Decanting Trusts Under North Carolina’s Uniform Trust Decanting Act

The North Carolina Uniform Trust Decanting Act (UTDA) allows trustees to “decant” or transfer assets from an irrevocable trust to a new trust. This provides an opportunity to modify the trust’s terms while preserving its original intent. Under N.C. Gen. Stat. § 36C-8B-8, trustees may decant a trust if they have discretionary authority over distributions of trust principal.

Key Provisions of The North Carolina Uniform Trust Decanting Act

Discretionary Power: The trustee must have the power to make discretionary distributions of principal in the original trust, as stated in N.C. Gen. Stat. § 36C-8B-9. The broader the trustee’s discretion, the more flexibility they have in changing the trust terms.
Notice Requirements: Under N.C. Gen. Stat. § 36C-8B-13, trustees must provide written notice to beneficiaries, trust protectors, and other interested parties 60 days before the decanting takes effect.
Fiduciary Duty: N.C. Gen. Stat. § 36C-8B-12 outlines that decanting must comply with the trustee’s fiduciary duties, ensuring the modification is in the best interest of the beneficiaries.
Exclusions: Trustees cannot decant to alter fixed beneficiary interests unless allowed by the original trust, per N.C. Gen. Stat. § 36C-8B-10.
Court Approval: Trustees may seek court approval to ensure legal validity under N.C. Gen. Stat. § 36C-8B-11, especially when there is ambiguity or conflict about the changes being made.

Tax Issues Related to Decanting Trusts

Decanting raises significant tax issues, including income tax, gift tax, estate tax, and generation-skipping transfer (GST) tax concerns. Careful consideration of these tax aspects is critical to ensuring that the decanting process does not trigger unintended tax consequences.

Income Tax Considerations

A primary concern when decanting is whether the transfer of assets to a new trust constitutes a taxable event. According to Treasury Regulation § 1.643(a)-3, a taxable event may occur if decanting results in a material difference between the old and new trust. However, if the old and new trusts are substantially similar, the IRS typically views the decanting as a non-taxable event.

Grantor Trust Status: PLR 200932019 illustrates the importance of preserving grantor trust status in decanting. The ruling concluded that decanting does not necessarily terminate grantor trust status if the changes do not alter the beneficial interests.
Non-Grantor Trusts: For non-grantor trusts, decanting should generally not result in immediate income tax liability under IRC § 662, as long as there is no significant modification in the beneficiaries’ interests. PLR 201730012 upheld this view, confirming that minor changes to trust administration do not trigger income tax consequences.

Gift Tax Implications

Decanting may trigger gift tax consequences if it shifts beneficial interests among the trust beneficiaries. Under IRC § 2511, a taxable gift occurs when property is transferred without adequate consideration. The IRS has provided guidance on this issue in several Private Letter Rulings, including PLR 200736002, which held that no gift tax was incurred in a decanting where the beneficial interests did not materially change.

Beneficiary Shift: Decanting that results in a change in beneficial interests may constitute a taxable gift under IRC § 2514. Trustees should avoid significant shifts that could be considered a gift transfer, as outlined in PLR 201633021.

Estate Tax Concerns

Decanting may also have estate tax implications, particularly if the modification causes the assets of the trust to be included in the settlor’s or a beneficiary’s estate. Under IRC § 2036, assets may be included in a decedent’s estate if they retain control or beneficial interest over the trust. For example, PLR 200607015 cautioned that changes affecting the settlor’s retained interest could bring trust assets back into the taxable estate.

Inclusion in Beneficiaries’ Estates: Decanting should be structured to ensure that assets do not inadvertently become includible in a beneficiary’s estate under IRC § 2041. PLR 201730009 illustrated that where a decanting does not expand a beneficiary’s power of appointment, estate tax consequences may be avoided.

Generation-Skipping Transfer (GST) Tax

Generation-skipping trusts are subject to GST tax under IRC § 2601, which imposes a tax on transfers to beneficiaries two or more generations below the settlor. Decanting may affect a trust’s GST-exempt status, especially if it alters the trust’s distribution scheme or extends its duration. PLR 201744001 confirmed that decanting into a GST-exempt trust did not result in the loss of exemption, as long as the trust’s original exempt status was preserved.

Treasury Regulation § 26.2601-1(b)(4) provides guidance on modifications to GST-exempt trusts, stating that as long as the modifications do not materially affect the transferor’s generation-skipping tax exemption, the exemption remains intact.

Conclusion

Decanting trusts under North Carolina’s Uniform Trust Decanting Act offers trustees a valuable tool for adapting irrevocable trusts to changing circumstances. However, trustees must carefully navigate the tax implications, including potential gift, estate, and generation-skipping transfer tax consequences. By considering relevant case law and IRS guidance, including Private Letter Rulings and Treasury Regulations, trustees can minimize tax risks and ensure that the decanting process remains compliant with both state and federal tax laws.

References
   •   N.C. Gen. Stat. § 36C-8B, North Carolina Uniform Trust Decanting Act
   •   IRC § 2036, Estate Tax Inclusion
   •   IRC § 2511, Gift Tax on Transfers
   •   IRC § 2601, Generation-Skipping Transfer Tax
   •   Treasury Regulation § 1.643(a)-3, Non-Taxable Events
   •   Treasury Regulation § 26.2601-1(b)(4), GST-Exempt Trust Modifications
   •   PLR 200932019, Grantor Trust Status in Decanting
   •   PLR 200736002, No Gift Tax on Decanting
   •   PLR 201730012, Income Tax in Decanting
   •   PLR 200607015, Estate Tax and Settlor’s Retained Interest

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