Wine and California seem to be synonymous, so you might be familiar with decanting as a method of improving wine by pouring it from its bottle into a decanter. The process allows you to separate the sediment from older wines or to improve the development of newer wines by allowing them to mix with oxygen. If you are wondering why the name of a process for improving wine appears in the title for an article about irrevocable trusts, read on to learn how recently enacted legislation in California offers an opportunity to breathe new life into old, and even young, irrevocable trusts.
Benefits of an Irrevocable Trust
As a general rule, an irrevocable trust cannot be modified, changed or terminated once established. Once a settlor places assets under the control of the trustee of an irrevocable trust, they are effectively out of the settlor’s control and subject only to the terms of the trust agreement.
Some of the reasons a person might wish to relinquish control over assets through the use of an irrevocable trust include:
- Asset protection: Certain professions, such as physicians, have a higher risk of lawsuits than others. Protecting assets from the effects of a judgment in a lawsuit can be achieved through an irrevocable trust because assets become the property of the trust once transferred to it.
- Minimizing estate taxes: Estate taxes are based upon an estate’s value at the time of a person’s death. Because assets held in an irrevocable trust are out of the reach and control of the settlor or creator of the trust, they do not factor into computing the taxes owed on the estate of the individual upon his or her death.
- Keeping assets separate from marital assets: Although assets received by gift or bequest are the separate property of the recipient under California’s community property law, it can be difficult for those assets to retain their separate property character. Putting them into an irrevocable trust makes it much easier to do so. The benefits associated with the creation of an irrevocable trust can be outweighed when the passage of time brings with it changes in the needs of beneficiaries of the trust or new tax laws making provisions of the trust less advantageous than they were when it was created. Decanting could offer a trustee an option for addressing the need to modify an irrevocable trust. California Adoption of the Uniform Trust Decanting ActCalifornia adopted its version of the Uniform Trust Decanting Act on September 14, 2018. The law applies to trusts created before, on or after its effective date of January 1, 2019. The law allows the trustee of an irrevocable trust governed by California law to terminate the trust by establishing a new irrevocable trust and moving the assets from the terminated trust to the new one. There are a number of different reasons for a trustee resorting to trust decanting, but one of the common ones has to do with the rapid increase of the federal estate tax credit. It first went to $5.49 million in 2017 and then to $11.2 million in 2018. Trusts established prior to these changes might not be as advantageous from a tax perspective as they had been when the settlor created the trust.It was common, prior to changes in the federal estate tax credit, for a couple with children creating an estate plan to provide for the establishment of an irrevocable trust (“Bypass Trust”) upon the death of one of the spouses. The trust provided for a lifetime benefit to the surviving spouse with the remainder to their children. The assets in the Bypass Trust were not subject to estate taxes on the death of the survivor and were distributed to the children free of an estate tax obligation.
When the assets passed to the children, it was without a second step-up in the income tax basis. Only assets that are part of a decedent’s estate at death increase or “step-up” to their date of death fair market value to avoid income taxes on any appreciation prior to that death.
The increased federal estate tax credit and the loss of the step-up in basis upon the second death create a situation in which it could be a disadvantage to have assets in a Bypass Trust. Instead, it could be worthwhile to terminate the Bypass Trust and use the Uniform Trust Decanting Act to move the assets into a new trust set up in a way that allows the assets in the new trust to be included as part of the estate upon the death of the surviving spouse if its value will be less than the $11.2 million federal estate tax credit. The result is no estate taxes imposed on the assets that were in the Bypass Trust, but they do get a step-up in basis for income tax purposes.
Find out If the California Trust Decanting Act Could Help You
If you have questions or concerns about your estate plan, including whether application of the new trust decanting law could benefit you, contact the trust and estate planning attorneys at Magee & Adler. Call us today at 562-432-1001 to schedule an appointment with one of our attorneys.