties with interest in the trust. As with decanting, non-judicial settlement agreements are not permitted in all jurisdictions.