Many clients establish irrevocable trusts or are the beneficiaries of existing irrevocable trusts, which no longer reflect the grantor’s objectives. Because of changes in the tax laws, the terms of an irrevocable trust may no longer be appropriate and may even have adverse tax consequences. In addition, beneficiaries may desire to modify the trusteeship provisions of an irrevocable trust by removing an independent or corporate trustee or to combine multiple trusts with similar dispositive provisions into one trust to improve administration.
Florida’s Irrevocable Trust Modification Policy
The 2007 changes to Florida’s Trust Code gave more flexibility than ever before to irrevocable trust modifications. Specifically, Florida law provides for the modification of an irrevocable trust in certain circumstances, including when (i) the purposes of the trust have been fulfilled or have become impracticable to fulfill; (ii) because of circumstances not anticipated by the settlor, compliance with the terms of the trust would defeat or substantially impair the accomplishment or a material purpose of the trust; or (iii) a material purpose of the trust no longer exists.
A court may also modify an irrevocable trust created after December 31, 2000, if compliance with the terms of the trust is not in the best interests of the beneficiaries. Other grounds for judicial modification are also available. In modifying an irrevocable trust, a court may, among other things, amend or change the terms of the trust, including terms governing distribution of the trust income or principal or terms governing the administration of the trust. Nonjudicial modification may also be available if the trustee(s) and beneficiaries of the trust unanimously agree to the terms of the modification and the trust was created after December 31, 2000. Finally, after providing notice to the beneficiaries, a trustee may combine two or more similar trusts into a single trust if the result does not impair rights of any beneficiary or adversely affect achievement of the purposes of the trusts.
Tax Consequences of Trust Modifications
The potential tax consequences resulting from an irrevocable trust modification should be carefully evaluated. For example, if a beneficiary renounces his interest in a trust, or permits such interest to be shifted to another person in a trust modification, the beneficiary may be deemed to have made a gift, unless the renunciation was made in the context of a settlement of bone fide litigation between the beneficiary and the other person.
In addition, certain pre-1987 trusts, which are “grandfathered” or exempt from generation-skipping transfer (GST) tax, must follow the safe harbor rules provided by the Internal Revenue Service in order to maintain their special tax-exempt status when they are the subject of a trust modification, judicial construction, settlement agreement or merger.
In particular, if grandfathered trusts are merged, perhaps to make administration of the trusts more cost-efficient and to enhance the management of the trust assets, extreme caution should be used so that the trusts do not become subject to GST taxation. A number of other tax implications, aside from those mentioned here, can arise in the context of trust modifications.
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If you have established an irrevocable trust or trusts, or are the beneficiary of an existing irrevocable trust or trusts, which may benefit from a modification or merger, you should speak with your estate planning attorney regarding trust administration, trustee services and all the options available to you and their potential tax consequences.