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WEALTH TIP OF THE MONTH

Can You Change an Irrevocable Trust? Yes, But Be Careful 

 

 

Irrevocable trusts, often established with the intention of lasting generations, sometimes require adjustments when circumstances change, tax laws evolve, or family goals shift. Contrary to popular belief, the terms of an irrevocable trust can be modified, provided you approach the process carefully and with a full understanding of the implications. 

 

Understanding the Need for Changes 
 

The need to modernize an irrevocable trust can arise for various reasons. Trust provisions that made sense when initially established may become outdated or inappropriate over time. Non-tax reasons for modifying an irrevocable trust might include correcting drafting errors, addressing changed family circumstances, providing for a special needs trust, or altering trustee provisions. Tax-related reasons could involve moving a trust to a state with lower income taxes, modifying powers of appointment, converting between grantor and non-grantor trust status, or ensuring the trust complies with specific tax requirements, like those for owning stock in an S corporation. 

 

Potential Trust Modifications 
 

The approach to modifying an irrevocable trust depends on the governing laws and the specific terms of the trust. Here's what to consider: 

  1. Review the Trust Terms: Start by thoroughly reviewing the trust document to understand its provisions. Some trusts include clauses that allow for changes, while others may restrict or facilitate modifications. 

  1. Evaluate Governing Laws: Trust laws vary by state, and these laws may have changed since the trust's creation. Some states allow for modifications under certain conditions, with or without court approval. Others, like New York and California, have decanting statutes that permit the trustee to transfer assets into a new trust with updated terms. 

  1. Consider Modification Options: In some states, it’s possible to modify a trust without court involvement if all beneficiaries consent. Alternatively, a court may need to approve changes, particularly if beneficiaries are unable to consent or the modifications are complex. 

  1. Explore Decanting: If direct modification is challenging, decanting might be an option. This involves transferring assets from the old trust into a new trust with revised terms. Decanting can be useful when the original trust needs significant updates but requires careful consideration of state laws governing the process. 

 

Tax Considerations 
 

When modifying an irrevocable trust, it's crucial to assess all potential tax consequences: 

  • Estate and Generation-Skipping Transfer Taxes: Consider whether changes will impact whether trust assets are included in a beneficiary’s estate. Inclusion might be beneficial for basis step-up purposes if the estate is below the exemption limit, but detrimental if the estate exceeds it. 

  • Income Tax: Decanting might lead to different tax implications, especially if it results in a change in the trust's taxpayer status or alters how income is distributed and taxed. State income tax responsibilities should also be considered. 

  • Gift Tax: Generally, modifications or decanting do not trigger gift taxes, but significant changes in beneficiary interests could result in a gift that needs to be reported and taxed. 

 

After the Modification 
 

After making changes to an irrevocable trust, it’s essential to ensure all parties are informed, assets are transferred correctly, and titles are updated. Failure to follow through on the practical aspects of a change could necessitate further modifications down the line. 

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Given that irrevocable trusts are designed to endure, periodic reviews are recommended to ensure the trust’s terms remain aligned with current laws and family goals. With the right legal guidance, it is possible to modernize an irrevocable trust to better suit evolving circumstances. 

 

For further insights into the irrevocable trust modifications and other tax planning options, feel free to reach out to us. 
 

barry.boscoe@brightonadvisory.com  

Office: 818-342-9950 

Mobile: 818-802-0686 

Barry serves on the exclusive SCOPE™ faculty in California helping to educate successful people. 

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