With In Re Kroll, 971 N.Y.S.2d 863, the Nassau Surrogate Court has issued what may be the first opinion dealing with the amended decanting statute under New York Estates, Powers and Trusts Law ("EPTL") § 10-6.6.
At issue was a trust for a grandchild created in 1992, apparently in accordance with § 2503(c) of the Internal Revenue Code. The trust provided that, while the beneficiary was under age 21, distributions of income and principal could be made to him at the discretion of the Trustees. At age 21, the beneficiary had the power to withdraw the entirety of the trust principal. Thereafter, the beneficiary was entitled to receive the income from any principal that he did not withdraw. One half of any remaining principal would be distributed outright to the beneficiary upon his attaining age 30, with the entirety of the principal being distributed outright at age 35.
The trust was created when the beneficiary was still an infant. However, by the time the beneficiary approached his twenty-first birthday, he suffered from several disabilities and was the recipient of Medicaid and SSI benefits.
The Trustees determined that the trust assets should be "decanted" under EPTL § 10-6.6 into a new supplemental needs trust, which would eliminate the beneficiary's right to withdraw principal, to receive mandatory income payments or to receive the principal outright at ages 25 and 30. Because § 10-6.6(n) prohibits decanting to eliminate a beneficiary's current right to income (or to withdraw the trust's assets), it was necessary for the Trustees to decant the trust's assets before the beneficiary attained age 21 (since until then he had no current, mandatory right to trust income or principal).
Under EPTL § 10-6.6, a decant is generally only effective thirty days after notice has been given to all interested parties. However, the Kroll Trustees were nonetheless able to decant the trust six days before the beneficiary's twenty-first birthday, since the interested parties consented to an immediate effective date as permitted by EPTL § 10-6.6(j) (since the beneficiary was under a legal disability, his father consented on his behalf).
The New York Attorney General objected on behalf of the New York Department of State (i.e., the agency with oversight over the Medicaid benefits that the beneficiary would continue to receive as a result of the decant).
The court upheld the appointment of assets from the old to the new trust, noting that since the decanting exercise took effect prior to the beneficiary's twenty-first birthday, the beneficiary at no point actually held a mandatory right to receive or withdraw income or principal, and thus the supplemental needs trust to which the trust assets were appointed would not be considered a self-settled trust (and thus the new trust did not need to require that, at the beneficiary's death, the trust remainder be used to repay New York for any funds it expended for the beneficiary's medical expenses).
The Kroll opinion is a welcome affirmation of the power of § 10-6.6 to provide flexibility where time and circumstances have rendered the terms of an irrevocable trust undesirable. However, it is possible that the cost of that flexibility in this case is an increased tax burden.
Under the Code, a donor's annual gift tax exclusion amount generally is not applicable to gifts to a trust. Two exceptions to this rule are trusts where a beneficiary has the power to withdraw a portion of contributions made to the trust ("Crummey trusts"), and trusts that, along with certain other required provisions, provide that the beneficiary may withdraw the entirety of the trust's assets upon attaining age 21 ("§ 2503(c) trusts").
If the trust at issue in Kroll was originally a § 2503(c) trust, it ceased to be so once the Trustees effectively eliminated the beneficiary's power to withdraw principal at age 21.
As such, it is likely that the IRS would argue that the gifts by which the trust was funded originally by the beneficiary's grandfather were thereby no longer sheltered by the grandfather's annual gift tax exclusion amounts. If the grandfather had used up the entirety of his lifetime gift tax exemption before making his contributions to the trust, then this loss of § 2503(c) status means that each gift the grandfather made to the trust gave rise to a gift tax.
However, this may have been a result the Trustees were willing to live with, particularly if the grandfather at all times had sufficient lifetime gift tax exemption remaining to make the gifts and did not need to rely on his annual gift tax exclusion amounts with respect to the beneficiary.